Tencent Holdings Ltd

HKEX:700

Earnings Call Transcript 2019-Q2

[Operator]

Thank you for standing by, and welcome to the Tencent Holdings Limited 2019 Second Quarter and Interim Results Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today.

I would now like to hand the conference over to your host today, Ms. Jane Yip from Tencent. Please go ahead, Ms. Yip.

[Jane Yip, executive]

Thank you, and good evening. Welcome to our 2019 second quarter and interim results conference call. I'm Jane Yip from the IR team of Tencent.

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-GAAP 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-GAAP measures, please refer to our disclosure document 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 [ your ] business review; and our Chief Financial Officer, John Lo, will conclude with a financial review before we open the floor for questions.

I will now turn the call over to Pony.

[Huateng Ma, executive]

Thank you, Jane. Good evening. Thank you for joining us.

During the second quarter of 2019, we sustained solid year-on-year growth in users, revenues and profits. In games, we released successful new titles in several genres and popularized the innovative game experience while promoting balanced gameplay for young players.

In Payment, we widened merchant adoption and grew average transaction and total payment value rapidly. In content, we deepened our exclusive relationship with NBA, the most-watched professional sports league in China, and reinforced our position as the leading digital entertainment platform.

Our diversified business portfolio has broadened our revenue streams and strengthened our base business in the current challenging business environment. We will continue to invest to enhance our platform, services and technologies to better support our users and enterprise customers.

I will now share a few highlight numbers. Total revenue was RMB 88.8 billion, up 21% year-on-year and 4% quarter-on-quarter. Gross profit was RMB 39.1 billion, up 14% year-on-year or down 2% quarter-on-quarter. Non-GAAP operating profit was RMB 27.3 billion, up 23% year-on-year or down 4% quarter-on-quarter. Non-GAAP net profit attributable to shareholders was RMB 23.5 billion, up 19% year-on-year or 12% quarter-on-quarter.

Moving to platform update. In social, combined MAU of Weixin and WeChat increased 7% year-on-year to 1.133 billion, benefiting from the wide adoption of Mini Programs and Weixin Pay. Smart devices MAU of QQ was largely stable at 707 million. In games, our new game, Peacekeeper Elite, has become one of the better-performing games in China. Users' activities increased in our flagship titles, driven by new content and season passes. Internationally, PUBG MOBILE grew our global user base.

In media, daily video views within Tencent Video apps increased year-on-year due to our popular anime series and video clips from hit genres. We are enhancing short and mini video distribution across Mobile QQ Browser, QQ KanDian and Weixin [ Top Stories ].

In Payment, we operate the largest mobile payment platform in China with a robust growth in users, merchants and transaction volumes.

In Cloud, we are the #2 public cloud service provider in China, steadily picking up market share amidst intense competition.

In utilities, QQ Browser is a key platform for distributing our content feeds. We applied our industry in leading security capabilities to enhance the offerings of our smart industry solutions for the financial, health care and retail sectors.

I will now invite Martin to discuss the strategic review.

[Chi Ping Lau, executive]

Thank you, Pony, and good morning, good evening to everybody. Today, I'll walk -- talk about our leadership in creating and providing high-quality content, which is a key strategic asset and capability in our overall content business and has fueled the growth of our long video platform. We also provide differentiated content for our short video and mini video platforms going forward.

Many observers question the role of high-quality content, given the recent boom in user-generated content such as mini videos. We believe high-quality content has enduring and persistent appeal, providing users with education, lifelong bonding experiences, immersion and stimulation in a way that is difficult for short-form, user-generated content to match. While short and mini videos have captured significant time spent, we believe it was mostly additive to Internet time spent as opposed to taking time away from high-quality content. The length of user time spent on high-quality content such as professional sports, eSports and popular drama series continues to show healthy growth trends.

Moreover, there are emerging synergies between long and short form content, and we can capture the growing opportunities of both. For example, we are repurposing our high-quality content to produce video clips and highlights for mini videos, contributing to rapid growth in short video consumption within our Tencent Video application as well as in our new feeds. Our leading games are also sources of many popular short and mini videos.

We believe we have unrivaled capabilities in terms of producing, curating and operating high-quality content. First, we source high-quality content both internally and externally. On the one hand, we possess market-leading in-house IP incubation platforms such as China Leadership Group, Tencent Games, Tencent Video and Tencent Comics. On the other hand, we partner with global best-in-class content providers such as the NBA, Sony, Universal, Warner and the BBC to name a few, to bring their content to target audiences in China.

Second, we have accumulated insights and expertise in content management. Our operations team manage, curate and deliver content to target audiences in suitable formats coupled with the right storytelling and packaging while our technology groups ensure smooth content delivery.

Third, we use our content platforms, such as Tencent Games and Tencent Video, as well as our communication social platforms, Weixin and QQ, to bringing content to the widest possible user base with amplification through social interactions. In turn, the users become enthusiastic fans of the content, creating resonance and loyalty to the IP.

