Tencent Holdings Ltd

HKEX:700

Earnings Call Transcript 2021-Q1

[Operator]

Good day, and thank you for standing by. Welcome to Tencent Holdings Limited 2021 First Quarter Results Announcement Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]

Now I'd like to hand the conference over to Ms. Wendy Huang from Tencent IR team. Thank you. Please go ahead, ma'am.

[Wendy Huang, executive]

Thank you, Amber. Good evening. Welcome to our 2021 first 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.

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 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.

[Huateng Ma, executive]

Thank you, Wendy. Good evening. Thanks, everyone, for joining us. During the first quarter, we achieved solid growth across our businesses, in particular, and in our FinTech and Business Services and advertising revenue streams. We are also stepping up investment in areas, including Business Services and enterprise software, high-production-value games and short-form video, which will be covered in more details in the strategy section.

Now let me go through the headline financial numbers for the quarter. Total revenue was RMB 135 billion, up 25% year-on-year and 1% quarter-on-quarter. Gross profit was RMB 63 billion, up 19% year-on-year and 6% quarter-on-quarter. Non-IFRS operating profit was RMB 43 billion, up 20% year-on-year and 12% quarter-on-quarter. Non-IFRS net profit attributable to equity holders was RMB 33 billion, up 22% year-on-year and stable quarter-on-quarter.

For our key services, despite intense competition across the China Internet industry, we generally retained or expand our first place position in activities, including social, games, long-form video, news, music, literature, payment and mobile utilities, and we believe we gained market share in cloud services. Combined MAU of Weixin and WeChat was 1.24 billion. Mobile devices MAU of QQ was 606 million. Martin and James will discuss our future strategy and progress across some of these activities in detail.

And I hand over to Martin for the strategy review.

[Chi Ping Lau, executive]

Thank you, Pony, and good evening, and good morning to everybody. Today, I will walk you through a few strategic investment areas that we believe will support our long-term growth. In the course of 2020, we saw exciting new market opportunities emerging.

Now first, businesses are accelerating their movement online, and industries are speeding up digitization across the value chains. Second, the audience for games structurally expanded due to the stay-at-home period. We believe emerging genres and advanced technologies would drive further game audience growth. Third, as the short video market matures, we believe users will seek more diverse and nutritious short-form building content.

At the same time, the entire Internet industry is undergoing a new round of additional investment in which investors and companies are prioritizing growth over profit. We can see this in our own investee portfolio where heavy investments are made in areas such as community group buy, electric vehicles and user acquisition. On the other hand, these initiatives boosted market valuation were the market value either sticks or investees exceeding $200 billion as of quarter end. On the other hand, our top 5 loss-making associates reduced non-IFRS net profit by 7% in the first quarter.

As for Tencent, we see opportunities to proactively invest in several areas where we can be an early mover and a shaper of industry evolution rather than playing catch up later. First of all, Business Services. We're adding headcount and infrastructure to assist the digitalization of various industries. Second, games. We're investing in high-production-value games with global appeal. Third, short-form video content. We're cultivating multiple ecosystems to meet users' emerging needs for more interesting content. Fourth, sustainable social value. We announced the establishment of new SSV.org to bring technology benefits to the society.

Funding these investments will absorb a portion of our incremental profits from existing businesses for 2021, but we expect such investment would deliver very high return over the longer run. In the next few slides, I will discuss the specific opportunities, the progress and achievements we have made so far and the initiatives that we are funding going forward.

Now let's start with Business Services. Since we upgraded our strategy to embrace industrial Internet in 2018, we have seen product and service providers and customers aspiring to optimize their connection with consumers digitally. Various industries are deepening digitalization across customer engagement, operations, production and supply chain, particularly after COVID-19. Meanwhile, enterprises widely adopted online collaboration tools internally to improve their efficiency.

We have achieved some structural strength in this area. For example, on the scale front, we believe that across our internal usage and external customers, our cloud service now run the largest number of servers in China. In the platform and software front, we provide the leading CRM, collaboration and productivity solutions in a market where those services are highly valued by enterprises. After a period of disruption due to COVID-19, our cloud services moved back to an above-industry revenue growth rate in the first quarter.

To double down on these trends, we're increasing headcount for product development to enhance our service offering and also expanding our sales team to facilitate client acquisitions and service. We're strengthening the capabilities and interconnections of our productivity SaaS products and security software to extend their leadership positions. At the same time, we're growing the networks of independent software vendors and SaaS partners through strategic cooperations and investments. We're also deepening our smart industry strategy by expanding coverage and enhancing up-selling/cross-sell competencies in key verticals such as health care, retail, education and transportation.

Turning to games. We believe the global industry opportunities and the resources required to capture the opportunities are larger than ever. First, mobile devices are expanding the total addressable market for games, which was further boosted by the stay-at-home period. We believe emerging genres and development toward the Metaverse will further expand the market.

Second, game players are becoming more discerning and quality sensitive. High-production-value, innovative and cross-platform games can attract and retain large audiences to an extent not previously possible.

Thirdly, Chinese game developers are attaining early success in global markets. We believe we are already in the early stages of capitalizing on these trends. Our high DAU franchise games such as Honour of Kings, PUBG Mobile, Peacekeeper Elite and League of Legends uphold our leadership in major genres. Each one of them consistently deliver large, loyal audiences as well as solid monetization.

On top of that, our internal and investee studios are working on a large and diverse game pipeline. International revenues now also account for a substantial portion of our game revenues, and titles such as PUBG Mobile, League of Legends and Valorant have achieved sustained player recognition globally.

Looking forward, we aspire to lead the industry and are committing the necessary additional resources. We are making long-term investments in developing large-scale, high-production-value games to attract players globally. We're funding development of innovative games in emerging verticals. We're building up IP franchises suitable for games and expanding across media. We'll step up marketing expenditures and attract bigger audience to new games. And we are investing in emerging areas, such as our cloud gaming services.

