Tencent Holdings Ltd

HKEX:700

Earnings Call Transcript 2022-Q2

[Wendy Huang, executive]

Good day, and good evening. Thank you for standing by. Welcome to Tencent Holdings Limited 2022 Second Quarter Results Announcement reading. I'm Wendy Huang from Tencent IR team. [Operator Instructions] Please be advised that today's webinar is being recorded.

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 group'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.

Now let me introduce the management team on the webinar 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 provide a business review. Chief Financial Officer, John Lo, will conclude with financial discussion before we open the floor for questions. I will now pass it to Pony.

[Huateng Ma, executive]

Thank you, Wendy. Good evening. Thanks, everyone, for joining us. During the second quarter, we actively exit noncore businesses, our marketing spending and changing the operating expenses. This enabled us to sequentially increase our earnings despite difficult revenue conditions. Total revenue was RMB 134 billion, down 3% year-on-year and 1% quarter-on-quarter. Gross profit was RMB 58 billion, down 8% year-on-year, but up 1% quarter-on-quarter. Non-IFRS operating profit was RMB 37 billion, down 14% year-on-year, but up 0.4% quarter-on-quarter. Non-IFRS net profit attributable to equity holders was RMB 28 billion, down 17% year-on-year, but up 10% quarter-on-quarter.

For our key services, we generally became our first place positions in activities, including social games, long-form video, news, music, literature, payment and mobile browser. Combined MAU of Weixin and WeChat was $1.3 billion. Mobile devices MAU of 2Q was 569 million.

Before I hand over to Martin, I would like to welcome Professor John as a new Director and a member of Corporate Governance Committee. Broadening our Board's independence, gender diversity and areas of expertise. With that, I hand over to Martin for a strategic review.

[Chi Ping Lau, executive]

Thank you, Pony, and good evening, and good morning to everybody. The Internet industry in China has really faced significant changes and challenges since early 2021. And as a result, our revenue conditions have become difficult and financial performance was under pressure over the last few quarters. When we announced our results for the fourth quarter of 2021 in March, we laid out our strategic plan to proactively embrace changes and reposition our businesses to align with the new industry paradigm. So today, in this section, I would like to share with you the encouraging progress that we've made so far.

To start with, let me walk you through efficiency initiatives that we have implemented that reduced our costs and are stabilizing our earnings. First of all, we closed down certain noncore or redundant businesses in areas such as online education, e-commerce and game live streaming. Second, we rationalized underperforming businesses, including loss-making digital content services and subscale social media products. Third, we tightened our control measures for marketing programs and cut down spending with low return on investments, especially in the area of user acquisition. As a result, we reduced our selling and marketing expenses for the second quarter significantly by 21% year-on-year.

Fourth, we migrated all domestic in-house services to Tencent Cloud for higher productivity and enhanced cost efficiency. Fifth, we controlled our headcount by optimizing our workforce and controlled growth in staff costs. At the end of the second quarter, our total headcount was down by over 5,000 sequentially. While our second quarter results reflected the initial cost savings from these efficiency initiatives, we expect to benefit more from them in the coming quarters.

So in addition to the aforesaid efficiency initiatives that help us stabilizing earnings, we have been and will be implementing additional efficiency initiatives at business level to support our earnings recovery even while the macro environment remains challenging. For cloud services, we have been scaling back loss-making activities and shifting focus from customization and subcontracting heavy projects to more rapidly growing our internally developed products, driving margin improvements.

For commercial payments, we're proactively managing our funding channels to lower our unit transaction costs. And we are targeting our development and operational efforts on higher-value services, such as industry-specific use cases, which will enhance our unit economics and margins. With long-form video, we are introducing more discipline in our content spending and putting a strong focus on return on investments. We're reducing discounts on Tencent video subscriptions, which has the effect of raising our effective video ARPU. For Video Accounts with our ecosystem reaching a virtuous cycle stage of critical mass, when more viewers attract more content creators and vice versa, we can reduce our content procurement spendings. And with the product reaching scale, we can also devote our engineering resource to optimize bandwidth and server utilization associated with the service, bringing down our unit cost per video view. So in addition to the last 2 stages, if you will, we have also developing -- we have been developing new and high-quality revenue streams that will drive earnings growth in this period.

Now today, I will discuss the most immediate of these revenue initiatives, and that is advertising within Video Accounts. Video Accounts has become one of the most popular short video services in China with substantial user engagement. In the second quarter, its total time spend exceeded 80% of Moments level. Its total video views increased robustly by over 200% year-on-year. In addition, several features of the Weixin ecosystem amplify the effectiveness of Video accounts ads for advertisers.

Firstly, we provide transactional functionalities within Weixin, such as Mini Programs where advertisers create powerful landing pages and facilitate transactions and WeCom where advertiser salespeople can interact with interested consumers. So advertisers can drive sales and leads conversion seamlessly within the Weixin ecosystem. Secondly, the range of interactions with our users enable us to help advertisers better target their audiences. And thirdly, our social graph enables advertisers to reach a broad audience base and build deep user engagement.

We believe that Video Accounts in-feed ads represent a very significant value creation opportunity for us because strategically, they allow us to expand our end market share. As advertisers have already been spending aggressively on multiple short-form video platforms, we should be able to capture more advertising budgets. And financially, they layer a new revenue stream with high incremental margin onto our existing cost base.

In terms of schedule, we launched in-feed ads in mid-July, initially selling the ads on a contract basis, and we will be making additional inventory available on a bidding basis by the end of August. Our monetization framework for video accounts ads is similar to that of Weixin Moments in terms of a progressive climb over time. For your reference, Weixin Moments took 5 quarters to reach RMB 1 billion in quarterly ad revenue. We expect to surpass that level more quickly with video accounts given the current size of traffic and already strong advertiser demand for short-form video ads. Video accounts will eventually grow into a substantial revenue source for us over time.

Before closing my strategy review section, I would like to share with you how we are positioned to enhance and broaden our revenue growth when the macro environment improves. On top of driving a near-term earnings bottoming out as well as recovery through efficiency and revenue initiatives that I just talked about.