In the next 2 pages, I'll discuss 2 case studies to illustrate how we create, curate and enhance high-quality content using our platforms. The first one is on novels. With our subsidiary, China Literature, we have become the market leader in terms of incubating online novels and converting them into hit entertainment formats in China. For example, The King's Avatar is a popular China literature novel about an eSports player. We have created drama series and anime series based on The King's Avatar IP, with each ranked #1 of its kind by video views during their broadcast periods. We are also about to release a movie and will develop and publish mobile games based on this IP.

The Master of Diabolism is another novel from a joint venture under China Literature and is especially popular among female readers. We have produced 2 series of its anime, accumulated -- generated over 2.2 billion video views on our platform. We also released a drama series based on The Master of Diabolism, which ranked the top costume drama by video views in the heavily contested month of July of this year.

Our second case study illustrates our ability to partner with the best content internationally and sharply upsize its China audience base. Since we signed our first exclusive contract with the NBA in 2015, we have helped the NBA to approximately triple its full season audience to 490 million viewers and its average per game livestreaming audience to 3.7 million viewers. This growth both boosted the NBA's brand power in China and substantially increased its monetization capability. On the other hand, it has also contributed to Tencent Sports becoming the top online destination for sports fans.

Based on the success of the first contract, we recently announced that we have successfully extended our partnership with NBA for 5 more years. Looking forward, we intend to deliver NBA content across high-DAU platforms and live streaming, video on demand, short and mini video formats with even better innovative packaging. We intend to enrich NBA VIP and membership benefits, including club merchandise and online streaming privileges. And at the same time, we intend to cooperate further with NBA in developing NBA-branded mobile games and eSports events.

So with that, I'll pass to James to talk about the business review.

[James Mitchell, executive]

Thank you, Martin.

For the second quarter of 2019, our total revenue grew 21% year-on-year. VAS remains our largest revenue segment, representing 54% of our revenue, within which online games were 31% and social networks 23%. Online advertising was 18% of our revenue and FinTech and Business Services represented 26%.

Looking at Value Added Services, segment revenue was CNY 48.1 billion in the second quarter, up 14% year-on-year and down 2% quarter-on-quarter. Social networks revenue was CNY 20.8 billion, up 23% year-on-year and up 2% quarter-on-quarter. Virtual item sales and live streaming services in games contributed notably to the year-on-year and quarter-on-quarter growth rates.

Our VAS subscription counts increased 10% year-on-year to 169 million due to the growth of online video and music subscription services, within which video subscriptions were 97 million, up 30% year-on-year and up 9% quarter-on-quarter due to factors including joint membership promotions with our partners such as JD.com and Meituan-Dianping, as well as the popularity of our Chinese anime series.

For online games, total smartphone games revenue increased 26% year-on-year to CNY 22.2 billion, benefiting from the popularity of key titles and new releases. Sequentially, smartphone game revenue grew 5% as we launched more games following the renewal of the BanHao approval process offsetting weak seasonality.

PC client game revenue decreased 9% year-on-year while their cash receipts increased year-on-year. PC client game revenue decreased 15% quarter-on-quarter due to adverse seasonality.

Focusing on our social networks, Weixin and QQ continue to enhance their chat experiences and content consumption, boosting user engagement and time spent. For Weixin, we're successfully building out a uniquely vibrant Mini Programs ecosystem. By providing development tools, access to consumers and monetization opportunities, Mini Programs help developers and service providers efficiently expand their businesses online. The number of mid and long-term Mini Programs more than doubled year-on-year.

Mini Programs are also becoming more diversified in nature. For example, content Mini Programs allow users to conveniently create, upload and share videos, music and news within Weixin. More than a dozen content Mini Programs have attained over 1 million DAUs.

Benefiting from the popularity of Mini Programs, Weixin broadened its use cases and grew its user time spent. In our latest upgrade for Mobile QQ, we introduced QQ Mini Programs, within which entertainment and game categories are particularly popular among the QQ users. We enriched the QQ chat experience via enhanced functionalities for video and voice messages and added an extended screen photo format, boosting daily messages by user quarter-on-quarter. And we helped users expand their social graph through an upgraded algorithm to recommend connections based on common interest and shared contacts.

For smartphone games, existing titles and recent releases drove resumed revenue growth. We launched 10 games this quarter, up from 1 game in the first quarter, including an augmented reality game, Catchya; and role-playing games, such as Fairy Tail and Raziel. Honour of Kings increased its revenue year-on-year, benefiting from its season pass initiative. Other games that notably contributed to quarterly revenue included earlier releases such as Naruto Mobile and Red Alert Online, as well as more recent titles such as Perfect World Mobile. Peacekeeper Elite has now exceeded 50 million daily active users and is in early-stage monetization, particularly via season passes. However, its revenue contribution this quarter was very small due to our revenue deferral policy.

