Tencent Holdings Ltd

HKEX:700

Earnings Call Analysis

Tencent's Q2 2024 results show significant profit growth and robust revenue sources

Tencent's Q2 2024 results indicated strong performance with total revenue rising by 8% year-on-year to RMB 161.1 billion. Gross profit surged 21% to RMB 85.9 billion, while net profit attributable to equity holders jumped 53% to RMB 57.3 billion. The company's impressive performance was driven by higher-margin revenue streams such as domestic and international games, online advertising, and cloud services. Notably, the company's gross margin increased by 6 percentage points to 53%. For the full year of 2024, Tencent expects its non-IFRS effective tax rate to range between 18% and 20%【6:0†source】【6:5†source】【6:6†source】.

Introduction to Tencent's Q2 2024 Performance

In the second quarter of 2024, Tencent has demonstrated resilient growth and strategic agility amidst a challenging macroeconomic environment. The company reported a total revenue of RMB 161.1 billion, marking an 8% growth year-on-year and a 1% increase quarter-on-quarter. This growth was largely driven by the robust performance of its cloud services, high-margin video account e-commerce transactions, and enhanced cost efficiencies across its businesses【4:0†source】.

Solid Financial Metrics

Tencent saw significant improvements in its profitability metrics. Gross profit surged by 21% year-on-year to RMB 85.9 billion, while the gross margin increased by 6 percentage points to 53%. Operating profit soared by 40% to RMB 50.7 billion, showcasing the company's ability to maintain strong margins despite broader economic headwinds. Furthermore, net profit attributable to equity holders grew by an impressive 53% to RMB 57.3 billion【4:1†source】【4:2†source】.

Segment Performance Insights

Breaking down the revenue streams, Value-added Services (VAS) generated RMB 79 billion, a 6% increase year-on-year. Social network revenue rebounded positively, supported by increased music and video subscriptions as well as mini-games platform service fees. The domestic games segment saw a 9% revenue increase, driven by titles like VALORANT and Dungeon & Fighter Mobile (DnF Mobile). International games also performed robustly, with a 9% revenue growth attributed to titles such as PUBG Mobile and Supercell's games【4:2†source】【4:4†source】.

Advertising and FinTech Growth

Online advertising revenue grew by 19% year-on-year, bolstered by high-margin video account advertising and strong associated monetization strategies. Tencent's FinTech and business services segment also showed impressive growth, with a 4% increase in revenue year-on-year. This was driven by the rise in commercial payment transactions and wealth management revenues amid a cautious consumer spending environment【4:1†source】【4:6†source】.

AI and Technological Advancements

Tencent has been effectively leveraging AI technologies to enhance its services and operational efficiencies. Significant investments in high-performance computing infrastructure have enabled the company to offer advanced AI-powered solutions such as image, video generation engines, and knowledge engines for various industries. These platforms not only enhance customer service but also unlock new revenue streams from high-margin services【4:0†source】【4:6†source】.

Strategic Investments and Cost Management

The company demonstrated meticulous financial management, with cost efficiencies prominently visible across segments. Selling and marketing expenses grew by 10% year-on-year, reaching RMB 9.2 billion. Investments in AI and technology infrastructure were reflected in a 144% year-on-year increase in operating capital expenditure, driven predominantly by GPU and CPU server investments. This strategic focus supports Tencent's long-term revenue growth and profitability【4:2†source】【4:5†source】.

Final Remarks and Outlook

Looking ahead, Tencent remains committed to innovation and strategic investments in its core areas of gaming, digital content, cloud services, and AI technologies. The management expects the continuation of high-margin revenue growth and enhanced profitability. With a strong balance sheet and prudent cost management, Tencent is well-positioned to navigate future market dynamics and deliver sustainable growth for its shareholders【4:6†source】【4:9†source】.

Earnings Call Transcript 2024-Q2

[Wendy Huang, executive]

Good day, and good evening. Thank you for standing by. Welcome to Tencent Holdings Limited 2024 Second Quarter Results Announcement Webinar. I'm Wendy Huang from Tencent IR team.

[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's control. 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 IFRS measures, please refer to our disclosure documents on the IR section of our website.

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, and Chief Strategy Officer, James Mitchell, will provide a business review. Chief Financial Officer, John Lo, will conclude with financial discussions, before we open up floor for questions.

I will now pass it to Pony.

[Huateng Ma, executive]

Great. Thank you, Wendy. Good evening. Thank you, everyone, for joining us. Our second quarter 2024 results demonstrate the strength of our platform plus content strategy. Our Domestic Games revenue resumed growth and our International Game revenue accelerated growth due to increased user engagement at several of our evergreen titles, and the successful launch of certain new games. Tencent Video achieved a notable audience and subscriber growth with drama series developed from China Literature IP and produced internationally -- internally. Looking forward, we continue to invest in our platforms and technology, including AI, enabling us to create new business value and better serve use needs.

Looking at our financial numbers for the quarter. Total revenue was RMB 161 billion, up 8% year-on-year and 1% quarter-on-quarter. Gross profit was RMB 86 billion, up 21% year-on-year and 2% quarter-on-quarter. Non-IFRS operating profit was RMB 58 billion, up 27% year-on-year or flat quarter-on-quarter.

Turning to our key services. For Communication and Social Networks, combined MAU of Weixin and WeChat year-on-year and quarter-on-quarter to 1.37 billion. For Digital Content, Tencent video lead industry in terms of audience subscriptions. For Games, our proactive judgment to several of our leading games earlier in the year are yielding positive results with healthy user chain for our evergreen games and substantial popularity for several new games. For Cloud enterprise SaaS, WeCom and Tencent Meeting increased penetration in major industry verticals and upsold more pay functionalities.

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

[Chi Ping Lau, executive]

Thank you, Pony, and good evening and good morning to everybody. For the second quarter of 2024, our total revenue was up 8% year-on-year. That represented 49% of our total revenue, within which Social Networks subsegment was 19%. Domestic Games subsegment was 21% and International Games was 9%. Online Advertising was 19% of total revenue, and FinTech and Business Services was 31% of total revenue.

