Tencent Holdings Ltd

HKEX:700

Earnings Call Transcript 2023-Q2

[Wendy Huang, IR]

Good day, and good evening. Thank you for standing by. Welcome to Tencent Holdings Limited 2023 Second Quarter Results Announcement Webinar. I'm Wendy Huang from Tencent IR team. At this time, all participants are in a listen-only mode. After the management's presentation, there will be a question-and-answer session. [Operator Instructions] And 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.

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; and Chief Strategy Officer, James Mitchell will provide a business review and update on our progress on some strategic growth drivers. Chief Financial Officer, John Lo, will conclude with financial discussion before we open the floor for questions.

I will now pass it to Pony.

[Pony Ma, Chairman & CEO]

Okay. Thank you, Wendy. Good evening. Thank you, everyone for joining us. During the second quarter of 2023, we sustained a solid revenue growth rate, along with a gravitation to a higher-quality revenue streams with better margins. This transition combined with careful cost discipline developed in the previous years, resulted in profit growth exceeding revenue growth. We achieved notably rapid growth in advertising revenue, benefitting from deploying machine learning on our advertising platform and from Video Accounts monetization.

Now let me go through the headline financial numbers for the quarter. Total revenue was RMB149 billion, up 11% year-on-year or down 1% quarter-on-quarter. Gross profit was RMB71 billion, up 22% year-on-year and 4% quarter-on-quarter. Non-IFRS operating profit was RMB50 billion, up 37% year-on-year and 4% quarter-on-quarter. Non-IFRS net profit attributable to equity holders was RMB38 billion, up 33% year-on-year and 15% quarter-on-quarter.

Turning to our key services. Our Communications and Social Networks combined MAU of Weixin and WeChat [indiscernible] year-on-year and quarter-on-quarter to 1.3 billion, with increased synergies among Video Accounts, Mini Programs and Moments. For Games, we released two high-quality PC games in China, our most important PC game launches since 2015. In generative AI, we are internally testing our own proprietary foundation model in different use cases, and are providing Tencent Cloud Model-as-a-Service solutions to facilitate the efficient deployment of open-source foundation models in multiple industry verticals.

I will now hand over to Martin and James for business review.

[Martin Lau, President]

Thank you, Pony, and good evening and good morning to everybody. For the second quarter of 2023, our total revenue was up 11% year-on-year. VAS represented 50% of our total revenue, within which Social Networks sub-segment was 20%, Domestic Games sub-segment was 21%, and International Games was 9%. Online Advertising was 17% of total revenue and FinTech and Business Services was 32%.

Our Value-Added services segment revenue was RMB74 billion, up 4% year-on-year. Social Networks revenue was up 2% year-on-year to RMB30 billion, driven by increased revenue from Mini Games and music subscriptions, which was partially offset by lower revenue from music and games-related live streaming services. Long-form video subscription revenue decreased 2% year-on-year.

Video subscriptions declined at 5% year-on-year, but increased 2% quarter-on-quarter to RMB115 million, benefitting from our original animated series and drama series. We're consistently upgrading our content production capabilities. For example, we're now applying unreal engine for producing animated content such as our series, The Land of Warriors, in order to streamline the workflow and enhance production capacity and efficiency.

Music subscription revenue increased 37% year-on-year as both ARPU and subscriptions grew at double-digit rates year-on-year. TME has enriched its subscription offerings in terms of membership privileges and content. And in June, our music subscriptions count achieved a record high of 100 million. Domestic Games revenue was stable year-on-year at RMB32 billion, partly due to less commercial content scheduling for our biggest games after a very robust first quarter.

Revenue from our relatively new and growing competitive eSports games, Arena Breakout and Fight of The Golden Spatula increased. International Games revenue increased 19% year-on-year, up 12% in constant currency terms to RMB13 billion, benefitting from the robust performance of VALORANT, NIKKE and Triple Match 3D.

Moving on to Communications and Social Networks. Weixin total user time spent increased healthily in the second quarter, benefiting from greater engagement across Video Accounts, Mini Programs and Moments. Video Accounts expanded its user base and deepened user engagement. Total time spent almost doubled year-on-year in the second quarter, driven by double-digit growth in DAU, a much faster growth in terms of per-user time spent. Meanwhile, we achieved strong growth in user interactions such as likes and comments.

We are strengthening our content ecosystem by facilitating a thriving creator community as daily active creators and daily video uploads sustained robust year-on-year growth in the second quarter. We're providing tools, which help creators scale their Video Accounts presence while also contributing to our ad revenue growth.

Video on deeper user engagement and a stronger content ecosystem, we’re making significant progress in expanding monetization opportunities within Video Accounts. For Advertising, we're in the early stages of establishing a significant revenue stream with high incremental margins. We believe there is still a very substantial revenue potential to be realized going forward.

Live streaming eCommerce, which is still at early stage of development achieved 150% year-on-year GMV growth in the second quarter, providing an opportunity for us to create a new high margin commission based revenue stream. During the quarter, we upgraded our consumer shopping experience and boosted repeat sales for merchants by sourcing more branded products, introducing shipping return insurance and upgrading customer service functionalities.

Turning to Mini Programs. We're now serving more than 1.1 billion users on monthly basis, and their engagement grew significantly as time spent per DAU increased double-digit year-on-year in the second quarter. 4 million developers participate in our Mini Program ecosystem, offering a breadth of Mini Programs ranging from public services and productivity tools to AI powered power -- photo editors.

Today, I would like to walk you through our recent success in Mini Games as a vertical use case example. Mini Games engage over 400 million MAU and 300,000 game developers build a point that Mini Program framework. Both leading game companies and smaller studios actively develop and operate Mini Games, including casual games, card games and many other types of games. In the second quarter, more than 100 mini games, each achieved quarterly gross receipts of over RMB10 million.