Firstly, we believe that the regulatory environment in China is progressing from rectification to normalization gradually, which should bode well for the industry over time. Specifically, the platform economy, we saw recent regulatory direction trending more positive and supportive, supporting well-regulated healthy and sustainable development of the industry. For games, we believe the issuance of new Banhao should help the overall industry renew growth over time. We expect to receive Banhao in the future, which should benefit our domestic game business.

Secondly, several of our businesses were adversely affected by COVID-19 resurgence and economic deceleration, but are significantly geared toward a future economic upturn. Approximately half of our revenues are from activities that closely contribute to and benefit from China's economic activity in the form of FBS and advertising. As an example, our commercial payment volume slowed to low single-digit growth in April as major cities locked down, but recovered to high-teens growth in June. For advertising business, the revenue decline rate stabilized in the second quarter before the benefit of launching video accounts, in-feed ads and under the current macro environment. So in conclusion, we remain confident about our resilience in navigating through challenges and our ability to capture opportunities when they arise. Now, with that I'll pass to James to talk about the business review.

[James Mitchell, executive]

Thank you, Martin. For the second quarter of 2022, our total revenue was down 3% year-on-year. VAS represented 53% of our total revenue, within which the social network subsegment was 21%, domestic games 24% and international games 8%, online advertising was 14% and FinTech and Business Services was 32% of total revenue. For value-added services, segment revenue was RMB 72 billion, broadly flat year-on-year. Social network revenue was up 1% year-on-year to RMB 29.2 billion. Increased revenue from video accounts live-streaming services were largely offset by decreased revenue from music- and games-related live streaming services. Video subscription revenue increased year-on-year as less promotional activity resulted in subscriptions dipping to 122 million, but higher ARPUs. We launched several popular self-commissioned drama series such as a Dream of Splendor, which ranked 1st by video views across all online platforms in China in June.

Per Quest Mobile, Tencent Video widened its audience lead with its mobile DAU more than 20% higher than that of its closest peer in June. Our music subscription count and subscription revenue increased year-on-year. In July, Tencent Music sold over 6 million units of Jay Chou's digital album, reflecting pent-up demand for user engagement with artists. Domestic game revenue was down 1% year-on-year to RMB 31.8 billion, reflecting transitional industry-wide challenges, including fewer big game releases, lower user spending and minor protection measures. Revenue from existing games, Honor of Kings, League of Legends and Moonlight Blade Mobile decreased our recently launched games, Fight of the Golden Spatula, Wild Rift and Return to Empire contributed incremental revenue.

International game revenue decreased 1% year-on-year to RMB 10.7 billion due to an industry-wide normalization in user spending on mobile games post-COVID. PC game revenue increased, benefiting from robust growth in VALORANT and the launch of V Rising.

The Weixin video accounts on the consumer side, total video views increased over 200% year-on-year benefiting from increased social sharing and improved AI recommendation algorithms with video of use for AI recommended content increasing over 400% year-on-year. On the producer side, daily active creators and video uploads in video accounts grew over 100% year-on-year, providing additional content breadth and depth to support future consumer engagement. We increased video accounts mind share among live streaming fans with a series of live concerts each attracting tens of millions of viewers as well as top-tier sponsors.

On Q2, we enriched virtual experiences where users interact using their Super QQ Show avatars. We introduced shared virtual spaces where users can make friends and engage in community activities such as holding virtual beach parties and graduation ceremonies. And we enabled users to chat over live audio using their avatars.

Turning to domestic games. We're using the current digestion periods to develop our technical capabilities and sustain our player engagement, which should position us well once conditions normalize. For measuring engagement, one can look at the time spent on our games in the most popular and fastest-growing game categories relative to competing titles in those categories in relative to the past. The most popular game categories in China are battle arena and action shooter games. Within which our flagship Honor of Kings battle arena game was the first place game by total time spent across all games in China in the second quarter.

While its monetization decreased year-on-year, its total time spent by adult players slightly increased, and our newer battle arena game Wild Rift ranked 6th by total time spent. Our action shooter game PeaceKeeper Elite was the second place game by total time spent industry-wide and also increased its adult player total time spent year-on-year. Among the fastest-growing genres, we entered the management simulation category with the July release of League of Legends Esports Manager, which is currently the highest grossing simulation game year-to-date. We entered the extraction shooter category with Arena Breakout, which ranked 8th by total time spent among all games in July. And our auto battler game Fight of the Golden Spatula released late last year has climbed to the 4th highest time spent game industry-wide in the second quarter.

The international games is also experiencing a digestion period, but we're progressing on some key strategic initiatives, which we view as positive signposts for the future. Illustrating our studios game operation capabilities, Riot's 2-year-old VALORANT achieved record high MAU and quarterly grossing receipts in the second quarter. VALORANT has broken into and crowned the crowded tactical shooter category through super serving unmet player needs, prioritizing fairness over monetization and they're in highly professional esports activities on top of the core compelling competitive experience.

On the acquisition front, our European mobile game studio Miniclip recently acquired SYBO, developer of the endless runner game Subway Surfers. Subway Surfers is the most downloaded mobile game globally over the past decade and boosts Miniclip's daily active user base by 30 million to a total of 70 million, positioning Miniclip as one of the biggest developers by DAU worldwide.

On the new game front, our Swedish studio, Stunlock's V Rising game sold over 2 million copies in its first month of early access on stream, showcasing our competitiveness in the increasingly important genre of survival open-world crafting games.

Moving to online advertising. Our advertising revenue was RMB 19 billion in the second quarter, down 18% year-on-year, reflecting weakness, particularly in the Internet services, education and finance sectors. However, this quarter marked our first sequential revenue growth since the second quarter of 2021, with a tailwind from positive seasonality and a headwind from comparing against the Winter Olympics in the first quarter this year. Ad spending on our platform was impacted in April and May by the pandemic resurgence and logistics disruptions. In June, the year-on-year decline rate narrowed as large e-commerce platforms increased ad spend with us for the 618 promotions as year-on-year comparisons began to ease and as underlying advertising demand slightly improved.

