Tencent executives stated that capital expenditures are mainly used for purchasing GPUs, which have brought high ROI. With breakthroughs in DeepSeek technology, the efficiency of GPU resource utilization has improved, eliminating the need for large-scale GPU purchases as originally planned. AI-enhanced technology has improved returns on investment for advertisers, contributing to Tencent's growth rate, which exceeds the Industry average. At the same time, AI has also supported the Business sector, with deferred revenue (primarily from games) experiencing a year-on-year growth in the high double digits at the end of last year, and it is expected to gradually convert into reported revenue this year and next. AI has become a key investment area while also taking into account Shareholder returns.
On Wednesday the 19th, $TENCENT (00700.HK)$ the Earnings Reports for the last quarter of last year and for the entire year of 2024 were released, showing that TENCENT's Q4 Net income increased by 90% year-on-year, with annual capital expenditures skyrocketing by 221%, reaching a new high.
Regarding capital expenditure, Tencent executives pointed out at the financial report release that R&D expenditure would not pressure profit margins. Capital expenditure is mainly used to purchase GPUs to support advertising and gaming business, large language model training, and cloud business. These capital expenditures actually resulted in good profit margins and high returns. Additionally, with breakthroughs in DeepSeek technology, the entire industry (including us) can utilize existing GPU resources more efficiently, improving the training efficiency of large models without the need to purchase GPUs on a large scale as originally expected.
In terms of advertising business, Tencent noted that the company's advertising growth rate surpassed the industry average, partly because Tencent's AI-enhanced technology provided advertisers with higher ROI.
Regarding the gaming business, Tencent executives stated that by the end of last year, the company's deferred revenue (mainly from the gaming business) grew high double digits year-on-year, and it is expected to gradually convert into reported revenue in the first half and second half of 2025 and part of 2026. During this year's Spring Festival, the daily active users of the company's five highest-grossing games increased year-on-year, indicating the popularity of the games, which serves as a positive leading indicator. The gaming business will directly and indirectly benefit from enhancements in AI technology.
In terms of e-commerce strategy, Tencent executives stated that the mini-program store is a long-term strategic direction for Tencent. For example, with the red envelope gift function, many people use this feature to give gifts to friends, who will enter their delivery address, which actually helps Tencent improve its delivery address map, and makes it easier for many users who have already entered addresses to complete transactions. Furthermore, the gift recipient may continue to pass the gift on to others.
In terms of AI, Tencent executives mentioned that AI agents can be deployed within WeChat and QQ. In the future competition of large models, one of Tencent's advantages is that WeChat users have high daily usage time and frequent app openings. Additionally, WeChat has a rich variety of activities that cover socializing, entertainment, learning, etc., allowing AI agents to deeply integrate into the mini-program ecosystem to meet users' diverse needs.
In terms of capital allocation, TENCENT has revealed that AI is a key investment area. It aims to invest in the future (like AI) while also providing short-term returns to shareholders through dividends and Share Buyback. This year, it has announced a dividend payment of 41 billion HKD, and the scale of Share Buyback has been reduced from 100 billion HKD last year to 80 billion HKD, leaving 20 billion HKD as a flexible buffer to determine whether to further invest in AI based on actual circumstances.
The following is the full text of the Q&A.
Q1: Regarding the impact of AI capital expenditure on finances. As our capital expenditure in the AI field increases, additional depreciation and R&D expenses will inevitably drag down our profit margins. In recent years, with our focus on high-quality growth, profit margins have significantly improved. So, in the future, how can we find a balance between growth and improving profitability?
People often say that the only inevitabilities in life are death and taxes. As the company's management, if we say that a decline in profit margins is unavoidable, that is obviously irresponsible. And we indeed do not believe that this is inevitable.
Regarding AI-related R&D expenditure, in fact, throughout Tencent's development, we have increased R&D investment in various projects annually. Therefore, we do not believe that R&D expenditure itself will put pressure on our profit margins.
In contrast, capital expenditure (CapEx) is a more complex topic. Indeed, we raised capital expenditure to a higher stable level in the fourth quarter of last year, and over time, this additional capital expenditure will gradually translate into extra depreciation in the coming years.