Next, we'll talk about our investment in the short-form video arena. China consumers have shown great appetite for watching short-form video, and we are investing to address how we see that appetite evolving going forward. First, we're positioning Video Accounts as a new infrastructure in Weixin, connecting users with real-life content and bridging high-quality content creators with consumers. We'll provide resources as well as handy creation and monetization tools to attract diverse content creators, thus incubating a unique content portfolio.

We optimize technology to unlock the potential of social plus algorithmic recommendations, leveraging the strength to increase exposure of knowledge-based content. Besides, we are adding service and bandwidth to support the solid organic growth in Video Accounts. We're confident that these investments will benefit the ecosystem and engage greater audience over time.

Second, we recently merged Tencent Video and WeiShi, our short-form video app in PCG, seeking to bring integrated viewing experiences to users, enrich content offerings as well as sharpen algorithmic recommendation. Along with this internal business reorg, we are escalating self-commissioned production to further expand our IP content library, which can facilitate creation of more video clips by our creator network and better serve users' emerging needs for high-quality short content. We'll also leverage our capabilities acquired through building up WeiShi to empower our long-form video business in terms of content creation, recommendation, user acquisition and operations.

Finally, we announced our aspiration to promote sustainable innovations for social value. We seek to bring sustainable benefits and value to society by leveraging our technology and products and to elevate the importance of sustainable social value when making decisions in all our products and services. By integrating our existing corporate social responsibility and charitable activities into a new Sustainable Social Value Organization, SSV.org, we created a dedicated team to deploy social value initiatives in a professional and entrepreneurial way. We'll incubate projects in various areas, such as basic science, education, innovation, rural revitalization, carbon neutrality and food, energy and water provision. Where appropriate, we'll link these projects with our existing businesses.

In addition to making charitable donations, we seek to promote the development of self-sustainable operations, which could create new value for related industries and for society. Throughout the process, we'll pursue long-term social value rather than economic profits. We are committing an initial capital of RMB 50 billion to be funded by our investment gains. We believe that our strategic upgrade and the new initiatives will allow us to make an even more positive impact to the society and usher in a new phase of development for Tencent.

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

[James Mitchell, executive]

Thank you very much, Martin. For the first quarter of 2021, our total revenue grew 25% year-on-year. VAS represented 54% of our revenue. Within which, games were 32% and social networks 22%. Online advertising was 16%. And FinTech and Business Services represented 29% of total revenue.

For Value Added Services, segment revenue was CNY 72 billion, up 16% year-on-year and up 8% quarter-on-quarter. Social networks revenue increased 15% year-on-year to CNY 29 billion on moderate growth of digital content subscriptions and in-game item sales. Total VAS subscriptions increased 14% year-on-year to 226 million. Video subscriptions grew 12% to 125 million, benefiting from adaptation of IPs such as The Land of Warriors into animated and live-action drama series. Music subscriptions expanded 43% to 61 million due to better content, effective marketing campaigns and an improved retention rate.

Games revenue grew 17% year-on-year to CNY 44 billion against the high base stay-at-home period, which started in China in the first quarter of 2020. Growth was primarily driven by mobile games in China and by mobile and PC games in international markets. Sequentially, game revenue increased 12% due to Chinese New Year seasonality.

For mobile games, total revenue increased 19% year-on-year to CNY 41 billion, benefiting from robust performance of existing games, such as Honour of Kings, PUBG Mobile and Peacekeeper Elite as well as contributions from new games such as Moonlight Blade Mobile and Call of Duty Mobile in China.

For PC client games, revenue increased 1% year-on-year to CNY 12 billion as contributions from Valorant and Warframe as well as growth in CrossFire offset a decline in Dungeon & Fighter.

For Weixin, we provided more support for our partners and are together building a vibrant content and service ecosystem. On the content front, we attract and cultivate video accounts creators by providing customized onboarding services, favorable traffic allocation to build their initial audiences and training in video production best practices.

On the services front, we provide capabilities to increase penetration of Mini Programs, particularly among SMEs. Our low code development platform enables smaller businesses to create Mini Programs in a more cost-effective way. And we launched new tools to assist system integrators. The number of active Mini Programs served by system integrators more than tripled year-on-year.

For QQ, we're leveraging technology to better integrate social and content consumption experiences such as seamless connection between instant messaging and games. Users can team up with QQ friends to start a multiplayer game battle with one click. And QQ Mini Programs facilitate users staying up to date within game events. Looking forward, QQ's new leadership team will seek to upgrade the product's technology, operations and content to better serve the social and entertainment needs for younger users.

Turning to games. Aggregate user engagement and user spending increased year-on-year despite the high 1Q 2020 comparison period. We released Honour of Kings' biggest update in January to improve graphics and game experiences and then launched appealing marketing campaigns with top-tier skins during the Chinese New Year, which drove the game's DAU and paying users to record high levels in February.

We reduced the application file size of PUBG Mobile and enhanced our local market operating capabilities, boosting PUBG Mobile's DAU in countries, including Turkey, Egypt and Russia. For League of Legends, we distributed bigger and better Lunar Revels content for the core game mode as well as for Teamfight Tactics, contributing to higher global revenue year-on-year.

Beyond these large audience games, we're also cultivating emerging genres. For example, new releases, Komori Life and The Walnut Diary, ranked among China's top 10 life simulation mobile games by DAU in April. Our pipeline includes action, battle arena, role playing, simulation, strategy and survival games. For China, many of these new games are adapted from popular existing game and literature IPs. Internationally, we expect our substantial prior investments in best-in-class PC, console and mobile studios to begin contributing a range of genre-innovating games in the quarters to come.

