Tencent Holdings Limited (TCEHY) CEO Pony Ma on Q2 2021 Results – Earnings Call Transcript

Tencent Holdings Limited Q2 2021 Earnings Conference Call August 18, 2021 8:00 AM ET

Company Participants

  • Wendy Huang – Investor Relations
  • Pony Ma – Chairman & Chief Executive Officer
  • Martin Lau – President
  • James Mitchell – Chief Strategy Officer
  • John Lo – Chief Financial Officer

Conference Call Participants

  • Alicia Yap – Citigroup
  • Han Joon Kim – Macquarie
  • Gary Yu – Morgan Stanley
  • Robin Zhu – Bernstein
  • John Choi – Daiwa Capital Markets
  • Alex Yao – JPMorgan
  • Garret Wang – CITIC Securities
  • William Packer – BNP Paribas
  • Eddie Leung – Bank of America Merrill Lynch
  • Thomas Chong – Jefferies

Operator

Good day, and thank you for standing by. Welcome to Tencent Holdings Limited 2021 Second Quarter Results Announcement Conference Call. At this time, all the participants are in a listen-only mode. After the speakers presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]

And now I’d like to turn the call over to Ms. Wendy Huang from the Tencent IR Team. Thank you. Please go ahead.

Wendy Huang

Thank you. Good evening, everyone. Welcome to our 2021 second quarter results conference call.

Before we start the presentation, we would like to remind you that it includes forward-looking statements, which are underlined by a number of risks and uncertainties and may not be realized in the future for various reasons. Information about general market conditions is coming from a variety of sources outside of Tencent. This presentation also contains some unaudited non-IFRS financial measures that should be considered in addition to, but not as a substitute for, measures of the company’s financial performance prepared in accordance with IFRS. For a detailed discussion of risk factors and non-IFRS measures, please refer to our disclosure documents on the IR section of our website.

Now, let me introduce the management team on the call tonight. Our Chairman and CEO, Pony Ma, will kick off with a short overview; President, Martin Lau, will discuss strategy review; Chief Strategy Officer, James Mitchell, will speak to business review; and the Chief Financial Officer, John Lo, will conclude with financial discussion before we open the floor for questions.

I will now turn the call over to Pony.

Pony Ma

Thank you, Wendy. Good evening. Thanks, everyone, for joining us. In the second quarter, we enhanced our services and achieved healthy growth across our businesses, particularly Business Services and advertising, while our game revenue benefited from international growth.

Now, let me go through the headline number — financial numbers for the quarter. Total revenue was RMB138 billion, up 20% year-on-year and 2% quarter-on-quarter. Gross profit was RMB63 billion, up 18% year-on-year and stable quarter-on-quarter. Non-IFRS operating profit was RMB43 billion, up 14% year-on-year and stable quarter-on-quarter. Non-IFRS net profit attributable to equity holders was RMB34 billion, up 13% year-on-year and 3% quarter-on-quarter. For our key services, we generally retain our first place position in activities, including social games, long-form video, music, literature, payment, and mobile utilities. And we believe we gained market share in cloud services. Combined MAU of Weixin and WeChat was 1.25 billion. Mobile devices MAU of QQ was 591 million. Martin and James will discuss our strategy to help view economy and society as well as focus across different businesses.

Now, I will hand over to Martin for the strategic review.

Martin Lau

Thank you, Pony, and good evening and good morning to everybody.

Today, I would like to share with you the encouraging progress of our communication and productivity SaaS products, which are generating user and social value despite contributing very little revenue to us for now. Since the outbreak of COVID-19, we have seen accelerated demand for digitization across industries. Our communication and productivity SaaS product suite, namely WeCom, Tencent Meeting, and Tencent Docs, assisted this digitization process and contribute to the growth of the economy. We’ll keep this by leveraging a number of our capabilities developed over the years: First, our advanced technologies and domains such as AI, real-time communications, and security; second, our proven experience in operating large-scale Internet services with robust performance and reliability; third, our ubiquitous coverage and deep engagement with consumers via Weixin and QQ, which facilitates industries building direct connection with their users; and fourth, our vertical solutions for providing business services, including cloud services to key industries through our own product innovation and partnerships.

By helping industries digitize, we believe we deliver critical benefits to different stakeholders. For SMEs, we have significantly lowered the barrier for technology adoption. They can leverage our products to increase customer engagement themselves as well as to enhance cost efficiency without making significant IT investments on their own. For public services, when they enable real-time and direct connection with citizens and enterprises, we also facilitate productivity enhancements through improving their workflows and increasing their collaboration efficiency. For individual users, we help reduce their traveling burden and enhance convenience. We also enable instant access to and sharing of vital information.

Going through the different products; WeCom enabled better connections within enterprises and with consumers externally. WeCom offers collaboration tools for enterprises to enhance management efficiency. It is deeply integrated with Weixin chats, Mini Programs, and Weixin Payments. Enterprises can use WeCom as a back end to communicate with and serve customers on Weixin, enabling convenient and efficient customer management on one single platform. All customer relationship will be retained by enterprises and will be preserved even after the frontline staff’s departure. Examples of how we can assist digitization include, for the government, we can support the Seventh National Population Census, the first digitized census in China’s history. WeCom enabled around 7 million census tickers to submit a massive amount of data online in a secured and reliable way, and facilitated the efficient management and coordination of this large and mobile workforce.

In the public education sector; WeCom has been increasingly adopted as a software for enhancing communications and operations management of schools. WeCom enables real-time and direct communications between teachers and parents, where teachers can benefit from WeCom’s CRM functionality, while parents can interact with teachers using the parent’s own regular Weixin accounts and app. WeCom also provide tools for education bureaus and schools to manage their day-to-day operations more efficiently. In the business sector; we have been upgrading tools in WeCom to enhance the private domain operations of retailers and brands as we improve their resources management. We believe these tools can help retailers and brands increase sales and improve cost efficiency.