However, it is worth exploring where these capital expenditures are specifically used to determine whether depreciation will really pressure profit margins. The most direct use of capital expenditures is to purchase GPUs to support our advertising technology and gaming business. From our Earnings Reports data, it is evident that this capital expenditure actually brought good profit margins and high returns. Liu Chuanping also mentioned in previous discussions that these investments are effective.
The second use is for GPUs used in training large language models (LLM). Last year, there was a period when the industry generally believed that each new generation of language models required an order of magnitude more GPU resources. However, with the technical breakthroughs from DeepSeek, this trend has changed. Now, the whole industry, including us, is able to significantly improve the efficiency of training large language models by utilizing existing GPU resources without needing to increase GPU purchases at the previously expected rates.
The third direction of capital expenditure is related to our cloud business. We purchase GPU servers and then rent them out to clients, generating returns. Although this may not be the highest ROI sector in our business portfolio, it is still a positive return business that can cover the costs of GPUs and related depreciation expenses.
Finally, the pressure that may exist in the short term is the capital expenditure used for to C (consumer side) inference. This is indeed an additional cost pressure, but it is considered a manageable cost pressure since this part of the capital expenditure is only a portion of the total capital expenditure. Furthermore, we are optimistic about the future because we believe that over time, our consumer-facing inference activities will monetize through advertising revenue and value-added services, just like activities on other Tencent platforms.
Overall, while we understand your concerns about the increase in capital expenditures and its impact on long-term profitability, we are actually very optimistic that we can continue to drive Business growth while protecting our margins.
In consumer-facing inference products, there are indeed many ways to reduce unit costs through technological means, software optimization, and better algorithms. This is also a factor that needs to be kept in mind.
Q2: Regarding the Wechat Mini Program store. We launched the Wechat Mini Program store and red envelope gift feature in the third quarter, which were warmly welcomed by users. Can management share this year's strategy and key initiatives in the e-commerce sector?
The Wechat Mini Program store is a long-term strategic direction for us. Any specific initiatives are just one of many efforts we are making in the long term to build this ecosystem.
I want to remind everyone of the positioning of the Wechat Mini Program store. It is actually a unified platform that connects different parts of the entire Wechat ecosystem. Through a standardized product information data structure, product information can flow freely between different components of the Wechat ecosystem. The aim is to enable consumers to find high-quality products and merchants.
If you observe the different components of the Wechat ecosystem, you will find that it includes social infrastructure, content, search, Mini Programs, trading platforms, and Wechat for Business. These components together constitute a unified Wechat ecosystem.
The Wechat Mini Program store indeed wants to attract users to engage deeply. If you look at the red envelope gift feature, it is actually a function within the social components of the Wechat ecosystem. This is just one of our many features aimed at fully utilizing the potential of the entire Wechat ecosystem.
From the initial feedback, as you mentioned, this feature has been warmly welcomed by users. We observed that many people used this feature to send gifts to friends during the Spring Festival. This gifting behavior has actually amplified the word-of-mouth effect of high-quality products, as you only give gifts that you truly believe are good products.
For the recipients of the gifts, this behavior further amplifies the impact of the initial purchase. They will input their delivery addresses, which actually helps us build an infrastructure of delivery address mapping, making it easier for many users who have already inputted their addresses to complete transactions.
Generally, gift recipients sometimes further give the gifts to their friends. Therefore, overall, I believe this word-of-mouth effect is very positive, and the merchants' feedback is also very encouraging. But this is just one component within the entire Wechat ecosystem, right?
Therefore, we believe that over time, we will continue to patiently build this ecosystem and platform, viewing it as a marathon rather than a sprint. We are confident that we can go far and long on this path. If you look at the GMV (Gross Merchandise Volume) of the mini program store, it continued to maintain very rapid growth in the fourth quarter of last year.
Q3: Regarding enterprise-oriented services. I would like to ask management to elaborate on the demand and adoption rate of the Ask service over the past two months, as well as your outlook on the demand growth in the coming quarters. In addition to the mentioned Tencent Meeting and Tencent Docs, could you share some of our planned SaaS product solutions that may assist in cross-selling and upselling to cloud customers?