Moving to online advertising. Total revenue was CNY 22 billion in the quarter, up 23% year-on-year, assisted by 3 factors beyond our ongoing product innovation and ad tech improvements: first, higher ad spend from the eCommerce and education verticals; second, FMCG and automobile-related advertising revenue benefiting from economic growth; and third, full quarter consolidation of the Bitauto automobile vertical site.

We enhanced the transaction capabilities of our ad properties and customized marketing solutions for key verticals, including games, retail and automobiles, delivering higher ROIs for advertisers. Looking forward, IDFA deprecation on iOS devices appears to have limited impact on the China ad market so far, while other potential uncertainties include possible regulatory headwinds for K-12 education and potential delays to the video content release schedule.

Our social and others advertising revenue expanded 27% year-on-year to CNY 19 billion, driven by Moments and mobile ad network, within which, Moments impressions and revenue increased as we added inventory and as more advertisers adopted Mini Programs as landing pages. Our mobile ad network revenue grew rapidly, reflecting increased video ad inventories, primarily within games, online reading and tool applications. Our media advertising revenue rose 7% year-on-year is CNY 3 billion, largely due to increased ad inventory and eCPM within our music apps. During the quarter, we released several popular self-commissioned variety shows, including Chuang 2021 and Roast Season 5, driving our sponsorship ad revenue.

Looking at FinTech and Business Services. Segment revenue was CNY 39 billion, up , up 47% year-on-year and up 1% quarter-on-quarter. Within FinTech Services, the year-on-year revenue growth rate was higher than in prior quarters, benefiting from an easy base period as stay-at-home activity reduced off-line consumption in 1Q 2020.

Our payment business is also structurally benefiting from the broader digitalization of consumer habits and of the economy. Payment volume and revenue increased slightly quarter-on-quarter despite seasonally reduced eCommerce activity. Offline spending picked up as many people stayed in the cities in which they worked during the Chinese New Year holiday, which boosted local spending on retail and dining services.

For Business Services, revenue grew at a healthy rate year-on-year, benefiting from resumed project deployment and robust demand from industries, including enterprise software and online video provisioning. Increased customer uptake of our security, communication and CRM solutions drove notable growth in our PaaS and SaaS revenue, both absolutely and as a proportion of our overall Business Services revenue.

Our cloud marketplace now includes thousands of partners' Software-as-a-Service products. We launched Enterprise App Connector with unified logging accounts and data flows across different SaaS products, allowing SaaS providers to develop and deliver their products more efficiently while facilitating enterprise clients to better integrate multiple software solutions.

And with that, I'll pass to John to discuss the financials.

[Shek Hon Lo, executive]

Thank you, James. For the first quarter of 2021, total revenue was CNY 135.3 billion, up 25% year-on-year or 1% quarter-on-quarter. Gross profit was CNY 62.6 billion, up 19% year-on-year or 6% quarter-on-quarter. Net other gains were CNY 19.5 billion, up 384% year-on-year or down 41% quarter-on-quarter. This mainly comprised on IFRS adjustment items, including fair value gains, reflecting increased valuation of the investments, investee companies in verticals such as fintech and social media as well as net gains on deemed disposal and disposals of certain investee companies.

Operating profit was CNY 56.3 billion, up 51% year-on-year or down 12% quarter-on-quarter. Net finance costs were CNY 1.4 billion, down 19% year-on-year or 39% quarter-on-quarter. The year-on-year decrease was mainly driven by reduced interest rate as we captured favorable interest environment in our treasury exercise. The Q-on-Q decrease was primarily caused by ForEx gain this quarter, while we recorded ForEx loss a quarter ago.

Share of profit of associates and joint ventures was CNY 1.3 billion compared to share of losses for the fourth -- first quarter last year as we benefited from non-IFRS adjusted items, including a nonrecurring fair value gain on the investment of an associate as well as improved performance of certain associates. On a non-IFRS basis, we record a share of profit of CNY 0.5 billion for the first quarter of 2021 comparing to CNY 164 million a year ago.

Income tax expense was CNY 7.2 billion this quarter. The effective tax rate for the quarter was 12.9%. IFRS net profit attributable to equity holders was CNY 47.8 billion, up 65% year-on-year or down 19% quarter-on-quarter. Diluted EPS was CNY 4.917, 64% year-on-year or down 20% quarter-on-quarter.

Now I'll share with you our non-IFRS financial figures for the first quarter. Operating profit was CNY 42.8 billion, up 20% year-on-year or 12% quarter-on-quarter. Net profit after NCI was CNY 33.1 billion, up 22% year-on-year or largely stable quarter-on-quarter. Diluted EPS was CNY 3.415, up 21% year-on-year or largely stable quarter-on-quarter.

Moving on to gross margin. The overall gross margin was 46.3%, down 2.6 percentage points year-on-year or up 2.3 percentage points quarter-on-quarter. Analyzed by segment, gross margin for VAS was 55.1%, down 3.9 percentage points year-on-year or up 3.6 percentage points quarter-on-quarter. The year-on-year decline was mainly due to: number one, increased content cost for more airing of dramas and variety shows versus a year ago; number two is revenue mix shift from higher-margin PC client games and QQ subscriptions to lower-margin digital content services. The sequential increase benefited from revenue mix shift towards higher-margin mobile games amid favorable [indiscernible] games.

Gross margin for online advertising was 45.1%, down 4.1 percentage points year-on-year and 8.2 percentage points quarter-on-quarter. The year-on-year decrease was mainly due to higher revenue contribution from mobile ad network business, which carry a lower margin. Sequentially, the decline mainly reflected seasonal -- seasonality and increased content cost for more airing of drama series and sport events.

Gross margin for FinTech and Business Services was 32.3%, up 4.4 percentage points year-on-year and 3.8 percentage points quarter-on-quarter. Both year-on-year and quarter-on-quarter margin growth were mainly due to revenue mix shift towards merchant payment and wealth management services, which carry relatively higher profit margin. In addition, better operational efficiency of Business Services helped on our sequential margin growth.

