Tencent (NASDAQOTH:TCEHY) had plenty to prove during the first quarter, since its fourth-quarter report in March raised serious concerns about runaway spending and contracting margins. Yet the Chinese tech giant allayed those fears when it revealed its first-quarter numbers on May 16.
Tencent's total revenue rose 48% annually to 73.5 billion yuan ($11.7 billion), easily beating the consensus estimate of 70.8 billion yuan. Its gross margin dipped one percentage point annually to 50%, but still easily topped the consensus estimate of 47%. Its net profit jumped 65% to 24 billion yuan ($3.8 billion).
Its non-GAAP net profit attributable to shareholders -- which excludes certain noncash items and the impact of certain investments and acquisitions -- rose 29% annually to 18.3 billion yuan ($2.9 billion), or 1.92 yuan per diluted share. That missed the consensus estimate of 1.94 yuan per share, but the miss was easily offset by Tencent's robust revenue growth and better-than-expected margins.
Tencent's OTC shares jumped 7% after the report, while its Hong Kong-listed shares climbed 4% the following day. Let's examine the four biggest takeaways from Tencent's first-quarter report.
1. Transitioning from PC to mobile games
Tencent is the largest video game publisher in the world by annual revenue. Its most popular PC titles include esports classic League of Legends and the newer beat 'em up DnF (Dungeon & Fighter).
It also owns a 40% stake in Epic Games, which publishes the hit game Fortnite Battle Royale. However, Tencent's PC gaming revenue stayed roughly flat year over year at 14.1 billion yuan ($2.2 billion), due to an ongoing market shift from PC titles to mobile gaming.
Its top mobile games include Honor of Kings (also known as Arena of Valor), QQ Speed Mobile, and the mobile versions of PlayerUnknown's Battlegrounds. Those titles helped boost its total mobile gaming revenue by 68% annually to 21.7 billion yuan ($3.4 billion), easily offsetting the slower growth of its PC games.
2. An expanding social ecosystem
Tencent's WeChat (also known as Weixin), the most popular mobile messaging app in China, grew its monthly active users (MAUs) 11% annually to 1.04 billion. Mobile MAUs for its older QQ messaging app rose 2% to 694 million. That growth offset an 11% decline in MAUs in its older Qzone social network, which still has 562 million MAUs.
That expanding social media presence is essential to its growth strategy, which centers on turning WeChat into an all-in-one "super app" for payments, ridesharing, deliveries, and e-commerce services that are integrated with a growing list of online and offline retail partners.
That expansion of WeChat complements Tencent's forays into other ad-supported markets like streaming video and streaming music. During the quarter, its total ad revenue rose 55% annually to 10.7 billion yuan ($1.7 billion) -- buoyed by 31% growth in media ad revenue (including 64% growth in video ads) and 69% growth in advertising revenue from its social media and other apps.
Tencent's total revenue from value-added services -- which includes nonadvertising revenue from its ecosystem transactions (like virtual gifts on social media, fees from certain services, and microtransactions in games) -- jumped 34% annually to 46.9 billion yuan ($7.4 billion).
3. Cloud and payments growth
Tencent's "other" revenue -- which mainly comes from its cloud platform, payments related services (WeChat Pay), and investments -- surged 111% to nearly 16 billion yuan ($2.5 billion). Tencent owns the second largest cloud platform in China after Alibaba (NYSE:BABA) Cloud, and it's been tethering a growing list of financial institutions and retailers to that platform. WeChat Pay is the second largest payments platform in China after the Alibaba-backed Alipay.
Tencent's main cloud strategy is to offer businesses integration with WeChat's massive user base, which enables Tencent to cross-sell analytics and security services. Tencent also tries to tether those businesses to WeChat Pay's financial ecosystem to counter Alipay.
Those two issues are at the center of the escalating battle between Tencent and Alibaba, which forced both companies to significantly boost spending in recent quarters.
4. Rising costs
However, all that growth comes at a price. Tencent's cost of revenue still rose 51% to 36.5 billion yuan ($5.7 billion) and outpaced its revenue growth rate. But that wasn't nearly as alarming as its 72% jump in costs during the fourth quarter.
The bottom line
Tencent's first-quarter numbers tell us three main things: Analysts' concerns about its high spending crushing its margins were mostly unfounded; its ecosystem continues to evolve as its social, gaming, and cloud businesses start overlapping; and it can maintain impressive revenue and earnings growth while widening its moat against rivals like Alibaba.