Regarding the demand for iService, it is actually very strong. We are currently supply constrained. One reason for the significant increase in capital expenditures in the fourth quarter of last year is that we received a batch of urgent orders to purchase GPUs to support inference and cloud services. We can only fully meet the growth of iService demand after we install these GPUs in the datacenter, which takes some time.
Therefore, I would like to say that in the first quarter we may not have fully captured this growth in demand, but over time, with the arrival and installation of the GPUs, we will be able to meet more demand.
Regarding different software solutions, you mentioned Tencent Meeting and Tencent Docs, while WeChat for Work is another very powerful product. In fact, this is our highest revenue-generating SaaS product, with revenue doubling year-on-year in the last quarter.
In addition, we have also seen security access software and audio-video access software, including real-time communications and live streaming software, which are being sold to our cloud customers. Many of these products can also be empowered by AI technology to provide additional value to customers.
In terms of consumer-facing applications, we indeed have a large number of different consumer applications, and you can expect more new products to be launched in the future.
Q4: Regarding consumer-facing applications. In addition to the significant breakthroughs made by the Hunyuan large model overseas in the past few months, there are also EMA Copilot (an AI assistant) and enhanced search functions. I would like to know how these products will gradually develop over time, and whether Hunyuan will position itself as an AI gateway that integrates all search and discovery entrances, thus complementing the WeChat super app?
I believe AI is still in a very early stage, so it is difficult to talk about what the final state will look like. But I want to say that every product will continue to evolve and become very useful tools for users, or even more powerful.
For example, the Yuanbao can become a very powerful AI native assistant. The email Copilot can serve as your personal knowledge base as well as a shared knowledge base for team collaboration. WeChat may launch many different functions in the future.
In addition, I believe our Other Products will also integrate the AI experience, including QQ, browsers, and more. Therefore, we will see more and more AI products for consumers. At the same time, each product will continue to evolve.
If you look at Yuanbao, it truly integrates many different functions, but it will not be the only entry point. Every product we have will try to find unique use cases to leverage AI to provide exceptional experiences for users. At the same time, our different products can also cooperate to provide suitable paths for user growth of AI products.
Therefore, I think this will be a continuously evolving process that will help us build a series of consumer-facing AI solutions and applications.
Q5: My question is actually a continuation of the previous one. We have seen that Tencent's Yuanbao has shown very strong growth momentum since this year. Can management provide a detailed explanation of the strategy to further grow its user base in a competitive market? Yuanbao is a combination of AI chat and AI search; which part is Tencent more interested in? Additionally, related to this, what will be the market share of AI search in the overall search market (based on search query volume) in the future? And how does Tencent plan to monetize AI search in the future?
Currently, Yuanbao is a product that combines chat and search functions, but over time, it will develop into a multifunctional AI assistant serving different types of users.
Its user range will cover students (for learning), knowledge workers (for completing work tasks), and users who need to conduct in-depth research (for exploring different topics deeply).
Thus, Yuanbao will have many different application scenarios. The unique advantages of Yuanbao are: first, innovation capability, by continuously adding new features and characteristics to meet user needs. Second, content ecosystem, Yuanbao can access Tencent's content ecosystem, especially public accounts and video accounts, which are sources of high-quality information. Third, multi-model strategy, Tencent's multi-model strategy allows users to access the best models and use a combination of models to meet complex needs.
In the future, as I mentioned earlier, many of our high daily active users (DAU) products will start adding various AI functions and features, and some of these products will integrate with Yuanbao to create a synergy effect. Our product array will support each other and develop together.
Therefore, we believe that these ongoing efforts will keep us competitive, and we also possess some unique advantages.
Regarding the broader question you mentioned about the relationship between AI prompts and traditional search, I think different people will have different views, and this requires time to validate. But from a macro perspective, if we look back at the history of web search, including early web directories, and compare our behavior using AI prompts with traditional search, I believe AI search has the potential to replace traditional search.
Because ultimately, web directories, traditional search, and AI prompts are all mechanisms for accessing the Internet knowledge graph. But among these mechanisms, AI prompts bring new technologies, new efficiencies, and new transactional capabilities realized through proxy AI, which traditional search cannot achieve.