In July, we released 3 games in different genres. KartRider Rush is a racing car game, Game of Thrones: Winter is Coming is a strategy game and Dragon Raja is a role-playing game. The fact that all 3 games have achieved top 10 positions in the iOS Grossing Chart in China is a positive sign for our industry, pointing to player demand from a range of experiences which appear to complement rather than cannibalize each other.

Internationally, PUBG MOBILE obtained over 50 million daily active users while new games, Speed Drifter and Chess Rush, achieved initial popularity.

For PC client games, League of Legends' new play mode, Teamfight Tactics, has become the clear global leader in the auto-chess category since releasing internationally in June and in China in July, benefiting its daily active users and time spent. League of Legends China cash receipts increased year-on-year due to popular eSports-themed skins. For Dungeon & Fighter, we're currently prioritizing enhancing the user experience and putting less emphasis on player spending initiatives for the next few months.

Moving to our online advertising business. Segment revenue increased 16% year-on-year to CNY 16.4 billion amidst challenging macroeconomic conditions and increased short video ad inventory supply. We expect these negative factors may continue impacting the industry through the rest of this year. Sequentially, our advertising revenue increased 23%, benefiting from seasonally high demand from categories such as eCommerce and online education.

Our media advertising revenue is CNY 4.4 billion, down 7% year-on-year or up 26% quarter-on-quarter. The year-on-year decrease was mainly due to the absence of the FIFA World Cup this year and the unexpected delay of certain top-tier drama series.

Operationally, our mobile video DAU is stable year-on-year as consumers continue to value the differentiated storytelling and immersive experiences that long-form video can provide versus short-form video. In April, we released season 2 of Produce 101, a highly popular variety show which achieved record ad billings from Tencent Video program.

Our social and others advertising revenue was CNY 12 billion, up 28% year-on-year and up 21% quarter-on-quarter. Growth benefited from more ad inventory and impressions, notably the third ad load in Weixin Moments and the ad inventory in our QQ KanDian news feed.

Looking at FinTech and Business Services, segment revenue was CNY 22.9 billion, up 37% year-on-year and up 5% quarter-on-quarter. Excluding the negative impact of reduced interest income on custodian cash balances, segment revenue was up 57% year-on-year and up 7% quarter-on-quarter.

Within FinTech services, commercial payment grew rapidly in terms of users, merchants, transaction volumes and revenue driving the year-to-year segment revenue growth. Our commercial payment volume grew over 10% quarter-on-quarter. LiCaiTong grew its AUM over 30% in the past 6 months to over CNY 800 billion as of June, indicating a trend that our users are increasingly keeping money within our payment system. This trend lowers the frictional cost for users to use Weixin Pay and also has the effect of reducing our withdrawal fees and thus our revenue as well as our bank charge expenses.

The overall impact should enhance the vitality of our FinTech business in the long run. We continue to focus on FinTech risk management to sustain long-term platform growth.

Within Business Services, expanding our industry-facing sales teams and enhancing our product offerings enabled us to sign up more key accounts and large contracts, which contributed to rapid cloud services revenue growth year-on-year. Through close partnerships with independent software vendors and resellers, we've also increased our cloud services penetration among small and medium businesses.

And with that, I'll pass it to John to discuss the financial review.

[Shek Hon Lo, executive]

Thank you, James. Hello, everyone. For the second quarter of 2019, total revenue was CNY 88.8 billion, up 21% year-on-year or 4% quarter-on-quarter. Gross profit was CNY 39.1 billion, up 14% year-on-year or down 2% quarter-on-quarter. Net other gains was CNY 4 billion, down 64% sequentially. Lower net gains from investees and high impairment provision against certain investments, which are both non-GAAP adjustments, were the reasons for sequential decrease.

Operating profit was CNY 27.5 billion, up 26% year-on-year or down 25% quarter-on-quarter. Net finance costs were CNY 2 billion, up 72% year-on-year and 77% quarter-on-quarter. The increase was primarily driven by greater interest expense as a result of recent bond issuance and ForEx loss.

Share of profit of associates and joint venture was approximately CNY 2.4 billion compared to share of losses of CNY 3 billion last quarter. On a non-GAAP basis, share of profit of associates and JV was CNY 2.4 billion compared to share of losses of 518 million last quarter due to improved performance of certain investees.

Income tax expense was CNY 3.2 billion, down 10% year-on-year and 33% quarter-on-quarter mainly due to recognition of tax benefits. The effective tax rate for the quarter was 11.6%.

GAAP net profit attributable to shareholders was CNY 24.1 billion and GAAP diluted EPS was CNY 2.52, both metrics up 35% year-on-year or down 11% quarter-on-quarter. On a non-GAAP basis, net profit was CNY 23.5 billion as diluted EPS was CNY 2.46, both went up 19% year-on-year and 12% quarter-on-quarter.

Let me walk you through our non-GAAP financial numbers.

Operating profit was CNY 27.3 billion, up 23% year-on-year or down 4% quarter-on-quarter. Operating margin was 30.7%, up 0.5 percentage points year-on-year or down 2.6 percentage points quarter-on-quarter. Net margin was 27.2%, down 0.6 percentage points year-on-year or up 1.8 percentage points quarter-on-quarter.