Now, turning to Tencent Meeting; the most used stand-alone cloud conferencing app in China. Tencent Meeting has achieved double-digit growth in both MAU and time spent per user in June 2021 compared with December 2020. We’re increasing it’s penetration in medical and public education sectors, leveraging our vertical solutions, and expanding industry partnerships. To enrich our solutions for meeting rooms, Tencent Meeting supports a wide range of hardware from around 30 partner vendors. We upgraded the growth quality by launching our self-developed voice solution, Tencent’s Ethereal Audio. With enhanced AI-based noise cancellation, our solution enables speech capture from up to 12 meters away in standard meeting rooms. Examples of how Tencent Meetings assist digitization includes the large enterprises, for example, such as state grid cooperation with China and China Communications Construction company.

We customized solutions compatible with their existing IT systems and equipment for efficient collaboration. This illustrates our capabilities in supporting enterprises with vast operations and sophisticated requirements. For large-scale conferences, we deliver secure, reliable and high-performance solutions, among which we have supported China importing export fair or known as the Canton Fair for 3 consecutive events since April 2020. Finally, Tencent Docs is now the leading cloud-based productivity suite in China with spreadsheet, Word processing, and slide deck applications. It also allows easy sharing of files via Weixin and QQ. Building on it’s initial success in education sector, Tencent Docs is gaining popularity in traditional sectors such as finance, media, and legal. This reflects increasing functionality of the service as well as it’s unique user experience for collaborated data collection and sharing.

In July 2021, student volunteers used Tencent Docs as a real-time collaborative tool for helping rescue our people track in Henan floods via data collection, editing and sharing. Our infrastructure and operations support Tencent Docs to deliver reliable performance in such an extreme situation with the documents edited over 300,000 times and accessed to over 2.5 million times within 24 hours, and in that process, saved many life.

Now with that, I will pass to James to talk about our business review.

James Mitchell

Thank you, Martin. For the second quarter of 2021, our revenue grew 20% year-on-year. VAS represented 52% of our revenue, within which the game subsegment was 31% and the social network subsegment, 21%. Online advertising was 17%, and FinTech and Business Services reached 30% of our total revenue.

For value-added services, segment revenue was RMB72 billion for the quarter, up 11% year-on-year and stable quarter-on-quarter. Social network subsegment revenue increased 9% year-on-year to RMB29 billion, reflecting moderate growth of digital content subscriptions and in-game item sales. Total VAS subscriptions grew 13% year-on-year to 229 million. Video subscriptions increased 9% to 125 million, benefiting from our diversified content across sports, animated series, drama series, and movies. For example, our animated series, Land of Warriors as well as Battle Through the Heavens Season 4 attracted wide audience bases. Music subscriptions expanded 41% to 66 million, driven by the TME’s effective marketing and by increased consumer willingness to subscribe for music services.

Games subsegment revenue increased 12% year-on-year to RMB43 billion. Our international games revenue grew 29% to RMB11 billion, or 37% in constant currency terms. Mobile games VAS revenue increased 13% year-on-year to RMB41 billion, with higher ARPU and paying user ratios. Revenue growth was primarily driven by Honor of Kings and Moonlight Blade Mobile in China and by PUBG Mobile and Clash of Clans internationally. PC client game revenue increased 1% year-on-year to RMB11 billion, as international growth from Valorant and Warframe offset domestic softness from Dungeon and Fighter.

Turning to Weixin; Mini Programs GMV more than doubled year-on-year as our decentralized commerce environment helps businesses drive their own channels and their own user relationships, while also enabling them to achieve higher profit margins than on other channels. Summarizing how the Weixin ecosystem can deliver success for our partners, brands and merchants can acquire customers for their Mini Programs off-line via QR codes and Weixin Pay. They can create and distribute content by their own off-line accounts in Weixin groups, engaging their users and driving repeat visits to Mini Programs. With powerful shopping functionalities such as single merchant membership rewards, Mini Programs can convert visits into transactions. And we’re also developing video accounts and live streaming as additional touch points for deepening user connectivity.

For Q2, we enhanced the camera capabilities so as to provide better augmented reality experiences in user-generated content production and video chat. We automated the in-app video editing process, encouraging users to generate and share more appealing video content.

Turning to games, we reinforced the IP value of our leading titles. We adapted Honor of Kings into a drama series, You Are My Glory, which is now the most watched drama series on Tencent Video by video views per episode year-to-date. Honor of Kings also released a series of popular skins. PUBG Mobile collaborated with the movie, Godzilla vs. Kong, to create crossover content. And we revamped PUBG Mobile’s battlefield design and combat features in July, increasing average user time spent. For Clash of Clans, we released a major content upgrade in April and launched the ninth anniversary event in August. Supercell is developing 3 new games based on the Clash IP, including the turn-based strategy game Clash Quest, which has begun beta testing in Scandinavia. Valorant achieved 14 million monthly active users on it’s first anniversary, benefiting from the game’s competitive gameplay, robust technology, and eSports activities. Riot is developing a mobile version of Valorant. We’re also extending our presence in newly emerging games genres. Alchemy Stars, developed by our Tourdog Studio, was the most downloaded tactical RPG in Japan in July benefiting from it’s anime art style unique tile-connecting gameplay and narrative created by a reputable Japanese scriptwriter.

Light and Night developed by our Aurora Studio, it became China’s top dating simulation game by DAU in July with particular popularity among female players due to it’s storyline. Our first survival open world crafting game, Undawn, developed by the Lightspeed & Quantum Studios, has accumulated over 30 million preregistrations in China to date, ahead of it’s release on mobile. As a leader in the game industry, we have, for many years, sought to foster a healthy game-playing environment. We believe playing appropriate games in moderation can provide players with experiences such as teamwork, leadership, and skills mastery, enhance their familiarity and facility with software and, in some cases, represent a first step toward acquiring coding skills.

In 2017 we pioneered a system helping parents manage minors’ game activity. In 2018 we introduced the strictest in-game measures in the China industry, with mandatory real name verification and stringent game time and spending limits. Earlier this month, we further tightened our game time spending limits beyond regulatory requirements, initially for Honor of Kings and Peacekeeper Elite and in future for our other games. We reduced the time limit for minors to 1 hour per day on non-statutory holidays, and 2 hours per day on statutory holidays. And we prevented in-game spending by players aged under 12. We’re also cracking down on minors misusing adult accounts and transactions of adult accounts and third-party platforms. To fully implement a healthy game environment in China, we’ve advocated industry-wide coordinated discussion around regulating minors’ total time spend across game, further researching age-based game classification systems and/or potentially restricting under 12-year olds from playing games altogether. During the second quarter, under 16-year olds accounted for 2.6% of our China game grossing receipts and under 12-year olds accounted for 0.3%.