Turning to gross profit. Our overall gross profit growth was 21% year-on-year in the second quarter, driven by growth in high-margin revenue streams, such as Domestic Games revenues, Video Accounts advertising revenues, Mini Games platform service fees and e-commerce technology service fees within Video Accounts, as well as cost-saving initiatives.

By segment, VAS gross profit increased 12% year-on-year to RMB 45 billion, representing 52% of our total gross profit. Online Advertising gross profit increased 36% year-on-year to RMB 17 billion, contributed 19% of total gross profit. And FinTech and Business Services gross profit increased 29% year-on-year to RMB 24 billion, contributing 28% of total gross profit.

Moving into business by segment. For Value-Added Services, segment revenue was RMB 79 billion, up 6% year-on-year. Social Network revenue returned to positive growth, up 2% year-on-year, driven by increased revenue from music and video subscriptions, Mini Games platform service fees and app-based game item sales, which was partially offset by decreased revenue from music and games related live streaming services. Long-form video subscription revenue increased 12% year-on-year as average daily subscriptions increased 13% year-on-year to RMB 117 million.

Consumers are increasingly seeking out high-quality IP and high production value in drama series. Our novel, comics and games platforms nurture high-quality IPs, while our studios, including New Classics Media create high production value building content. During the first half of 2024, out of the top 3 most watched drama series on China's online video platforms, the first and second were produced by New Classics Media and broadcast by Tencent Video, and all 3 were based on China Literature's web novel IPs.

Music subscription revenue increased 29% year-on-year, supported by growth in subscription and ARPU. Strengthened cooperation with labels and artists releasing original soundtracks for Tencent Video popular drama series, and provided live music experiences through off-line events and concert tours.

Domestic Games revenue resumed growth, up by 9% year-on-year to RMB 35 billion mainly driven by VALORANT and new title, DnF Mobile. Total gross receipts of Domestic Games grew faster than revenue in the second quarter. International Games revenue increased by 9% year-on-year in both reported and constant currency terms to RMB 14 billion, benefiting from the robust performance of PUBG Mobile as well as contributions from Supercell's games. Total gross receipts of International Games grew substantially faster than revenue in the second quarter.

For Communications and Social Network, we enhanced functionalities and enriched content across our platforms, including Video Accounts, Mini Programs and Tencent Channels. For Video Account, the user time spend increased significantly year-on-year in the second quarter, benefiting from enhanced algorithms and more local content. Our thriving content ecosystem enabled creators to reach a wider audience and generate increased revenue. The number of creators that generate closed loop revenue from their video accounts more than tripled year-on-year, showing a much more vibrant content ecosystem.

To facilitate e-commerce activity, we're enhancing transaction capabilities in a systematic way to deliver a seamless shopping experience to users and drive sales for merchants. Mini Programs have become an increasingly powerful platform for users to connect with merchants and content providers off-line and online. Total user time spend on Mini Programs increased over 20% year-on-year in the second quarter. GMV facilitated by Mini Programs grew double-digit percentage year-on-year.

For Mini Games, total gross receipts increased over 30% year-on-year. And as a testimony to the diversity of the games, more than 140 Mini Games each achieved total gross receipts of over RMB 10 million during the quarter.

Lastly, Tencent Channels served as a community-based platform in which moderators can manage and present content and demand via customizable tools, while users can interact via text, image or live streaming. We recently upgraded and rebranded Tencent Channels, previously known as QQ channels, and our users can join channels from Weixin and from game apps in addition to QQ. Tencent Channels have gained notable popularity among game players and university students who are early adopters and promoters of Channels' advanced functionalities.

With that, I'll pass to James.

[James Mitchell, executive]

Thank you, Martin. Moving on to Domestic Games. Peacekeeper Elite grew its gross receipts by a double-digit percentage year-on-year in the second quarter, with popular Egyptian-themed and anime-themed outfits. We introduced Metro Royale, an extraction shooter game mode that's already proven attractive in PUBG Mobile and which resulted in Peacekeeper Elite's DAU resuming year-on-year growth in July. Honour of Kings also increased its post receipts year-on-year in the second quarter, benefiting from adjustments we made that spread out the timing of high-value virtual item sales throughout the year, as well as from enhanced content design.

And the retail mobile achieved a new milestone of 10 million average daily active users in May, as marketing activities have boosted its new player acquisition, while enriched theme content has reengaged its existing user base. Among new releases, DnF Mobile has emerged as one of the most successful mobile games in China. The game reactivated millions of DnF IP fans. And more importantly, for long-term success, we're seeing high user retention rates due to proven gameplay, abundant content and active local publishing, which together positioned the game to become our next evergreen major hit.

Need for Speed Mobile launched in July is attracting millions of DAUs by providing a range of driving centric activities within an open world city experience.

Among our international games, PUBG Mobile's DAU and gross receipts achieved double-digit growth year-on-year, driven by the new Mecha Fusion Mode, The Golden Moon Event and lion-themed top-tier outfit.

Brawl Star's gross receipts grew more than tenfold year-on-year. Average DAU achieved a historical high and ranked Brawl as the third highest mobile game across the entire industry by DAU in international markets in the quarter. These achievements flowed from frequent content updates, such as an IP collaboration with Godzilla; and social features, such as the thumbs up for Brawl event.

VALORANT's MAUs grew year-on-year, benefiting from high-quality content updates such as new agent, Clove, and new map, Abyss, the first VALORANT map with no outer boundaries. 2 international e-Sports events, Masters Madrid and Masters Shanghai expanded VALORANT's global IP influence. Squad Busters, a casual PVP, PVE action game with real-time strategy elements and super Supercell character collection, launched on May 29. Sqaud Busters has established critical mass in the key North America and Western Europe regions, and Supercell will be adding new game modes and social features to the game to further expand its fan base worldwide.