Turning to segment gross margin. Gross margin for VAS was 52.6%, down 6.4 percentage points year-on-year and 5 percentage points quarter-on-quarter. The year-on-year decrease reflected revenue mix shift to low-margin products. Sequentially, margin contraction was a result of higher video content costs and revenue mix shift to lower-margin products, such as [indiscernible] and licensed games.

Gross margin for online advertising was 48.6%, up 11.2 percentage points year-on-year and 6.7 percentage points quarter-on-quarter. The year-on-year increase primarily reflected rapid growth of social apps. Sequentially, seasonal uptick of China advertising market contributed to margin expansion.

Gross margin for FinTech and Business Services was 24%, down 2 percentage points year-on-year and 4.5 percentage points quarter-on-quarter. The absence of interest income from the custodian accounts per PBOC guidelines since mid-January was the main reason behind the year-on-year decrease. The rapid growth of commercial payment business accounts for the sequential decline.

On operating expenses, sales and marketing expenses were CNY 4.7 billion, down 26% year-on-year or up 11% quarter-on-quarter. The year-on-year decrease reflected our prudent cost management initiatives. Sequentially, selling and marketing expenses increased due to marketing activities for new game releases following the resumption of BanHao approval process. Selling and marketing expense represented 5.3% of quarterly revenue.

G&A expenses were CNY 12.6 billion, up 28% year-on-year and 11% quarter-on-quarter, primarily driven by increase in R&D expenses and staff force. Within G&A, R&D expenses were CNY 7.1 billion, up 24% year-on-year and 10% quarter-on-quarter. As a percentage of quarterly revenue, G&A was 14.2% and R&D was 8%. At quarter end, we had approximately 56,300 employees, up 15% year-on-year and 3% quarter-on-quarter.

Let's take a look at the margin ratios. Gross margin was 44.1%, down 2% -- 2.7 percentage points year-on-year and 2.5 percentage points quarter-on-quarter. Our blended gross margin contracted due to pull-through from reduced VAS gross margin and mix shift to lower-margin revenues.

Non-GAAP operating margin was 30.7%, broadly stable year-on-year and down 2.6 percentage points quarter-on-quarter. Non-GAAP net margin was 27.2%, broadly stable year-on-year and up 1.8 percentage points quarter-on-quarter.

Before I close my remarks, I will share some key financial metrics for the second quarter. Total CapEx was CNY 4.4 billion, down 38% year-on-year and 3% quarter-on-quarter, of which operating CapEx dropped 43% year-on-year to CNY 3.8 billion because last year we purchased a large quantity of service to support our cloud business expansion. Nonoperating CapEx increased year-on-year to CNY 602 million.

Free cash flow was CNY 20.7 billion, up 27% year-on-year or down 14% quarter-on-quarter. Net debt position was CNY 15.8 billion, which had improved 55% compared to last year. In the second quarter, our total cash grew 6% quarter-on-quarter following payments for annual dividends and M&A activities, while total debt grew 9% quarter-on-quarter due to a recent bond issuance. As a result, our net debt position increased 64% from the previous quarter.

The fair value of our shareholdings in listed investee companies excluding subsidiaries was approximately CNY 302 billion or roughly USD 48 billion compared to CNY 310.7 billion or roughly USD 46 billion last quarter.

Thank you. We shall open the floor for questions.

[Jane Yip, executive]

Operator, shall we have the first question, please?

[Operator]

We have the first questions, comes from the line of Alex Yao from JPMorgan. [Operator Instructions]

[Alex Yao, analyst]

Very quick one on the advertising outlook in the coming quarters. Can you talk about the macro environment as well as the oversupply situation? I think, James, you mentioned that you expect this oversupply situation will persist into second half this year. What are your strategies to address such a market condition and how do you think about the 2020 outlook? Do you think the current oversupply situation will be better? Would there be a new incremental advertising release over the next 4 quarters or so?

[James Mitchell, executive]

Thank you for the question, Alex. So our assumption is that the macro environment will remain difficult for the rest of the year and that the situation of a heavy supply of advertising inventory will continue for the rest of the year and potentially into next year. And that obviously flows through to some extent into our advertising revenue, particularly on the media side and particularly with industries such as automobiles, real estate, financial services. In terms of what we can do then, some of these challenges around the macroeconomic situation, around the industry-wide inventory supply are not within our direct control. What we can control are factors such as the rate of our own inventory growth, our ability to provide new tools to advertisers, our capabilities in terms of targeting ads to the right users. And those factors also have an impact on our growth rate. And so we seek to use those factors to sustain what we view as a healthy, although not super rapid, rate of advertising in the current challenging environment. Thank you.

[Operator]

The next questions comes from the line of Alicia Yap from Citigroup.

