Tencent (OTC:TCEH.Y) started developing a cloud gaming platform with Intel (NASDAQ:INTC) in late 2018. The service was initially called "Instant Play" during demos and was rebranded as "Start" when beta tests started in China last April.

Start was initially powered by Intel's Xeon CPUs and Iris Pro GPUs. But in late 2019, Tencent announced that NVIDIA's (NASDAQ:NVDA) GPUs would power the platform as it expanded toward higher-end triple-A games -- which indicated Intel's Iris Pro GPUs would be replaced with NVIDIA's higher-end gaming GPUs.

Tencent also recently launched an innovation lab to co-develop a cloud gaming platform with Chinese tech giant Huawei. The lab will run Tencent's cloud gaming services on Huawei's Kunpeng CPUs, one of its four homegrown chipsets (including Ascend, Kirin, and Honghu) targeting Intel's dominance of the CPU market.

Tencent didn't explain if its partnership with Huawei would impact its relationship with Intel, but its recent actions suggest it could cut ties with the chipmaker in the near future. Let's see what that divorce could mean for the two companies' cloud gaming ambitions.

A gamer plays a PC game.

Image source: Getty Images.

What cloud gaming means to Tencent

Tencent is the largest game publisher in the world. Its portfolio includes hit games like League of Legends, Honor of Kings, PUBG Mobile, Peacekeeper Elite, and Clash of Clans. It also owns stakes in Fortnite publisher Epic Games, Activision Blizzard, Ubisoft, and other video game companies.

Tencent's online gaming revenue rose 25% annually and accounted for 29% of its top line last quarter. But the business generates volatile returns due to fickle gamers, tough competition, and unpredictable censorship and gameplay restrictions in China.

Pivoting toward subscription-based services like cloud gaming could stabilize that business. Tencent already owns the second-largest cloud infrastructure platform in China, so it can easily host a cloud gaming service.

Tencent also owns China's top social messaging platform, one of its largest video streaming services, and significant stakes in top esport streaming platforms like Huya and DouYu. Connecting all those dots could form the foundation of a cloud gaming ecosystem with integrated social media and live streaming features.

The stickiness of that ecosystem would widen Tencent's moat against its top rival NetEase, which also started testing a cloud gaming service last year. It would also help Tencent keep up in the nascent cloud gaming market, which already includes Alphabet's Google Stadia, NVIDIA's GeForce Now, Sony's PS Now, and Microsoft's upcoming xCloud service.

What cloud gaming means to Intel

Intel is the largest manufacturer of data center chips in the world. Its data center revenue rose 19% annually last quarter and accounted for 36% of its top line.

Servers in a data center.

Image source: Getty Images.

Usage of data centers is currently rising as the COVID-19 pandemic forces more people to stay home and use more cloud-based services. Cloud gaming only represents a tiny sliver of that market, but it could blossom over the next few years. Research and Markets estimates that the global cloud gaming market could grow from $306 million in 2019 to $3.1 billion by 2024 as both broadband and wireless connections improve.

Meanwhile, Intel's main rival AMD (NASDAQ:AMD) is marking significant progress in both the data center and cloud gaming markets. Its Epyc CPUs are denting the Xeon's near-monopoly in servers, and Google and Microsoft both chose AMD's custom GPUs to power their cloud gaming services. Intel is currently developing its own high-end GPU, but it faces a tough uphill battle against AMD and NVIDIA's industry-leading chips.

That's why Intel partnered with Tencent. Partnering with the world's largest gaming publisher to develop a cloud gaming platform sounded like a smart move -- but Tencent also seems to be shopping around for other partners.

Why is Tencent pulling away from Intel?

Tencent could be pulling away from Intel for two reasons. First, Chinese companies are aggressively developing domestic chips to reduce the country's dependence on American technologies. Installing Huawei's Kunpeng chips into its cloud servers is a vote of confidence for those efforts, and could keep the company in the government's good graces.

Second, Tencent is probably testing out different hardware configurations, including combinations of Intel, Kunpeng, and NVIDIA chips, for various types of games. It doesn't necessarily mean that Tencent is abandoning its initial partnership with Intel -- just that it's onboarding more partners as it expands the platform.

The cloud gaming market won't move the needle for Tencent or Intel anytime soon. However, investors should still keep an eye on its growth to spot the potential long-term benefits for both companies.