Moving to Online Advertising; total revenue was RMB23 billion in the second quarter, up 23% year-on-year as growth in Internet services, consumer staples, and automobile sectors outweighed weakness in education. Since May, the China Online Advertising industry has been impacted by the sharp decline of ad spend from K-9 after-school tuition services and, to a lesser extent, by regulation of launch screen advertisements. Conversely, Apple’s IDFA changes appear to have had less impact in China than widely expected. We expanded our overall advertiser base by enhancing industry solutions, enabling merchants to better manage their private and main operations within Weixin. During the Tokyo 2020 Olympic Games, we provided integrated marketing solutions across Weixin, QQ, Tencent Video, Tencent Sports, and Tencent News. Leveraging our strengths in social long-form and short-form video distribution as well as in content management, we believe we outperformed other online platforms in terms of video views and user sharing and activity. Our social and others advertising revenue increased 28% year-on-year to RMB20 billion, primarily driven by Weixin properties, in particular, Mini Programs as well as our mobile ad network.

For Moments advertising; more advertisers adopted Mini Programs as landing pages, leading to higher sales conversion and thus, revenue growth. Video ad inventories contributed close to half of Moments revenue. Ad revenue inside Mini Programs also doubled year-on-year, following the growth in Mini Programs’ GMV. Official accounts revenue grew to the release of inventories in notification fees, and increasing recognition of Official Accounts rolled in generating sales leads. Our media advertising revenue was stable year-on-year, as increased monetization of our music apps offset weakness in our advertising on our news app.

Looking at FinTech and Business Services; segment revenue was RMB42 billion, up 40% year-on-year and 7% quarter-on-quarter with Business Services growing at a notably rapid rate. Within FinTech, year-on-year revenue growth was mainly driven by mobile payment volume growth. The number of consumers using our payment services and the number of payment transactions per consumer each increased. We believe the SMEs play a valuable role enriching our payment ecosystem and generating payment user engagement and we, in turn, seek to help SMEs benefit from greater mobile payments acceptance by charging very low or even zero payment take rates in certain cases, and by our commitment of resources and services to support SMEs growth. We’re also researching new opportunities in the payment industry such as participating as a pilot in the digital yuan project where we’re supporting WeBank in developing and testing it’s new interface within the PBOC’s digital yuan e-RMB application.

For Business Services; our revenue grew at a rapid rate year-on-year as we helped digitalization of public services in traditional industries. We experienced an increasing number of customers adopting our platform and software services such as security, AI and data analytics. Video cloud solutions are an important and rapidly growing Platform-as-a-Service segment. And according to IDC, we ranked first in China in terms of video cloud solution revenues. During the quarter, we integrated our real-time communication, instant messaging, and CDN infrastructure into a unified solution called RT1 network. For developers, RT1 enhances their efficiency by providing a one-stop software development kit for audio and video path solutions. For Tencent Cloud RT1 expands cross-selling opportunities and increases cost efficiency.

With that, I’ll pass to John to discuss the financial review.

John Lo

Thank you, James. Hello, everyone. For the second quarter of 2021 total revenue was RMB138.3 billion, up 20% year-on-year or 2% quarter-on-quarter. Gross profit was RMB62.7 billion, up 18% year-on-year or stable quarter-on-quarter. Net other gains were RMB20.8 billion, up 141% year-on-year or 6% quarter-on-quarter. This mainly included non-IFRS adjustments relating to our invested companies, number one; net fair value gains, reflecting increased valuations of investees, in particular, in the sectors of transportation, services, FinTech Services and local services; number two, net gains on deemed disposal and disposal of certain investee companies. These were partially offset by fair value losses or impairment against certain investees.

Operating profit was RMB52.5 billion, up 34% year-on-year or down 7% quarter-on-quarter. Net finance costs were RMB1.9 billion, down 3% year-on-year or up 42% quarter-on-quarter. The 3% year-on-year decrease was a result of lower ForEx losses, partly offset higher interest expenses due to higher amount of indebtedness. The Q-on-Q increase reflected ForEx losses in the second quarter versus ForEx gains last quarter. Share of losses of associates and joint ventures was RMB3.9 billion compared to RMB295 million a year ago. This resulted from non-IFRS adjustments of certain associates and increased investments in community group buying initiatives by certain associates, as well as losses recognized from certain associates. On a non-IFRS basis, we shared losses of RMB449 million this quarter compared to share of profit of RMB658 million a year ago. Interest tax — income tax expense was RMB3.7 billion this quarter. The effective tax rate for the quarter was 7.9%. IFRS net profit attributable to shareholders was RMB42.6 billion, up 49% year-on-year or down 11% quarter-on-quarter. Diluted EPS was RMB4.387, up 28% year-on-year or down 11% quarter-on-quarter.

Now, I’ll share our non-IFRS financials. For the second quarter, operating profit was RMB42.8 billion, up 14% year-on-year or largely stable quarter-on-quarter. Net profit after NCI was RMB34 billion, up 13% year-on-year or 3% quarter-on-quarter. Diluted EPS was RMB3.504, up 12% year-on-year or 3% quarter-on-quarter.

Moving on to gross margin; the overall gross margin was 45.4%, down 0.9 percentage points both year-on-year and quarter-on-quarter. By segment, gross margin for VAS was 52.9%, down 0.8 points year-on-year and 2.2 percentage points quarter-on-quarter. The year-on-year decline was mainly due to lower contribution from privileged subscriptions and PC games, which carry relatively higher margins. The sequential decline was also due to lower revenue contributions from PC games and higher revenue mix of lower-margin digital content services with increased content costs. Gross margin for Online Advertising was 48.8%, down 2.6 percentage points year-on-year or up 3.7 percentage points quarter-on-quarter. The year-on-year decrease was mainly due to increased bandwidth and server costs, sequential increase mainly benefited from mix shift to higher-margin owned and operated inventories. Gross margin for FinTech and Business Services was 32%, up 3.1 percentage points year-on-year and stable quarter-on-quarter. The year-on-year increase reflected improvement in gross margin of Business Services and mix shifts within FinTech service.