On operating expenses, selling and marketing expenses were CNY 8.5 billion, up 21% year-on-year or down 15% quarter-on-quarter. The year-on-year increase was mainly due to increased marketing spending, particularly on Business Services and games, and the consolidation of newly acquired subsidiaries, such as Bitauto as well as higher staff costs and welfare expenses. Sequentially, marketing expense was lower because of seasonality. As a percentage of revenues, selling and marketing expenses was 6.3% of revenues, largely stable when compared to first quarter of 2020.

G&A expenses were CNY 19 billion, up 34% year-on-year or down 4% quarter-on-quarter. The year-on-year increase mainly reflected greater R&D costs. The Q-on-Q decline was mainly driven by seasonally lower office travel and entertainment expenses. Within G&A, R&D expenses were CNY 11.3 billion, up 41% year-on-year and 1% quarter-on-quarter. G&A and R&D represented 14% and 8.4% of revenues, respectively. As at quarter end, we had approximately 89,000 employees, an increase of 39% year-on-year and 4% quarter-on-quarter.

Let's take a look at the operating and net margin ratios. For the first quarter 2021, non-IFRS operating margin was 31.6%, down 1.3 percentage points year-on-year or up 3.1 percentage points quarter-on-quarter. Non-IFRS net margin was 25.5%, largely stable both year-on-year and quarter-on-quarter.

Finally, I'll share some key financial metrics for the quarter. Total CapEx was CNY 7.7 billion, an increase of 26% year-on-year or a decrease of 20% quarter-on-quarter. Within which, operating CapEx grew 20% year-on-year to CNY 6.6 billion due to more spending on servers and network equipment to open our business group. Nonoperating CapEx increased 69% year-on-year to CNY 1.1 billion, mainly driven by increased expenditure on cloud, data centers and office properties. Free cash flow for the quarter was CNY 33.2 billion, down 15% year-on-year or up 20% quarter-on-quarter.

Net cash position declined sequentially to CNY 5.6 billion, mainly due to net cash outflow for M&A activities, partially offset by free cash flow generation. The fair value of our shareholdings in listed investee companies, excluding subsidiaries, was approximately CNY 1.4 trillion or USD 207 billion as at the end of first quarter.

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

[Wendy Huang, executive]

Operator, we will take one main question up to one follow-up question each time. Please invite the first question. Thank you.

[Operator]

[Operator Instructions] Our first question comes from the line of Alicia Yap from Citigroup.

[Alicis a Yap, analyst]

Congrats on the solid results. I have 2 questions. The first one is regarding your comment about stepping up the investment in game development. When you say the large-scale and high-production-value games, do you plan to invest games that will turn into strong global IP that the gamers will play and maybe remember for their lifetime? Or is that mean we could take multiple years of development before we see any final product? And is this rationale also because of we are seeing growing gamer tractions in markets such as like India, LatAm, EMEA or even in the U.S. that we look into penetrate further that we can leverage our experience in mobile game development to grow our global share?

The second question is on the cloud business. We are seeing or hearing from peers some -- a little bit slowdown in the industry. So is Tencent Cloud also experienced some industry transition where the existing infrastructure cloud customer, which is already quite sizable and maybe facing industry slowdown and making some penetration effort into new industry vertical? Or is that fair to say we actually are already envision this transition better and already started to move more proactively in strengthening these -- the higher-margin SaaS capability that we actually could start to see the cloud revenue to further reaccelerate in the coming quarters?

[James Mitchell, executive]

Alicia, thank you for the questions, and I'll take a shot at both of them, although Martin will likely supplement. So the short answer to the first question is yes. We absolutely would aspire to make games that players enjoy and ideally play for life. But of course, it's easier to express that aspiration than realize that aspiration.

Now you're right to say that creating those lifelong game experiences requires many years of game development, but this is a trend that we've identified many years ago. And we have a number of products that have indeed already been in development for many years. And some of those are games that we're creating in China in our big internal studios, like TiMi and Quantum and MoreFun and Aurora; and some of those are games that we're creating outside China at studios which we invest in around the world. And over the coming quarters and years, we hope to bring some of those big-budget, long-production-cycle games to market.

Now as to why we're focused on this now and what changes now versus the past then, we are indeed seeing that the global audience for games has grown both before, during and after COVID. And we're seeing particular growth in emerging markets, such as the ones you highlight, but also in developed markets. And we're also seeing that our game players are increasingly willing to form longer-term relationships with games that they particularly enjoy, such as a League of Legends or a Fortnite or an Honour of Kings, which have very high retention rates. And gamers, even if they churn, they come back to and enjoy again.

And on our side while historically, our focus was primarily on the China market, as you know, in recent quarters, we've had some hits globally that were developed in China, including PUBG Mobile, including Call of Duty Mobile, all of which gives us more confidence to step up our rate of investment. And step up our rate of investment means fund bigger, better games, if necessary, for longer periods of time. It also means fund more experimental games. It also means invest more in game marketing and game publishing capabilities. And then finally, it means investing in frontier technologies, such as cloud-based gaming, that will further grow the game industry in the future. So that's on your game question.

With regard to your cloud question then, I think that we don't necessarily see a sudden transition in the industry this year versus previous years. Rather, our belief is that when you're in the cloud business, it is inevitable that if you're renting infrastructure to very big companies, then those big companies will use their negotiating power to protect their own economics.

And as a result, the path to long-term economic returns in cloud is not to get big fast on infrastructure, but actually to cultivate Platform-as-a-Service and Software-as-a-Service. And that's something that we've been doing now for several years. Platform-as-a-Service, in particular, is a substantial percentage of our total cloud revenues now. And so that's an important underlying reason why we believe that we're able to outgrow the industry in the first quarter this year.