In Moments, we introduced frame breaking ads, which are popular with brand advertisers. We began rolling out video accounts in-feed ads on a contract basis in July to influential brands such as BMW, Armani and Louis Vuitton. For media advertising, our long-form video ad revenue increased quarter-on-quarter due to stronger content releases and positive seasonality despite a tough comparison against the Winter Olympics.

Looking at FinTech and Business Services segment revenue was RMB 42 billion, up 1% year-on-year and down 1% quarter-on-quarter. The FinTech Services revenue growth paused in April and May as disruptive COVID-19 resurgence has impacted commercial payment activities. Nationwide, our commercial payment volumes slowed to low single-digit growth in April, but bounced back to high teens growth in June. On a regional basis, payment volume for every province in Tier 1 city in Mainland China has now returned positive on year growth rates. For Business Services, our revenue declined slightly year-on-year as we continued to scale back loss-making activities, in particular projects with a high proportion of subcontracting. Our own products revenue grew sequentially, especially in areas such as database, Big Data and AI. Hence, our business services gross margin increased quarter-on-quarter, benefiting from the improved revenue mix and reduced cost base.

In Platform as a Service, our TDSQL database revenue grew over 30% year-on-year, contributing over 5% of our cloud revenue. Key financial institutions increasingly adopted our database for their core systems. We released a new version of our cloud-native solution, TDSQLC with comprehensive upgrades in product architecture, hardware capabilities and engine kernels. Frost & Sullivan named TDSQL, the leader in distributed databases in China, citing our strengths in areas such as scalability and industry solution service support. The Software as a Service, Tencent Meeting launched a marketplace plug-ins in June. Examples of plug-ins include Tencent eSignature, which enables users an enterprise to sign agreements in a secure manner anywhere. Evernote, which provides a convenient way for participants to create notes during meetings. And NeoCRMs plug-in, which simplifies scheduling before a call, database access during a call and maintaining leasing records after a call. Now I'll now pass to John to discuss the financial review.

[Shek Hon Lo, executive]

Hi, everyone. For the second quarter of 2022, total revenue was RMB 134 billion, down 3% year-on-year or 1% quarter-on-quarter. Gross profit was RMB 57.9 billion, down 8% year-on-year or up 1.4% quarter-on-quarter. Net other gains were RMB 4.4 billion, down 79% year-on-year or 66% Q-on-Q, which were primarily non-IFRS adjustment items such as net gains on deemed disposals, disposals and revaluation of certain investments, partly offset by impairment provisions against certain domestic investees.

Operating profit was RMB 30.1 billion, down 43% year-on-year or 19% Q-on-Q. Net finance costs were RMB 1.8 billion, down 7% year-on-year and quarter-on-quarter. The year-on-year change was mainly due to ForEx gains recognized this quarter compared to losses for the same period last year, partly offset by the increase in interest expenses due to increased indebtedness. Share of losses of associates and JV were RMB 4.5 billion compared to RMB 3.9 billion last year. Non-IFRS share of losses were RMB 1.0 billion or RMB 1 billion compared to RMB 0.4 billion last year, mainly reflecting the impact from JD.com ceasing to be an associate.

Income tax expense increased by 25% year-on-year to RMB 4.6 billion, primarily driven by a low base effect resulted from one-off deferred tax adjustment associated with an investee last year as well as the provision of withholding tax during the quarter. The effective tax rate was 19.2%. IFRS net profit attributable to equity holders was RMB 18.6 billion, down 56% year-on-year or 20% Q-on-Q. Diluted EPS was RMB 1.915, down 56% Y-o-Y and 20% Q-on-Q. On non-IFRS basis, operating profit was RMB 36.7 billion, down 14% Y-on-Y or up 0.4% quarter-on-quarter. Net profit attributable to equity holders was RMB 28.1 billion, down 17% year-on-year or 10% -- or up 10% Q-on-Q. Diluted EPS was RMB 2.896 down 17% Y-o-Y or up 11% Q-on-Q.

Moving on to gross margins. The overall gross margin was 43.2%, down 2.2 percentage points year-on-year or 1.1 percentage points Q-on-Q. By segment, gross margin for VAS was 50.6%, down 2.3 percentage points Y-on-Y or up 0.2 percentage points Q-on-Q. The year-on-year margin decrease was a result of revenue mix shift within the segment, particularly more revenue contribution from lower-margin video accounts live streaming services as well as higher staff costs with stable revenue. Gross margin for online advertising was 40.6%, down 8.2 percentage points year-on-year or up 3.9 percentage points Q-on-Q. The year-on-year margin decrease reflected higher operating costs, in particular, cost associated with video account, staff force as well as the fact that full exemption from cultural construction fee no longer available this year. The Q-on-Q margin improvement was driven by 618 e-commerce festival, video content cost optimization as well as the absence of content cost from Winter Olympics.

Gross margin for FinTech and Business Services was 33.3%, up 1.3 percentage points year-on-year or 1.7 percentage points Q-on-Q. The year-on-year margin improvement was due to favorable mix shift within FinTech Services and lower revenue proportion from Business Services, which carry a lower margin. The Q-on-Q margin improvement was driven by cost optimization and reduction of loss-making activities of cloud services.

On operating expenses, selling and marketing expense was RMB 7.9 billion, down 21% Y-o-Y or 2% Q-on-Q, reflecting more disciplined marketing activities, particularly for digital content services. Selling and marketing expense was 5.9% of revenues, down 1.3 percentage points year-on-year. R&D expenses were RMB 15 billion, up 17% year-on-year or down 2% Q-on-Q. The year-on-year increase was mainly due to higher staff costs and Q-on-Q decline reflected our efforts to optimize workforce and control growth and staff force. R&D expenses was 11.2% of revenues. G&A expenses, excluding R&D, were RMB 11.2 billion, up 14% Y-o-Y or down 0.6% Q-on-Q. Year-on-year increase was mainly due to higher staff force and office expenses. As at quarter end, we had approximately 111,000 employees, up 18% year-on-year or down 5% quarter-on-quarter.

