A revenue miss caused by slower advertising and payments-related growth is overshadowing Tencent's (TCEHY) EPS beat.
The Chinese tech giant is down over 4% amid an ugly market selloff after it reported Q2 revenue of RMB88.82 billion (up 21% annually and equal to $12.92 billion) and EPS of RMB2.46 ($0.36). EPS beat a $0.32 consensus, but revenue missed a $13.43 billion consensus.
Tencent's giant gaming business, which was stung in late 2018 and early 2019 by a halt in game monetization approvals by Chinese regulators, continued rebounding: The company's "online games" revenue rose 26% to RMB27.3 billion ($3.96 billion), as a 26% increase in smartphone gaming revenue more than offset a 9% drop in PC gaming revenue. For comparison, online games revenue was flat in Q1 and down 1% in Q4.
EPS, meanwhile, benefited from a 26% drop in sales and marketing spend, something Tencent attributed to "prudent cost-management initiatives." That helped offset a 28% increase in "G&A" spend, which for Tencent includes its R&D spend, and a 2.7-point drop in its gross margin to 44.1%.
But Tencent's online ad revenue came in at RMB16.41 billion (up 16% and equal to $2.38 billion), missing an RMB17.86 billion consensus. And its "FinTech and Business Services" revenue, which covers (among other things) its WeChat Pay and Tencent Cloud platforms, saw revenue of RMB22.89 billion (up 37% and equal to $3.32 billion), missing an RMB24.98 billion consensus. Revenue growth for the segments fell from Q1 rates of 25% and 44%, respectively.
Tencent blamed its online ad growth slowdown on a tougher macro environment and the "increased supply of short video advertising inventories across the industry." The latter is at least partly a reference to the rapid growth of private ByteDance's Douyin video platform (it's known as TikTok outside of China).
In a recent note, Mizuho analyst James Lee reported that ByteDance, which also owns a popular news/content app known as Toutiao, has been gaining advertising share in the education, gaming and e-commerce verticals. He also reported Tencent has lowered its key performance indicators (KPIs) for ad agencies and raised their rebate payments, something that he thinks is a sign of industry oversupply.
Within FinTech and Business Services, Tencent indicated its cloud business (the No. 2 player in China's public cloud services market behind Alibaba's (BABA) AliCloud) continued growing strongly. But it also said that the segment's revenue was hurt by the transferring of custodian cash balances to the People's Bank of China, which lowered its interest income.
And notably, though it said the platform is still seeing strong user, merchant and transaction growth, Tencent said its Weixin (WeChat) Pay revenue is being hurt in the near-term by a greater tendency among its massive WeChat Pay user base to keep money within WeChat Pay wallets. This has the effect of lowering Tencent's withdrawal fee revenue.
This particular issue might not be anything to get nervous about: As Tencent pointed out, the company stands to benefit over the long run from larger WeChat Pay wallet balances, both via greater transaction volumes and the ability to monetize those balances via other financial services.
On the other hand, the challenges faced by the ad business, which Tencent expects to persist during the second half of 2019, is a little more worrisome. While the business still likely has a lot of room to grow over the long-term, given both the Chinese online ad market's secular growth drivers and the massive reach of WeChat and other Tencent platforms, a surge in ad supply right when China is seeing businesses become nervous about a growth slowdown and trade tensions is the kind of problem that could take some time to fix.
Relative to Alibaba, which reports on Thursday morning and gets much of its Chinese revenue from ad sales and commissions related to listings on its e-commerce platforms, Tencent's ad business is more tied to brand advertising and other types of discretionary ad buys. As a result, while both businesses would get hurt during a major economic slowdown, Tencent's is more vulnerable to the arrival of a more cautious mood among businesses when it comes to discretionary spending and investments.
This isn't the kind of problem that spells doom for a company that possesses some of China's most valuable digital platforms, and has shown quite the knack for monetizing them over the years. But it could remain a headache for the next few quarters -- particularly if macro/trade worries remain high and/or ByteDance continues seeing strong growth.