Core views

4Q24 dnFM saw little month-on-month increase in sales based on Nexon's guidelines. Combined with Tencent's performance conference, it is expected that 1Q25 will catalyze a significant increase in the volume of content and activities launched during the Spring Festival. Furthermore, due to weak consumption on the payment side, the growth rate of payment revenue is still lower than the growth in transaction volume (~ 10%). Overall, there is some headwind in 4Q24 revenue growth, but there is still plenty of room for profit margin improvement. The steady growth in the game & advertising business in 2025 and the profit improvement in the FBS business are expected to continue to maintain high double-digit growth in EPS, with high revenue unit growth. r/r has a good appeal.

occurrences

Tencent released 3Q24 results. Revenue was basically in line with expectations. The profit side was better than expected. Tencent's 3Q24 revenue +8% YoY reached 167.2 billion, which is basically in line with consistent expectations (Vis ib LeAlpha 167 billion yuan). In terms of profit, Tencent 3Q24 achieved adjusted operating profit of 61.3 billion yuan, +19% year over year, while adjusted net profit was 59.8 billion yuan, +33% year over year (Visible Alpha 53.7 billion yuan). By business, game revenue increased 13%, in line with expectations, and the delay cycle was extended, implying that the growth rate of game traffic exceeded expectations; advertising business was +17%, in line with expectations, mainly due to increased contributions from video numbers, search, and applets; FBS grew 2%, slightly lower than expected. Among them, payments declined year-on-year due to weak consumption, while cloud business and financial services continued to grow. On the profit side, this quarter focused on the contribution of cloud service loss reduction to gross margin. Gross margin maintained a year-on-year increase of +16%. Considering the game & advertising product structure and channel optimization process, the subsequent sharp increase in gross margin is expected mainly due to the loss reduction of cloud services and an increase in the share of financial management revenue.

Brief review

Reiterating the game business strategy, focusing on maintaining high-quality growth rather than aggressive investment, the game business continued to grow healthily this quarter, and achieved steady growth even after overseas games extended the deferral period, implying that actual performance was better than expected. As the game market matures, the growth of new game users has slowed, and the liquidity of the game market has decreased. This means “the scarcity of evergreen games has increased”. For Tencent, the ROI of maintaining the high quality game products in hand has increased. On the other hand, the difficulty of creating an evergreen game from 0 to 1 is also increasing (opportunities for higher quality products to compete more scarce). During the performance conference call, Tencent management continued to emphasize that Tencent fully trusts the ability of internal game studios in their specialty categories, and also strengthens partnerships with high-quality game development teams in other categories through external investment, thus occupying a position in different categories of ecosystems.

In the long run, e-commerce GMV is an important factor affecting the scale of advertising, but currently WeChat focuses on infrastructure construction and is still quite far from the monetization ceiling, so there is no need to worry about the industry environment in the short term. In August, Tencent issued an announcement to upgrade the video store to a WeChat store and continue to improve the e-commerce infrastructure within the WeChat ecosystem. Management said during the conference call that after infrastructure standardization, transaction costs between consumers and e-commerce merchants can be reduced. For example, GMV favors natural growth after the applet is built. A significant proportion of the 2 TrillionGMV in a single quarter was service consumption. Users settled through WeChat Pay even when trading offline, reflecting that standardized infrastructure can win the trust of users, thus laying the foundation for the growth of transaction scale. Management mentioned that when the ad load of video accounts reaches about 10% (2/3 of peers), internal circulation e-commerce will become a decisive factor in advertising growth. Currently, ad load on video accounts is far from reaching a similar level, so the current advertising growth trend is not very correlated with the progress of e-commerce monetization, which means that healthy and sustainable excessive growth can still be maintained for the next few years.

Cooperation with Taobao/Tmall is progressing well, and there is still huge room for future cooperation. It is not ruled out that future open cooperation with other platforms will follow, and focus on WeChat's ecological attraction. Communication between Taobao/Tmall and WeChat is still in the early stages. Data since October shows a good adoption rate of WeChat Pay on Taobao. This cooperation is beneficial to both parties. It has enriched the overall e-commerce GMV and revenue for WeChat, and can also bring some new users to Taobao.