Just to take a look at our operating and net margin ratios. Non-IFRS net margin was 27.4%, down 3.6 percentage points year-on-year or up 0.4 percentage point quarter-on-quarter. Non-IFRS net margin was 21.6%, down 3.8 percentage points year-on-year or up 2.2 percentage points Q-on-Q. The sequential improvement reflects our business rationalization and cost optimization initiatives as well as lower associates' losses.

Finally, I will summarize some key cash flow and balance sheet metrics. Total CapEx was RMB 3 billion, down 57% both year-on-year and quarter-on-quarter. Within CapEx, operating CapEx was RMB 2.1 billion, down 65% year-on-year as we proactively reassessed and tightened our spending trend for the year. Nonoperating CapEx decreased by 8% year-on-year to RMB 0.9 billion. Operating cash flow for the quarter was RMB 35.7 billion, up 12% year-on-year and 6% quarter-on-quarter. Free cash flow for the quarter was RMB 22.5 billion, up 30% year-on-year or 47% Q-on-Q, reflecting operating cash flow generation and modest disciplined spending towards CapEx in media content.

Net debt position was RMB 20.4 billion compared to RMB 11 billion last quarter. In addition to currency translation difference, the sequential increase was mainly due to payment of cash dividend by the company amounting to RMB 13 billion and repurchase of shares by the company amounted to RMB 3 billion, largely funded by free cash flow generation during the quarter. The fair value of our shareholdings and listed investee companies, excluding subsidiaries, was approximately RMB 602 billion, as of 30th of June 2022.

[Operator]

[Operator Instructions] Our first question comes from Ronald Keung of Goldman Sachs.

[Ronald Keung, analyst]

Tony, Martin, James and John, hearing all the impressive user and time spent growth of video accounts. So I want to hear what is management's expectation of the potential room for advertising revenues from this video accounts if we benchmark with other short-form video platforms? How do we see e-commerce as a potential within that? And would there be any time spent cannibalization within WeChat as video accounts continue to grow?

[Huateng Ma, executive]

Yes. Thank you very much for the question, Ronald. So in terms of benchmarking the long-term revenue opportunity for video accounts, then we provided a couple of references. What is the video accounts now represent roughly 80% as much time spent as Weixin Moments, and that ratio has, of course, been rapidly climbing. All else equal, the eCPM on video accounts will likely be slightly lower than Moments, but the advertising intensity will be higher. And so net-net, the revenue potential per minute of user time spent will be higher. Another way of benchmarking is against the incumbent short-form video services. Currently, video accounts has lower aggregate time spent, but the CPM appears competitive with those incumbent services or superior to those incumbent services.

And I think if you take the 2 together, they actually tie out fairly similar outcomes to each other. In terms of the risk of video accounts cannibalizing Weixin Moments, then we have not seen such cannibalization, and we do not expect to see such cannibalization because the different services provide different user needs just as the growth of Moments did not cannibalize Weixin Chat. We believe the chat experience, the experience of sharing photos and articles with your friends and the experience of watching short-form videos provided by AI algorithms at 3 discrete Internet use cases.

[James Mitchell, executive]

In terms of e-commerce, right, I would say we do see e-commerce live streaming to be an opportunity potential, but that would take some time. I think in terms of staging, right, we actually have to go from the short-form video to live streaming. As you can see, we actually have been building the user habit of live streaming over time, including the very successful launch of some of the live concerts. And once we have built a habit of people watching live streaming, then we actually need to have an ad system, right, which actually can allow some of the merchants to bring traffic, not just from organic basis, but also by throwing ad dollars to attract the users to -- into their live stream e-commerce.

And then, when that happens, then we need to recruit merchants to be doing live streaming for the purpose of e-commerce. After all this is done, right, I think our ecosystem advantage would start coming into play because our mini programs can actually very easily help the merchants to conclude transactions. And our private domain advantage can actually help merchants to accumulate customers of their own and establish a longer-term relationship than just a onetime transaction. So I think those will be sort of the progression of the live streaming e-commerce, and we try to do it on a stage-by-stage basis.

[Operator]

Next question comes from the William Packer of Exane.

[William Packer, analyst]

Firstly, could you update us on any developments in the recognition backdrop following the recent commentary from the authorities around the healthy development of the platform economy and completion for rectification. Last quarter, you provided some helpful observations arguing it would likely take time for these high-level directives to filter through to specific regulators. And I'd also likely follow a sequence. Are there any developments to highlight? Then secondly, operating cost growth slowed further in Q2 relative to recent quarters demonstrating good cost control. Could you help us think through the trajectory of cost growth over the rest of the year and the key puts and takes?

[Huateng Ma, executive]

Okay. Well, in terms of your first question on the regulatory front, I think we have given some of the highlights in our strategy section. But I think as you have observed, right, the recent regulatory direction is actually trending towards more positive tone for platform economy and the key message is like one to promote well-regulated, healthy and sustainable development, two, to complete the ratification, and three, to carry out regular supervision. And that's reiterated in both the state council meetings as well as the politburo meetings in late July. And I would say along that guiding principle, right, we have seen a number of observations. Number one is that there's actually no new regulation this year that are materially detrimental to the industry. And the second one is there is a resumption of the issuance of Banhao and there are multiple batches that have been issued.

And in addition to that, thirdly, we also have seen initiatives to formulate more supporting policies for platform economy across various regulatory bodies. For example, one is NDRC-led interim ministerial task force that has been set up to foster the development of digital economy and coordinate policies on strategic areas such as Big Data and Internet Plus. And the Ministry of Commerce also announced opinions to promote the development cultural content, for example, expanding pilot program of game approval fostering internationally renowned brands in games. So we have seen quite a few new developments along the line of the general more supportive direction. Having said that, we do expect the supporting measures will take time to play out, and we look forward to seeing more of them coming in the near future.

