Tencent (TCEHY 0.10%) recently agreed to buy a 29% stake in Funcom (FCMKF), best known for its Conan the Barbarian games, to become the Norwegian game developer's top shareholder. Norway-based KGJ Capital AS, Funcom's top investor, will sell its entire stake to Tencent.

The deal values Funcom at 1.22 billion Norwegian crowns ($134 million), a 22% premium over its closing price last Friday, and implies that Tencent paid about 354 million crowns ($39 million) for KGJ's stake.

Conan Exiles.

Image source: Funcom.

Funcom CEO Ruin Casais states that the company is "very pleased to see Tencent come in as the largest shareholder," since it has a "reputation for being a responsible long-term investor, and for its renowned operational capabilities in online games." Let's see how Funcom could bolster Tencent's core gaming business.

What does Funcom bring to the table?

Funcom's total revenue rose 46% to $33.8 million last year, fueled by the strength of Conan Exiles, Age of Conan, Secret World Legends, and Anarchy Online. Its net profit rose 22% to $6 million.

At the end of 2018, it launched a new shooter called Mutant Year Zero: Road to Eden, and unveiled its next Conan title, the real-time strategy game Conan Unconquered. It will launch a "cosmic horror" game called Moons of Madness this Halloween, the cartoonish hack-and-slash game Conan Chop Shop in 2020, and a new game based on the sci-fi classic Dune.

Funcom's revenue soared 117% annually to $5.8 million in the first quarter, thanks to the strength of Conan Exiles and Mutant Year Zero, but fell 42% annually to $8.9 million in the second quarter due to a tough comparison to the launch of Conan Exiles in the prior year quarter.

Funcom's profit plunged 91% annually to $281,000 in the first half of 2019 due to higher development and marketing costs. Teaming up with Tencent, the biggest game publisher in the world, could alleviate some of that pain.

Another piece of Tencent's gaming portfolio

Funcom's business is tiny compared to Tencent's gaming unit, which generated 77.8 billion yuan ($10.9 billion) in mobile gaming revenue and 50.6 billion yuan ($7.1 billion) in PC gaming revenue last year.

Therefore, Tencent's investment in Funcom is unlikely to move the needle on its own. The value of the investment, at $39 million, is also pocket change for a company that ended the first half of 2019 with 122.8 billion yuan ($17.2 billion) in cash and equivalents.

Conan Exiles.

Image source: Funcom.

However, Funcom represents another piece of Tencent's sprawling portfolio of investments in high-growth gaming companies. It already owns League of Legends developer Riot Games, Clash of Clans maker Supercell, nearly half of Fortnite maker Epic Games, a significant stake in PUBG maker Bluehole, investments in gaming giants Activision Blizzard and Ubisoft, and stakes in other game makers.

In short, if there's a hot game anywhere in the world, Tencent wants a piece of the action. Investing in overseas game makers also diversifies Tencent's gaming business away from China -- which is the world's top gaming market, but also highly vulnerable to censorship and regulatory crackdowns.

For example, Chinese regulators froze new gaming approvals for nine months last year due to concerns about gaming addiction. The state-backed media also pilloried Tencent for fueling that addiction with its top mobile game, Honor of Kings (known as Arena of Valor overseas), which forced it to implement playtime limits for younger players.

Tencent restructured its businesses last year to reduce its dependence on games and prioritize the growth of its WeChat, cloud, and fintech units, but its gaming business still generated nearly a third of its revenue last quarter.

How Funcom could help Tencent

Tencent likely invested in Funcom because it saw long-term value in the Conan franchise, which has remained consistently popular for over 80 years, and it was impressed by the growth of its Conan games and its expanding pipeline of titles.

The investment also gives Tencent another foothold in overseas gaming markets, as well as more overseas games to license for Chinese gamers -- which would diversify its domestic business away from top games like Honor of Kings and Game for Peace.