On operating expenses; selling and marketing expenses were RMB10 billion, up 29% year-on-year or 17% quarter-on-quarter. Both year-on-year and quarter-on-quarter increase mainly reflected increased market spending on Business Services, digital content services and games, including marketing spend associated with subsidiaries we consolidated over the past year. As a percentage of revenues, S&M expenses was 7% of revenues, broadly stable compared to the second quarter of 2020. R&D expenses were RMB12.8 billion, up 30% year-on-year or 14% quarter-on-quarter. R&D expenses represented 9% of revenues. G&A expenses, excluding R&D, were RMB9.8 billion, up 48% year-on-year or 28% quarter-on-quarter. Both year-on-year and quarter-on-quarter increase reflected retail staff force. Excluding share-based compensation, it increased by 37% year-on-year or 10% quarter-on-quarter. At quarter end we had approximately 94,000 employees, up 33% year-on-year or 6% quarter-on-quarter.

Let’s take a look at the operating and net margin ratios. For the second quarter, net non-IFRS operating margin was 31%, down 1.8 percentage points year-on-year and 0.6 percentage points quarter-on-quarter. Non-IFRS net margin was 25.4%, down 1.8 percentage points year-on-year or largely stable quarter-on-quarter. Finally, I will share some key financial metrics for the quarter. Total CapEx was RMB6.9 billion, down 27% year-on-year or 10% quarter-on-quarter, within which operating CapEx was RMB5.9 billion, down 29% from the high base in the second quarter of 2020 as we advance procurement and amidst the pandemic at that time. Non-operating CapEx decreased 11% year-on-year to RMB1.1 billion, reflecting lower spending on land use rights and data center construction.

Free cash flow for the quarter was RMB17.3 billion, down 39% year-on-year or 48% quarter-on-quarter. Net debt position was RMB21 billion compared to net cash of RMB5.6 billion last quarter, mainly due to a net cash outflow for M&A activities and 2020 dividends of RMB12.5 billion, partly offset by free cash flow generation. The fair value of our shareholdings and listed investee companies, excluding subsidiaries, was approximately RMB1.45 trillion or US$224 billion at the end of the second quarter.

Thank you. We shall now open the floor for questions.

Wendy Huang

Operator, we will take one questions with up to one follow-up question from each analyst [ph]. We invite the first question.

Question-and-Answer Session

People are seen in front of the Tencent headquarters in Shenzhen, Guangdong province

Operator

Thank you. May we invite the first question from Hanjin — sorry, from Alicia Yap from Citigroup. Please go ahead.

Alicia Yap

Hi, good evening, management. Thanks for taking my questions. My first question is related to the advertising. So how should we think about this overall ad revenue growth in the second half of this year given there are more advertiser adopting the Mini Programs as the landing pages, which will help Moments advertising that lead to higher revenue opportunity. But in the meantime, there are regulatory headwinds on limiting this launch screen app and also overall macro weakness that might lead to some cautious ad spending. So, any color on the near-term ad revenue growth outlook, and also the longer-term ad revenue opportunity given further integration of these video account and Moments that you’re going to have within your Mini Programs ecosystem? Second question, very quickly is, you mentioned about you’re deploying more of your technology and expertise to help the SME, the public service, and also the enterprises with Tencent Docs and all these cloud-based productivity solution. How should we think about these — any complementary service that could evolve and develop around this software that could translate to future business opportunity? Thank you.

James Mitchell

So Alicia, on your first question around advertising, I think you summarized the puts and takes fairly well. Taking a long-term strategic view, we’re very happy with our position and how it’s evolving, particularly in a couple of areas. One being, as you alluded to, the increasing adoption of Mini Programs by enterprises within Weixin, which helps us in a number of ways. First, it means that advertising within Weixin has more of a performance component, more akin to a search environment or a marketplace environment rather than the media environment, which is beneficial for advertising activity within Weixin Moments, within Weixin Official Accounts and elsewhere. And then secondly, the Mini Programs themselves constitute advertising inventory. So we mentioned that the advertising revenue within the Mini Programs themselves, which is quite substantial, more than doubled year-on-year during the second quarter. And overall, you can see that our advertising gross margins improved somewhat from the first quarter to the second quarter due to a mix shift from our lower-margin ad network business toward our higher-margin Weixin properties.

Then secondly, from an inventory perspective, we’re seeing good growth in video accounts, DAU, and time spent. And that growth has benefited from the addition of high-quality content such as the Olympics in recent weeks. And over the longer term, when we monetize that video accounts inventory, and we know from the experience of other short video services that both the ad loads and the CPMs can be attractive, relative to other advertising properties. So, those are 2 structural drivers over the longer term, the Mini Programs adoption and the video account inventory creation. In the near term, our expectation is the overall online ad industry will experience slower growth in the third quarter than the second quarter, and that is partly because of the full quarter impact of a very sharp reduction in advertising by K-9 after-school tuition services, to a lesser extent, the negative effect on the supply side from the flash screen advertising regulation changes and then potentially a deceleration in overall consumer activity as well; so that’s on the advertising side.

Martin Lau

Now, in terms of the productivity software side; I think these are services, which we don’t monetize directly at this point in time, but we believe the category, a lot of value to the customers. And overtime, they’ll be valuable commercial products as well. But more immediately, right, a lot of these solutions, when they are deployed by enterprise customers, it actually help us to open the door and as a result, can help us to sell our cloud services as well as our ad services to these companies; that’s the immediate benefits. And then overtime, if you look at the U.S. market, right, each one of the product that we have actually has got a very successful commercial product in the U.S. For example, Tencent Meeting, the counterpart is Zoom. And if you look at WeCom, it’s partly Salesforce, partly Shopify. And Tencent Docs, it’s Google Docs and Microsoft Office. And these services all have their own monetization and business models. And I think overtime, while we don’t charge at this point in time, at the time, we may develop value-added service and for certain customers who want to use these value-added services, there will be some kind of a commercial solution.