[James Mitchell, executive]

And well, on your second question around the impact of the various margin initiatives, then Martin talked about the first batch of cost initiatives that we've already implemented. And for those, I think you've started to see the marketing expenses come down quite sharply already. You have begun to see a partial although not full flow through to lower cost of sales, and you haven't yet in the second quarter, but you will in subsequent quarters, see a flow-through to G&A from some of the headcount and compensation adjustments we made. Martin also talked about a second batch of expense initiatives, which are more business group specific, which will take effect and show through during the second half of the year. And then finally, we have some high-margin revenue initiatives, of which the most immediate is video accounts that will flow through, too. So we believe with those 3 sets of initiatives taken together, we can return the business to year-on-year earnings growth even if the macro environment remains as it is today.

[Operator]

Next question comes from the Thomas Chong of the Jeffrey.

[Thomas Chong, analyst]

I have a question regarding the macro headwinds that we are seeing globally. I understand that management has different initiatives and cost control measures. But just wanted to get some color with regard to the gaming side. We are seeing our international game and domestic games are impacted by software gamer spending. Just wanted to get some color about our gaming strategy on this regard. How would we tackle these macro headwinds going forward? And then my second question is also relating to the cost side. Given that we have done a great job in the post control measure, just wanted to get some color about the earnings growth with all these initiatives? Should we expect this to happen starting in Q3?

[Chi Ping Lau, executive]

Thomas, so on the cost control, as we mentioned, we've taken a number of steps in the first half of the year. Some of those have already borne fruit in the second quarter results. Others will bear fruit in the second half of the year. We'll take some further steps. And we believe that we can return to earnings growth in the coming quarters even if our revenue remains as it is now. In terms of the game business, then you're right, it is a digestion year for different reasons, both for domestic and international games. And our strategy is to accept that and to focus on really deepening our engagement with users, which we've talked about in terms of our leadership in total time spent and also focus on developing our capabilities, especially in the international markets as well.

So our growth model is not predicated on the game business returning to revenue growth. We believe we can grow earnings even with the game business as it is now. And for the game business, both domestically and internationally, we're focused on engagement and capabilities, and we believe -- and also developing good new games. And we believe that in time as we move into next year, then that will position us for very well to resume game revenue growth. But I want to reemphasize that game revenue growth is not a precondition for earnings growth.

[Operator]

Next question comes from Eddie Leung of the Bank of America. It seems that Eddie has some technical problem. Let's move to the next question. Next is the Hyungwook Choi from Daiwa.

[John Choi, analyst]

Okay. Can you hear me?

[Operator]

Yes, we can.

[John Choi, analyst]

Okay. My question is more on the cloud business services. I think you guys mentioned that with the more internal strategy shift, focusing more on quality revenue growth, such as reducing loss-making activities. This has been a major reason. How long do you think this will last? Can you provide some color there? And at the same time, we are hearing the macro conditions are preventing a lot of the cloud deployment from many of your customers. Are you also seeing that of a major bigger impact? And just quickly on the margins, what are the key areas that we could further improve profitability, except for introducing more on SaaS, PaaS products? And a quick follow-up earlier I think you guys did mention on the ads video accounts that you will be progressive, but at the same time, it will be faster than what happened to Weixin Moments. So should we be expecting a different growth or trajectory for video accounts revenue momentum in the coming quarters?

[James Mitchell, executive]

Yes. In terms of cloud, I would say it is indeed partly macro and partly proactive initiative from our side to reduce the loss-making activities. Now on the macro side, there clearly the most impacted industry vertical is actually Internet industry. Industry -- internet customers basically got impacted the most as the industry faced macro challenges as a whole. And then at the same time, the macro environment also impacted some enterprise clients. And even in some cases, the deployment already signed contracts -- deployment actually sort of got impacted because of COVID-19 resurgence in different cities. So those are the factors on the macro side. And then on the proactive side, I would say one is actually, we reduced loss-making activities such as subcontracting and very heavy customization because those tends to be loss-making businesses.

And at the same time, we also refrained from cutthroat pricing. So certain projects, which clearly are going to lose money, and at the same time, they are of little value add, for example, if it's purely a CDN type of business without much opportunity for upselling than we, in the past, would still fight for those projects. More recently, we actually sort of intend to keep them up. So those combination of factors would mean that our revenue actually is seeing less growth. And in the past quarter, it actually declined year-on-year. But I think what we try to drive for is actually an increase in terms of gross profit and the narrowing of the losses that the business actually incur over time. And I think we're actually making good progress toward those goals.

Now in terms of margins, I would say, a very important part it's actually given we have very large existing customer base already. We actually focus our development and our operational and marketing effort on upselling our existing customers into our higher-margin PaaS and SaaS products, especially when these products are internally developed. They carry both revenue opportunities as well as margin improvement and profit-generating opportunities. Now in addition to that, I would say on the [ ICE ] and on the cost side, right, we actually also try to improve our cost efficiency by managing our supply chain better by introducing newer technologies such as newer tech and newer chip technologies.

In some cases, we actually sort of work with the chip developers very closely and sometimes we'd work with domestic chip developers very closely to get cheaper supplies. And at the same time, we actually mentioned that as part of the cost effort and as a very long initiative of moving all our domestic in-house services onto our cloud infrastructure, we finally, after 2 years have got it done. And this actually helped to increase the scale of our cloud infrastructure. And by that, it's not just about the procurement but also on the same tech infrastructure, it's supporting both internal and external clients, and that actually helps to improve our cost efficiency. And these are all activities, which would help to increase our margin.

[Chi Ping Lau, executive]

And on the video accounts, your question was whether the advertising ramp would be faster for video accounts for Moments? And the answer is yes, it is. And you'll see in coming days, we'll launch the bidding for the video account and feed ads to supplement the contractual pricing which should contribute to that ramp.

[Operator]

We are trying to reconnect with Eddie Leung. So next is Eddie Leung from the Bank of America.

[Eddie Leung, analyst]

Can you hear me?

[Operator]

Yes, we can hear you now.

[Eddie Leung, analyst]

And I apologize. Just a follow-up question about video account. I think you guys mentioned quite a bit about e-commerce advertisers. Definitely, with the connection to mini programs and WeCom we can see that. But just wondering down the road, for example, in 1 or 2 years' time, what type of use cases you can foresee from video account advertising beyond e-commerce transactions? And then related to that, how video account will affect the online advertising space, specifically, do you think it's more competing for budget on other, let's say, online media platforms? Or do you think it's creating new advertising demand and why?

