Chinese regulators suspended all new video game approvals back in March due to vague concerns about gaming addiction and childhood myopia. The abrupt freeze caused the world's biggest gaming market to generate just 5% annual sales growth during the first half of 2018 -- down from nearly 30% growth in the previous year.
The government reportedly plans to centralize gaming approvals to a single bureau, then ultimately limit its number of annual approvals. However, this new system probably won't be implemented until early 2019, according to The South China Morning Post.
Those developments cast a dark cloud over many Chinese video game makers. Shares of Tencent (OTC:TCEHY), the world's biggest game publisher, declined about 30% this year. Its total online gaming revenue rose just 6% annually last quarter, as approvals for its biggest licensed games (Fortnite, PUBG, and Monster Hunter World) remained in limbo. Tencent's gaming revenue accounted for over a third of its top line.
With Beijing's "video game winter" now set to drag on for at least two more quarters, Tencent looks like it's in trouble. But over the long term, these challenges probably won't kill Tencent or derail its long-term growth.
China isn't banning all video games
Investors should realize that regulators are merely freezing new video game approvals, not banning existing video games. This means that Tencent's top games just need to keep generating steady revenues until the government starts approving new games again.
Tencent still tops the global charts in PC gaming. League of Legends, which is published by its subsidiary Riot Games, remains the most popular core PC game in North America and Europe, according to Newzoo. Tencent also owns a 40% stake in Epic Games, the publisher of Fortnite, which ranks second.
Tencent still publishes 10 of the 20 highest-grossing iOS games in China, according to App Annie's rankings for the week of Oct. 14. Its top game, the MOBA (multiplayer online battle arena) title Honor of Kings (also known as Arena of Valor), consistently topped the charts after its launch in 2015. Another top 10 game, the kart racer QQ Speed, was launched a decade ago.
Tencent also generates mobile game revenue from overseas markets like the U.S. Among the top 10 highest-grossing iOS games in the U.S., Tencent holds minority stakes in the publishers of three titles (Fortnite and two Candy Crush games), and owns Clash Royale and Clash of Clans through its subsidiary Supercell. Therefore, Tencent's top games should help it tread water (albeit with single-digit sales growth) until newer games arrive.
The competition gets frozen, too
The video game freeze also temporarily eliminates one of the biggest challenges for Tencent in the gaming market: endless competition from new game makers.
Tencent's biggest rival is NetEase (NASDAQ:NTES), which publishes five of the 20 highest-grossing iOS games in China. NetEase's top game, Fantasy Westward Journey, consistently ranks second after Tencent's Honor of Kings. Like Tencent, NetEase's gaming growth decelerated significantly, with just 7% annual sales growth last quarter.
With the Chinese gaming market basically "frozen" for a year, market leaders like Tencent and NetEase should continue to dominate the market with their older games. This means that both companies can probably spend a bit less money on research and development and marketing costs.
Other irons in the fire
Tencent is commonly seen as a video game company, but it also generates significant revenue from its expanding WeChat ecosystem, online ads, streaming services like Tencent Video and Tencent Music, cloud services, and other investments.
That's why the company recently restructured its business units to prioritize the growth of its cloud and content businesses over its gaming unit. As a diversified tech company, Tencent can probably offset the softness of its weaker businesses with the growth of its stronger ones over the long term.
Therefore, it's shortsighted to sell Tencent's stock based on fears about a long winter for video games. Instead, investors should realize that these challenges should be short-lived and that the tech giant still has plenty of irons in the fire.