Tencent (OTC:TCEH.Y) recently announced its first major restructuring in six years after its stock tumbled about 20% this year amid concerns about its slowing growth and regulatory headwinds for its gaming business. Let's take a look at the four key things investors should know.
1. Reducing its number of business units
The restructuring will reduce Tencent's total number of business units from seven to six by shuffling and merging certain businesses. Four of the original units -- the Corporate Development Group (investments and incubators), the Weixin (WeChat) Group, the Interactive Entertainment Group (video games), and the Technology and Engineering Group -- will remain.
Meanwhile, the Mobile Internet Group, Online Media Group, and Social Network Group will be restructured into two new units -- the Cloud and Smart Industries Group and the Platform and Content Group.
2. Challenging Alibaba in the cloud
Tencent's new Cloud and Smart Industries Group (once part of its "other" businesses) will focus on digitizing industries like healthcare, education, transportation, manufacturing, and energy with cloud services and Internet of Things (IoT) applications.
The group will also form a committee to boost its investments in next-gen technologies like artificial intelligence (AI), robotics, and quantum computing. Tencent's cloud business already offers over 60 industrial solutions that help companies track their production facilities in real time. It also offers an AI-powered service called MIAIS, which helps doctors detect certain types of cancers.
This move could help Tencent catch up to Alibaba in the cloud platform market. Alibaba Cloud is the second-largest cloud infrastructure platform in the Asia-Pacific region after Amazon's (NASDAQ:AMZN) AWS (Amazon Web Services), according to Synergy Research. Microsoft and Alphabet's Google rank third and fourth in the region, respectively, while Tencent ranks a distant fifth.
Alibaba recently widened its moat against Tencent and other rivals with a sweeping partnership with Intel across the cloud, AI, and IoT markets. However, we should note that Tencent's cloud revenue "doubled" year over year last quarter (without disclosing an exact revenue figure) as it expanded its reach in "key sectors" like finance, smart retail, and municipal services. Tencent's "other" revenue -- which mainly consisted of its cloud and payments businesses (part of the Weixin Group) last quarter -- grew 81% annually and accounted for 24% of its top line.
3. Pulling together its content, social networking, and ad technologies
Tencent's new Platform and Content Group will focus on integrating digital content like streaming videos, music, anime, books, and sports into its social networking apps and ad platforms. The unit's main pillar of growth will likely be Tencent Video, which surpassed Baidu's iQiyi (NASDAQ:IQ) as China's top online streaming video platform during the second quarter, according to China Internet Watch, as its 46.1% share topped iQiyi's 43.6% share.
Tencent stated that Tencent Video had nearly 63 million paid subscribers in March, up from 43 million last September. It also cited Tencent Video as a core growth driver for both its advertising business and value-added services last quarter.
Tencent also plans to launch an IPO for Tencent Music Entertainment (TME), the largest streaming music platform in China with over 700 million monthly active users. Tencent plans to retain a majority stake in TME, but the spinoff could free up some cash for expanding its portfolio of licensed and original content. That strategy could also widen its moat against high-growth rivals like ByteDance -- which plans to challenge Tencent Video and iQiyi with premium videos for its Xigua video app.
4. Reducing its dependence on video games
Tencent likely hopes that emphasizing the growth of its cloud and content businesses, along with the expansion of WeChat's online-to-offline services, payment services, and mini-programs, will pivot the market's attention away from its video game business -- which generated over a third of its revenue last quarter.
Tencent's video game sales are decelerating due to tighter playtime restrictions for minors, a temporary suspension of new video game license approvals in China, and a shift from PC games to mobile games.
However, investors should remember that Tencent's gross margin for its "other" businesses (mostly cloud and payment services) was just 24.9% last quarter, significantly lower than the gross margins of its value-added services (59%) and online advertising business (37.4%). Therefore, Tencent's earnings could remain under pressure as it aggressively expands its lower-margin businesses -- especially since it doesn't plan to lay off any employees during the restructuring process.