[Chi Ping Lau, executive]

Yes, Eddie. So it's obviously competing with other short-form video platforms. Advertisers have a budget for short-form video, and they already split that 2 ways. And going forward, they're increasingly splitting that 3 ways. So advertisers say we're going to spend X amount online, Y percent of that will be on short-form video. And previously, we didn't tap into the X percent and now we've begun doing so. So that's where we think the budgets will come from. In terms of the e-commerce commentary, then with regard to the second quarter, what we called out was really that we saw an uplift in our e-commerce advertising spending in June and an uplift for the overall quarter versus the first quarter.

And there's a number of reasons for that, including the proliferation of mini programs, also including some of the changes in the China Internet landscape meant that some big e-commerce companies which underspent on Tencent properties in the past have begun spending more aggressively on Tencent properties. So there's been a market share shift in our favor from those really big companies. So in terms of video accounts, advertisers by category, then just as with Moments, we expect a broad spread of categories. So e-commerce is one, but Internet services is another consumer goods, food and beverage, automobiles, all important as well. And automobile is actually or another area where advertising has been slightly healthier in the last couple of months for us.

[Operator]

Next, we will take the question from Alicia Yap of Citigroup.

[Alicis a Yap, analyst]

I have 2. The first one is regarding the global gaming landscape. Obviously, we mentioned this is a post-pandemic digestion period. Is that fair to assume these digestion period will start to normalize in the next couple of quarters? How should we factor in the inflation issues into the gaming virtual item pricings versus the entertainment spending priority among the global gamers? So will gaming industry also face challenges on the backdrop of these global macro weakness? Or if we actually if we maintain the virtual item pricing despite these inflationary environment, will gaming actually become more affordable entertainment choices that we could actually see benefiting from there? So any thoughts that management could help us think about this growth prospect of the global gaming industry would be helpful.

And then second, very quickly on the cloud business. So I understand we have made some progress on enhancing and upgrading the various productivity software service. So and monetization may be still at early stage. But any color on the latest adoption rate for this new solution? Will this slight decline year-over-year that you mentioned on business services revenue taper-off in the second half then we could see -- started to see the positive growth earlier than expected?

[James Mitchell, executive]

Alicia, so on the game question, there's a great deal to unpack there, and I won't even begin to start because it's actually not the most important thing for us. So whether the international game industry returns to growth as we enter next year or takes longer, depends on whether the weakness we're seeing now is primarily a post-COVID phenomenon which should cycle out late this year, which would be positive or whether it's primarily a macroeconomic phenomenon which could last for longer depending on how global economics play out. And historically, the game industry has not been very economically sensitive. However, historically, the game industry was more of an upfront purchase model now with much of the monetization of games being driven by in-game kind of cosmetics decisions, one could argue that the game industry has become more discretionary in nature, and there are consumers who have been playing their favorite game, have been purchasing items in their favorite game, and then when conditions are more difficult in terms of employment or inflation, they reduce their spending while still continuing to playing the game.

And the reality is we just don't know, and no one really knows what the answer is to those imponderables. What we do know is that we have some exciting games in the pipeline, and we'll be launching in China in the coming weeks, which we're very excited about. We have [indiscernible] coming up internationally in the coming months. And then what we do know is the irrespective of whether the game business for us takes months or quarters to reaccelerate, we can grow the rest of our business and deeper our overall earnings irrespective of what's happening with that game recovery.

[Chi Ping Lau, executive]

Now in terms of the productivity software and the monetization, I would say this is definitely a revenue opportunity, right? And it's one of the revenue opportunities that we have in our coffer, but because it's not the most immediate and sizable in the near future. So that's why we didn't talk about it in the strategy update. So instead, within the strategy update, we only talk about the ads within the video accounts. But longer term, obviously, this is a revenue opportunity. In terms of the stage, I would say the adoption is still at the beginning. While it's encouraging, it's still small in absolute numbers, and we believe there needs to be a longer conversion and educational process through which we can get the enterprises to start paying for these productivity software.

As a matter of fact, if you would notice, right, this conference call now, we have actually moved from previous webcast to our own Tencent Meeting Service. So in effect, our department has become a paid user of our own productivity software. And we hope the service level is actually satisfactory, and you would actually help us to promote this service to other enterprises. Now in terms of the Business Services, in particular, cloud, right, which is the biggest component. I would say, for the moment, we're actually much more focused on making sure that we can grow our gross profit pool. And at the same time, we can narrow our absolute dollar in terms of losses of the cloud business. So this is actually the more near-term objective. And I would say in terms of the revenue growth, right, I think we're probably pushing it into the next year.

[Operator]

Our next question comes from the Charlene from the HSBC.

[Charlene Liu, analyst]

I would like to ask about -- I would like to ask if we can get some comments on recent news on potential for the divestment of your portfolio companies Meituan. And can you tell us your thoughts more broadly on the subject and whether there is any lesson learned from our early disposal of JD and Sea stakes this year? And a related question is on how are you thinking about your buyback plans under the backdrop of Prosus and Naspers lowering their holding in Tencent as well as our long-term and continual investment in strategic areas like international game SaaS and Video Accounts?

[Chi Ping Lau, executive]

Yes. Thank you, Charlene. So the specific news article you cited was not accurate. We are very focused on capital -- returning capital to shareholders given what we believe our share price is very undervalued and also undervalued in the context of our investment portfolio. So if you look at what we've done year-to-date, we've returned around $17 billion, $18 billion to Tencent shareholders. And we've been largely neutral in terms of our investments, divestments in other companies, excluding the substantial JD divestiture. So our focus from a sort of investments perspective has been buying back and dividending to our own stock, and that will likely remain the case going forward for some period of time.