[Alicis a Yap, analyst]

My question is regarding the online games. How should we reconcile this discrepancy between our expectation versus the reported games revenue and the deferred revenue growth this quarter? You noted in the press release that the Peacekeeper Elite, the game has decent initial success, right, in monetization but with limited reported revenues in the second quarter due to the deferred impact. But yet your sequential growth in the deferred revenue really didn't show very strong number. So we understand it could be related to different movement or contribution from different games and the timing. But could you walk us through how we should be looking at the provided number to judge or estimate the trend for the third quarter and the second half gaming revenue growth?

[James Mitchell, executive]

Thank you, Alicia. So in terms of the game revenue trends in the second quarter, as you are probably aware, the second quarter is seasonally a much slower quarter than the first quarter. And if you look at our history, then historically, our game reported revenue and the deferred revenue associated with games have often declined quarter-on-quarter from the first quarter. If you look at some of our listed comparables, their deferred revenue associated with games declined at a double-digit rate quarter-on-quarter. So I think that on our side, the fact that this year's second quarter, both our reported revenue and our deferred revenue increased quarter-on-quarter for the smartphone games is actually quite positive and encouraging. And zooming in on Peacekeeper Elite, the game has launched strongly. It is generating healthy revenue now from its season passes. However, the very large majority of our Peacekeeper Elite's cash flow generation in the second quarter was deferred to subsequent quarters. So only a minority -- a small minority was captured in our reported revenue line and Peacekeeper Elite was not even among our top 10 games in terms of reported revenue in the second quarter.

On the other hand, we saw pretty healthy quarter-on-quarter trends from a number of our mobile games, including PUBG MOBILE internationally; including our new game, Catchya; including Perfect World Mobile. So I think overall, we were quite happy with the recovery in smartphone game revenue. Now obviously, it takes some time for what we see to flow through fully into the reported financials because of the revenue example. But the fact that deferred revenue was up quarter-on-quarter in what was seasonally a slow quarter for deferred revenue, I think gives us some confidence on our side.

[Operator]

The next questions comes from the line of Eddie Leung from Bank of America.

[Eddie Leung, analyst]

Could you tell a little bit about your strategy in high-quality content? Especially how you decide on being an independent user platform versus investing in certain upstream content providers, given your past experience in investing in game studios for our information. And then just a follow-up question on games. James, could you also give us your thought on the potential new entrants from the short video industry?

[Chi Ping Lau, executive]

Yes, in terms of the high-quality content one, I would say our platform strategy is actually to be an all-inclusive platform, right? We try to include as much content as possible. So that, you can see with respect to our video platform and as well as China Literature. But at the same time, what we find is that -- and that applies to our music platform as well, but what we find in becoming a strong all-inclusive content platform, there is actually a lot of synergies if we can work with the content providers more closely. And as a result, when you look at our games platform, for example, right, we have been very early on investing in game studios so that we try to establish a very deep partnership as well as close partnership relationship with the content providers. Because we saw that once we have that relationship, a lot of times what we can do is we can curate the content better. We can take a long-term perspective and invest in the content better and we can understand the content more and we can help the content developers to understand how platform works. So that as a whole, we can actually help the content to be more popular within our user base and at the same time, for our user base, we can contribute more traffic to the content developers. So it's a win-win relationship that we can build once we have a deeper relationship as opposed to just a mercantile relationship.

So in almost every single content platform, we have tried to find different ways to establish a stronger relationship with the content providers. And that is one of the reason why we have very strong capability in creating, in curating as well as in popularizing the high-quality content.

Now I would say within the games segment, right, when you look at potential new entrants from mini video player, I think overall, we felt there's already a lot of competitors in the gaming sector, and throughout the history, the game industry actually thrive on having a lot of different competition. And to some extent, I would say we welcome new entrants to some extent because when people bring in new ideas, this is exactly how we can actually expand the gaming industry. The gaming industry is actually driven by innovation. Now we do believe that, in order to be a very strong player in games, you actually require a lot of domain expertise, which took us many, many, many years to build. And at the same time, I would also want to say that for our existing games, and especially the very large games, right, there's an extremely strong network effect in the games, especially when it's coupled with our social network. And that's a unique advantage that we have.

So I think overall, we are not too concerned about having more and more players to be playing in the gaming market. And I would also want to point out that when you are already a player that's making a lot of revenue from ads, the incentive to move into gaming is actually not extremely obvious because to some extent, you are already making a lot of revenue from the gaming industry as a whole. So that's sort of what my reaction is.

[Operator]

The next questions comes from the line of Grace Chen from Morgan Stanley.

[Grace Chen, analyst]

My question's about the cloud business. I notice that in the press release that Tencent didn't publish a penetration in the small and medium business through close partnerships with independent software vendors. So I'm wondering whether the management can elaborate more about the partnerships with software vendors. Are there -- are these mainly international or domestic software partners? And then which type of software solutions? Also, is Tencent interested in developing in-house software solutions, and what type of software solutions that could be?