For online advertising, revenue grew 19% year-on-year, driven by increased ad spend from most categories, particularly games, e-commerce and education. The deceleration in consumption spending in China is a headwind to advertising eCPM pricing, and thus to our brand advertising and ad network trends. But we believe we'll continue improving our advertising market share and our advertising business should benefit once consumer spending improves.

For our ad tech, we upgraded our machine learning platform to analyze user interests over a longer time horizon of years rather than months, while processing signals more frequently. These changes enable us to gain deeper user insights and provide more relevant ad recommendations, thus boosting click-through rates and revenue. By property, Video Accounts' ad revenue increased over 80% year-on-year fueled by rising short video engagement as well as demand for live streaming options. Tencent Video ad revenue grew over 30% year-on-year despite weak branded ad spend market-wide, as our popular self-commissioned drama series, such as Joy of Life 2 and Tail of Rose, attracts sponsorship spend.

However, our mobile ad network revenue dropped year-on-year as certain internet services companies reduced their overall advertise spend.

Looking at FinTech and Business Services, segment revenue was RMB 50 billion, up 4% year-on-year. Our FinTech services revenue growth to a low single-digit year-on-year growth rate. The number of commercial payment transactions continue to increase at a healthy rate year-on-year, but the average value per payment transaction declined year-on-year due to slow consumer spending, causing further moderation in our commercial payment revenue growth. But given the continuing growth in number of transactions, we believe that our market share is quite stable, and we therefore expect our commercial payment revenue to improve once consumer spending picks up.

Our consumer loan services revenue decreased year-on-year as WeBank and Tencent proactively adopted more cautious credit extension policies in light of subdued consumption trends. Our wealth management revenue grew at a double-digit year-on-year due to increases in the number of users and in aggregate customer assets as consumers generally save more and spend less.

Turning to Business Services. Revenue grew at a teens rate year-on-year in the second quarter, benefiting from higher Cloud services revenue and increased technology service fees generated from rising Video Accounts e-commerce transaction volumes. Business Services gross profit rose significantly year-on-year due to the increased contribution of higher-margin revenue streams as well as in efficiency. In WeCom, merchants are increasingly willing to pay for advanced communication functionalities, such as customer service chat groups, and WeCom revenue accordingly increased significantly year-on-year.

Tencent Meeting deepened its adoption and monetization, especially in the pharmaceutical manufacturing and retail sectors. We're generating increasing AI-related external revenue from customers utilizing our high-performance computing infrastructure, such as GPUs and our model library services. We recently launched 3 AI-powered platform solutions for enterprises, image generation engine and video generation engine, which are pretty useful for advertisers creating ad content; as well as knowledge engine, which is particularly useful for finance, education and retail-related services, deploying customer service chat bots.

And now I part to John for the financial review.

[Shek Hon Lo, executive]

Thank you, James. Hello, everyone. For the second quarter of 2024, total revenue was RMB 161.1 billion, up 8% year-on-year. Gross profit was on RMB 85.9 billion, up 21% year-on-year. Operating profit was RMB 50.7 billion, up 40% year. Interest income was RMB 3.9 billion, up 13% year-on-year, driven by growth in cash reserves. Finance costs were RMB 3.1 billion, down 5% year-on-year due to a reduced debt level. Share of profit of associates and JV was RMB 7.7 billion compared to profit of RMB 1.2 billion in this period last year.

On a non-IFRS basis, share of profit was RMB 9.9 billion, up from profit of RMB 3.9 billion last year, driven by improved performance at certain domestic associates and at certain overseas games studio associates. Income tax expense declined by 9% year-on-year to RMB 10.1 billion, primarily due to the high base in the same quarter last year, resulting from an overseas subsidiaries deferred tax adjustment. Our domestic corporate income tax expense in the second quarter of 2024 increased year-on-year.

On non-IFRS financial figures. Operating profit was RMB 58.4 billion, up 27% year-on-year. Net profit attributable to equity holders was RMB 57.3 billion, up 53% year-on-year. The difference in year-on-year growth rates between operating profit and net profit was due to higher non-IFRS share of profit from associates and JV, which increased to RMB 9.9 billion this quarter from RMB 3.9 billion in the same quarter of last year, as well as lower income tax due to previously mentioned higher base impact.

Diluted EPS was RMB 6.014 up 55% year-on-year, outpacing non-IFRS profit growth due to reduced share count from share buybacks. For the second quarter of 2024, our weighted average number of shares for calculating diluted EPS decreased by 1.9% year-on-year.

Moving on to gross margin. Overall gross margin was 53%, up 6 percentage points year-on-year. By segment, Value-added Services gross margin was 57%, up 3 percentage points year-on-year due to improved margins in long-form video and games businesses, alongside our effective control of operating costs. Online advertising gross margin increased to 56%, up 7 percentage points year-on-year, primarily driven by growth in high-margin Video Accounts advertising revenue and margin improvement in long-form video advertising.

FinTech and Business Services gross margin increased to 48%, up 9 percentage points year-on-year. This was driven by enhanced cost efficiency in our Cloud business, higher contribution from high-margin wealth management services revenues and e-commerce technology service fees within Video Accounts, and improved monetization of WeCom and other business services.

On operating expenses. Selling and marketing expenses were RMB 9.2 billion, up 10% year-on-year, driven by increased spending on promoting advertising for new content release. Selling and marketing expenses represented 6% of revenue stable year-on-year. R&D expenses were RMB 7.3 billion, up 8% year-on-year. G&A expenses, excluding R&D, were RMB 10.2 billion, up 9% year-on-year due to an increase in staff cost, including performance-based reports. At quarter end, we had approximately 106,000 employees, up about 1% both year-on-year and quarter-on-quarter.

