When Chinese tech giant Tencent Holdings (OTC:TCEHY) reported the results of its second quarter, all eyes were firmly focused on the company's growth. For several quarters, investors have been concerned that slowing growth and shrinking margins would be the new normal. Even in light of last quarter's better-than-expected showing, the stock was still down about 15% so far this year.
For the second quarter, Tencent's results were a mixed bag. Revenue grew 30% year over year to $11.1 billion, but operating profit of $3.3 billion was a 3% decline from the prior-year quarter. This was a far cry from the 48% revenue gains and 59% increase in operating profit the company reported just last quarter.
The reason for the company's disappointing performance wasn't any of the usual suspects -- failure to control costs, increasing competition, or investing in future growth. Chinese regulators are believed to have played the biggest hand in Tencent's troubles this quarter -- and that should serve as a wake-up call for those who invest in companies located in China.
Delay of game
Certain Chinese government departments responsible for the approval of video game licenses are in the midst of restructuring, according to a report in Bloomberg. As a result, the process of issuing the licenses necessary to introduce new games is currently in limbo, and new game approvals are frozen.
Two departments are responsible for the approval process. One office, the National Radio and Television Administration, is said to have not issued licenses for about four months. The other, the Ministry of Culture and Tourism, has made the process of registering games more difficult, delaying approvals.
Reports indicate that due to the leadership transition and personnel changes, officials have been reluctant to make decisions that might be considered controversial, opting instead to delay the process.
As a result of this shake-up, Tencent hasn't received the approvals necessary to introduce games from the most promising new genre to the world's largest video game market. PlayerUnknown's Battlegrounds -- also known as PUBG -- and Fortnite are the biggest titles in the emerging battle royale genre that has taken much of the world by storm, as up to 100 players battle to be the last person standing. These free-to-play games make money by selling in-game items, but lacking the required licenses, these games are also in limbo.
Even if the approval process were to restart immediately, licenses typically take two to three months to be approved, indicating there likely won't be a quick fix.
Adding insult to injury
If the regulatory delays weren't bad enough, Tencent also reported that Chinese regulators forced the company to pull one of its most highly anticipated games -- Monster Hunter: World -- just days after it debuted. With more than 1 million pre-orders as of last week, the game was expected to be a blockbuster for Tencent. Chinese regulators withdrew the game license, forcing Tencent to suspend availability of the hot title.
While the exact reasons for the government's objection are not known, it isn't unusual for regulators in China to censor games with objectionable content, including excessive violence. Tencent reported that government officials pulled the games license after receiving "a large number of complaints" regarding the games content. Tencent will eventually be able to release the game, but will need to "adjust the content" so that it addresses the subject of recent complaints received by regulators.
All part of investing in China
The ability of government regulators in China to mete out harsh and swift edicts isn't anything new. Search giant Baidu (NASDAQ:BIDU) came under the gaze of Chinese government regulators in mid-2016, as revised internet advertising laws forced the company to enact stricter standards and cull dubious advertisers from its platforms. It took the company more than a year to resume its upward growth trajectory.
Tencent's issues will probably be resolved over the next several quarters, and it's unlikely that they will have any long-term consequences for investors. They do, however, serve as a stark reminder that the government in China has the last word, and this is one of the risks we undertake by investing in Chinese companies.