[Chi Ping Lau, executive]

In terms of our cloud business, as you know -- number one, I want to say our cloud business have actually sort of registered very strong growth in the quarter, and we believe we have been consistently picking up market share in the past few quarters.

Now with respect to the mix of the cloud business, right, we have been traditionally quite strong in terms of getting businesses from Internet players. And more recently, we have also made a pretty strong inroad into some of the enterprise sectors, including financial verticals, including government verticals. And the last piece of the puzzle is really building more exposure to the small and medium enterprises which I think, over the past couple of quarters, we have made good progress. And that progress is mainly made with respect to what you have described, which is building relationships through the ISVs; and through the ISVs who have a lot of connection to the different SMEs, right, we can actually sell our cloud solution to them. And these ISVs may be experts in a particular industry. So for example, they may be experts in the restaurant industry, some of them may be experts in the financial or retail industry and when we build relationships with them, we can actually, through them, cover a lot of smaller players and companies and customers within those sectors. There are also some companies who are bigger in size. And in some of these companies, we have actually invested in them in order to establish a stronger relationship. So take the example of Donghua Software or Beiming, right, there are a number of ISVs, larger ones, that we have invested in them so that we can actually go through them in order for us to cover the small and medium enterprises. I also want to point out that another initiative that we've done with respect to the small and medium enterprises is in increasing our toolkits for our Mini Programs. When we can provide a set of tools for companies to connect their Mini Programs to our cloud services, then we have a much higher probability of picking them up as our cloud solutions.

Now one more point to add is that in addition to all these initiatives, we've also been developing SaaS solutions both on our own as well as working with SaaS providers in China so that we have exposure to SaaS software solutions such as CRM, such as document processing, as well as enterprise messaging. So we believe our SaaS initiative is also another way through which we can cover small and medium enterprises in the cloud market.

[Operator]

The next questions comes from the line of John Choi from Daiwa Capital Market.

[John Choi, analyst]

I have a question on your marketing expense. This quarter, we've seen a pretty -- came down quite a bit on -- year-over-year. And I think on the press release said you guys have reduced less-effective marketing campaigns. Can you guys elaborate a bit more on these initiatives? And how should we think about the spending trend for marketing and also -- sales and marketing and also for other OpEx items towards the end of the year?

[Shek Hon Lo, executive]

Yes. I think since the last quarter last -- the last quarter last year, we had very strong control on sales and marketing expenses. In particular, we will look at -- while they are spending, we'll look at whether they have been spent effectively and efficiently. And if it doesn't meet our threshold, then we'll cut the entire campaign completely. As opposed to in the past, we tend to assign a budget and we just sort of let them finish all the marketing activities before doing a thorough assessment on the ROIs. And I think there are other ways in which we can measure the effectiveness by comparing similar activities between different business groups and between different partners to ensure that we get the best [indiscernible] those marketing activities.

Also, I think we do have -- we do give out budget on a piecemeal basis as opposed to in the past in which we gave out all the budget all at the same time. We do reviews on a monthly basis to ensure that the marketing objectives have been matched before assigning [indiscernible] budget for that. That's why you have been seeing a sharp decline in the selling and marketing expenses in the past 2 to 3 quarters on year-on-year basis. Going forward, of course this initiative will continue. But at the same time, as you understand, those marketing activities can dial [ up and down ] according to needs and demand and according to how our competitors spend, in particular in some areas just like payment. Like a year ago, we have been spending quite a lot in the payment side. But once we get to certain momentum and when compared with spending versus our peers, we tend to spend less and more wisely.

[Chi Ping Lau, executive]

So I think to summarize, one is a very strong cost control initiative at the company. Second, I would say there is some -- because of the macro environment, we can get better deals in terms of advertising and promotions. Thirdly, with respect to certain verticals such as payment, when the revenue of the market get hit, right, when interest income were actually taken away, the marketing spend of the different players actually get rationalized a bit. So it's a balancing act. But going forward, I think we believe a lot of fat has been cut already. And then when we are ready to promote for new games, right, then the marketing expenses will probably go up. But I think overall, because of the cost control and the overall market environment, I think it's a much healthier marketing environment now than before.

[Operator]

The next questions comes from the line of Binnie Wong from HSBC.

[Wai Yan Wong, analyst]

My question is on the video side. So on short-form video, thank you for highlighting the differentiation of your short video against your peers' in your opening remarks. And if you think about how to yield maximum synergies, right, from your unique advantages in your content creation platform, I guess what it boils down to is how effective and how targeted we can push the right format to your target audience. So I guess the question is how much data user insight is the short-video team or your technology team can be shared to do more right -- to do a better targeting than our peers?

And then the second question is on the long-form video side. How should we think about you mitigate the negative impact on the media as -- of unexpected drama delay, especially when we're approaching the National Day and there might be more regulatory -- I mean in terms of the tightening on the content side? And then how are you thinking about any operational measures such as any product change in terms of the type of drama to drive an ad revenue growth on the media front?