Regarding the monetization methods for AI prompts, time will provide the answer, but we have already observed in the Western market that the initial monetization model was through subscription, followed by performance advertising. In China, I believe it will start with performance advertising, followed by value-added services.
Q6: Regarding the advertising business. We have seen a healthy 17% growth in the advertising business. Can the growth rate in the fourth quarter be regarded as a reference for the entire year of 2025? Additionally, regarding AI-driven advertising enhancement technology, we see from Meta's machine learning and Advantage+ shopping ads that these AI technologies can drive growth acceleration among global peers. Therefore, with more AI applications being implemented this year, is there a possibility for the advertising business to further accelerate growth?
Regarding the advertising business, we are very satisfied with the growth rate in the fourth quarter, which significantly exceeds the industry average. The growth primarily comes from organic growth rather than external factors, and it covers almost all the industries we monitor.
We believe this is because the AI enhancement technology we deployed provides advertisers with a higher ROI than ever before across nearly all the industries we monitor, and it also outperforms other platforms. You compared us with some global peers, which I think is the correct approach, but it should be noted that global peers tend to fully load their ads in the early stages of their product evolution.
For example, in the short video sector, we tend to gradually increase the ad load of new products, and this strategy remains unchanged. Therefore, I believe we have differences in ad loading speed compared to some global peers. However, overall, as long as the macroeconomic environment does not change drastically, we are quite satisfied with the performance of the advertising business.
Q7: Regarding the gaming business. How should we view the growth prospects of domestic and international gaming businesses this year, especially considering the high base effect of the domestic gaming business in the second half of this year? Moreover, what is the impact of AI on the gaming business? You mentioned the extension of game lifespan, but also noted changes in competition and cost structure.
Regarding the gaming business, you mentioned the high base effect in the second half of this year. I think this is the 'curse' of the industry – if you do well, people will worry about the base effect a year later.
But I would like to point out some observable facts about our gaming business; one is the growth of deferred revenue. By the end of last year, our deferred revenue (most of which comes from the gaming business) grew by a high double-digit percentage year-on-year. This deferred revenue will gradually convert into reported revenue in the first half of 2025, the second half of 2025, and part of 2026.
One is the user behavior during the Spring Festival. User behavior during the Spring Festival is an important indicator of the popularity of games. During this year's Spring Festival, the daily active users (DAU) of our five highest-grossing games all increased year-on-year, which is a positive leading indicator.
In addition, there are some subjective views. We subjectively believe that several games are gradually developing into evergreen games, among which we mentioned one game - 'Delta Force'. This is a very important opportunity and growth momentum.
Secondly, as mentioned in our prepared remarks, we have many new games in development, and we are very much looking forward to these games.
Third, we believe that the gaming business will benefit directly or indirectly from the enhancement of AI technology. Directly, game developers can use AI technology to create more content faster and serve more users more effectively.
Indirectly, this could be a trend lasting decades, not just a story for the second half of this year. As humans use AI more broadly, we believe people will have more time, and the demand for high autonomy activities (such as games) will also increase, as AI grants people more capabilities and freedom.
Therefore, for users, interactive entertainment (such as games) is one of the best ways for them to express themselves in a high-autonomy manner (rather than passively).
I would like to add that when we think about competitive dynamics, we believe AI will make evergreen games more durable. We have already seen how AI helps us execute and amplify our evergreen strategy. Part of it is reflected in content production: high-quality content can now be produced in a shorter time, allowing games to be updated more frequently to maintain user interest.
In PvE (player versus environment) experiences, games can become more exciting with smarter robots, resembling PvP (player versus player) more closely. In PvP, AI can significantly improve aspects such as matchmaking, balance, and newcomer guidance, thus enhancing user experience. All of this will help already popular massive games become even more popular, making them more appealing to users.
Q8: Regarding the commercial payment business. It is gratifying to see that commercial payment revenue has shifted from negative growth in the third quarter to being roughly flat in the fourth quarter. Could you Share your observations on the trends in commercial payment activities for the first quarter of 2025?
Regarding commercial payments, our observation is that transaction volume is actually continuing to grow, but the average selling price (ASP) is still under significant pricing pressure. Therefore, from a value perspective, revenue remains roughly flat.