Non-IFRS operating margin was 36%, up 5 percentage points year-on-year, in line with gross margin expansion. To conclude, I will highlight some key cash flow and balance sheet metrics. Operating CapEx was RMB 7.2 billion, up 144% year-on-year driven by investment in GPU and CPU servers. On a quarter-on-quarter basis, operating CapEx was up 8%. Non-operating CapEx was RMB 1.5 billion, up 53% year-on-year, driven by construction and progress. On a quarter-on-quarter basis, non-operating CapEx was down 80% from the high base in the prior quarter. As a result, total CapEx was RMB 8.7 billion, up 121% year-on-year. Free cash flow was RMB 40.4 billion, up 35% year-on-year due to higher gross receipts from games.

On a quarter-on-quarter basis, free cash flow was down 22% due to a seasonal decline in games because receivable Chinese New Year holiday period. Net cash position was RMB 71.8 billion, down 22% quarter-on-quarter, primarily due to RMb 34.2 billion share repurchase and RMB 28.9 billion dividend payment for year 2024 during this quarter was largely funded by our free cash flow generation.

Thank you.

[Wendy Huang, executive]

[Operator Instructions] The first question comes from Alicia Yap from Citigroup.

[Alicis a Yap, analyst]

Congrats on the solid result. First question, can management elaborate a little bit your recent upgrade of the advertising technology platform? When management noted on the prepared remarks, the upgraded technology will analyze the user interest over a longer time horizon, does that mean you are thinking back into the longer historical usage pattern to form more precise targeting attribute and to capture the potential change of the user habits over the years? Maybe can you share a little bit the details. And also how will these upgrade at platform attract higher ad spend and maybe support the future ad revenue growth potential?

Second question, given there's a recent supportive comments from the state council on the digital content, including gaming and others, will that change any of the company R&D resource deployment in the coming future in order to help boost more entertainment-related content consumption opportunity?

[James Mitchell, executive]

Thank you very much for your questions, and I'll attempt to take the first one. So yes, indeed, we are looking further back at actions over years rather than months. And the main benefit is to form a more comprehensive user interest graph. On the other hand, we're also looking with greater frequency at the most recent actions. And the main benefit of the most recent actions is to have a more precise and timely view on user's current commercial intent.

And so looking further back, so looking more frequently at the most recent data are both beneficial but for different reasons. And in terms of how the processes then attract more advertising spend, by understanding the user's interest graph better, by having more precision around their current commercial intent, we can improve the click-through rate. And today, in China and worldwide, as you boost the click-through rates, then the majority of advertisers automatically allocate more advertising spend to you because you're delivering more clicks with the higher click-through rate.

[Chi Ping Lau, executive]

In terms of the second question, I would say, obviously, the comments is actually supportive and very encouraging to us and our content business, especially the relative around gaming, which is yet another approval and affirmation of the value of the industry in addition to the continued issuance of BanHao. And we felt this is definitely incrementally positive to the overall content industry.

But having said that, we have already been making very long-term investments and strategic investments in the content industry. And the nature of the content industry, be it games or be it drama series, which originate from novels is that they are actually very long term in nature. So if you look at the recent revival of our gaming business as well as the success of our drama series, they really originate from investments that we made years ago.

So from that perspective, rest assured that as a major player in the content industry, we have been making very strategic and long-term investments in the content industry and even when the industry was actually in turmoil. And that's the reason why we are now reaping the benefit of our investments. So we're not going to be sort of that short-term oriented just reacting to one piece of news. But as an important player, we have been making very strategic investments all along the way, and we'll continue to do that.

[Wendy Huang, executive]

We will take the next question from Kenneth Fong from UBS.

[Kenneth Fong, analyst]

I have 2 questions. First is on the live streaming e-commerce. We noticed that there have been a meaningful slowdown in the GMV growth in the short video platform, live streaming e-commerce for the competitor in the recent quarter. Can management share with us the e-commerce strategy for our Video Accounts?

My second question is on the accounting side, specifically taking into 2 items. First, for the G&A, which is up 8% on a year-on-year basis. Understand that the headcount is rather flattish on a year-on-year basis. So how much of this 8% increase is one-off in nature? And secondly, on tax, how should we model the effective tax break over the next few quarters as it has come down a lot in this quarter?

[Chi Ping Lau, executive]

I'll take the first question. In terms of the e-commerce activity in our Weixin ecosystem, so apart from the Mini Programs, e-commerce, just on what you would call the live streaming e-commerce, our growth in the quarter has still been very solid, very significant growth. So we're not seeing a slowdown in terms of GMV growth relative to the other short video platforms. And the main reason is because the size of our e-commerce GMV is actually very small compared to the size of theirs. So there's still a lot of headroom for us to grow.

But having said that, we have recently repositioned our live streaming e-commerce to make it more of Weixin e-commerce system in the sense that we are going to build that ecosystem, not just to base -- a point at the Video Accounts and live streaming channel. Instead, we are going to build our e-commerce ecosystem within Weixin, tying to the entire Weixin ecosystem, and that would obviously still draw a lot of strength from our official -- from our Video Accounts as well as our live streaming channel.

But at the same time, it will be connected to all the elements of the Weixin ecosystem, including official accounts, including Mini Programs, including enterprise Weixin, including all the social and group activities that are happening within Weixin so that we would want to build an ecosystem in a very patient but systematic way so that it will be differentiated from just live streaming e-commerce, and it will be much more valuable to the merchants and the users. And we also hope to solve the problem that you are seeing, right? There's a material slowdown in terms of GMV growth. Because live streaming e-commerce can grow very fast, but then there is a natural [indiscernible].

But if we can build the e-commerce ecosystem with Weixin in the systematic way, leveraging all the source of strength within Weixin, then hopefully, we can actually build much bigger and meaningful and high-ceiling e-commerce ecosystem. And to some extent, this is similar to the way we build our Mini Programs for quite a few years, we built that ecosystem patiently. And it doesn't seem like it's generating a lot of revenue. But when it actually unleash its power, it generates a lot of user engagement, it becomes extremely valuable to merchants and content providers online and offline, and it becomes a significant source of revenue in many different areas, including Mini Games as well. So that's the way we approach the Weixin e-commerce.