The strong growth of Mini Games demonstrates our compelling value proposition for developers. Firstly, for developers with innovative game concepts, we help them to reduce entry barriers and launch costs. They can build user base through social sharing, pre-existing log-in and instant play infrastructure offered by the Weixin ecosystem. Secondly, for developers with successful app games will enable them to extend their reach to a new audience of non-app users by porting to mini games.

Thirdly, developers can benefit from advancement in mini games infrastructure, leveraging our know-how and game technology. For example, our infrastructure can now support sophisticated genres such as shooters with fast loading and smooth gameplay.

Mini Games also provide Tencent with significant strategic value. First, through mini games, we host the largest casual game community in China with hundreds of millions of MAU, substantially exceeding the MAU of the largest app-based casual games in the market. Second, mini games allow us to expand our audience base and cultivate new gamers. Over 50% of mini games MAU do not play Tencent app games and half of mini games MAU are female. Finally, mini games provide us with game distribution and ad revenues characterized by high margins and platform economics as opposed to hit-driven dynamics.

From a reporting perspective, we report net platform fees to Tencent instead of gross user spend as revenue and we allocate these fees to Social Networks sub-segments instead of Games sub-segment, therefore growth in third-party mini games does not benefit our Games segment revenue, but flows through to our VAS segment in a form of high margin revenues. Developers can also buy advertising and contribute to our advertising revenue.

With that, I will now hand over to James to talk about the other business updates.

[James Mitchell, Chief Strategy Officer]

Thank you very much, Martin. For Domestic Games, our mobile and PC games MAU and DAU, each increased year-on-year in the second quarter. After releasing highly commercial content in the first quarter, we reduced such releases in the second quarter. Based on trends quarter-to-date, this reduction was a temporary phenomenon and we believe our Domestic Games revenue should resume year-on-year growth in the third quarter.

Taking a longer view, three of our new game launches in the past two years, Fight of the Golden Spatula, Arena Breakout and Wild Rift have been steadily building their user bases and each ranked among the top 10 mobile games from all developers in China by total time spent in the second quarter. While different new games from different developers show up in the top download and top grossing charts from month to month, we're more focused on cultivating evergreen successes for which the trend in total time spent is a better leading indicator of longevity as well as long-term revenue generation.

For example, Fight of the Golden Spatula achieved a new milestone of 15 million daily active users in June and ranked fourth by total time spent across all mobile games in China in the quarter. Arena Breakout also achieved record DAU in the second quarter and ranked eighth across all mobile games by time spent. As a high production value extraction shoot for our (ph) mobile, we believe Arena Breakout is the first of its kind globally, and we launched the game in International markets from July.

Meanwhile, the number of our existing long-life titles demonstrated their ongoing vitality, Naruto Mobile, which we launched in 2016 achieved all-time highs in gross receipts and average DAUs in the second quarter, driven by engaging gameplay, additional stories and attractive new characters with distinctive combat techniques. Despite multiple competitive launches over the years, Naruto Mobile is declared China leader in the fighting genre.

Dungeon & Fighter released 15th anniversary content update in June featuring a more contemporary anime-type art-style and improved combat visuals. As a result, DnF's average DAU increased by double-digit percentage year-on-year in June. While the second quarter was a quiet period for new mobile game launches for us, we have recently launched two big PC games in China, which will begin contributing to revenue in the third quarter.

VALORANT, a top tactical shooter in International markets was our most successful PC game release ever in China, measured by the number of active users on launch day. Among all games released since 2019, VALORANT is the most viewed game on the leading live streaming platforms. Lost Ark is currently the most played MMO action role playing game on Steam, with a 3D combat system captivating storyline and vast game border (ph) exploration. Since we launched Lost Ark in China in July, the game has become the most popular MMO game on live streaming platforms in China.

Turning to International Games. We saw ongoing growth from PC games, signs that the post-pandemic dip in activity is moving behind us in mobile games and positive contributions from certain recently released games. VALORANT continued its strong performance with DAU and gross receipts increasing year-on-year, fueled by the introduction of popular new agent Gekko, appealing items including weapons and skins as well as a new game mode premier that offers a professional tournament experience.

After a lengthy post-pandemic consolidation period, PUBG Mobile returned to year-on-year growth in DAU and gross receipts in June, driven by an upgraded Royale Pass system, a new dinosaur themed game mode and successful brand collaborations with Fabric and Ducati. Since its launch in November last year, NIKKE has increased user engagement through popular content updates, including new premium characters, added storylines with fully voiced scenes and successful thematic events.

Our Online Advertising revenue grew 34% year-on-year to RMB25 billion. While our growth rate certainly benefited from comparison against the pandemic depressed period a year ago, we believe we outpaced the overall industry, which we attribute to enhancements to the machine learning systems powering our ad platform as well as robust demand for Video Accounts ad. Advertising spending with ads grew at a double-digit year-on-year rate from every major advertiser category except transportation.

On Weixin, Video Accounts ad revenue exceeded RMB3 billion in the second quarter. More broadly, the deployment of eCommerce tools such as discovery of live streaming eCommerce and digital shops within Video Accounts contributed to the vibrancy of Weixin's overall commerce ecosystem, attracting merchants and brands to allocate increased ad budgets across multiple Weixin properties. Consequently, during the quarter, ad revenue increased year-on-year not only for Video Accounts but also from Moments, Mini Programs, and Official Accounts.

For content platforms, our music ad revenue grew notably year-on-year driven by ad-supported music service as well as brand sponsorship of offline music events, including TME's Wave Maker event. Our mobile ad network revenue increased significantly year-on-year, benefiting from partnerships with apps with high commercial value inventory. We upgraded our mobile ad network's infrastructure, enhancing efficiency and matching advertisers' demand with traffic supply and delivering higher ROIs for advertisers.

