Tencent (TCEHY +0.59%) is often known as the world's top video game publisher and the owner of WeChat, the most popular messaging app in China. Yet Tencent's gaming and advertising units both struggled in recent quarters due to tighter regulations on games, competition from other game publishers, and the Chinese economy's slowdown choking sales of digital ads.
That's why Tencent restructured its businesses last October to prioritize the growth of its cloud and fintech units. Tencent bundled those two divisions into its new "fintech and businesses services" group at the beginning of the year, and it's now Tencent's fastest-growing business. Let's discuss four key things investors should know about this new growth engine.
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1. It accounts for over a quarter of Tencent's revenue
Tencent's fintech and business services revenue rose 36% annually to 26.8 billion RMB ($3.8 billion) last quarter and accounted for 28% of its top line. The unit's weight on Tencent's top line has also gradually increased since its introduction in the first quarter.
|
Fintech and business services |
Q1 2019 |
Q2 2019 |
Q3 2019 |
|---|---|---|---|
|
Revenue |
21.8 billion RMB |
22.9 billion RMB |
26.8 billion RMB |
|
YOY growth |
43.5% |
37.3% |
35.9% |
|
% of Total revenue |
25.5% |
25.8% |
27.5% |
YOY = Year-over-year. Source: Tencent quarterly reports.
The unit's growth reduced the weight of its video game business from 33% to 31% of its revenue between the first and third quarters. Therefore, Tencent's fintech and business services unit could overtake the gaming unit as its biggest division in the near future.
2. Its cloud business is still smaller than Alibaba's
Tencent revealed its cloud revenue for the first time in the third quarter, stating that it grew 80% annually to 4.7 billion RMB ($670 million). That growth rate is impressive, but Tencent Cloud remains much smaller than Alibaba (BABA +3.00%) Cloud, which grew its revenue 64% annually to 9.3 billion RMB ($1.3 billion) last quarter.
Alibaba still controlled 43% of China's cloud market in the second quarter of 2019, according to research firm Canalys. Tencent ranked a distant second with a 17% share.
But there could still be plenty of room for both platforms to grow. China's cloud platform (infrastructure-as-a-service) market grew 72% in 2017, according to IDC, and accelerated to 86% growth in 2018. That ongoing acceleration could allow Tencent to grow its cloud business without clashing too frequently with Alibaba.
3. WeChat Pay still shares a duopoly with AliPay
WeChat Pay is the heart of Tencent's fintech business. The online payment platform is tightly integrated into WeChat (known as Weixin in China), which serves 1.15 billion monthly active users (MAUs).
Unlike basic messaging apps, WeChat is a platform for over a million "mini programs" that serve more than 300 million daily active users (DAUs). Payments on these mini programs -- which include e-commerce, deliveries, bill payment, and ride-hailing services -- are processed by WeChat Pay. WeChat Pay is also accepted at many brick-and-mortar stores, hospitals, and public transportation networks across China.
Image source: Getty Images.
WeChat Pay's only notable competitor is Ant Financial's AliPay. Alibaba owns a major stake in Ant Financial, so it integrates AliPay into all of its core commerce platforms. These two platforms share a duopoly in China: An Ipsos survey at the end of 2018 found that 86% of respondents used WeChat Pay (or its predecessor TenPay), 71% used AliPay, and 64% used both apps.
Tencent is using WeChat Pay as a launchpad for other fintech services like its wealth management platform LiCaiTong. Its integration into Tencent Cloud also allows the platform to crunch large amounts of customer data into actionable analytics for merchants.
4. Its gross margins are expanding
The fintech and business services unit operates at a much lower gross margin than its gaming or advertising businesses, which typically remain above 40%.
But profitability is gradually improving. The unit's gross margin rose 260 basis points annually (and 370 basis points sequentially) to 27.7% last quarter, thanks to higher payment volumes and service fees on WeChat Pay.
Tencent didn't disclose the exact margins of Tencent Cloud or WeChat Pay, but it sounds like the higher margins of its fintech business -- which has superior scale and pricing power -- are offsetting the lower margins of its cloud business, which still faces stiff competition from Alibaba.
Tencent is currently evolving into a more diversified tech giant, and its fintech and business services unit is quickly taking the spotlight. Over time, the growth of this unit could pivot its business away from video games and ads and widen its moat against Alibaba -- but investors should expect the rival company to push back in both markets.