[Chi Ping Lau, executive]

Just one point to add, right. On the gaming side, I think you emphasized point is like new creation of IPs and true, is many years before you can see final product. I think if you look at our recent pipeline of games, which we have announced of more than 40 of them, I think it's a combination, right? Some are original IPs, which would take a very long time to develop. Some are actually existing IPs that we're going to take existing assets, a pretty proven game play, and we will add our innovation for mobile, and then we developed it for launch.

And then there are also some smaller trial titles, right, niche titles, which would have multiple iterations. It probably sort of will be developed and released within a shorter period of time and then iterate over time in order to make them bigger. So it's a combination of these different types of titles that constitute our pipeline.

[Operator]

Our next question comes from William Packer from BNP Paribas.

[William Packer, analyst]

Congrats on the strong numbers. First question is, in your update today, you've presented investment plans to exploit the growth opportunities for the future. In Q1 '21, you invested and delivered a 25% profit drop-through on your 25% revenue growth. Should we think of Q1 as a relevant benchmark for the rest of the year?

And my second question is around regulation. The news flow has continued to be intense. Last quarter, you provided a helpful update on regulation of fintech and your minority investments. Is there any incremental update to share today?

[Chi Ping Lau, executive]

In terms of the incremental investment plan, right, I would not say the first quarter is the right benchmark. I think our investment plan is actually stepping up from the first quarter level. So if you look at the first quarter results, I would say the benchmark is that our non-IFRS profit grew by 22% year-on-year. And what we're seeing is that we're going to be investing a portion of the incremental profit into new areas. And so that means it's somewhere between 0% and 22% from a quantitative basis. I think, yes, that's the quantification.

Now in terms of the regulatory news, well, I think the most significant one is basically after the first quarter results, there was a meeting in which the financial regulator asked 13 fintech companies to have a meeting and also and add certain principles as well as ask the fintech companies to have an internal review of their own business and practices. And I think the principle is largely public, right? And they are largely focused on all businesses have to be conducted through licensed entities, and they ask for transparency.

And at the same time, there's quite a bit of focus on making sure that there's not going to be systemic risk. And my understanding is it's quite focused on the size of lending business and making sure that there's no overlending or overborrowing by consumers, right?

And toward that front, I would say, as we have emphasized in our last conference call, we are very focused on compliance. We're very focused on risk management. We're very self-restrained in terms of the size of our nonpayment financial products, especially on the lending side. So when we look into the internal review and when we look into what are the things that need to be done in order to make sure that we are compliant with the spirit of the regulators, right, I think it's actually relatively manageable. So that's sort of the update I have on the regulatory side.

[Operator]

Our next question comes from John Choi from Daiwa Capital Market.

[Hyungwook Choi, analyst]

I have 2 questions here. So on the reinvesting our profits, I think, Martin, you just mentioned that's about 0% to 22%. But if you look at it, can you kind of walk us through like what are going to be the pecking order of the 3 that you guys did mention of Business Services and games and now short-form video? And also, is it going to be a combination of your like equity investments or through actually investment in operation that will have a P&L impact. And that's my first question.

And the second question is a follow-up to your game business. I think it's interesting to see that we're seeing a lot of new genre games, that Tencent probably has been strong exposure. But also, at the same time, there are new genres like Metaverse, et cetera, that you -- that Tencent doesn't have that much exposure in your market. So how do you see the opportunities here? And what kind of relevant investments and strategic decisions that you have to make in order to take advantage of these new genres emerging throughout the world?

[James Mitchell, executive]

So why don't I start on the second question. There are continuing new genres emerging, and some of them are best left to our partners, our investee companies to address. But others are genres that we think we can bring some value to the table, bring some innovation to users and, therefore, we would address ourselves.

Now I wouldn't say that Metaverse is a genre. Metaverse is more of an overarching opportunity in which different kinds of games are played within a single sort of social graph and software suite. So if you look at Roblox, then Roblox is arguably a Metaverse for younger gamers.

But over time, as graphical fidelity improves, then we believe it's highly probable that you'll see similar Metaverses emerge that are consistent with the demands and expectations of all the users. And that's a wide open field at the moment. No one has realized that vision yet, although some people are closer than others. And we certainly believe that we're in a good position to be one of the companies that realizes that vision given our expertise at creating and operating games, given our history of facilitating social interactions and also given our cloud infrastructure at the back end because the Metaverse will be very infrastructure intensive. So I think that's on the games question.

In terms of the reinvestments question then, I'll let Martin speak to it. But I would just say that from a -- when we talk about reinvestment in this situation, we're talking about owned and operated businesses primarily. I think that in each of these 3 verticals, we've already been active for a number of years in terms of investing in successful game studios, both in China and globally, in terms of investing in successful short video companies, such as Kuaishou in China, and investing in a very wide range now of early-stage enterprise software companies.

[Chi Ping Lau, executive]

And in terms of the areas of investment, I would say, mostly, as James talked about, it's on the operating side. So a big part of it is actually sort of people, right, John. These are engineers that we're going to hire additionally to create the products, perfect the products and develop better services. And some of these new employees are higher paid because they are essential experts and professionals in their respective areas. And to a lesser extent, it will be bandwidth and infrastructure costs and to some extent, maybe delayed monetization on the video side, for example, right? And so these are sort of the investments that we're talking about, which are actually are having a bottom line impact.

And in terms of the magnitude, I would say, Business Services, games and video in that pecking order. And the nature is slightly different. Business Services would actually take a longer time, and it's a larger strategy of building scale first and then over time monetizing. Games, basically, you can monetize relatively quickly once you can launch the game and achieve success. But the investment is actually in the development phase in which there's no revenue, but then you have to incur the costs. Versus video, as I said, right, there's a continuous increase in terms of the number of people in order for us to improve the product, improve the operations, improve the tools and at the same time, in some cases, some extent of delayed monetization on the advertising front.