Looking at FinTech and Business Services, segment revenue was RMB49 billion up 15% year-on-year. Starting with FinTech Services, for commercial payments daily active users and transaction per user both increased year-on-year, and online and offline payment volumes grew year-on-year at similar rates as consumption spending generally picked up. Our wealth management business experienced healthy growth in the second quarter as we enhanced our investor education and services and users and AUM increased year-on-year.

On the regulatory front, we have completed self-inspection and corresponding rectification for Tenpay and upgraded the compliance capability of our payment business. We look forward to progressing our business and providing innovative services under the supportive regulatory framework. The Business Services year-on-year revenue growth returned to a low-double-digit rate in the quarter driven by fees collected on Video Accounts live streaming eCommerce transactions plus modest growth of cloud services.

Cloud Services revenue benefited from increased spending by industries, such as finance and automotive. Business Services gross margin increased notably year-on-year due to cost optimization as well as the new fee-based revenue streams. Within Cloud Services, we launched Model-as-a-Service solutions, leveraging our proprietary vector database and high-performance computing clusters. We're enabling enterprises in multiple industries, including tourism and public services to develop customized large models at higher efficiency and lower cost.

And I'll now pass to John.

[John Lo, CFO]

Thank you, James. Hello, everyone. For the second quarter of 2023, total revenue was RMB149.2 billion, up 11% year-on-year. Gross profit was RMB70.8 billion, up 22% year-on-year. Net other losses were RMB0.2 billion, mainly due to compliance-related costs, partially offset by net gains from deemed disposals and disposals of certain investee companies.

Operating profit was RMB40.3 billion, up 34% year-on-year. Net finance costs were RMB3.4 billion, up 82% year-on-year. This increase was due to the ForEx losses this quarter versus gains in the same period last year along with higher interest expenses. Share of profit of associates & JVs was RMB1.2 billion compared to share of loss of RMB4.5 billion in the second quarter of 2022.

On a non-IFRS basis, share of profit was RMB3.9 billion, improving from share of loss of RMB1 billion last year. This was due to better profitability among certain domestic associates, driven by their revenue growth and improved cost efficiency. Income tax expense increased by 144% year-on-year to RMB11.1 billion, due to pre-tax profit growth, increased withholding tax provision, and a true-up of deferred tax adjustments related to an overseas subsidiary. IFRS net profit attributable to equity holders was RMB26.2 billion, up 41% year-on-year. Diluted EPS was RMB2.695, up 41% year-on-year.

Now, I'll share our non-IFRS financial figures. Operating profit was RMB50.1 billion, up 37% year-on-year. Net profit attributable to equity holders was RMB37.5 billion, up 33% year-on-year. Diluted EPS was RMB3.875, up 34% year-on-year.

Moving on to gross margins. Overall gross margin was 47.5%, up 4.3 percentage points year-on-year. By segment, gross margin for VAS was 54%, up 3.4 percentage points year-on-year, driven by high margin game related revenue, including those from Mini Games, increased music subscription margin due to subscriber growth and ARPU expansion, and cost efficiency improvements across our digital content services.

Gross margin for Online Advertising was 48.9%, up 8.3 percentage points year-on-year due to increased mix of high margin Video Accounts at our revenue and improved cost efficiencies. Gross margin for FinTech and Business Services was 38.4%, up 5.1 percentage points year-on-year, reflecting Cloud Services cost optimization and high margin revenue from Video Accounts live streaming eCommerce transactions.

On operating expenses, selling and marketing expenses were RMB8.3 billion, up 5% year-on-year and representing 5.6% of revenues. R&D expenses were RMB16 billion, up 7% year-on-year. G&A expenses, excluding R&D were RMB9.4 billion, down 16% year-on-year, mainly due to reduced staff costs including share-based compensation expenses. At quarter end, we had approximately 105,000 employees, down 6% year-on-year or 2% quarter-on-quarter.

Let's look at our operating and net margin ratios. For the second quarter of 2023, non-IFRS operating margin was 33.6%, up 6.2 percentage points year-on-year. Non-IFRS net margin was 25.9%, up 4.3 percentage points year-on-year.

To conclude, I will highlight some key cash flow and balance sheet metrics. Total CapEx was RMB4 billion, up 31% year-on-year. Within total CapEx, operating CapEx was RMB3 billion, up 43% year-on-year, driven by increasing investment in GPUs and servers. Non-operating CapEx rose by 6% year-on-year to RMB1 billion.

Free cash flow for the quarter was RMB29.9 billion, up 34% year-on-year due to increased operating cash flow and decreased payment in CapEx. Net cash position was RMB17.7 billion, down 44% quarter-on-quarter. The sequential change was mainly due to dividend payments and share repurchases during the quarter. Thank you.

[Wendy Huang, IR]

Thank you, John. We shall now open the floor for questions. [Operator Instructions] Now let's take the first question from Ronald Keung from Goldman Sachs.

[Ronald Keung, Goldman Sachs]

Thank you, Wendy (ph). Thank you, Pony, Martin, James, and Wendy, and congratulations on the strong results. Want to ask about, firstly, on advertising that this has come through very strong at 34% with Video Accounts that you just mentioned, which is over RMB3 billion. So we're back to the two-year kind of CAGR positive growth. So how does management assess the second half outlook on -- with a few different drivers with your Video Accounts monetization? You also mentioned about the algo upgrades with the machine learning at the back, live streaming, so these are the positives. Well, how do we see -- with this coupled with the macro, how should we think about the second half outlook for advertising growth after this very strong second quarter? Thank you.

[James Mitchell, Chief Strategy Officer]

Yeah. Thank you for the question, Ronald. So the second quarter was strong. We had unusually easy base month for advertising in April because that was really the sharp point of the lockdowns last year. And then, we saw -- it is still fast but not as fast growth in May, June, and that continues in July. We continue to see all ad categories, except automotive, up double-digits year-on-year as we -- in recent weeks. I think that looking forward through the rest of the year, obviously, advertising does depend to some extent on domestic consumption trends. But it's important to bear in mind that, first of all, domestic consumption trends weren't that good during the second quarter, and yet, we grew 34% year-on-year.