And looking further into the future, these solutions also have to build an ecosystem of SaaS software. So there will be other SaaS software who can actually rely on our productivity too and provide their services to the enterprise customers, and we can actually derive some value from there as well. So all in all, we believe that at this point in time, it’s a very valuable suite of service from a user value perspective. Overtime, they would help us to generate commercial values as well.

Wendy Huang

Operator, let’s go to the next question.

Operator

Thank you. Certainly. The next question comes from Han Joon Kim from Macquarie. Please ask your questions.

Han Joon Kim

Great. Thank you for your time today management. The first question really goes to kind of — there’s been a lot of regulatory developments in the market. Are there any in particular that you want to call out as things that might have been different from the way that you were envisioning in a few months or a few quarters ago, and how that might impact our strategic initiatives or priorities and so forth? So if you can just kind of call out 1 or 2 of them; that would be great. And that dovetails into my second question, which is around perpetual [ph] tax that I think the industry has been benefiting from over the years. And I think some of your peers in the market have indicated that perhaps some of those perpetual treatment might be slowing to ebb away. So I just wanted to get some impression from how your conversations with the regulators have been about the idea that you redeploy your capital into investing for the benefit of society, and whether you think that’s still valid and that the perpetual tax treatment should remain for us on an ongoing basis. Thank you.

Martin Lau

I think if you want to identify a regulatory action, it’s probably sort of around the after-school tuition frame, which is actually impacting a pretty big advertiser group on our advertising and across the industry. And we’re seeing part of the impact this quarter and we’re going to be seeing the entire impact of — full quarter impact next quarter. And that essentially take away a big buyer of advertising today on our platforms and the inventories that’s due there. So overtime, we’ll be able to fill up the inventory with other advertisers. But there will be an impact initially. So, I think that’s the most direct impact. But I think there’s going to be a lot of questions with respect to regulations, so I might as well just sort of answer the more systemic view, right? I think that the point we want to make is that number one, we felt that regulation on Internet is a global trend, and it’s not just limited to China. It’s actually happening in the U.S., in Europe. But China, it’s a bit ahead in terms of the execution of a more structural regulation framework. And I think this should be expected because the regulation has been actually quite loose over an industry like the Internet, considering it’s size and the importance.

Now secondly, I would like to say in terms of the regulators, the regulators are very focused on identifying and rectifying industry misbehaviors and also establishing regulations, they emphasize compliance, social responsibility as well as fair and proper behavior. And we should expect in the future — in the near future, more regulations should be coming. Thirdly, what I would go — to go from — our understanding is that the government actually wants to foster a long-term sustainable development of the Internet industry. The government does recognize the importance on the economic side and social side of the Internet industry and also the contribution of the industry to global competitiveness. So that’s why it does want to foster a long-term healthy environment. Fourthly, I would say our attitude during this wave of regulation is that we want to embrace this new environment fully, and we want to establish ourselves as fully compliant. And we felt that this is actually going to be good for us and for the entire industry over the long run.

And on a relative basis, we felt we are also quite well positioned to embrace the regulatory environment because we have been fully compliant with all regulations. This has always been our operating philosophy. And our strategy has always been trying to create value for users. And we have always been quite self-restrained in terms of monetization. We have run our platforms so that we establish open platforms to support individual enterprises and entities. And we have also, all along the way, quite emphasized social responsibility and emphasized we want to use our tech for good. So given all these factors, right, I would say there will be short-term uncertainties and there are a lot of new regulations that will be coming, but we are pretty confident that we can be compliant. And over the long run, it would actually position the industry for healthy growth, and we’ll be a beneficiary of that.

John?

John Lo

In relation to tax, you know, I think the tax rebate has been reducing generally overtime by implementing more detailed categorization of key software enterprise. Beforehand, the group has about 4 to 5 companies which were qualified for key software enterprise. Well, for last year we still had but the number reduced by quite a lot. We only accrued tax at preferential rate of 10% when we are sure that we can get it normally in the subsequent year. We also accrued withholding tax when we generated profits as opposed to some of our peers which accrued when they need to remit money. As you can see, the effective tax rate for 2020 was about 11% and the first half of 2021 was about 11% as well. We expect that the effective tax rate for the entire year will be at similar level. On the face of it, the tax seemingly is very low taking into account of a lot of non-IFRS adjustments such as non-taxable book profits on deemed disposal, disposal or other value valuation gains on investment. If we take out all this — all the non-IFRS adjustment that is what are the noises and withholding tax as well, the effective tax rate would have been approximately low teens for 2020 and mid-teens for 2021. All in all, the total tax rate differential would be around 3%.

Wendy Huang

Operator, let’s move to the next question.

Operator

Thank you. Our next question comes from Gary Yu from Morgan Stanley. Please ask your question.

Gary Yu

Hi, thank you for the opportunity to ask questions. I have one follow-up on regulation. I appreciate the fact that management has been proactive in kind of talking to the regulator and self-regulate some of the practices in the market. Based on our conversation with the regulator, do we see the risk of more kind of drastic measures that the regulator may impose on the gaming industry? So for example, we try to limit restriction on time for minors or below 12. Is there any discussion on teenagers, about 18 years old in terms of time spent on games? So that’s my question on regulation. Thank you.

Martin Lau

On games, I think that the key issue at this point in time is still the amount of time and the amount of money that the minors spend on games. And this is an area that we are very focused on. And as a result, as you can see in our latest pronouncements, we have put in a number of different measures that James had already talked about. But there is one issue, which I think we proactively think up to the regulators, which is about the total amount of time and money that minors spend on games. Because right now, I think a lot of the regulations is actually around each game. But if you look at across the industry, and most of the people are — when they have concerns, they’re concerned over minors spending too much time on games as a category. So, if we can actually find a way to regulate the total amount of time that’s spent across different games; that would address the problem. And it actually requires — it’s a complicated issue requiring consensus of the regulator as well as the industry, if it requires a regulation. It also requires a system to police it but from the practicality perspective, it’s actually doable.

