Chinese tech giant Tencent (TCEHY +0.76%) recently posted its fourth-quarter earnings, which remained fairly stable as it approached the novel coronavirus crisis, which intensified in the first quarter.
Tencent's revenue rose 25% annually to 105.8 billion yuan ($15.2 billion), beating estimates by 2.1 billion yuan. Its net profit grew 52% to 21.6 billion yuan ($3.1 billion) but missed the consensus forecast by 1.2 billion yuan.
On a non-GAAP basis -- which excludes acquisitions, investments, and divestments -- Tencent's net profit rose 29% to 25.5 billion yuan ($3.7 billion). Those growth rates remain robust, but how will Tencent's business fare in the first quarter and the rest of the year?
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Its gaming business grows as people stay home
Tencent's online gaming revenue rose 25% annually, marking a significant acceleration from its 11% growth in the third quarter, and accounted for 29% of its total revenue.
It attributed that growth to the strength of its mobile games in both China and overseas markets. Top games included Honor of Kings, Peacekeeper Elite, PUBG Mobile, Call of Duty Online, and Supercell's Clash of Clans and Clash Royale. That growth offset lower revenue from PC-based games like Dungeon Fighter Online.
Tencent didn't offer exact guidance for its first-quarter gaming revenue, but chief strategy officer James Mitchell noted that video games -- along with other at-home activities like streaming music and videos -- experienced "increased usage" as major Chinese cities were locked down. Tencent also generated 23% of its gaming revenue overseas, which indicates that lockdowns in other countries could boost its gaming revenue.
The ad business looks strong ... for now
Tencent's online advertising revenue rose 19% annually, accelerating from its 13% growth in the third quarter, and accounted for 19% of its top line. That acceleration was surprising since the slowdown in the Chinese economy had already been throttling its ad sales prior to the coronavirus outbreak.
That growth was sparked by stronger demand for ads on WeChat, which grew its monthly active users (MAUs) 6% annually to 1.16 billion, and its mobile advertising network, which displays ads in third-party apps. That growth offset waning ad revenue at Tencent Video, which dealt with a temporary suspension of NBA broadcasts, and Tencent News, which faced tough competition from ByteDance's Jinri Toutiao.
But looking ahead, Tencent's ad revenue growth will likely decelerate in the first quarter as the coronavirus crisis forced businesses to close and rein in the ad spending. The NBA's recent suspension of its entire season on coronavirus concerns should also exacerbate Tencent Video's slowdown.
Its fastest-growing business is putting pressure on Alibaba
Tencent's fintech and business services revenue rose 39% annually, accelerating slightly from its 36% growth in the third quarter, and accounted for 28% of its top line. Tencent attributed that growth to higher revenue from its payment platform, WeChat Pay, and the growth of its cloud business, which surpassed a million paying customers during the quarter.
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Canalys recently reported that Tencent Cloud's share of China's cloud infrastructure market rose from 15.4% to 18% between the first and fourth quarters of 2019. During the same period, Alibaba's (BABA +6.94%) share dipped from 47.3% to 46.4%. WeChat Pay also shares a near-duopoly in China's digital payments market with Alibaba-backed AliPay.
Tencent might operate these businesses at lower margins to gain market share against Alibaba's cloud and payments ecosystem, but it can subsidize its growth with its higher-margin revenue from gaming, ads, and investments.
After all, Tencent's operating margin expanded 700 basis points annually to 27% during the quarter -- and could continue rising after the crisis ends. That margin expansion and market share growth could cause problems for Alibaba.
The coronavirus crisis is a double-edged sword
The coronavirus outbreak should impact Tencent in several ways. It will hurt Tencent's ad business but help its gaming business. Its payment business should remain stable as online payments offset lower volumes from brick-and-mortar stores, and its cloud revenue could rise as companies deal with the surging usage of apps and streaming services.
WeChat has also become an invaluable tool for communication, remote work, and accessing basic services throughout the crisis. That ecosystem is now becoming the foundation for new remote services like Tencent Health, Tencent Education, Tencent Meeting, and WeChat Work -- which should all continue expanding after the crisis ends.
The road ahead
It's unclear if Tencent's strengths will outweigh its weaknesses as its first-quarter results bear the brunt of the coronavirus crisis. However, the infection rates in China are decelerating as businesses come back online -- which indicates that any slowdown could be short-lived. Investors should stick with Tencent throughout this crisis since it will likely benefit from China's recovery and emerge as a much stronger company.