In terms of your question as to how we can fund ongoing buybacks and dividends, then if you take our second quarter results, we generated annualized free cash flow of mid-teens billions of U.S. dollars and that's after investing in the CapEx and so forth to support Video Accounts and support international games and support enterprise software. In addition to that, we have disclosed that we have an investment portfolio whose market value was $90 billion at the end of the quarter. And we have demonstrated with JD and Sea that we're willing to work down that investment portfolio over time to more effectively return capital to Tencent shareholders. In addition to that, we have unlisted our private investment portfolio where the book value is over USD 50 billion. And we believe there's been substantial appreciation on that over $50 billion book value. And we also look for opportunities to return capital from that private investment portfolio in the form of dividends, distributions and buybacks.

So I think if you add all of the above, the annual free cash flow in the teens billions of dollars, the listed and unlisted investments in excess of $150 billion, then you'll see that we have substantial ammunition relative to our $370 billion market cap to continue doing dividends and buybacks at an aggressive rate. In terms of what are the lessons we have learnt from the JD distributions, then I would say that we've learned how to process some of the logistics efficiently, which is good. Means we can do future such distributions or sales more rapidly. We've also developed our ability to manage relationships around those transactions and demonstrate that while we have sharply reduced our stake in JD as an example, we continue to have a very good business relationship with JD and also with Sea on an ongoing basis. And then finally, I think our investors have responded quite favorably to the dividends and distributions. And that encourages us to think about how to continue down that capital return path going forward. Thank you.

[Operator]

Next question comes from the Gary Yu of Morgan Stanley.

[Gary Yu, analyst]

My first question is related to FinTech or payments business. How should we look at the revenue opportunity going forward? This is a revenue line which mostly related to consumption of macroeconomy. So how should we look at that in the second half or maybe going into next year? Second is a follow-up on Video Accounts. I think we mentioned that time spend is exceeding 80% of Moments. And if assuming this should surpass the time spend on Moments very soon, so does it mean that sometime next year or in the foreseeable future, Video Accounts will very soon become our #1 kind of advertising channel within the Tencent ecosystem with revenue even exceeding the Moments? And if we compare with other peers, are we confident that we can have a revenue per time spend, which is at least equivalent or even better than some of the other short video peers?

[Chi Ping Lau, executive]

Yes. Thank you for the questions, Gary. So on the FinTech business, then I think sometimes people operate onto the misapprehension that Tencent operates more in the virtual world rather than the physical world and is therefore immune to slowdowns and unaffected by re-accelerations in the broader economy. And there may have been some truth to that misperception many years ago, but it's no longer the case today. Today, the FinTech business is our biggest single activity. And if you look at payment merchant acceptance businesses like Visa or Mastercard in the Western world, then they're very clearly geared to economic activity. They slowed down a great deal. When Western economy slowed down and they reaccelerated as Western economies reopened. And the same thing is proving true for our payment business.

As we mentioned in the introductory remarks, our payment volume growth slowed to low single digits year-on-year in April and May when cities went through the COVID-19 shocks. And then accelerated to high-teens growth year-on-year in June and accelerated again in July. And the payment volume growth correlates quite neat with the payment revenue growth. So we had a sharp deceleration just as Visa and Mastercard did because of COVID-19 shocks, and now we're experiencing an upturn. And to the extent the China's economy reaccelerates, then certainly our payment business, also our advertising and our business services activities should enjoy the benefits just as they've suffered during the slowdown period. So that's on the FinTech question.

In terms of the Video Accounts and how we stack up versus peers from a monetization perspective, then we have been running in-feed ads within the Video Accounts for several weeks now. Those in-feed ads are sold on a contract basis currently. Those -- the eCPM on those contract adds is moderately lower than the eCPM on contract adds on Moments, but it's higher than the eCPMs, the blended eCPM for ads on the 2 incumbent short video services. We will be rolling out bidding price adds within Video Accounts in the coming days. And from that experience, we will have a clearer picture of what the long-term eCPM is for Video Accounts based on the 2 incumbent services. But based on the data that we've seen so far from both the contract priced ads and before that from the quality and the enthusiasm of the sponsors for the live stream concepts on Video Accounts, I'd say that we're quite optimistic that the eCPMs will achieve for our Video Accounts ads should be at least par with the eCPM of the leading short video platform in China today.

[Operator]

We will take the next question from Jerry Liu of UBS.

[Yuan Liu, analyst]

I wanted to ask about maybe a little bit of the reverse of some of the questions earlier about cost control. It sounds like with payments, with advertising we're seeing some improvement in these businesses in just recent months and weeks. And sooner or later, we're going to have new games coming through. So one of the investor questions we've been getting is, as that happens, are we going to ramp up some of the sales and marketing and spending? So I get that if revenue is flattish than where we're seeing is we can still get to our earnings growth environment. Now would we -- if we have the opportunity go back to slight investment mode to drive revenue growth?

[Chi Ping Lau, executive]

I think the assumption is correct. If we have a new game then, of course, we're actually supported with a marketing campaign, and we believe that will be money well spent and especially if it's on a pretty significant title like Undawn.

[Yuan Liu, analyst]

If I may ask a follow-up. So there's been some questions recently about just the ramp of Video Accounts. And I'm just wondering what is the kind of the limiting factor to the bottleneck due to the pace of the ramp, if you will? I know in the past, for example, with Moments we've talked about user experience in terms of how fast we crank up the ad load. Is that also the key consideration here? Or what is maybe the priority to determine the pace we can ramp up advertising?

[James Mitchell, executive]

Yes. So there's continual optimization and reoptimization process where we expand the percentage of Video Accounts users who can see ads. We show them 1 add per user day. We measure the performance of that ad. We optimize. Then we increase the number of ads per user day. We measure the performance of the incremental ads we reoptimized. And for Weixin Moments that optimization and reoptimization took a long time because it was the first time we've done it at scale, at least within a Weixin property and because we didn't have external comps to benchmark against. For the Video Accounts, we're going through that process faster because we have the experience of Moments, because we have the external comps to benchmark against. And also, I believe, because machine learning, hardware and software are better now than they were then. So by point of reference, I think if you look back at Moments then the time lag between us launching contract price ads versus bidding ads was many quarters versus for Video Accounts is a few weeks.

