Last March, Chinese regulators halted all approvals of new video games on vague concerns about children's eyesight, gaming addiction, and violence in games. That ban was dire news for Tencent (TCEHY +0.59%), the largest game publisher in China and the world. Nearly a third of Tencent's revenues came from online games last quarter.
That's why Tencent investors breathed a sigh of relief when regulators restarted the approval process last December. Yet the two subsequent rounds of approvals, which cleared 257 new games for Chinese gamers, didn't include any Tencent games. Tencent's biggest gaming rival, NetEase (NTES +0.95%), was also left out in the cold.
Image source: Getty Images.
Should investors worry about this ongoing delay? Or is it merely a speed bump on the road toward the revival of Tencent's gaming business?
How the gaming freeze hurt Tencent
Tencent's gaming portfolio includes the e-sport favorite League of Legends, the mobile hits Clash of Clans and Honor of Kings (also known as Arena of Valor), and the popular kart racer QQ Speed. It also licenses Capcom's (CCOEF +0.00%) Monster Hunter World, Epic Games' Fortnite, and Bluehole's PUBG. Tencent owns major stakes in both Epic Games and Bluehole.
Regulators froze gaming approvals just as Tencent was rolling out Monster Hunter World, PUBG, and Fortnite to Chinese gamers to reduce its dependence on aging titles like Honor of Kings -- which remains the top mobile game in China.
The government abruptly forced Tencent to halt sales of Monster Hunter World for PC gamers over the summer and put the PC approvals of PUBG and Fortnite on ice. Tencent was also blocked from monetizing PUBG Mobile with loot boxes and micro-transactions. All those headwinds caused its gaming business to hit a brick wall over the past two quarters:
|
Q3 2017 |
Q4 2017 |
Q1 2018 |
Q2 2018 |
Q3 2018 | |
|---|---|---|---|---|---|
|
Revenues* |
26.8 billion |
24.4 billion |
28.8 billion |
25.2 billion |
25.8 billion |
|
YOY growth |
48% |
32% |
26% |
6% |
(4%) |
Tencent's online gaming revenues. Source: Quarterly reports. *RMB. YOY = year over year.
On the bright side, Tencent's 4% drop in gaming revenues topped expectations and it actually launched 10 mobile games that were approved prior to the freeze. That delayed-launch strategy boosted its mobile gaming revenues 7% annually, but that growth was completely offset by a 15% decline in its PC gaming revenues.
Tencent also stated that it still had 15 other pre-approved games in its pipeline, which indicates that it can still tread water as it waits for the long-awaited approvals of Monster Hunter World, PUBG, and Fortnite.
Monster Hunter: World. Image source: Capcom.
Will Tencent need to alter its games?
Tencent and NetEase probably aren't being intentionally left out of the latest approvals since regulators are still wading through a massive backlog of games. It's also unclear if regulators have flagged specific issues with Monster Hunter World, PUBG, and Fortnite.
However, we should recall that over a decade ago, Activision Blizzard (ATVI +0.00%) was forced to replace certain graphical assets in World of Warcraft -- including skeletons, blood, and severed heads -- with more family friendly content. NetEase, which took over as Blizzard's World of Warcraft's distributor in 2009, helped implement some of those changes.
Therefore, Monster Hunter World, PUBG, and Fortnite could all need to be significantly altered before being approved for Chinese gamers. Tencent could also struggle to convince regulators to approve loot boxes for PUBG Mobile, since regulators have repeatedly claimed that loot boxes cause gaming addiction and gambling problems.
Investors should focus on Tencent's other businesses
Tencent's lack of new game approvals is disappointing, but investors should focus on the growth of its WeChat, advertising, digital content, payment platforms, and investments -- which boosted its revenue and net income by 24% and 30%, respectively, last quarter. They should also focus on its recent restructuring, which better aligns its digital platform businesses to compete against ByteDance.
Tencent's gaming business also isn't out of options yet. The unit is still mulling investments in other high-growth gaming companies, like South Korea's Nexon, and expanding Honor of Kings to fresh overseas markets via the Nintendo Switch. Therefore, investors shouldn't fret over the approval process. The "gaming winter" forced Tencent to prioritize the growth of its other businesses, which should offset its declines in gaming revenues for the foreseeable future.
Check out the latest Tencent Holdings earnings call transcript.