[Shek Hon Lo, executive]

In relation to G&A expenses, I will speak into 2 parts to expect. R&D expenses increased by 8% year-on-year in quarter 2, while G&A, excluding R&D increased by about 8% to 9% also year-on-year in quarter 2, 2024. In whole of 2024, we expect R&D to increase by high single digit, while G&A, excluding R&D, also will increase by single digit as well on IFRS basis. So as a result, we expect that for the full year of 2024 full year based on the latest estimate, it will increase by high single-digit as well.

In relation to the income tax, the non-IFRS, we should really look at the non-IFRS profit. We can see that the decrease in income tax expense was due to deferred tax asset reversal in overseas subsidiary in Q2 last year, which form a lower base for this year comparison. And it was, of course, offset by the increase by domestic income tax. The non-IFRS effective tax rate for last year, full year, was 22%. And we expect that in non-IFRS effective tax rate for 2024 will be within the range of 18% to 20%.

[Wendy Huang, executive]

Next question from Miranda [indiscernible] from [indiscernible].

Hello? So maybe let's take the -- Okay, Miranda. Can you hear us? Maybe we move to the next question.

[Unknown Analyst]

Yes, I can hear you now.

[Wendy Huang, executive]

Okay. Thank you. Go ahead.

[Unknown Analyst]

So my questions are about the profit. My key question is about -- so the new higher-margin revenue streams have been driving strong profit split for the several quarters. Can management update us about metrics of these higher-margin streams? For example, what are the mix from them in revenue or gross profit, how fast are they growing? How much do they contribute to the gross profit growth rate? And then looking at how do you think about the room of further upside to your gross margins of the key business segments.

And then my follow-up question about the profit is that we have seen that the share of profit from associates and JVs increased significantly quarter-over-quarter and also year-over-year, contributing to a significant portion of company's adjusted profit. So can management help us understand what are the drivers? And then as your investors are generally in a profit improving trend, I'm sure we expect this line item to contribute to more profit upside and to continue to trend up going forward.

[James Mitchell, executive]

Thank you, Miranda. Thank you for the questions. I'll take the first one in terms of the impact of the mix shift toward higher-margin revenue streams. So we don't quantify each one of them individually or the aggregate collectively. But one way of visualizing the trend is that in recent periods, gross profit has grown 2-point-x as fast as our revenue, and that's been for 2 reasons. The primary reason has been the mix shift toward these higher-margin revenue streams that you talked about. And then the secondary reason has been efficiency initiatives, cost management initiatives. And together, those have resulted in the multiplier from revenue growth to 2-point-x faster gross profit growth.

Looking forward, then we do assume at some point, some of the efficiency initiatives will have yielded the efficiencies that we sought to capture. And therefore, that driver of gross profit growth exceeding multiplying revenue growth will decelerate. On the other hand, we believe that the mix shift to higher-margin revenue streams is a phenomenon that has many years to run. And therefore, we think that our gross profit will continue to increase faster than our revenue but potentially at a 1-point-x multiplier rather than at a 2-point-x multiplier looking forward.

[Shek Hon Lo, executive]

Yes. In terms of the share of profit of associates, on a non-GAAP basis, it increased from RMB 3.9 billion a year ago to RMB 9.9 billion due to contribution from associates like PDD and, to a lesser extent, Kuaishou and Epic. As the share of associate profit started to pick up from quarter 2, 2023 and further accelerated in later quarters of 2023. Due the route of large numbers, we expect that the year-on-year growth will reduce to a lower level in the second half of the year.

[Wendy Huang, executive]

Thank you. Next, we will take the question from Ronald Keung from Goldman Sachs.

[Ronald Keung, analyst]

I want to ask 2 questions. One is on Games, that very big contrast versus last year. This year, we're seeing your reacceleration in Domestic and International Games, your proactive adjusted evergreen existing games, launch of new titles and then strong Supercell grossing. So how are we planning ahead? I think to smooth -- maybe partially smooth this hyper growth trends that we're seeing in the gross receipts momentum for investors to see this into a sustained multiyear Games revenue growth, just looking at it from a overall portfolio basis, how do we want to manage and smooth this very strong trend that we're seeing recently?

Second, on the investment portfolio, as we talked about, this will be a self-sustaining portfolio for the time being. What are the likely methods of divestments for mature -- a more mature asset? Some may not be large enough to distribute or some may not be liquid to sell, how are you thinking on the methods of divestments and then what are the new areas of investments that we are working on?

[James Mitchell, executive]

So starting with the second question. If you look at the second quarter of this year, then divestitures were substantially in excess of our gross new investments. So if you take divestitures plus dividends received plus fund distributions received, then that was over 50% greater than the capital we deployed in new investments. So the portfolio is indeed self-funding. In terms of our ability to conduct divestitures, then the majority of our portfolio value is in listed companies, and much of it is in relatively large and liquid listed securities. And so in the second quarter, we divested well over $1 billion by seeing shares on the market, and I think that trend can continue.

On the first question about Games, so we don't aspire to smooth out our Game gross receipts growth necessarily. And from a reported perspective, our financial results smooth themselves out because we defer the gross receipts into our profit and loss in some cases, over the course of several years. And so that in and of itself exerts a naturally smoothing ability. But that's an accounting necessity. It's not a business choice on our part. But I think in terms of the underlying question behind your question, what we are experiencing a step-up because of Dungeon & Fighter Mobile and so how do we sustain the underlying step-up, I'd make a few points.

One is that in Dungeon & Fighter Mobile is one contributor, but we also had other contributors. If we look purely at the China revenue than actually the launch of VALORANT in China contributed almost as much to our year-on-year revenue growth as the launch of DnF Mobile this quarter. So it's not DnF Mobile in isolation.