However, it should be emphasized that the process of open cooperation did not happen overnight; the engineering and compliance efforts behind it may affect the progress of openness. Management emphasized that WeChat needs to standardize many designs and agreements in the process to ensure that the user experience is well protected. For example, not many spam emails target WeChat users. For example, in terms of compliance, WeChat needs to ensure that all businesses go through proper review processes to comply with regulations. These require Tencent and Ali to work together to resolve them. As a result of these factors, the WeChat ecosystem cooperation is a non-standardized process, and it is difficult to quickly replicate it to other platforms in batches, but there is no need to worry about WeChat's ecological gravity. There is still plenty of room for subsequent cooperation, but the pace is expected to slow down.

The clear scenario for AI commercialization is ad targeting and content recommendation. GPU leasing and API service progress still lags behind the US CSP.

Similar to Meta's AI RoadMap, content recommendations can bring additional user retention time and increase user engagement (likes, comments, retweets, etc.), which directly improves ad revenue and operational data. Management mentioned that Gen AI-driven ad targeting and content recommendations have begun to be deployed on a large scale on video accounts. In terms of cloud business, AI accounts for Teens (12% +) of Tencent Cloud's IaaS revenue, but the absolute revenue is less than that of US cloud vendors, mainly due to 1) the relatively small domestic enterprise market, 2) the domestic SaaS ecosystem is not mature enough; 3) AI startups are relatively small. Tencent is also testing the integration of AI into production processes internally. Management is seeing increasing adoption across different products and services, and it may take several quarters to see real large-scale use cases.

The payment business in FBS is being dragged down by structural adjustments and weak consumption, but macroeconomic policy stimulus is expected to reverse the payment business trend after some time.

WeChat Pay's performance in 3Q24 was weaker than the market. The gap was mainly due to 1) excluding low gross margin businesses during the year, which had some impact on transaction volume; 2) WeChat Pay's coverage was incomplete and did not represent the market. On the other hand, 3Q24 order volume actually increased 10% + year over year, and the decline in payment revenue was mainly due to changes in the average value of the order. Regarding the economic environment, 3Q24 saw a year-on-year decline in the average transaction price, but the October data improved after the domestic macroeconomic policy was introduced. Management believes that China's economy is expected to accelerate again, but the implementation of the current policy will take some time, and it may take some time for the average transaction price to return to growth (not necessarily seen in 4Q24).

Investment suggestions: Overall, the game business has a delayed cycle of +25 years of product release, and is still on an upward trend; advertising business management emphasizes that video accounts can steadily release the pace of commercialization and continue to contribute to excessive advertising growth, even though it may take time to improve the economic environment; FBS China Wealth Management is driven by MMF AUM improvements, and the cloud business has broken out of the base effect+improved profit margins, and payments are suppressed by weak consumption. As a result, Tencent is expected to achieve steady revenue growth, and the profit side will continue to maintain the Mid/High-Teens growth outlook, and r/r is quite attractive. Maintain a “buy” rating.

Risk analysis

Regulatory risk: Since the company's various businesses are affected by regulation to varying degrees, for example, the game business product cycle is affected by the pace of version distribution, and fintech and corporate services are subject to industry-specific regulations, changes in regulation may have varying degrees of impact on the company's business.

Changes in the macro or industry environment: Since part of the company's business is in a period of exploration or growth, the business model is not yet mature, and at the same time, the macro and industry environment may develop and change, most predictions about the future at the present time rely on the assumption that the environment has not changed much or is basically stable. If there are major changes in the macro and industry environment, the impact on the company's business may exceed our expectations.

Competition increases risk: Some of the company's businesses, such as video accounts, cloud services, and fintech, face direct competition from major Internet platform companies, and there is also a risk that potential competitors will enter the market.