Secondly, we have our own sort of endogenous drivers, particularly around the ad tech enhancements as well as the monetization of Video Accounts. And then thirdly, in the event that domestic consumption were to be substantially weaker later in the year, the natural response from advertisers would be to pull back first from the lower ROI inventories that they've been purchasing. And we believe that the ad tech platform enhancements we've put in place, leveraging large neural network models have substantially improved the ROI of advertising on our platform. And therefore, if there were to be weakness, we probably see it later than other people. So overall, certainly very cognizant of the macro risks, but there's been macro risk all year, and optimistic that we'll continue outgrowing the industry through the rest of the year.

[Ronald Keung, Goldman Sachs]

Thank you, James. And maybe following up on that on generative AI, which is the top of theme. Besides the – to business side, I want to hear more about how to consume, or any things that we're thinking on chatbot or anything within our Tencent ecosystem. And kind of linking on to that advertising question will you see any forms of monetization from generative AI usage scenarios? Thank you.

[Martin Lau, President]

Yeah. So in terms of the generative AI, I think and more broadly, the foundation model, I would like to say, we look at the opportunity and the technology much more broadly than just sort of a chatbot and a question-and-answer type of experience. Of course, that is a product form factor, which can be added to our large DAU products like Weixin and QQ over time. But I think just to look at it more broadly, right, AI is -- really, the more we look at it, the more excited we are for that asset growth multiplier across our many businesses. It would serve to enhance efficiency and the quality of our user-to-user services, and at the same time, when you facilitate the improvement in terms of our ad targeting, data targeting and also cost-efficient production of a lot of our content. So there are really multiple ways through which we can benefit from the continued development of generative AI.

And in terms of just the development, I would say, there are multi initiatives that's going on at the company. The first one, obviously, is building our own proprietary foundation model, and that is actually progressing very well. The training is actually on track and making very good progress. We have started internal testing in our different businesses, including games, ads, cloud, FinTech for them to start testing the model and start working on the integration. In terms of the performance of the model so far, I think based on our own testing, it's among the top leading foundation models produced in China. And we are very relentlessly working on the upgrade and the iteration, right, to prepare it for launch at some point of time in the latter part of this year.

And in terms of additional efforts, we are also on the cloud side providing a MaaS solution for enterprises, right? So basically providing a marketplace so that different enterprise clients can choose different types of open source large models for them to customize for their own use with their own data. And we have a whole set of technology infrastructure as well as tools to help them to make the choice as well as to do the training and do the deployment. And we believe this is going to be a pretty high value added and high margin product for the enterprise clients. And at the same time, our different products have already been deploying different types of AIGC tools in order to enhance their efficiency or improve their product competitiveness.

For example, Tencent Meeting has already been deploying a model that is developed by one of our investee companies to provide summary of the meeting notes, and it's actually providing pretty good user experience and productivity gains for the customers. So I think we are actually embracing generative AI on multiple fronts, and they are all making very good progress. And over the mid to long run, we believe this is actually a very positive driver for our business.

[Ronald Keung, Goldman Sachs]

Wonderful. Thank you, Martin and James.

[Wendy Huang, IR]

Thank you, Ronald. Next question will be Kenneth Fong from Credit Suisse.

[Kenneth Fong, Credit Suisse]

Hi. Good evening. Thanks management for taking my questions and congrats for another solid set of results. My first question is on games. Understand that the lack of key title launches has been the reason behind the rather flattish Domestic Games revenue. But the new games aside, given that our legacy games monetization level is still very low, so how should we think about the longevity of existing titles and potentially growth going forward? And down to the VAS GP margin, second quarter was flat on a quarter-over-quarter basis, which historically is normally down 2 percentage points. So how should we think about margin sustainability going forward? And I have a follow-up. Thank you.

[James Mitchell, Chief Strategy Officer]

Hi, Kenneth. So on your second question, the improvement in Value-added Services business gross margin is structural, and it flows from a number of positive mix shifts. One mix shift is the very rapid increase in Mini Game activity. And as Martin discussed, Mini Games we book on a net revenue basis rather than a gross revenue basis. So the flow-through from Mini Games reported revenue to gross profit is substantially higher than for the traditional game business.

Another factor that's affected us more recently is the reduction in live streaming entertainment revenue at our subsidiaries, Tencent Music and Huya. And as you're probably aware, that revenue is unusually low margin. So those two examples of structural shifts away from lower margin revenue streams toward higher margin revenue streams, which we view as ongoing, and therefore, we believe the higher levels of Value-added Services gross margin is sustainable.

On the game question, then we believe that the primary driver of the flat Domestic Game revenue in the second quarter was not lack of new titles. We did launch some PC game titles. We didn't launch many mobile game titles, but even if we had, our revenue [indiscernible] means that will contribute more later in the year than during the second quarter. The primary factor was our decision to temporarily release less commercially impactful content.

During the first quarter, we released the large quantity of commercially impactful content that resulted in our game grossing receipts increasing quite notably, substantially more than our game domestic revenue. And then in the second quarter, we took sort of a pause period, and in the third quarter, we've resumed releasing this commercially impactful content.

In terms of the longevity of our evergreen games spend, we cited some data points around both bigger and smaller games as well as around some of the newer games that we hope to cultivate into evergreen status, including Fight of the Golden Spatula, including Arena Breakout, including Wild Rift. And I think in general, if you compare our competitive eSports type evergreen titles with more content driven titles, then there's a gigantic difference in terms of retention.