So, this is one thing that we felt we would want to take up to the industry and the regulator to discuss. And if that can be achieved, and I think most of the criticism on the gaming industry, it will be resolved.

Operator

Thank you. Our next question comes from Robin Zhu from Bernstein. Please ask your question.

Robin Zhu

Thanks, management. Thanks for the opportunity to ask a question. I guess couple of questions, please. The first one is, there’s been a lot of reports about the opening of the ecosystems between yourselves and peers in the industry. Can management just talk a little bit about the impacts — or, first of all, the — whether this is happening, whether there’s a time line for it to happen and, subsequently, the likely impact that you think will happen to — for Tencent business or the opportunities that might open up? The other one is that — just a focus on video accounts. I think James mentioned that DAUs and time spent have been going out. Could you just share some thoughts on the monetization strategy here? At what point in the development of video accounts or what other prerequisites for monetization of video accounts to happen? Where are you on content depth and creative depth and so on? Thank you.

Martin Lau

Yes. In terms of the ecosystem I think our ecosystem is fundamentally open, and the priority of our ecosystem is actually helping smaller companies and SMEs and brands and merchants to be successful. Now, if you look at our ecosystem right now, it’s fundamentally open. Links are — not a lot of things are blocked. Users can always copy-paste. Some links are not particularly enhanced with rich presentation. And why is that the case, right? Now the ecosystem, if you look at our Weixin ecosystem, it’s really built on the principle that it allow individuals, SMEs, brands, and merchants to engage with their users directly and in an untethered way. When — and we have actually always uphold that principle and we have built a lot of different tools, and we’re putting a lot of guidelines and rules of operations in order to support this vision. Now, when platforms actually interact with platforms, different questions arose. It becomes much more complicated. Platforms do not offer individual services. They actually sort of have to have a lot of other merchants behind them, right? In a lot of cases, in some cases, there are like millions or tens of millions of merchants behind these very large and dominant platforms. And the platform rules are very different from ours.

So, that actually raised a lot of complicated questions such as will users be spent especially when other platforms with a lot of resources can offer subsidies. How do we deal with counterfeit’s and content piracy? How do we deal with commercial policies, which are completely different? For example, we don’t charge any take rate on our merchants and the brands, right, but other platforms do. So how do we reconcile that? So we felt these are very complicated questions and need to be discussed and resolved overtime, and it’s really not the most important priority for our vision. And if these questions are not handled well, then it will be bad for our users, it will be bad for the brands and merchants on our platform. So we want to handle these questions in a very cautious way.

Now in terms of Video Accounts; I would say Video Accounts has been growing quite nicely and healthily in terms of DAU and time spent per DAU as well as the number of content contributors. The Olympics content was also a positive for Video Accounts. Right now, we are very focused on increasing the content — improving the content ecosystem, including increasing the high-quality content, as well as enhancing our core capabilities such as our recommendation engine. Monetization is not a focus for now; we know that at some point in time, there will be monetization because monetization mechanism is actually well established in that industry but for now our focus is not on monetization.

Operator

Thank you. [Operator Instructions] The next question comes from John Choi from Daiwa Capital Markets. Please ask your question.

John Choi

Good evening, management. Thank you for taking my question. I have a question on your online games and then another follow-up on the regulation. So on online games, I think you guys mentioned earlier that China market was about 8%. I understand last year was also a pretty high base. But as we go into the second half this year with the more tighter regulatory environment targeting the minors, how should we think about the gaming growth, particularly for the domestic market? I do understand that we do have a few games in the pipeline, but it seems like the pipeline could be a bit more softer depending on the delays. And a quick follow-up on the regulatory front. I think, Martin, you mentioned that while you guys are compliant more with the regulations, would this have somewhat impact on how we execute our business, meaning that should we be seeing more of a slower business growth opportunity within your different businesses as you guys try to comply to the new regulatory standards? Thank you.

James Mitchell

John, so on your first question around our game business outlook then. We did quantify the impact of not generating revenue from users aged 12-years old and under, which is 0.3% of our China again, revenue and therefore, a smaller percentage of aggregate game revenue. And then, on the positive side, I think you made some comments about a soft game pipeline, which is not our perception. We’re actually quite positively excited about our game pipeline within China. And then without China, outside China, we have what we think is also a fairly healthy robust game pipeline. And we’ve seen some success recently, really for the first time in Japan and Korea with our tactical RPG. We’re seeing good traction, again, arguably for the first time with a console-first game in the form of Pokémon Unite. So, I think it’s an uncertain environment. There’s lots of moving pieces. But overall, we believe we have a very high-quality game pipeline, both inside China and internationally.

Martin Lau

In terms of regulations, I would say there will definitely be short-term adjustments that are needed for the different businesses. But on the other hand, the long-term strategy, I think, for us, is actually very intact. We have always executed our strategy around creating services that has user value, that help businesses and industries, and then also create social value. And in that process, we invest in these services, we monetize in a very self-restrained way and I think that strategy will continue.

Operator

Thank you. Our next question comes from Alex Yao from JPMorgan. Please ask your question.

Alex Yao

Thank you management for taking my question. First question is on long-term financial impact from increasing the more social response initiative to take social responsibilities. In this quarter, you guys announced 2 more initiatives to social responsibility. Number one is the suspension of minor monetization for people under 12 years old. And then number two is the — you will charge very low to 0 payment take rate for some cases. As you take on more and more of those social responsibilities, how should we think about impact on your long-term margin structure? And then secondly, I have a follow-up on Martin’s comments around more regulation coming to the market. Can you share with us your thoughts on the directions and the areas of future regulatory direction or the areas that you expected to see more regulatory measures? Thank you.