Our interpretation of this trend is that consumer willingness to spend is recovering, but there is still significant pricing pressure on the supply side. Therefore, we hope this is a good sign indicating that we are nearing the end of a difficult market. As consumer demand continues to improve, competition among suppliers may gradually ease, ultimately leading to value growth. However, this is something we need to further observe in the future.
Q9: Follow-up question regarding AI and capital expenditure (CapEx). You mentioned that the capital expenditure to revenue ratio will remain in the low double digits in 2025, which is similar to the ratio in 2024. This guidance implies that capital expenditure growth will significantly slow down. Could you explain the logic behind this capital expenditure to revenue ratio in detail? Is it because you foresee a slowdown in demand for generative AI, or because the substantial increase in 2024 is already sufficient to meet the generative AI demand in 2025?
Yes, the increase in capital expenditure at the end of 2024 should be sufficient to meet the demands of generative AI and other businesses in 2025 and to maintain sustainable development at a new normal operation level. There is a time lag between ordering GPU servers and fully deploying them in the Datacenter. Therefore, for part of the time in the fourth quarter and the first quarter, we are in this state. But as Liu Chiping mentioned, by the end of the first quarter, we are deploying these GPUs and benefiting from them, fulfilling both our internal demand for Yuanbao inference and the demands of external Tencent Cloud customers, generating direct income through renting GPU servers.
If viewed from a more macro perspective, last year there was a period when people were asking whether our capital expenditure was sufficient, whether compared to peers in China or globally. Now, among listed companies, I believe our capital expenditure in the fourth quarter is the largest among Chinese technology companies. Therefore, we are in a leading position among our Chinese counterparts.
Overall, capital expenditure as a percentage of revenue for Chinese technology companies is lower than that of some Western counterparts. However, we believe that the reason for this phenomenon is that Chinese companies generally prioritize efficiency and the effective utilization of GPU servers, which does not necessarily affect the final impact of the technology. The success of DeepSeek actually symbolizes and reinforces this.
An additional point is that this is a very dynamic situation. What we provide is actually our current expectations, but frankly, these expectations may change. If there is a sudden surge in demand, we will certainly increase our GPU orders. Therefore, I believe we will maintain high flexibility and dynamic responsiveness to adapt to market changes.
Q10: Regarding follow-up questions on advertising business, can management share more details? You mentioned that advertising spending has increased in most sectors, so which verticals have benefited the most? Additionally, in terms of advertiser behavior, we noticed significant growth in features such as short video accounts, media advertising, and search ads. What changes have occurred in advertiser behavior, and how have these changes driven the growth of advertising revenue?
In terms of your questions about the advertising business, we see that the sectors with year-on-year growth include e-commerce, finance, fast-moving consumer goods, gaming, local services, education, and medical. This is a wide-ranging industry list.
As we deploy these AI-enhanced technologies, we typically apply them first in short video accounts, gradually infiltrating other parts of the WeChat ecosystem, Tencent's other products, and our advertising network. Therefore, over time, the benefits brought by these technologies will be increasingly felt. This is a part of the advertising business.
Q11: Regarding capital allocation. Management mentioned that this year's share buybacks will be less than last year, but on the other hand, dividends will increase. So, what is our priority in capital allocation? At the same time, in the context of strong demand in the current AI industry, how should we view merger and acquisition investments?
Regarding capital allocation, I think a key principle is that we want to create returns for the company and shareholders through investments. This means that at different times, we will invest in different areas. Sometimes, we invest heavily in the ecosystem and our core business.
We have previously made substantial investments in ecosystem partners and built a very large portfolio. Subsequently, we began to return cash to shareholders through dividends and share buybacks. Now that AI has become our focus investment area, we believe AI has great potential to create returns for the company in the future. Therefore, our current investment strategy is to invest in the future (such as AI), while also providing immediate returns to shareholders through dividends and share buybacks.
I think this is our core principle. From our financial capability perspective, we have a very strong capacity to achieve this goal because we have very strong cash flows at the operational level, along with a large and valuable investment portfolio, a significant portion of which consists of highly liquid assets.
Therefore, we have sufficient financial resources to invest for the future, whether in AI or other necessary investment activities. Our portfolio is basically self-sustaining while also providing immediate returns to shareholders.