And for many of our competitive eSports titles, there are actually periods and Fight of the Golden Spatula has been doing this in recent months, where net churn is negative, meaning that new content, in this case, Set-9 has caused more returning users or more lapsed users to return to the game, then we actually churned out of the game, which is something you don't really see in contact driven games. So we have many years of experience of operating evergreen games. Some of our earlier evergreen games, like League of Legends and Honour of Kings are still very healthy today in terms of users and monetization.

One aspect of operating those games for decades rather than years or quarters is alternating between heavier commercialization quarters versus lighter commercialization quarters. But the benefit is those games are popular and enduring for decades, and that's what we now also hope to achieve with the new would-be evergreen games such as Fight of the Golden Spatula, Arena Breakout, or Wild Rift. Thank you.

[Martin Lau, President]

The other point I would like to make is, I think the game revenue actually does not really capture fully the development in our game franchise because it doesn't really cover the very fast growth in our presence within the casual games segment through the development of our Mini Games platform, right? Mini Games platform is now by far the largest mini -- a casual game platform in China and vis-a-vis any of the casual game title or platform within China, I think it has multiple times in terms of user base and multiple times in terms of gross receipts. But the financial benefit actually does not show up in the game revenue. And actually, one shows up as only a commission instead of the full gross receipts, and it's actually showing up in the VAS revenue rather than in the games revenue. So a very important development and growth of our casual games segment was actually not covered in the game revenue.

[Kenneth Fong, Credit Suisse]

Got it. My second question is on the advertising side. We noticed that we have a lot of initiatives including internally, we upgrade our ad system that lift the ROI overall lead us to outperform peers. And externally, we also noticed some cross-platform cooperations, like, in 618 with a key eCommerce platform and some Mini Game ads within other short-form video platforms. So with near-term macro, we're still uncertain, how much more of this kind of operational initiative for opportunities that we can capture to drive growth that will lead us to continue to outperform peers going forward? Thank you.

[James Mitchell, Chief Strategy Officer]

So I think there's a number of both longer-term and more immediate opportunities in the immediate but also ongoing opportunities. Then, if you look at Video Accounts, ad load is a tiny fraction of what our peers are already operating at. And so going forward, we will progressively enhance our ad load and that translates mechanically into more revenue. In addition, our peers generate around half of their advertising revenue from endemic or sort of native advertisers who are conducting eCommerce within their short video services.

So as we grow the eCommerce within the Video Accounts, leveraging our existing Mini Program and Tenpay infrastructure, we're in a good place to cultivate that approximate doubling in advertising revenue opportunity. And then as Martin discussed, the time spent, which is the ultimate raw material for advertising revenue in Video Accounts almost doubled year-on-year as well. So a very long runway for Video Accounts driven by higher times spent, driven by normalizing ad load, driven by cultivation of endemic advertisers.

Then in terms of advertising technology, and if you look at the big ad tech-driven companies in the West, such as Metro (ph), that's a never-ending journey in terms of just continuing to invest more in CPU and then GPU-driven machine learning infrastructure, continuing to enhance the neural network models for doing the ad targeting, continuing to shrink the rate at which you update the models through weekly, to daily, to hourly to minute-by-minute to real-time, and that's a gift that appears to never stop giving.

And for better or worse, we're still not at equivalency with great measure (ph) in some of that ad tech deployment. But we believe we have a longer road to run because we're not as far along the road and also because we have so many different kinds of inventory and so many different kinds of data that are not available to either our global or our local peers. Beyond that, we have new advertising inventories such as the search inventory within Weixin. And overall, we believe that there's an ample runway for growth.

And yes, the overall economy is uncertain, but it has been uncertain for the past couple of years. It was uncertain in the first half of this year, and we've been able to grow through that. And we believe we'll keep growing going forward as we enhance the return on investment to advertisers and therefore, enhance what advertisers are willing to spend with us.

[Kenneth Fong, Credit Suisse]

That's very clear. Thank you, Martin and James. Congrats again.

[James Mitchell, Chief Strategy Officer]

Thank you.

[Martin Lau, President]

Thank you.

[Wendy Huang, IR]

Okay. We will take the next question from Alicia Yap from Citi.

[Alicia Yap, Citigroup]

Hi. Good evening, management. Can you hear me okay?

[Wendy Huang, IR]

Yes.

[Alicia Yap, Citigroup]

Okay. All right. Thanks for taking my questions. My first question is on the Tencent Cloud Model-as-a-Service solution. So does management view this solution to be initially adopted by a larger enterprise within the industry that process large volume of data? So besides tourism and public service that you mentioned, what other industry verticals do you plan to penetrate? Do you expect a medium-sized and the smaller-sized enterprise could also benefit and deploy the service? And lastly, is this Model-as-a-Service solution is a high recurring revenues and a higher margin than the existing business service offering that you have?

Second question, I wanted to follow up on the advertising. So if management can elaborate a little bit what exactly the integrations of the machine learning on your app platform that benefit the ad revenue [Technical Difficulty]. It does look like it is just a very beginning and we might see more positive impact from this AI on the ad revenue growth in the coming future. So any color you could share would be appreciated. Thank you.

[James Mitchell, Chief Strategy Officer]

Yeah. In terms of the AI and Model-as-a-Service solution, we -- besides, we think a lot of the industries will actually benefit from it, right? Initially, it would definitely be larger companies. And in terms of the verticals in addition to tourism and public services, we believe verticals such as financial institutions, retail enterprises, especially the large ones and industrial companies and even some mid-size Internet companies, right? I think these are the companies which has data and user engagement, and I think they would be able to train their models and really assist in their interaction with their customers.

I think over time, as the industry become more mature, obviously, the medium-sized and smaller-sized enterprises will probably benefit. But I don't think they will be benefiting from using -- training their own model, right? But then they would probably be benefiting from using the already trained models directly, so -- through APIs. So I think that's sort of the way the industry will probably evolve over time.