And then looking forward, we have the rebooting that we've done with 2 of our biggest games that we talked about yielding positive results this quarter, which we expect to continue yielding positive results going forward as those 2 big games become more and more platform-like. And the injection of new game modes, such as Metro Royale or Extraction Shooter into those platforms drives further user and gross receipts growth.

We have the ongoing growth that we've talked about in some of our newer evergreen games such as League of Legends: Wild Rift. We have -- and Fight for the Golden Spatula. And then, of course, we have a number of games in pipeline, that we're optimistic about, whether that's Delta Force or a Path of Exile 2 or One Piece that we believe have the potential to become evergreen games in their own right going forward as well. So that's how we think about driving continued growth for our game business over the long term.

[Chi Ping Lau, executive]

Yes. I would just add to that and basically say we did have a good quarter and the traction is actually quite nice. But let's not lose sight of the fact that we have seen a very challenging business environment in the past couple of years. And that's really the nature of the gaming business, right, which is, number one, it's increasingly difficult to come up with the very successful new titles these days because the quality of the game and the expectation of the gamers are very high. And at the same time, the quality and the franchise value of existing titles are very strong. So that if you want to launch a new game, you actually sort of -- you have to come up with really good quality or a very differentiated gameplay in order to attract users.

And as such, we just need to work very hard to come up with good new titles. While at the same time, we do think that the existing franchises are actually becoming more and more sustainable. But having said that, in order to grow existing franchises, we also have to keep on innovating and as a result, getting our users excited. And overall, I would say, the gaming industry is still -- have got a lot of potential. But then it's, to some extent, cyclical because when there is a [ dirt ] in innovation or new supply or new excitement, then it seems to be indulgent. And then when there is a new wave of innovation, then the gaming business, suddenly sort of -- and the industries suddenly expect. And we just you have to continue to work very, very hard in order to drive innovation.

And we felt if we can do that, we can actually grow this business over a longer period of time. But ourselves as well as investors probably need to recognize that the fact that there's be some cyclicality in the gaming business. When there's smaller years -- when there's less innovation, then it grows less. And when there's sort of suddenly a big emergence of innovation, then it will grow faster.

[Wendy Huang, executive]

Thank you. We will take the next question from Ellie Jiang from Macquarie.

[Ellie Jiang, analyst]

I have 2. Number one is really on the advertising segment. So second quarter, we've delivered 19% growth, seemed much more resilient versus the prior expectations, especially considering in the opening remarks, management, you pointed out the impact on the advertising pricing under the current environment. Just wondering what we have done differently both with Video Accounts and the other ad formats, and how we have observed the advertisers' behavior shift under the current dynamics and how we're planning to defend the macro volatilities.

The second one is really on the AI integration progress within our ecosystem. We already heard some exciting upgrades with the advertising segment. Just wondering if anything else you could share, such as the large language model training progress, application explorations opportunities and how we plan to strategize to further bump up the efficiency adoption.

[James Mitchell, executive]

So I'll take the advertising question. And we haven't made dramatic changes. We're just continuing to execute along our path. And we are benefiting from deployment of neural network artificial intelligence on a GPU infrastructure to boost the click-through rate on our advertising inventory. We are benefiting from a mix shift of advertising within Weixin increasingly being of a closed-loop nature. And all else equal, as you can see from the big e-commerce marketplaces and short video services, closed-loop advertising tends to achieve higher, both higher CPM, but also a click-through rate versus non-closed-loop advertising.

And then we have the potential to benefit from releasing more inventory, especially in Video Accounts. But in reality, in the first half of the year, we didn't release incremental inventory. So the growth that we experienced were a function of the first 2 features.

[Chi Ping Lau, executive]

In terms of AI, I would say we look at AI as a more complete suite than just large language model. There are the neural networks, machine learning-based recommendation engines, which we use for content recommendation, video recommendation as well as the talking in the ads and content use case, which is already delivering very good result. If you take Video Accounts as an example, by using AI, we actually are able to deliver better content and that generates more use time -- a pretty big part of the growth in terms of the Video Accounts user time. It's actually driven by better targeting, better recommendation and that's in turn driven by AI.

And at the same time, on the ad recommendation end, if we can actually increase conversion by 10%, right, that's sort of pretty modest improvement. The revenue actually grows quite a bit, right? So I think that's areas in which we are leveraging AI to deliver material and tangible commercial results.

In addition, in the area of games, we're actually using AI to bridge the gap between PVE and PVP, right? So when you have games, which allow people to play against other players, but at the same time, sometimes you actually want to create a game mode in which a player actually play against the machine, right? Then -- in the past, the machine is actually quite dumb, right? And with AI, we can actually make the machine play like a real player. And we can actually sort of have it to play a varying levels of skills and make the user experience and the gameplay very fun.

So I think those are the areas which are not LLM but generating very tangible results for our businesses. Now in terms of LLM, the key thing for us is actually improving the technology. And as we shared before, we have already built an MOE architecture model, which is performing as one of the top models in China. And when compared with international models on Chinese language, I think we are at that top of the pack. And we are deploying our LLM in Yuanbao, which is an app that we have launched which allowed users to interact with our large language model in multiple ways.

And one way is enhanced search functionality so that users can actually ask a question. And based on search results, we can actually provide a very direct answer to the questions that our users pose and we have rolled it out to a large enough sample size to get user feedback and the feedback so far has been quite positive. But of course, at the same time, we're also receiving a lot of constructive feedback and then we're using that to keep improving our product as well as our model. And over time, Yuanbao, when it gets to a certain level of quality, then we're going to increase our promotional resources and try to get more users into the app.

And at the same time, when it gets to an even better level of expertise, then we can actually start incorporating it into different parts of our ecosystem. We have a lot of apps which actually has got interaction use cases, which we can leverage our generative AI technology. And we incorporating our tool into those use cases at the time when the quality of our product is good. And at the same time, as we continue to prove the efficiency of the model so that these products can be delivered to the users at a cost effective way.

[Wendy Huang, executive]

Thank you. We will take the next question from Alex Yao from JPMorgan.