[Operator]

Our next question comes from Han Joon King from Macquarie.

[Han Joon Kim, analyst]

Great. I have a two-part question on advertisement. You guys have talked about a lot of different things and confluence of events going on there. I was wondering if you can kind of help us repackage that into sort of ad inventory growth versus kind of eCPM growth and kind of where we're seeing the trajectory therein for that.

And that leads us to the second part of the question, which is as we more videolization -- and a lot of the industry is going towards video. So in theory, I think the ad inventory for [ you to create an on ] market does increase. How does that sort of impact the overall market rates, eCPM rates and sort of where ad pricing can go from here?

[James Mitchell, executive]

Yes. Thank you for the question, Han Joon. Actually, it wasn't completely clear, so I apologize if we misheard sections of it. But we'll try to answer. So on the first part around inventory versus pricing growth then, both are increasing. I think on the inventory side, sometimes the outside world oversimplifies that into looking at what's happening with Weixin Moments. In reality, Weixin Moments is a pretty small fraction of the inventory of the number of daily impressions we bring to bear. And our ad network, for example, is a much bigger source of raw impressions. And our ad network continues to grow in impressions quite quickly as we -- as the overall China Internet expands and diversifies, and as more media owners join our ad network. So ad inventory expanding, both for internal reasons like unlocking more inventory in Weixin Moments as well as for sort of more market-driven reasons, such as the growth of our ad network.

And then our eCPM growth, yes, I think that over time, given increasing appetite of demand, it's natural that pricing trends sideways to upwards. There was disruption period when there was a sort of supply shock from the short video companies in 2019, but that's been somewhat digested by the industry as a whole now. And in general, what we see is that pricing is flattish for nonvideo and then increases as videolization occurs.

And in terms of videolization and the eCPMs around video in general, as you would expect, video eCPMs are high. But there are an interesting sort of discrepancies between the different video formats. So actually, the highest eCPM is often the promotional video ads within the ad networks. Those would typically be for game companies, education companies, perhaps eCommerce companies. And there, you could be looking at CNY 40 plus in revenue per thousand impressions or -- and then the short video eCPMs are also quite high and are fairly stable just because there's so much short video inventory now in China.

And then interestingly, the long-form video eCPMs are actually very low. And so whereas in the rest of the world, you would expect that, let's say, Hulu eCPMs would be higher than YouTube eCPMs. In China, it's the other way around. And the eCPMs for drama series and movies and so forth are about half the level of the eCPMs for short video. And I think that's because advertisers currently find it easier to create 5-second commercials that are suitable for short video than 15-second commercials for the -- for long video. And also because users have a higher propensity to click through ads within a short video site, where they're constantly clicking through short videos they do and don't like versus a lower propensity to click through adds on a long video site, which is more of a lean-back experience.

But it's a sort of challenge for the China Internet industry as a whole in that it's forcing monetization and, therefore, investment toward short video at the expense of long video. Eventually, it will probably sort of mean revert as consumers and advertisers recognize the distinctive perpetuality-generated quality of long-form video, but that process isn't yet happening today. So anyway, overall, videolization results in higher eCPMs, which is good for the industry and good for us within the industry.

[Operator]

Our next question comes from Eddie Leung from Bank of America Merrill Lynch.

[Eddie Leung, analyst]

Just a follow-up to Alicia and Han Joon Kim's questions on games. I understand, James, your point about developing large-scale and high-production-value games, which could last a long term. But for example, you mentioned that there have been some success of other Chinese studios in overseas markets recently. But when we look at quite a number of them are actually not those traditional blockbuster games, right? We are looking at, let's say, card games, makeover games, costume-changing games. So it seems like they are actually quite [ casual ] designed games, but not necessarily those like large-scale and high-production-value games. That's only my own interpretation. So just wondering if you could share your thoughts on this one, so between your investment strategy and what we have observed recently.

And then secondly, just an accounting question on the sustainable social value organization. Wondering about the timing of the funding. Will it be funded in full within a short period of time or over a long period of time? And in terms of accounting, would it be treated as a contra item to the investment gains or to be under other expenses?

[James Mitchell, executive]

Eddie, so you raise a good question on game industry trends. And if you take a step back, the game industry globally is a really big industry. It's about $150 billion in revenue a year, which means it's bigger than movies and music and literature and so forth put together. And when an industry is that big, then you can actually have different and apparently contradictory trends playing out at the same time. If you look at linear video then, on the one hand, there's an explosion in short video consumption globally. But on the other hand, there's an explosion in the number of people paying for Netflix and Disney+ and Paramount+ and HBO+ globally. So those are sort of 2 apparently contradictory trends: People are watching more ad-funded short video. They're also watching more subscription-funded long video, but the industry is big enough to accommodate both.

And I think the same thing is true in the game industry, that there is a very clear trend toward very casual games where the innovation is around quirky gameplay and where these games are able to onboard large numbers of users very quickly. And the challenge for these games will be establishing competitive moats and also retaining users over the much longer term. And that is a trend where, as you say, a number of sort of casual Chinese game developers are now doing very well.

On the other hand, there's also a trend for high-production-value games often made by studios, who have been focused on these games for 10 years or more, often studios with 1,000-plus employees to really catch the attention of a global audience in a way that wasn't possible before. And there, I'm thinking about a game like Genshin Impact where miHoYo has been making this kind of game for 10 years. It has over 1,000 employees. It spent many years on the game. I'm thinking about games like our own PUBG Mobile and Call of Duty Mobile, which exhibit similar characteristics.

So I think that the industry is big enough that both those trends are playing out. And there are certain studios of Tencent that are more focused on the first approach, the more casual, quirky, innovative games. And there are other studios in Tencent that are more focused on high production value. But when we talk about our desire to step up our rate of investments, then we're referring primarily to the second group, the desire to take games that we've already conceptualized or we've already begun development and really double down on the development process, increase development resources, lengthen the development cycle and then invest heavily in the marketing when we launch the game so that we give the games the best possible shot to a global audience when we do release them.