In terms of the business model, I think, obviously, the revenue model is still evolving. But I would say, theoretically, what you talk about the high margin and high recurring revenue is going to be true because we are adding more value to the customers. And once the customers start using these services, right, it will be built into their interaction with their customers, which will be much more sticky than if it's in their back-end systems. So I think that would probably be true.

[Martin Lau, President]

And in terms of the ad platform, I would say -- I think James talked about quite a bit of that, right? If you look at the key changes or key things that we have done with respect to machine learning on ad platform, I think the traditional challenge for us is that we have many different platforms. We have many different types of inventories. We have a very large coverage of user base and with a lot of data, right? And all these things make it actually very complicated for us to target customers based on just RU-based or CPU-based targeting system, which was actually what we have been deploying.

And a key change is that we have deployed a lot of GPUs, so moving from CPUs to GPUs, and we have built a very large neural network to basically accept all these different complexities and be able to come up with the optimal solution. And as a result, our ad targeting becomes much more effective and much higher speed and more accurate in terms of targeting. And as a result, right now, it actually provides a very strong boost to our targeting ability and also the ROI that we can deliver through our ad systems. And as James talked about, this is sort of early stage of this deployment and continuous improvement of our technology and I think this trend will continue.

[Alicia Yap, Citigroup]

Thank you.

[Wendy Huang, IR]

Thank you, Alicia. Next question will be Robin Zhu from Bernstein.

[Robin Zhu, Bernstein]

Thank you. Thanks, management. Hi. I guess a couple of questions, please. One, specifically on games. Could you talk about kind of the upcoming launch slates? What in particular excites you on the new games front, given everyone's desire to have kind of visibility on that front? And could you talk about the progress of AAA game development? I know the company kind of pivoted, what two or three years ago now. I just wanted to get an update on how you think that's doing.

And then I guess a housekeeping point on Mini Games. It's clear that management is very excited about it. Why not disclose some financials around it and what that's doing? There used to be a line on smartphone games that you stopped disclosing at the end of last year, so thoughts on bringing that back.

Second question on eCommerce, again, another kind of important growth driver. Wondering if management can share some thoughts on the size of total eCommerce across WeChat, how much that's growing and how much of that is live streaming at the moment. And whether management have plans or targets in terms of getting to peer levels of scale on the eCommerce front? Thank you.

[James Mitchell, Chief Strategy Officer]

Hi, Robin. So on the games, we have a number of titles, both domestically and internationally that we're looking forward to releasing in the coming months. In no particular order and with no implied favoritism on the domestic side, we have the high ability heroes game. We have an Honor of Kings tie-in. We have a Need For Speed game. On the international front, just in the last two weeks, I think, Riot demonstrated their new fighting game at the big fighting tournaments in Las Vegas, which received an excellent reception. Grinding Gear Games has shown off Path of Exile 2 that has garnered a very positive reception. And then we have a number of games being made in China and distributed globally that are also important and interesting. In terms of the Mini Game disclosures, then we review what we should disclose on an ongoing basis and we'll bear your counsel in mind. Thank you.

[Martin Lau, President]

In terms of eCommerce, I would say, before the launch of Video Accounts and live streaming eCommerce, right, we already have a lot of commerce activities that's happening on our Mini Programs. That's in the trillions of annualized GMV range. And I think out of that, a meaningful portion is actually related to physical products, eCommerce. So I think if you look at physical product, eCommerce GMV, it's exceeding RMB1 trillion in terms of annualized GMV. And if you look at live streaming, right, that's a new source of revenue and a new series of eCommerce activities. And so far, the size of it is in the tens of billions RMB annualized run rate. So that's why we feel that it's actually sort of at a very early stage of development. But the fundamental difference here is that these are eCommerce revenues that we can charge a take rate. And at the same time, it actually helps a lot of the merchants to acquire new customers, right?

If you look at the Mini Programs eCommerce activities, the merchants are essentially using their own channels to serve existing customers and try to drive repeat purchases from existing customers, whereas in the live streaming eCommerce activity is they're actually leveraging this platform to market their products and services to a new set of customers, right? And so, it actually represent a different dynamics and at the same time, without -- it complements the Mini Program eCommerce activities as well over time. So I would say, the live streaming eCommerce activity is a very nice addition to the overall eCommerce activities within the overall ecosystem. And it would actually be much more revenue generating for us as well because it generates commissionary (ph) revenue. It also generates more advertising within Video Accounts because all these merchants will be spending ad dollars in order to drive new customers into their live streaming eCommerce sessions.

[Wendy Huang, IR]

Thank you. We will take the next question from William Packer from BNP. William, your line is open.

[William Packer, Exane BNP Paribas]

Hi, management. Many, many thanks for taking my questions. Firstly, there have been quite a few moving parts in regulation since the last earnings call, including a significant fine, but also positive commentary on the platform economy from various state institutions. Firstly, like last quarter, could you update on recent domestic gaming, short-form video and FinTech regulatory developments in recent months? And then as a follow-up, the Cyberspace Administration of China have proposed new rules to protect minors online. Could you update us on any potential impact of those new rules on your business? Excluding video games, which you've already provided, do you have an estimate on the revenue exposure to those aged 18 and below? Thank you.

[Martin Lau, President]

Okay. I think we have been talking about industry regulation, and last time -- in the previous times, we have said it has been trending toward normalization. And I would say this time around, in addition to be trending toward normalization and there's actually sort of a bit of a more supportive stance and this is actually from a number of different new developments. Firstly, as you can see, the top leadership has recently repeatedly reiterated the prominent role of private sector and also platform economy and has reiterated its intention to foster platform companies healthy and sustainable development. So that's number one.