[Chi Ping Lau, executive]

Well, I think we do have a lot of data about our users. So over time we have been building a lot of technologies in order for us to leverage this data, right, for feeding the right short and mini video to our users. I think so far, the result has been encouraging, especially after the establishment of our PCG because we consolidated all our tech resources to create the tech platform that can support our long video, our short video and our mini video. I think more progress have been made on the short video front because if you look at the short video growth within our overall platform, it has actually grown very strongly across our QQ KanDian, our QQ Browser, as well as Tencent Video. So that actually has made very significant progress. Now with respect to mini videos, I think it would take some time before we really start to promote our Weixin. On Weixin, we actually view it as a very strategic product for us. We will be building up the technology, the content curation capability as well as the ability for us to target the mini video to the different users through a recommended feed over the long run. And as and when our engagement and retention have reached our target, we'll actually start promoting it in a very big way.

[James Mitchell, executive]

Binnie, in terms of your question about long-form video and how we mitigate the impact of the unexpected delays to key drama series, then -- I think at a high level, we don't necessarily seek to mitigate fluctuations in individual business lines by doing things in adjacent business lines. You saw last year that when our game revenue, which is a much bigger proportion of our total revenue than video, was under pressure, we didn't seek to accelerate monetization elsewhere. We believe we have a relatively diversified broad revenue mix and one of the strengths of the position we're in is that we can afford to take some hits in the nature of the business and rely on the breadth and depth of our capabilities to move us forward.

So that's a high-level answer. Now getting a little bit more granular in terms of what the video team are doing in this environment, clearly from a content perspective, given the difficulty of putting drama series, and especially historical costume drama series, on air, we have been doubling down our focus on some other content categories. So we've talked a great deal about Chinese anime, where we believe we're the clear market leader now in terms of both production and distribution and where we can leverage the competitive advantage that accrues to us from our relationship with China Literature as the upstream inspiration for many of these animated TV series. We have been an aggressive investor in documentaries. And then our Produce 101 variety show we think is the highest-rating and highest-grossing variety show in the market.

So that's on the content side. On the revenue side, the traditional 30-second spot advertising revenue is under pressure because of macro factors and because of the delays to the drama series. That said, we continue to grow our subscription revenue at a reasonably fast rate. And in the past 12 months, we've more than doubled or approximately tripled the advertising revenue on the news feed inside our Tencent Video app, which is less directly tied to individual hit content and more broadly related to the daily active user base of the app, which remains healthy despite some of the challenges we are facing.

[Operator]

Next questions comes from the line of Gregory Zhao from Barclays.

[Gregory Zhao, analyst]

So I think starting from September, JD [ reported ] team-buy business to your Weixin level 1 entry and we also know Pinduoduo actually leveraged your social network and launched a very unique team by business model in the past 2 years. So I just want to check your expectation on JD's new launch on the team buy. And also I want to understand your strategies to balance your resources at your investment company. And also a very quick follow-up on the content cost. I think you mentioned you increased your -- the cost in shorter video side. So I specifically want to understand in which area will you spend the money to directly pay for some MCNs or some video studios to produce some short video content?

[Chi Ping Lau, executive]

In terms of JD, we did renew the contract and they're going to launch a new user experience. We continue to believe that there's a lot of potential with respect to both building an eCommerce ecosystem within Weixin and the level 1 entry point for users. Because I think, as our experience shows, there are a lot of users who actually go into that entry point. And if the entry point is going to be able to provide a great user experience and at the same time provide great products to the users and have a high retention rate for the individual users as well as create some additional leverage over our social network, right, there could be a lot of potential in the level 1 entry point. So we do believe there's potential and we hope the new product design would actually sort of unleash some of this potential. I think interestingly you have brought up Pinduoduo, which for a long time, right, they did not have a level 1 entry point and they have been able to leverage the social network to bring great benefits to your own business which, to some extent, validates the point that I've made, which is there's a lot of potential within Weixin to build a strong ecosystem around eCommerce. And if you see now, we have provided a level 2 entry point for Pinduoduo. And I think these 2 user experiences are actually quite different and we do intend to provide help to both companies in order to generate the right user experience as well as the right user excitement according to their differentiated product experience and category management experience.

Now on content, maybe -- John, do you want to answer that question?

[Shek Hon Lo, executive]

All right. I think in terms of short video content, a lot of those content are self-generated and there are not a lot of content cost which we pay to MCNs or whatever right now.

[Operator]

The next questions comes from the line of Jerry Liu from UBS.

[Yuan Liu, analyst]

My question is on FinTech. We've seen pretty good revenue growth and margin improvement in this business. But this quarter, we also flagged the fact that users are not withdrawing the cash. Actually slowed the revenue growth and margins a bit. I just wanted to get an outlook for the next few quarters, maybe next couple of years, as we develop more financial products marketplace, as we do new services and products in this area. How do we see the revenue growth and margins trending?

