Tencent's Earnings Soar Despite Gaming Challenges

Tencent Holdings (TCEHY 0.10%) announced strong third-quarter 2018 results early Wednesday, highlighting the value of its diversified business and the early benefits of a recent companywide reorganization.

With shares of the internet services and gaming leader up around 5% as of this writing in response, let's take a closer look at what Tencent accomplished over the past few months, as well as what investors should be watching in the quarters ahead.

IMAGE SOURCE: GETTY IMAGES.

Tencent results: The raw numbers

DATA SOURCE: TENCENT HOLDINGS

What happened with Tencent this quarter?

• Adjusted for one-time items, Tencent's (non-GAAP) profit attributable to shareholders climbed 15.5% year over year to 19.71 billion yuan (or $2.865 billion), or 2.061 yuan per diluted share.
• Tencent does not provide specific quarterly financial guidance. But most analysts were modeling adjusted earnings of 1.91 yuan per share on slightly lower revenue.
• Combined monthly active users (MAUs) for WeChat and Weixin climbed 10.5% year over year to 1.0825 billion, up from 1.0577 billion last quarter. User activity and engagement grew thanks to social video content viewing and uploads, Weixin Pay, and increased penetration for Mini Programs in industries like transportation and healthcare.
• MAUs for instant-messaging platform QQ fell 4.8% year over year to 802.6 million, down slightly from 803.2 million last quarter. But MAUs for smart devices on QQ climbed 6.9% year over year to 697.9 million.
• Smart-device MAUs for social-networking site Qzone declined 3.8% to 531.1 million.
• Fee-based value-added services (VAS) subscriptions grew 23% year over year to 154.1 million, up from 153.9 million last quarter.
• VAS revenue increased 5% year over year to 44.049 billion yuan, including:
  • a 4% decline in online games revenue, as lower PC client games sales were partially offset by higher smart phone games revenue.
  • 19% growth from social networks, driven by digital content services like live broadcast and video streaming subscriptions.
• Online advertising revenue grew 47% year over year (accelerating from 39% growth last quarter) to 16.247 billion yuan, including:
  • 23% growth from media advertising to 5.09 billion yuan, with higher Tencent Video ad revenue driven by success in drama series and self-commissioned variety shows.
  • 61% growth from social and other ad revenue to 11.157 billion yuan, driven by Weixin Moments, new Mini Program ad formats, Tencent's mobile ad network, and the news feed QQ KanDian.
• Revenue from other businesses jumped 69% to 20.299 billion yuan, driven primarily by payment and cloud services.
• Adjusted EBITDA grew 15% to 29.577 billion yuan.

What management had to say

Tencent CEO Ma Huateng elaborated on the quarter, and the company's recently announced "strategic organizational upgrade":

During the third quarter of 2018, we registered strong operating results in our businesses and maintained healthy financial metrics. Our advertising, digital content, payment and cloud services sustained robust activity and revenue growth, and now account for the majority of our revenue. For our game business, we implemented stringent self-imposed limitations on games playing by minors, which we believe put the game industry on a healthy and more solid foundation for future development. At the end of the quarter, we upgraded our organisation to help enterprises and various industries to benefit from the new trend of industrial internet through digitisation and technology innovation, and to provide consumers with better integrated entertainment and social experiences, as well as to unify our advertising sales platforms. We believe this strategic organisational upgrade will position us well for future long-term growth.

Looking forward

For perspective, the recent Chinese regulatory shake-up and subsequent freeze on approvals for new game licenses is still in effect. But as Tencent shifts its focus to its other lucrative business segments, it's no coincidence that the aforementioned "self-imposed limitations" on minors playing its video games are in keeping with the goals of China's government -- that is, namely to more effectively regulate the gaming industry's environment and promote healthy economic growth.

But given Tencent's more pronounced return to bottom-line growth this quarter in spite of those challenges, it's no surprise to see shares rebounding now.