In terms of the different vertical ministries, right, I think there are a number of different illustrations. Around FinTech, the financial regulators in early July has basically stated they have concluded the disciplinary action on the FinTech sector. And going forward, they're going to be focused on normalized regulation and also supporting and encouraging platform economies to continue the effort in financial inclusion.

In terms of the investment category, the NDRC on the July 12 have issued a statement recognizing Internet platforms' investments in start-ups and these start-ups have contributed to technology innovation and Tencent was specifically mentioned in relation to two investments. In terms of games, we see a continued normalized issuance upon how. So I think across all these different segments that we have a significant business in, we have seen the regulatory environment trending towards normalization as well as a more supportive overall stance.

Now in terms of the CAC, consultation paper on minors protection, I think our view is that, number one, we actually fully support and embrace the policy because this is something that we have already been doing across many of our different products. For example, in games, we have already implemented the mandatory protection measures, and this -- the measure is actually much more stringent than what the consultation proposed. And within Video Accounts, the time spent limit in teenage mode for us is 40 minutes per day, which is at the low end of the consultation time spent of 40 minutes to 120 minutes per day.

So overall, we expect no material impact to our business because minimal revenue is actually generated from minors. And we will continue to be very committed to minor protection and full compliance of relevant regulations and work very constructively with the regulatory authorities on this consultation and the subsequent implementation.

[William Packer, Exane BNP Paribas]

Many thanks for the color.

[Wendy Huang, IR]

Thank you, Will. We will take the next question from Charlene Liu from HSBC.

[Charlene Liu, HSBC]

Thank you. Thank you, Wendy. The first question I have is on profit growth. So obviously, we've seen GPM and bottom line both came out ahead of consensus estimates. The high margin Video Accounts monetization obviously played a role in the results. I wanted to ask how should we think about profit growth trend for the second half of this year or even for 2024, particularly in the context of further monetization of Video Accounts and potential recovery of domestic games growth. Can we -- can these factors are staying kind of stronger growth in profit against top line? I have a follow-up later. Thank you.

[James Mitchell, Chief Strategy Officer]

Hi. Thank you for the questions. So we believe that we are benefiting from three factors on margins. One is the mix shift to higher margin revenue and you singled it out Video Accounts. I'd also say that the deployment of ad tech generally allows us to begin to sell inventory that was previously unsold, and so that's a very high incremental margin business for us. It also results in more competitive bidding inventory that we were previously selling, which is again, higher price translates into higher margins. So ad tech in general, boosts our margins.

In Mini Games, as we have discussed quite extensively, very substantial sort of GMV revenue stream, but we're only booking a minority percentage of that into reported revenue and then the flow-through on the reported revenue is much higher margin than for our mainstream game business. The eCommerce fees also disproportionately high margin because they're leveraging on the very substantial fixed investments into the Mini Program, Video Account infrastructure. So that's one bucket.

The second bucket is that we have scaled back certain lower margin revenue streams, including some of the resale businesses within cloud, including the live streaming entertainment that I referred to earlier, at Tencent Music and Huya. And then thirdly, we just have a different culture now of being very focused on cost discipline and efficiency, and that culture is here to stay. So I think for those three reasons, we believe we will continue to grow profits faster than revenue beyond the second half of this year and into the future.

[Charlene Liu, HSBC]

Thank you. That's really clear. Can I also get a sense on how much Mini Games is contributing to Social Network revenue and how much is Mini Games ads contributing to ad revenue and how should we think about synergies versus competition of Mini Games against our online game business, please? Thank you.

[James Mitchell, Chief Strategy Officer]

Well, why don't I talk about the synergies versus competition, and perhaps John will give you some thoughts on the first part of your question? On the dynamic, in general, we see three broad categories of games in China today. There are competitive eSports type games that handled properly are relatively evergreen in nature. And we have a very strong position in that market with all of the top games. And now with Wild Rift, Arena Breakout and Fight of the Golden Spatula, we believe we're nurturing three more of those games. And they are evergreen in nature, and they'll be generating cash flow for us for decades rather than years to come, we think.

Then secondly, there's the more story or content-driven games, which historically has been a weaker area for us. There's been a number of very good launches by our competitors in the last few months, including -- well, anyway. And we think that, that signals to some extent a renaissance in that category, and we would like to participate over time in that renaissance. So we have some big narrative driven content-rich games in development, and time will tell how successful they are. But for us, it's sort of greenfield and largely upside.

And then thirdly, there are casual games. And if you look at the Western world, then every year or two there's a new app-based casual game and among us sort of four guys that generates great attention, especially among younger users and then typically reaches a certain point and then declines from that point. But the really big development in the past five years, which we've been following extremely closely has been the emergence of platforms, in particular the Roblox platform.

And while the individual app-based games come and go in the casual category, in the platforms, then the individual experiences also come and go, but the platforms appear to – in extra be (ph) grow in terms of both users and revenue. So we believe that the right way to address the casual game opportunity is primarily -- not entirely, but primarily through the platform model. We have a platform that is over 5 times bigger than any single app-based casual game in terms of users and also in terms of revenue, and it's growing at an extremely rapid rate year-on-year as new casual game experiences appear on that platform.

In terms of the cannibalization, then there's three sort of broad buckets of users of roughly similar size. One bucket is those who have historically played app and client-based games continues to do so, do not play the Mini Games. A second bucket is those who had not previously played Tencent games at all and are only now playing Tencent Mini Games. And then a third bucket is those who do both. And we don't see any evidence of cannibalization because even for those who do both, they're generally playing different kinds of games, different dayparts for the Mini Games versus what they're doing through the app-based or client-based games.

So in our view, the Mini Game platform is largely incremental rather than cannibalistic to our app-based games. It gets us into this big emerging casual game opportunity, and it gets us into it in a way that we think is the best way to get into it, which is as a Roblox-like platform rather than as a stand-alone app with a standalone game experience that flourishes for a period of time and then it gives way to the next head.