[Shek Hon Lo, executive]

Yes. While we are still in the midst of working on the proper accounting treatment with our auditors, ideally, the treatment will be similar to that of donation that expands upon contribution to a separate pool. However, it hasn't been finalized yet. The other point I would like to make is it most likely to be treated as non-IFRS adjustment. If funding sources, basically our investment gain, which Martin has talked about earlier, those investment gains also recorded a non-IFRS adjustment. All this type of contribution will be captured under other gains in our financial statements.

And in terms of the funding timing, I think once the infrastructure has been set up, we will contribute the first set of funding into the pool. And I think usually, we might fund one -- once or twice in a year in respect of the 3 initiatives.

[Operator]

Our next question comes from Alex Yao from JPMorgan.

[Alex Yao, analyst]

The first one is to follow up the question on your investment strategy this year. You guys have been investing consistently for future growth in the past several years, particularly for the 3 areas that you plan to step up investment. All this has been around for quite some time. What make you to decide to further step up the investment in this year? What are the new opportunities and the challenges you are seeing that we are not aware of?

And then the second question is regarding your -- the social organization you just established. We understand that you guys will further pursue social responsibility. As a public company, how do you plan to align value creation to the society and the value creation to the shareholder?

[Chi Ping Lau, executive]

So Alex, in terms of the stepped-up investment, I think it's a bit of both, right? The most important driver is that we have seen an acceleration of market trends, as we have detailed in our strategy section, which include expanding business -- around the businesses moving online. And we have seen an expansion in terms of the game users, and we also seen the next stage of the short video content growth. So I think that's the main driver of our decision to step up because of COVID. Because of new trends emerging quickly, we want to put in additional resources so that we can actually stay ahead of the curve.

Part of that is also the fact that the industry is actually moving faster ahead, right. So if you look at this history of Tencent, we have always tried to stay ahead of the curve, invest ahead of the curve and be a shaper in terms of the industry trend. But if the entire industry is actually moving faster, then we actually sort of have to step up that gas pedal in order to stay even more ahead of the others. So I think that's sort of the secondary reason in terms of why we are stepping up the overall investment.

Now in terms of social responsibility, I'll answer it from a -- partly from a philosophical perspective, right. Running a company, building a company is like building a person, right? So you try to do the right things, and over time, you believe that good things will happen to that person. You don't really sort of, at every step of your way calculate, what is the individual gain in some of the movement that you make. So I think that's sort of our overall belief, when you build up an organization, if you do the right things, good things will happen.

On a more granular basis, I would say, if we actually sort of leverage our technology and leverage our products to deliver bigger social good, I think, overall, we'll be better received by our users, by our customers, by the government and by our employees. And when that happen, I think it's going to be good for the shareholders over the long run.

[Operator]

Our next call next question comes from Gary Yu from Morgan Stanley.

[Gary Yu, analyst]

I have one more follow-up question on the investment strategy. So in the statement, you specifically mentioned that we intend to invest a portion of 2021 incremental profit for these investments. Should we assume that beyond 2021 then, we probably expect the normal growth trend to go back to organic growth and then, hopefully, some of these investments will start to bear fruits in the form of faster growth in the future?

And when we look at kind of management, how to evaluate the potential returns of this investment, what are the key metrics that management usually follow to evaluate investment in Business Service, Video Accounts and games, respectively? And what kind of rate of return should we expect from these investments?

[Chi Ping Lau, executive]

Well, I have to disappoint you in saying there's no specific quantitative metrics, right. I think a lot of times in our industry, you actually sort of look at the trend, you look at the right things to do and then you put in the resources. And over time, if you actually sort of are right and if you do it well, the return is usually so much greater than what you can anticipate.

But if you do all the calculations and say, "Oh, this is actually the rate of investment and you invest according to that calculative mode, then usually, you won't be able to deliver over and beyond what the users want and you will not be able to be a leader at the trend. And usually, that means you're not going to even reap that return. So I think that's sort of essentially what it is.

I think what we are saying is like this year, we are stepping up the investment. That's a strategic move. And that increase in investment will actually continue. We will start to see some benefits over time. Now exactly what's the timing, I think it's hard to predict. But I think the -- it's fair to say, at least at this point in time, right, that the financial impact will probably be biggest as we start stepping into the investment.

[Operator]

Our next question comes from Robin Zhu from Bernstein.

[Robin Zhu, analyst]

I guess 2 questions, please. The first one is could we get an update on WeChat eCommerce? You very helpfully provided us with some numbers for 2020. Just wanted to get your thoughts on how that's trended so far in 2021. Your growth expectations for eCommerce growth, especially independent merchant growth for this year. And whether the company is doing anything proactively to drive growth. Or is it mainly just an organic process?

The second thing on WeChat Video Accounts, wondering if you could share some metrics in terms of the progress so far, whether it's time spent or video views. And again, strategically, longer term, do you envision this being more of a PGC versus UGC type of ecosystem? And yes, how do you -- any specific sort of examples of how you're trying to improve content depth?

[James Mitchell, executive]

Robin, so on the eCommerce within Weixin, we're very pleased with the progress. I think we said last quarter that the GMV was growing at a triple-digit rate year-on-year last year. And the GMV continued to grow at a triple-digit rate year-on-year in the first quarter of this year despite a challenging base period because of people staying at home and conducting more eCommerce transactions last year.

In terms of the specific initiatives we're undertaking to stimulate growth, we talked about some of them earlier in facilitating company -- smaller companies, making Mini Programs, building an ecosystem for intermediaries to assist merchants, off-line merchants in opening and operating their Mini Program experiences. So I don't think there's necessarily a single silver bullet at this point. We have the traffic. We have the payment solution. We have increasingly user trust and confidence and merchant trust and confidence. And so it's more just an ongoing process of organically assisting all of the participants in what's becoming an increasingly vibrant ecosystem and one that's very differentiated from the other platforms or retailers in the market.