Martin Lau

Well, on the last question, we have already provided the framework. I think it will be coming from all different regulator entities as well as on different segments of the industries. And we think there will be quite a few coming out. So we can’t provide a clinical analysis of that until they come out. Now in terms of the impact on our business; if you look at the under 12-year old, it’s only 0.3% of our total revenues. So it’s actually sort of very little. In terms of our SME benefits by and large, it would slow down the growth of revenue but I think it will be well within that scope. In terms of longer term impact, I would say our margin profile has always driven by our overall strategy of a combination of different components. One is monetization of profitable businesses which usually the monetization from our side is actually a restraint. And then, we’ll have free services, which could be monetized overtime. And then, we also have loss-making businesses, which by now are actually quite significant, but they would actually overtime hopefully, narrow losses and overtime, be able to generate some profit.

This overall strategic mix has been actually been quite consistent over the past many years, and we intend to keep this strategy stable, which means that our earnings profile, I would say, overtime would continue to be relatively stable, although there will be some short-term fluctuations. Now in terms of the SSB investment of RMB50 billion, it will be — again, I want to emphasize that funded from a non-IFRS profit in which we actually sort of have a pretty big pool. Oh IFRS profit pool, yes; so it will not impact our non-IFRS profit.

Operator

The next question comes from Natalie Wu from [indiscernible]. Please ask your question.

Unidentified Analyst

Hi, good evening. Thanks for taking my question. Just wondering, actually your FBS Financial Business Services line actually grew very fast this quarter. Just wondering how much of the growth is led by commercial payment, and how much is led by the cloud. And how should we see the future trend of this line? And also, if — just wondering, if the gross margin profile of cloud is similar with the FinTech business? Thank you.

James Mitchell

So on your question, Natalie, then both the commercial payment and the cloud were the 2 primary contributors to the growth. Within cloud, we saw very rapid, very substantially above-market growth infrastructure service and then more rapid growth Platform-as-a-Service and Software-as-a-Service. And that translated into the margin where, as John mentions, the gross margin for cloud improved year-on-year. That’s not because we’re at the stage on focusing on margin optimization yet, rather, it’s because there was a gentle mix shift from Infrastructure-as-a-Service towards Platform-as-a-Service and Software-as-a-Service. So, we’re still focused on maximizing client penetration and growing our market share, and helping industries digitize rather than on profitability, but the gross profit margin did improve notably year-on-year for Business Services because of the mix shift to PaaS and SaaS.

Operator

Thank you. Our next question comes from Garret Wang from CITIC Securities. Please go ahead.

Garret Wang

Hello, [indiscernible]. In the first half year, I noticed that there is some reorganization of our management team. Some management team from IEG and PCG is now leading China Literature [indiscernible] and some other business department. And since that we are focusing more on the content field, can the management team work out through demand strategy and the purpose of the Human Resource reorganization besides as the Internet traffic is reaching it’s upper limit? Under this background, what is the priority of our content investment? And can you give us some hints of our layout on the [indiscernible] Metaverse? Thank you.

James Mitchell

Yes, thank you for the questions Garret. So on your second question, the Metaverse is a topic of great interest to us, albeit a longer term rather than an immediate opportunity. And we believe there’s a number of potential pathways to the Metaverse, including very popular existing games that are highly social in nature, new games that are yet to be created as well as existing social networks that can become more Metaverse-like progressively overtime. We also think that there’s certain skill sets or attributes that will be highly beneficial to companies seeking to provide a Metaverse environment, including experience of handling huge numbers of users interacting with each other, with which is akin to communications and social networking, including managing digital economies between users, which is akin to online games. And then, also including the ability to take physical world assets such as human faces or buildings or mountains and digitize them in order to populate the Metaverse with people and with objects at a high speed. And we’re pursuing all of those paths, and we believe that we’re one of really a handful of companies globally that have all of those capabilities in terms of the social network expertise, in terms of the experience managing online games, and in terms of the ability to take real-world assets and digitize them for Metaverse purposes. So that’s on the second question.

In terms of your first question, it is an interesting and astute observation. And I think your conclusion is correct, that we are looking for opportunities to continually reinforce upstream content presence, whether that’s in digital literature, whether that’s in video and film and TV series, whether that’s in cartoons, comic and so forth. And we also believe that there’s increasing opportunities for synergies between the different media formats in China. And you can see that very clearly from the fact that — when we released the drama series based on Honor of Kings and that actually accretes to the popularity of the underlying Honor of Kings game. And so you can have a different media interpretations of the same underlying IP, which is they’re high-quality will self-reinforce each other. You can also see it in the fact that one of the China Literature’s IPs, the [indiscernible] is now seeding a wide range of animated series, drama series, mobile games and so forth. And with each iteration, and the popularity of the IP, that the respect for the IP in the market appears to deepen and grow. So that’s a very healthy trend, and we think that by moving people within our sort of content-centric groups and by ensuring that what has historically been more platform-centric products become increasingly mindful of the opportunities around content than we’re in a very good position to really help drive that change in China.

Operator

The next question comes from William Packer from Exane BNP Paribas. Please go ahead.

William Packer

Hi management, many thanks for taking my questions. So firstly, now you’ve further developed your reinvestment plans, could you perhaps — which you communicated it last quarter, could you provide more details on the scale of investment you’re planning for 2021, perhaps narrowing the range of guidance of 0% to 22% non-GAAP EPS growth? And then secondly, I wondered if you had any thoughts to share on 2022 in the context of both reinvestment plans and regulatory factors. Can you return to trend profit growth or is that too soon? Thank you.

James Mitchell

So William, unfortunately we typically don’t provide guidance and we did so last quarter as a means of signaling that there could be a deceleration in growth because of the reinvestments in our short video and in our game business and in enterprise. And at this point in time, I think what’s more important is really to measure whether we are or are not delivering on those reinvestments, meaning that from our perspective, when we look at our enterprise initiatives, the fact that our Business Services revenue growth accelerated so sharply, the fact that we’re seeing very strong user growth for Tencent Docs, and for WeCom, and for Tencent Meeting give us a degree of confidence that we’re moving in the right direction. For our investments in game studios and game content, the fact that our international game revenue growth grew 37% year-on-year, the fact that we’re, for the first time, successfully penetrating the Nintendo Switch opportunity, the first time moving into the Japanese market, give us a degree of confidence we’re moving in the right directions for games. And then for short video, the increases in DAU and time spent on the Weixin video accounts, we believe signal that we’re moving in the right direction.