[John Lo, CFO]

Yeah. In terms of the Mini Games contributions, Social Networks is at single-digits percentage and also with the online advertising is at single-digits.

[Charlene Liu, HSBC]

Thank you. This is really good color. Thanks, James. Thanks, John.

[Wendy Huang, IR]

Thank you. We will take the next question from Natalie Wu from Haitong International.

[Natalie Wu, Haitong International]

Hi. Thank you for taking my question. I have two here. First one is related with the game. Just curious, given that these days the domestic game license approval has been moving towards normalization, do you feel competition heats up and market share got like more dispersed lately? And secondly, with the -- we know that with the domestic China's macro trending weak, so just curious if we take a close look at our business lines, which will be the most vulnerable and which will be the most resilient and what kind of the measures did you take or plan to take to deal with macro headwinds? Any color would be helpful. Thank you.

[James Mitchell, Chief Strategy Officer]

Why don't I start on both of those and Martin may supplement? So on the competitive environment for games, I'll repeat some of the answers to the last question, which is we see these three broad categories. One being the more competitive eSports games where we already have a very strong presence. We're doubling down on that with the success of the three new eSports games we've talked about. A second being the more content or narrative-driven games where competition has intensified, a number of companies have brought some good games to market recently. That doesn't come at our expense because historically we generate very little revenue in that category, rather it's a category that we're looking forward to entering more actively in the years to come.

And then thirdly, with the casual games, where there's a number of industry peers who are sort of seeking to be among us, and we're seeking to be Roblox. And that's fine, both businesses are good businesses, but we certainly are very happy with the business choice we have made of adopting the platform approach. So that's on the game competition aspect. In terms of the sensitivity to the macro environment, then if we just touch briefly on each of advertising, FinTech and games.

Starting with games, while it was clearly not the best quarter for our domestic game revenue, I think that was completely unrelated to macro. In fact, in an environment where macro is challenged, consumers are shifting to lower ticket price experiences, consumers are shifting from goods to services, in theory is pretty good for the game industry. And as a parallel, I'd point you to the movie theater industry in China, the movie ticketing where, as you may know, movie ticketing has been extremely strong in the last two to three months as people look for affordable entertainment driven experiences rather than highly-priced luxuries and so forth.

So I think the game business both in China and globally, historically has not been economically cyclical and we don't believe it will become economically cyclical now in China. In terms of the advertising business, that could be economically cyclical. It should be economically cyclical. However, it's not sensitive so much to net exports or property prices. It's more directly sensitive to consumption spending. And so far, consumption spending has been recovering albeit at a very gradual measured pace.

Again, we believe that whatever happens going forward to the macro environment and if net exports and real estate and so forth eventually impact consumer, that we will outperform because we're in the early stages of monetizing Video Accounts because we're in the early stages of deploying ad tech and because we deliver very high ROIs, which mean advertisers should stay with us for longer.

And then on the FinTech business and particularly the commercial payments within FinTech, that does reflect economic activity, particularly consumer activity somewhat in real-time. And so, I think that, that is the business where macro variable plays the most into our revenue fluctuations. We do have a number of different services within FinTech beyond the immediate commercial payments.

We talked about how in this supportive regulatory environment, we look forward to extending and launching new such services, but a commercial payment is probably the area where for better or worse, we're most directly exposed to macroeconomic fluctuations on a month-to-month basis. Thank you.

[Martin Lau, President]

So if I want to add right now, I would say on the [indiscernible] side, we actually are very excited about the issuance of [indiscernible] because the gaming industry is really driven by innovation and without innovation, the market doesn't grow. And I think the fact that we have seen a growth in the overall market is because of the fact that we are seeing new innovations of new games. So when the overall market expanding, I think we benefit, we'll be bringing new titles to the market. And at the same time, I think if you look at the Mini Cash (ph) -- at the Mini Games platform, right, it actually benefits from the fact that there is more and more innovation within the market.

Now in terms of your second question on the consumption side, I think James has given a very good analysis of our own business. I just want to talk about sort of some overall thoughts. What we have seen is consumption is recovering from the COVID period. It may not be as fast as the market expects or wishes. But we also see that the focus of the top leaders, government leaders on economic development and on supporting growth is actually very clear. And at the same time, the government is rolling out a series of policies and measures to drive economic growth.

And at the same time, we also believe that there's a lot of resilience and entrepreneurship within the China economy. So it would take time for different measures to be rolled out, to be implemented and to take effect. But if you look at our own business, right, we are -- given in this waiting mode for the recovery to come in at a faster rate, we are already delivering a strong and solid set of revenue growth and even faster profit growth under the current environment. And that's due to the fact that we have very high-quality revenue streams, and we have a very strong discipline that has been developed during the difficult times. So we feel actually very good about our overall positioning.

[Natalie Wu, Haitong International]

That's very helpful. Thank you.

[Wendy Huang, IR]

Thank you. In the interest of time, we will take the last question from Thomas Chong from Jefferies.

[Thomas Chong, Jefferies]

Hi. Good evening. Thanks management for taking my questions. I have a question relating to the FinTech side. Can management comment about how we should think about the take rate trend given it is still relatively low? And on the other hand, for other FinTech segments such as online credit, wealth management, and insurance, is there any priorities for these new businesses going forward? Thank you.

[Martin Lau, President]

Well, in terms of take rate, I think this would stay largely stable. But having said that, I think there are a number of different value-added services that we can actually offer to merchants, and in those value-added services, we can actually sort of charge additional fees for the additional value that we offer to them. And in terms of the financial products, I think given the conclusion of the disciplinary action of the regulators at the regulation to clearly stating that, that they would be supporting healthy growth of FinTech industry, we believe there will be more opportunities going forward.

[Wendy Huang, IR]

Thank you. Thank you all for joining our results webinar. We are now ending the call. 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.