Shares of Tencent Holdings (TCEHY -0.44%) and other Chinese game companies have risen in the past few days, as Chinese regulators removed a big headwind to their businesses, lifting the game approval freeze that had been in effect for the past nine months.
Regulators have punished Chinese tech companies generally for over a year now, for practices they deem antithetical to "healthy" growth that's good for society. But with China's economy slowing and technology companies slowing hiring, it appears China's regulators may now be pivoting back to a focus on growth and jobs; therefore, the thawing of the game freeze could be a sign the overall regulatory assault may be loosening up.
As long as one is OK with the risk of investing in Chinese companies, these stocks may start to bounce back this year, after being beaten down so much.
Could regulators be changing their tune?
Chinese tech stocks, once the darlings of growth investors, have been absolutely hammered over the past year, with the KraneShares CSI China Internet ETF down more than 60% since a year ago.
Tencent has done better than most in the sector, down "only" 40%, likely due to its size, diverse earnings streams, and the fact that it was generally a good corporate citizen compared to others.
Still, as 2021 went on, eventually regulators found ways to go after Tencent's business. The country had frozen game approvals in 2018, as China sought to put game content revision and editing under more direct control of the state, eventually resuming approvals in late 2018 as the new regulatory body was set up and rules enforced. So it was a surprise when China froze game approvals again less than three years later last summer.
Much of the reasons were similar, but enforced to a higher degree. Regulators took on even greater censorship of what they deemed "appropriate" content, and gaming companies were put on notice to enforce a three-hour-per-week rule for minors under 18.
Still, unlike the last bout of regulations, games companies were still able to submit games to the regulator, so it was anticipated that the new freeze would eventually be lifted. Yet given the hostility and unpredictability of China's regulators over the past year, there was a high degree of uncertainty.
For its part, Tencent management said on its recent earnings call with analysts that it had submitted several new games, but that they were being held up by regulators. Management suspected the games would be published sometime in 2022, but analysts on the call seemed to fear the ban could last throughout 2022. Now, it looks as though the ban is being lifted less than one month later.
Image source: Getty Images.
This is a big deal for Tencent
A resumption of domestic game approvals is a big deal for Tencent. Domestic games made up RMB29.6 billion of the company's revenue in the fourth quarter and RMB128.8 billion for the full-year 2021, but only grew 1% and 6%, respectively, as the bans set in midyear. While international games grew strongly, the domestic segment is much bigger for Tencent, making up 23% of Tencent's total 2021 revenue.
But the impact is likely even greater than that for Tencent's bottom line. While Tencent's "fintech and business services" segment is now its largest segment today by revenue, making up 31% of the total, management said on the recent earnings call that much of its cloud business included in that segment is actually unprofitable at the moment. So games profits are a key to Tencent's ability to invest in new businesses, make more outside investments, or return cash to shareholders.
Finally, it's possible Tencent could come back stronger than it had been before. That's because unfortunately, some 14,000 video game-related companies in China shut down during the freeze, according to business registry firm Tianyancha.
With smaller, less financially strong companies shutting down, Tencent could be releasing games into a less-competitive Chinese market -- although there are still some very large competitors in the space such as NetEase.
Chinese stocks are cheap, and the regulatory assault could be easing
After a terrible year, Chinese tech companies are now cheaper than their U.S. peers. China's central bank is easing interest rates, while the U.S. is raising them. And now, there are signs the regulatory assault seen over the past 18 months may be easing.
Of course, geopolitical risks remain, as they do for any international stock. However, should one feel comfortable investing in China, now may be the time to start looking for the most well-positioned companies, with Tencent being a prime candidate to bounce back.