[Alex Yao, analyst]

Congrats on a strong quarter. My first question is regarding DnF Mobile. The game has achieved a strong initial momentum since the launch in late May. How do you guys think about the sustainability of this game? I'm asking because this is not a typical tactical e-Sports game such as Honour of Kings or Peacekeeper Elite, that we have a lot of expertise, domain knowledge and execution track records. So given the genre or nature of the game, what's the strategy and outlook for the game sustainability?

And then second question is regarding FinTech. The growth rate of the FinTech business was negatively affected by a slow consumption environment and also high price sensitivity among consumers. Have you observed the consumption behavior change in terms of financial product transaction on Weixin platform? If so, are these changes are structural or cyclical?

[James Mitchell, executive]

Alex, thank you. On Dungeon & Fighter Mobile, we're very optimistic about the sustainability. The first reason is that there is the Dungeon & Fighter PC game that has sustained at a high level, a very high level for 16 years. And so I think that we believe we do have expertise in operating this kind of game. We've done it for 16 years successfully with Dungeon & Fighter PC and now are extending it to a new platform.

Secondly, we can see that in the 60-odd days since launch, Dungeon & Fighter Mobile has very good retention rates. And of course, retention rates can fluctuate over time, but actually the first 30 days of the games life, those first 30-day retention rates are historically very good leading indicators for which games would enjoy the greatest longevity. And so whether it's League of Legends or Teamfight Tactics or Peacekeeper Elite or Honour of Kings, what marks them out in their first 30 days was not how many users downloaded the games. It's not how much revenue they generated, it was the high retention rates that they were displaying among those users who had installed and begun playing the game.

And we're also seeing very good retention rates for DnF Mobile. And of course, because the DnF Mobile game has been in development for an unusually long period, it's a very heavy content pipeline over the next 2 to 3 years that's already set up that will be progressively released. And of course, during those 2 to 3 years, Nexon and we will be working on the content pipeline for subsequent years. But the game is in an unusual situation where because of its unusually long development pipeline, there's now an unusually long post-release content pipeline that's already ready to release as and when we choose to do so. So that's on DnF Mobile.

[Chi Ping Lau, executive]

So on FinTech, if we dissect into different businesses, right, the payment business is definitely very tied to consumption growth. And as you can see in the official data, consumption growth in China is actually kind of weak. And we also clearly see that in our payment business in the sense that we saw a continued growth in terms of the number of transactions. So the number of transactions on the commercial side continue to grow double digit.

But on the other hand, the average transaction value has decreased, which is contrary to before, in which we have seen a pretty consistent growth in terms of average transaction value over a very long period of time. So we felt this is a clear demonstration of the fact that consumers are getting much more budget conscious. And so that's on the payment side.

In terms of the credit, we do see consumers actually wanting to borrow more at this point in time, but then the revenue actually decreased because we proactively control what we lend out and we then lend out because we want to tighten the credit at this point in time when the macro and consumption is kind of weak.

And on the other hand, wealth management actually increased because a lot of consumers instead of spending they actually save more during uncertain times. So these are the dynamics that's happening across the different product areas within FinTech, we felt this is more cyclical rather than structural because it's somewhat tied to the weak consumption pattern that's happening in the overall market.

And as a result of that, we have seen the government actually rolling out very proactive policies to encourage consumption. And we felt with these rollouts of such policies, at some point in time, the consumer sentiment as well as the economy will start turning. Because as evidenced in the wealth management service, right, it's not as like people don't have money. People actually sort of have money, but they choose to save rather to spend. And if the government policies can actually induce more confidence among the consumers and start revitalizing different parts of the economy that are felt, at some point in time, consumer sentiment would turn and that would be good for FinTech business.

[Wendy Huang, executive]

Thank you. Next, we will take the question from Charlene Liu from HSBC.

[Charlene Liu, analyst]

Martin mentioned that the bar for game quality and expectations have only gone up and turned more demanding. Can management discuss where we are in the investment cycle for AAA titles? And can you please give us an update on latest progress and whatnot? That's the first question.

And separately, we have seen that cross-pollination of literature or existing PC games IP has played quite a vital role for driving growth in long videos as well as for mobile games. Honour of Kings world is obviously a highly anticipated title, what is the progress there? And can management also discuss what other IPs in the reserve, which you expect to see similar potential and capable of driving more revenue potential across digital content segments.

[James Mitchell, executive]

I think the second question, we've talked about some of the other IP-based games that we're excited about earlier in this call and also at length at the fourth quarter results call, so I would refer back to that. But you can also look at what games we have that have become dramatically successful on PC such as VALORANT, which is now the biggest PC game in China. And of course, we'd like to bring that to mobile recently secured its Banhao or publishing license in China. And you can look, if you're so inclined, at some of the interesting IP being generated by China Literature and being generated by Tencent Comics and speculate as to whether that IP would make sense as the basis for games as well. So that's on the second question.

In terms of the first question, I'm not sure that there's a cycle per se in AAA game development. I think there's more of a relentless trend where the game industry is only becoming bigger and therefore, the budgets associated with the best games are also only becoming bigger, and we need to play in that arena, and that's what we're doing. And so we have being continually creating a large number of games as you know, we expense those costs through our P&L. We don't capitalize them. And so what you see is sort of what you get in terms of the income statement in tracking the cash flow quite closely. And we are indeed investing in a large number of what we believe will be very high-quality games.

As to defining which ones are AAA versus which ones are more systems-based, then I think the boundaries have become increasingly blurred. If you look at our game Delta Force that's now available for alpha testing on Steam and is quite popular. One of the reasons for the popularity is that, within Delta Force, there's a mode that is very cinematic, classic AAA experience that's modeled on the Black Hawk Down incident. And then there's 2 other modes, which are much more system-based, an extraction shooter mode and 30-versus-30 mode that are much more akin to some of our sort of competitive PVP games. And so Delta Force is an example of something that incorporates both the cinematic AAA experience as well as the competitive PVP experience.