[Chi Ping Lau, executive]

Now in terms of Video Accounts. I would say both the number of users using it as well as the user time spent on average has been growing on organic basis and solid basis. Now in terms of further cultivating the content ecosystem, I think what we wanted to be able to do is actually a funnel, right, in which it would include as many UGCs as possible. But then we would also provide all the tools and all the operating procedures and guidelines as well as the monetization tools.

So in order to help these UGCs to really leverage our tools and make themselves into more professional providers of video content. And as a result, right, they will become PUGCs over time. And these PUGCs would be offering very differentiated as well as high-quality content.

And because this users, a lot of times have got certain expertise and professional knowledge in different areas, so their content will be more nutritious and will be differentiated from the pure entertainment-related content, which are now in the other platforms. So that's sort of the way that we are trying to curate the ecosystem for Video Accounts.

[Operator]

Our next question comes from Thomas Chong from Jefferies.

[Thomas Chong, analyst]

I have a question relating to the payment side. Given that digital currency is getting increasingly popular in China, what's our strategy on this one? And in terms of the monetization on payment, are there any other new business model that we can tap into these opportunities?

And then my second question is relating to the advertising side. Given that management has talked about more stringent rules in the education sector as well as special event, how should we think about the trend on the advertising in the next couple of quarters?

[Chi Ping Lau, executive]

I think in terms of digital currency, I think we have already talked about it before in that our WeBank is actually a participant within the trial for digital currency. And we will be developing in order to get WeBank to be supporting that. And over time, as we continue to develop, our payment as well as our other platforms would actually sort of try to see whether we can provide more support for digital currency. The main reason is because digital currency is essentially a substitution for cash. And as a result, you can actually look at it as another form of cash that will be running through the banking system and then eventually running through the third-party payment system and getting into the merchants. So from that front, we are very clear that it will be quite conducive for our overall payment platform as well as for WeBank. So that's why we'll be participating in a very active way in the continuous rollout of digital currency.

Now in terms of the payment business, I think we have a very solid payment business. And the business model is actually multi-fold, right, in that for the large merchants, we actually sort of have a take rate on the payment for the online players, in particular, and you'll have a very solid payment take rate. And at the same time, there will also be multiple value-added services that we provide to the different merchants, such that we can actually sort of capture some kind of economics. And I think that business model is actually quite solid, and we'll continue to build on that.

[James Mitchell, executive]

On the advertising side then, given the size and scale of the China advertising market, I think it would be naive to assume that there will be a period going forward where every industry is green lights and overperforming and all cylinders firing all across the Chinese economy. And so when we look at the landscape today, of course, there are uncertainties. The impact of IDFA deprecation has actually been, I think, less than widely feared for a number of reasons. We are in a period when there's some sort of content airing uncertainty, but that should begin to clarify from July 1 onwards. So we're in the latter stages of that period.

And then we also mentioned in the prepared remarks that there's some uncertainty around the K-12 after-school tuition education. And that education sector has become one of the top 5 advertiser categories online. So what happens in that sector could have some moderate consequences industry-wide. But if you take a step back and look at the broader picture, then I think that all of us would agree that we'd much rather be in a world where the primary challenge is K-12 after-school education regulations than a world where the primary challenge is a COVID-19 pandemic ripping out of control, that appeared to be the case this time last year. So while there'll always be challenges, I think that in the grand scheme of things, the ad industry is in a much better place than it was a year ago.

[Wendy Huang, executive]

Operator, let's take the last question from the queue.

[Operator]

Certainly. Our last question comes from Jerry Liu from UBS.

[Yuan Liu, analyst]

I just have 2 quick ones. First on VAS. If I look at the gross margins this quarter, it was a little lower than the last 2 first quarters. So just wanted to dig a little bit more into the drivers and what's the implication for margins here the rest of the year. I assume maybe the video mix is up a little bit. But curious about what the drivers look like within, especially the gaming business.

And then secondarily, on -- going back again to the incremental investments we're laying out this year. If the focus here for us is more engineers and long-term development of games, et cetera, versus some of the other tiers in the sector, really a lot of what they're spending is on users and near-term promotions, et cetera. It just feels like our spend, the pace and the magnitude, may be a little smoother. I just want to see if that is the right understanding.

[Shek Hon Lo, executive]

Yes. I think in terms of the drop in the VAS margin, there are a couple -- a few reasons. Number one, that the higher live broadcast proportion that is due to the consolidation of the various [ apps ] and the organic growth of some of our live broadcasting services. At the same time, there's a mix shift of PC versus mobile games as PC sort of have a higher-margin profile. And in terms of other low-margin products, just like the digital subscription services, also pull down -- drag down the product -- or gross margin.

[Chi Ping Lau, executive]

Yes. In terms of the investment, I would say your observation is correct, right. That's the reason why we're saying we will be investing a portion of our incremental profits as opposed to other more eCommerce and transaction-related peers in the market in which it may be all of their incremental profit in some cases. And in some cases, it may be all of their profit. And so I think that's a correct observation.

I also want to point out that we do pick up some of the incremental investments industry-wide, right? Because as you look at our investment associate losses, right, we -- in the prepared remarks, I did point out that it actually has a 7% hit to our non-IFRS profit. So we have already, to some extent, weather it in the current quarter.

[Wendy Huang, executive]

Thank you, operator. I think -- operator?

[Operator]

Yes. I'll now hand the call back to Ms. Wendy Huang for closing remarks.

[Wendy Huang, executive]

Thank you. 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 very soon. Thank you, and see you next quarter.

[Operator]

Thank you. So that does conclude our conference for today. Thank you for participating. You may all disconnect.