Chinese tech giant Tencent (OTC:TCEH.Y) generates most of its revenue from its home market. But in recent years it's expanded overseas to reduce its dependence on China, where its social media and gaming businesses face tougher censorship and playtime restrictions, respectively.

One of those markets is Japan, the world's third-largest gaming market after China and the United States. Let's see how its investments in Japan could strengthen its business and widen its moat.

Shibuya Crossing in Tokyo.

Image source: Getty Images.

Tencent's growing presence in Japan

Tencent bought a stake in Japanese game maker Aiming, the developer of the RPG Caravan Stories, in 2014. But it didn't invest in any other Japanese companies until this January when it bought an undisclosed stake in Platinum Games, the Japanese developer of Bayonetta and Nier: Automata.

Platinum Games nearly went bankrupt in 2017 after Microsoft abruptly canceled the Xbox One and PC game Scalebound, but it was saved by robust sales of Nier: Automata, which was published by Square Enix (OTC:SQNX.F), later that year. Platinum declared Tencent's investment would have "no effect" on its independence but could help it launch more self-published games.

In late May, Tencent bought a 20% stake in Japanese game maker Marvelous, best known for the farming simulation game Story of Seasons, for $65 million to become its top shareholder. Tencent previously licensed assets from Story of Seasons to develop a new mobile game, which has yet to be released.

Like Platinum, Marvelous was struggling financially when Tencent swooped in. Its online gaming and consumer gaming profits plunged 78% and 29%, respectively, last year, due to lower revenue from its older titles and the weakness of its newer games. Tencent will likely help Marvelous develop new titles and expand its aging franchises into new markets.

Partnerships and ecosystem expansions

Aiming, Platinum, and Marvelous mark Tencent's biggest Japanese investments to date, but it also recently partnered with two of the country's video game giants: Square Enix, the publisher of Final Fantasy and Tomb Raider, and Nintendo (OTC:NTDOY)

In late 2018, Tencent formed a new joint venture with Square Enix to produce new games based on existing franchises and new IPs. In 2019, Tencent partnered with Nintendo to launch the Switch console in China.

Tencent invested $320 million in the Chinese digital media platform Bilibili (NASDAQ:BILI) in 2018 to increase its exposure to Japanese pop culture. Bilibili hosts a growing catalog of Japanese anime and comics, and it's been gradually increasing its investments in Japanese anime studios and game makers. Japanese conglomerate Sony also bought a $400 million stake in Bilibili earlier this year.

Why does Japan matter?

Japan's economy recently dipped into a recession as the COVID-19 crisis exacerbated its economic slowdown. However, it remains one of the world's top gaming markets, and the video game sector has been fairly resilient during macro slowdowns. Japan could also be considered a safe haven as the trade war between the U.S. and China escalates.

A gamer plays a mobile game.

Image source: Getty Images.

NetEase (NASDAQ:NTES), Tencent's biggest rival in China's gaming market, has also been expanding into Japan with hit games like Knives Out and Identity V. Tencent could curb that expansion with its investments and partnerships with Japanese game makers.

Tencent's investments in Japan won't move the needle for its gaming business on their own. But they will complement its other overseas subsidiaries, including League of Legends developer Riot Games, Clash of Clans developer Supercell, and Conan developer Funcom.

Tencent also owns stakes in Fortnite publisher Epic Games, PUBG maker Bluehole, Activision Blizzard, Ubisoft, and Glu Mobile. That sprawling portfolio makes Tencent the world's largest game publisher, and its recent investments in Japan will reinforce that position.

The key takeaway

Tencent is still heavily dependent on the Chinese market, but its development of international games like PUBG Mobile and Call of Duty Mobile could plant the seeds for future growth beyond China. These investments could strengthen its gaming business, which generated 35% of its revenue last quarter, and insulate it from the unpredictable censorship, playtime, and licensing headwinds in its home market.