[Operator]

Next question comes from the Esme Pau from Macquarie.

[Esme Pau, analyst]

Can you hear me?

[Operator]

Your line is kind of breaking.

[Esme Pau, analyst]

This is Esme Pau of Macquarie. My first question relates to Video Accounts. So I'm just commenting the previous questions that were asked. Obviously, the user engagement momentum is very strong as well as very clear road map that we have and that bodes well for monetization. So just looking at this very holistically, what are the synergies within the Weixin ecosystem? And how does that compare with ad formats such as Moments and Official accounts, given our perspective of a full funnel strategy? And I'll ask the second question about games later.

[James Mitchell, executive]

I think that Martin touched on some of the synergies in the opening remarks, including the facts that when an advertiser buys a video account they can have that link through to their Mini Program, which is their private domain transactional environment that they value very highly, including the fact that they can have the ad linked through to WeCom, so that a consumer who's interested in a high-value product, such as electric vehicle can then chat with a salesperson for the electric vehicle OEM or dealer.

[Chi Ping Lau, executive]

There's no cannibalization right now, both from the perspective of user time spent as well as from ad dollar spent.

[Esme Pau, analyst]

Sure. That's very clear. And then my second question would be in terms of our international game and also how that aligns with our investment strategy. So our product investment strategy would be to emphasize on strategic growth. And right now, we're in the face of rebalancing our portfolio. So given the recent news headlines about Tencent potentially raising stake in a global game company, how should we think about global M&A opportunities? And also, how does that align with Tencent's international game strategy?

[James Mitchell, executive]

Yes. So in terms of our international games strategy, there are sort of 3-prongs for delivering new games. One is the existing international investees bringing new games to market. And some of those investees -- consolidated investees such as Riot and Supercell are very well known to investors. But in the last 5 years, we've invested in a range of other investees, such as Stunlock that are less well known to investors. But with the success of Rerising or we hope the forthcoming success of Darktide we believe there'll be more understanding of the value of this with these international studios. And then secondly, we have our big domestic studios such as Quantum, TiMi, Aurora and Mo Fan that are developing games that will be released both in China and overseas such as [indiscernible]

And then thirdly, we continue to be quite active in terms of acquiring new game studios. So we called out the fact that we've recently Miniclip is acquired. What Miniclip is, as you probably know a consolidated subsidiary, has acquired Sybo. And Sybo brings with it the game Subway Surfers. And Subway Surfers has 30 million daily active users, which is actually a gigantic number. I mean, normally in China, when we look at international game studios, the revenue is very impressive, the product is very impressive, but the daily active users are in order of magnitude smaller than what equivalents would achieve in China because the China game market has many users. But 30 million daily active users is a big number by anyone's standards, including our standards. So as you can see from Sybo and it's 30 million people playing Subway Surfers each day, we continue to be active in acquiring game studios outside China.

[Operator]

We will take the last question from Alex Yao of JPMorgan.

[Alex Yao, analyst]

Two questions. Number one, can you share with us your latest thoughts on FinTech development strategy? For example, does Tencent need to apply for a financial holding company license? Does Tencent need to establish a separate credit scoring unit and apply for a relevant license? Are you guys going to build your FinTech business in a similar or different way compared to comparable-sized FinTech peers? So that's the number one question. And number two, I think after hearing your aspects of Video Accounts monetization, am I getting right that you guys are monetizing this ads property in a philosophically different way compared to your approach on Moments? And thinking about the long-term monetization potential, would you say you will run the ads load in a similar level as the current peers in the market, given that the ads load on Moments after years of monetization is still significantly below general purpose of feeds-based products?

[Chi Ping Lau, executive]

So in terms of our FinTech development, I think it's actually relatively stable and progressing quite well. And as you can see, FinTech is already a pretty significant part of our overall business. And in the past year, we have been engaging with the regulatory authorities to make sure that each part of the FinTech business is completely compliant and have gone through a lot of business changes to make sure that these are all done. And in terms of the financial holding company, we are still working with the regulators on the licensing part. And I would say we -- whether we're going to be getting a financial holding company license, it will not have a major impact on our businesses. The key goal is actually to understand what will be satisfying the regulators' most stringent requirements.

So if the end result of the exercise is that we will be applying and the regulator will give us 1 license then that will be grades, and we believe it will not have an impact on our business. Our business can continue to be conducted. And likewise, for the other specific questions about whether you need a license here or any of the license there or whether you need to make some changes to the current practice. We believe we have actually been through the examining exercise for the past 1.5 years. And we're pretty comfortable that we know exactly what we need to do in order to continue to grow our FinTech business.

[James Mitchell, executive]

And under Video Accounts monetization, has the philosophy changed versus Moments monetization? No, the philosophy is exactly the same and that we prioritize the user experience first. And you can see that, that prioritization is paying off because the number of video views within Video Accounts grew over 200% year-on-year. Now, there are some differences between now and when we began monetizing Moments. One difference is that the benchmarks are much clearer for short-form video than they were for Moments. The second difference is that the machine learning software and hardware is better. The third difference is arguably that the cost to the consumer of an ad load within short-form video is lower than within a social network such as Moments because within short-form video, the consumer is continually previewing videos, swiping through those she doesn't want to watch and accepting those she does want to watch.

And so if in the same way she sees an advertisement that she doesn't want to watch, she swipes through it. She doesn't view that as necessarily detracting from her overall engagement with the short-form video product. And that's why if you look at the 2 incumbent short-form video services in China, they're able to maintain ad loads of roughly 14% to 16%. For Moments, as you may know, the ad load, we show 3 to 4 ads per user day. Given not all users see all of those ads for various reasons, the effective ad load is closer to 2% to 3%. And yes, we do expect Video Accounts to transcend to overtake Moments in terms of ad load given where the 2 incumbent peers are ready actually.

[Operator]

We are now ending the webinar. Thank you all for joining our first results webinar held on our internally developed Tencent Meeting software. 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 webinar will also be available soon. Thank you, and see you next quarter.