Regarding this year's capital allocation, it has been announced that a cash dividend of 41 billion HKD will be paid, and the share buyback scale will be slightly reduced from last year's 100 billion HKD to this year's 80 billion HKD. This allows for a flexible buffer of 20 billion HKD to determine whether further investment in AI is needed throughout the year.
In comparison to the past two years, last year we paid a dividend of 32 billion HKD and a share buyback of 100 billion HKD, totaling a target return of 132 billion HKD.
This year's target return is 80 billion HKD (share buyback) plus 41 billion HKD (dividend), totaling 121 billion HKD. If we include last year's excess from the share buyback (15 billion HKD), this year's figure is actually similar to last year's target return.
Therefore, efforts are being made to provide a very good balance between current returns and future investments. At the same time, there are very strong financial resources to achieve this goal.
Q12: A discussion about expenditures and high margin businesses as well as monetization. Given that we have been pursuing a high-quality growth strategy over the past few years, we have also seen the story of margin expansion—operating profit growth outpacing revenue growth. However, it is noted that over time, the gap between the two will gradually narrow. Thus, tying these points together, how should we view the profit margin expansion story for 2025 and the coming years?
To some extent, one of the key reasons for the increase in operating margin over the past two years is that we have enjoyed the boost in gross profit margin. The reason for the increased gross profit margin is that while the overall gross profit margin of our core business is around 50%, many new sources of income (which contribute significantly to revenue growth) have a gross profit margin as high as 70% to 80%.
With this change in income structure, the gross profit margin has been raised, leading to gross profit growth outpacing revenue growth. Of course, over time, there will be a base effect, or more accurately, an asymptotic effect. If the overall gross profit margin gradually approaches the incremental gross profit margin, the rate of improvement in overall gross profit margin will inevitably slow down. I believe that this is unavoidable in the long term.
Nevertheless, when observing our high-quality sources of income, such as video account advertising, search advertising, value-added financial services, e-commerce transaction commissions, and self-developed games, the growth rate of these businesses typically exceeds overall revenue and their contribution to gross profit margin is far higher than the overall gross profit margin. Therefore, it is believed that the continued enjoyment of gross profit leverage will drive the improvement of operating profit leverage in the future.
From a progressive perspective, revenue growth will tend to stabilize. Of course, AI investment will actually have a certain offsetting effect on this trend.
Q13: Regarding AI and AI agents. We see many companies releasing their own large models and AI agents. How does management view the key competitive factors for future large models, and what is our competitive advantage? How should we enhance future user engagement by adding more features and characteristics?
I think there are many types of AI agents, right? An AI agent is essentially a model that utilizes model capabilities and connects to different software tools to complete complex tasks. This is a very broad concept.
You can have standalone AI agents, or you can have AI agents embedded in different applications. We believe there will be a wide variety of AI agents in the future, but for us, we will be able to build independent AI agents in the following ways. For instance, by leveraging high-quality models. By utilizing our large user base across different software platforms, such as our browser, Yuanbao, and so on.
At the same time, we can also deploy AI agents within WeChat and QQ. These AI agents can leverage the in-app ecosystem to provide excellent services to users by completing complex tasks. Taking WeChat as an example, one of our advantages is that the average daily usage time of WeChat users is very high, and the frequency of users opening the app is also very high.
The second advantage is that the activities within WeChat are very diverse, not only limited to entertainment and transactions but also including social communication and content consumption. Many people work and study in WeChat, and a large number of transactions are completed through WeChat. The WeChat Mini Program ecosystem supports a variety of different activities.
Therefore, if we observe the Mini Program ecosystem, we can easily build an AI agent based on the model, connecting to many different Mini Programs to help users complete various activities and complex tasks. I believe these are currently our very unique advantages.
Of course, these experiences require us to build very carefully and patiently to ensure we provide the right experience for users while highly valuing their data security, sense of safety, and comfort. These are all considerations we need to take into account when building these products. However, over time, I believe these are all huge opportunities we face.
Want to quickly find the key performance indicators? Earnings Express helps you get everything done in one go! Market > Hong Kong Stocks / US Stocks > Performance >Performance Express
Editor/Rocky