So in terms of where that shakes out from a bottom line perspective in the next 2 quarters or the next 6 quarters, there’s a huge number of moving parts. Some of them are within our control. Some of them are outside our control. But we’re less focused on those short-term moving parts, and we’re more focused on what are the businesses we are building 5, 10 years from now. And we firmly believe that if you look at our enterprise software suite, we have the products to with analogues of Zoom and Shopify and arguably Microsoft Office in China, which is a very good place to be. If you look at our video accounts, we have an opportunity to drive longer-term advertising revenue growth at substantial scale. If you look at our game business, we have the opportunity to aggressively reposition this from a primarily China-centric business to a truly global business and therefore, more than triple our addressable market for the game business group. So that’s our focus really around that longer-term opportunity rather than optimizing for the next 2 or 6 quarters.

Operator

Thank you. Our next question comes from Eddie Leung from Bank of America Merrill Lynch. Please go ahead.

Eddie Leung

Good evening. Thank you for taking my questions. The first question is a follow-up question on advertising and regulation. We have a ramp of various — from various media data there could be tightening in data connections and data privacy policy. So just wondering what could be the potential impact on the different marketing solutions under your platform. Should we expect certain marketing solutions to have less an impact than others? And then secondly, a follow-up question on James. You just mentioned about, for example, some of the overseas game opportunities. So just wondering, when we expand our presence in overseas, is actually game development — are we going to focus on mobile games? And how much we are actually looking at, as you mentioned, right, console games and other opportunities such as PC genes? We also noticed that you just established a couple of studios in U.S.; so this is kind of like along that line? Thanks.

James Mitchell

Yes, thank you. So on your first question about data collection and using data to target advertising, I think we’ve always been well known in the industry for being very thoughtful and judicious about the extent to which we use consumer data for our targeting purposes. And I won’t go into all of the details here. But I think at a high level, our assumption is that there could be fairly substantial changes in terms of the regulations around the use of data for advertising targeting purposes before those would have any meaningful negative impact on us simply because we have not been in nearly as aggressive as our Western peers or some of our local peers in terms of the granularity and the specificity of the ad targeting that we employ relative to the user data that we would potentially have access to. So that’s on the first question.

On the second question, I think it was specifically around whether we’re focused on mobile games globally or on PC and console games as well as mobile. And the answer is the latter. I think if you look at one of our biggest international game successes in the last year is Riot Games’ Valorant, which is a PC-first game. One of our big game successes last quarter is Pokémon Unite, which is a Nintendo Switch console game. Pulling back a little bit, then I think that in years gone by, it would have required effectively a tripling of headcount and a tripling of effort in order to address PC and console as well as mobile at the same time but that’s decreasingly the case for a few reasons. One is that the architecture of PC, Xbox, and PlayStation is increasingly convergent around x86. And meanwhile, the architecture of mobile and Switch is increasingly convergent around chipset design. And as a result, studios like TiMi that have been very much mobile-first find it easier to port to Switch than would have been the case when mobile and Nintendo architecturally are further apart.

And then secondly, there’s a perfusion of software tools, including our investee, Epic’s Unreal Engine, that simplify the process of developing for multiple platforms simultaneously. And thirdly, within Tencent, we’ve made a number of investments, often acquisitions, of what were historically work for higher studios outside China with a number of specializations, but one of the specializations was helping a great game on PC become a great game on console or mobile or vice versa. So I think for all of those reasons, we are addressing our PC console and mobile together internationally, and we’ll be increasingly doing so going forward.

Operator

Thank you. Our next question comes from Thomas Chong from Jefferies. Please go ahead.

Thomas Chong

Hi, good evening. Thanks management for taking my questions. My first question is about the online video landscape. Just want to get a sense about the regulatory environment in long form video. Are we seeing that is relaxing and we should expect more long-form drama series and variety shows to come out in the second half? And my second question is about — just a follow-up on the previous questions on the international gaming side. Given that we have seen quite a very strong growth momentum in international games, just want to get a sense about our strategies going forward. Should we expect this more to be driven by in-house development or M&A? And on that front, can management give us some color about the international gaming revenue contribution in Q2 as well as the long-term KPI? Thank you.

James Mitchell

So, why don’t I address the international games question. You know, we actually disclosed the international game revenue for 2Q and you can back out this; I think 25% of games segment revenue. And we also disclosed that the revenue grew 37% year-on-year in constant currency terms. In terms of the strategy, then I think it’s very much a content-first strategy in China, because of the QQ and Weixin distribution platforms with historically focused on both distribution and content creation, although increasingly shifting to content creation overtime versus outside China; it’s much more purely content-driven. In terms of where the revenue and where the growth is coming from, then it’s primarily existing studio, although supplemented periodically by acquisitions that we think can fill a particular hole or bring us a new technology capability we previously lacked. So looking at our international game revenue in the second quarter then, one big piece is games that we create in China, such as PUBG Mobile, such as Arena of Valor, and we export to the rest of the world.

A second big piece, relatively similar in size is games created by outside China, by some of our very successful investee studios outside China such as Riot with League of Legends and Valorant, such as Supercell with Clash of Clans and Clash Royale and Brawl Stars. And then, a smaller component is other studios outside China that are at more of an incubation stage or have released one big game previously, and are now at work on their second game. So that’s as far as our international games are concerned. I mean with regard to online video, Martin may supplement me, but I think that as you’re probably aware, in the first half of this year, there was some content constraints related to the July 1 celebration. And so it’s possible that there may be more drama series appearing, or we have experienced more successful drama series already this summer.

On the flip side, I think that there’s been some issues with variety shows and therefore, there’s some dislocations to the variety show output in the second half of the year. You’re probably aware that historically, variety shows tend to monetize primarily through advertising versus drama series monetize primarily through subscriptions. So our video business is increasingly subscription-driven and I think that will remain true going forward.

Wendy Huang

Thank you. Operator, we are closing the call now. Thank you, everyone. If you wish to check out our press release and other financial information, please visit the IR section of our company website at www.tencent.com. The replay of this webcast will also be available soon. Thank you and see you next quarter.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

Source: Tencent

You might also like