[Chi Ping Lau, executive]

So number one, as you have pointed out, the trend -- the short-term trend is actually -- the user is actually keeping more money within our ecosystem. And as a result, the short-term impact is that it affects the revenue because the users are withdrawing less cash. And since we have already paid for the cost, the banking cost of such cash, when they withdraw less, the margin also gets impacted negatively. But net-net, it's actually a very good trend from our perspective because it helps the users to be transferring money and paying for services at 0 cost when they keep the money within our system, right? So the frictional cost has been reduced. So it's actually structurally a great and very healthy trend for the overall payment system, which then brings to the next question which is, over the long run, we do believe the FinTech business has got a lot of potential, right? This is something which is, I would say similar to our social and performance ad, right? We view it as a multi-year growth opportunity. And there is already a very large user base, there is already a very large transaction volume and a lot of merchants actually rely on the payment platform to actually conduct their businesses. So by and large, we have a lot of traffic and platform franchise to actually monetize. But at the same time, what we want to do is actually monetize through value added way, not through just keep increasing the charges because without that, it's still a very competitive environment.

So in terms of going forward, FinTech services, particularly our micro loans could be quite important. But under the current environment, while there's still a lot of potential in terms of expanding our loan portfolio, we do want to make sure that it's expanded in a measured way so that our risk management is actually done in the proper way, especially under the current macro environment, right? We try to be erring even on the more conservative side to make sure that we're not exposing ourself to too much risk. And at the same time, since clearly there is a lot of headroom for us to grow, right, we want to spread over a multi-year period rather than try to do it all in a short period of time. So that's how we look at our overall FinTech services.

[Operator]

The next questions comes from the line of Piyush Mubayi from Goldman Sachs.

[Piyush Mubayi, analyst]

Martin, could I just ask another question on FinTech? You talked about the broader direction, you talked about a few specifics. Can you also talk through what's going on with the payment -- the competitive landscape at this point? Any new strategies that you're deploying, and concern whether there's been a change of guard from your side? And if I might ask, about 2 quarters ago, you talked about commercial being more than 50%. I think that was in the fourth quarter. Where are we on that number? And lastly, the gross margins were down about 400 basis points on a sequential basis. Is that a new number we should go with or can we see that potentially bounce back to where we were a quarter ago?

[Chi Ping Lau, executive]

I think in terms of the overall competitive landscape, I think our positioning is still very strong, especially in terms of the frequency payment. I think we are the highest DAU as well as MAU payment platform in China. And I think the number of transactions that we have is also highest. And in terms of the overall transaction volume of our commercial transactions, it has been growing at a faster rate than the overall transactions too. So I think the overall positioning is actually quite strong.

And in terms of -- what was your second question with respect to numbers? We missed that, sorry. Oh, the payment margin. I think it is a function of many different numbers. So I think in -- as the payment business is still in a flux of changes, particularly with the taking away of the interest and this new change in which we were able to retain more of the cash within the overall system which is having impact on both the revenue and the cost and the velocity of payment, I think at this point it's hard to make up a number at this point in time. I think it will probably take a couple of quarters for us to take a more stabilized view of the business, then we can probably give you a better number.

[Operator]

This is the last questions, comes from the line of Thomas Chong from Jefferies.

[Thomas Chong, analyst]

I have a question regarding our M&A strategies. Given we have talked a lot about content, should we expect our M&A strategies to focus more on music or short-form video going forward? Or are games [indiscernible] can management give us some direction on how we use our cash?

[James Mitchell, executive]

So thank you for the question, Thomas. In general, if you look at our -- the total amount of capital we're deploying in investments, then the rate of investment has slowed quite notably from the first half of 2018 to the second half of '18 and the first half of '19, and that's partly because the amount of capital we're deploying into investments has decelerated after an unusually rapid pace in the first half of '18 when we were investing in Smart Retail and game broadcast sites and that's partly also because the rate of divestments has picked up pretty sharply. So in recent months -- in some months, our rate of divestments has matched our rate of investments.

In terms of where we are focusing then, historically, for the past 10 years or so, we've been quite active investing in upstream content. And that includes game studios, that includes TV production businesses, literature and music. And that continues. But the greater change is that we have become more active in some of the sort of frontier opportunities, particularly enterprise software; also financial technology; education technology; to some extent, health-related technology opportunities.

So overall, we continue to invest but at a more measured pace than at the beginning of last year. And as the Internet transforms more aspects of everyday life, then we feel that Tencent has a role to play in helping that transformation, and sometimes we can play that role entirely by ourselves and sometimes we want to play that role in tandem with partners. And with some of those partners, it makes sense for us to form an equity relationship to deepen and institutionalize the relationship.

[Operator]

There are no more questions on the queue. Ms. Yip, please begin your closing remarks.

[Jane Yip, executive]

We are closing the call now. If you wish to check out our press release and other financial information, please visit the IR section of our company website. The replay of this webcast will also be available soon.

And see you next quarter.

[Operator]

That does conclude our conference for today. Thank you for participating Tencent Holdings Limited 2019 second quarter and interim results conference call.

You may all disconnect now.