[Chi Ping Lau, executive]

If I can add, right? And I think AAA is more like a means not an end, right? So you can have play mode-driven game, you can have sort of new content-driven game and AAA sort of is probably more geared toward content-driven. But I think for us, we really want to -- the end is actually building game titles to become evergreen titles and over time, getting big enough evergreen titles into platforms. And within the platform, you would have -- you have play mode-driven content, you also have content-driven play mode. So it will be interlaced within a game over -- a game world. So that's sort of what we felt will be happening, and we see a big opportunity.

In the future, of course, it would take some time to develop to put more content-driven playing experience into our competitive games. And we felt that it could be a pretty good opportunity for us to get our users within our competitive games to be exciting. And over time, right, with the advent of AI, as I said earlier, when we can actually blur the line between PVP and PVE, then there's actually more opportunity for us along that.

[Wendy Huang, executive]

Thank you. We will take the next question from William Packer from BNP Paribas.

[William Packer, analyst]

There's been some press speculation around tensions with app store owners in China regarding several factors, for example, fees and external payment systems, which is paralleling in Europe and elsewhere. Could you help us think through the challenges and opportunity across the portfolio? For example, do you still see upside for the gaming business gross margin from reducing payments? Or in contrast, should we be more cautious for elements of the week ecosystem? Any color would be appreciated.

[James Mitchell, executive]

So that's quite a dense question, and my answer may or may not sort of reflect all of the density, but let me attempt to answer. So there are indeed naturally tensions between the game industry or the digital content industry versus app stores. And the root cause of the tensions is that the app stores charge, what the game industry feels is a very onerous burden of 30% on games and other forms of digital content. Of course, the app stores would argue that they provide a beneficial ecosystem that is supportive of this digital content. But then the game industry would reply that, that ecosystem, if it benefits digital content, also benefits all sorts of other goods and services.

And so why is it the case that the burden of funding the ecosystem falls disproportionately entirely onto the digital content providers and not at all on to all of the other goods and services providers we could assist that. So I think that's the general backdrop. And over time, both for regulatory reasons and business reasons, there is a trend towards the app store take rate, reducing over time.

In terms of our position, then as you are aware, the Dungeon & Fighter Mobile game given the strength of the IP, given the fact we knew that the most enthusiastic players will seek out the game and download it from the URL, whether it's in an Android app store or not. We made the decision for that specific game to work mostly with internal channels, rather than with the onerous Android app store channels. And we're very happy with that decision. It's beneficial for our returns. And we think it's fine in terms of user experience.

But there will be other games we release in the future with different characteristics where we're seeking to build an audience from scratch, where we look forward to continue to cooperate with the app store operators. So that's in terms of new game releases. Your question, I think, also was touching on some of the press commentary around in Mini Games on iOS. And I think there's been some misunderstandings there about the nature of the current situation, which is that today, we don't monetize many games on iOS through in-app transactions. I think it would be in our interest and Apple's interests, but more so for the game developers and the users' interests if that monetization were made available. But we want to make it available on terms that we think are economically sustainable and that are also fair.

And so that's a discussion that's underway. And we hope that the discussion leads to a positive outcome because it will be a win-win-win. But in the event that the discussion doesn't progress, then the current status quo continues. In the event that the discussion does progress, then that's incremental revenue for us, incremental revenue for game developers, potentially incremental revenue for Apple and certainly a better experience for Apple users.

[Wendy Huang, executive]

Thank you. We will take the next question from Thomas Chong from Jefferies.

[Thomas Chong, analyst]

My first question is about Cloud business. Given that, I think in the prepared remarks, we talked about the AI-related revenue from high computing infrastructure, model library service and also our AI solution for enterprise. I just wanted to get some more color with regard to our Cloud revenue. What are our thoughts about the contribution from AI going forward? And my second question is about capital return. Considering the macro uncertainties these days, any thoughts about upsizing our share repurchase program?

[James Mitchell, executive]

So on the first question, clearly, for the U.S. hyperscale Cloud providers, renting out GPUs to other companies with AI requirements has become a very big business. In China, the same trend is evident, but to a lesser extent because you don't have the same multitude of extremely well-funded start-ups trying to build large language models on their own in China. There are many small companies, but they're capitalized for $1 billion, $2 billion. They're not capitalized at $10 billion or $90 billion, other way that some of the giant U.S. VC-funded start-ups are now capitalized in the space. And it's also a somewhat challenging economic environment.

Now that said, we have seen that within our Cloud, the demand from customers for renting GPUs for their own AI needs has been growing very swiftly. The percentage growth rates are very fast, but they're very fast partly because it's a low base. And also partly because, while some of that demand for renting GPUs in the Cloud is incremental, some of it is replacing demands that would otherwise have existed anyway for renting CPUs in the Cloud. And so while the business of GPU provision is doing very well, the business of CPU processing is more flat because the incremental demand is for GPU, not CPU.

[Chi Ping Lau, executive]

In terms of share buyback, at this point in time, we are continuing with our previously communicated share buyback program, and there's no update for now.

[Wendy Huang, executive]

We will take the last question from Gary Yu from Morgan Stanley.

[Gary Yu, analyst]

My first question is regarding Domestic Games, again, a follow-up on DnF. I think management mentioned that we expect this to be the next evergreen major hit. How should we look at the longevity and scale on a sustainable basis versus the other 2 evergreen games in terms of amount of DAU or revenue potential in kind of longer term relative to kind of Honour of Kings and Peacekeeper Elite?

And my second question is related to macro. I think management indicated that we have started to see some negative impact on payment. How has the recent trend been -- look like? So have we seen a stabilized trend or things are getting worse? And also we noticed that games and Tencent own ad probably seems to be very resilient under this kind of macro environment. How sustainable do we think we can kind of keep up the current resiliency in the games and advertising business in particular?

[James Mitchell, executive]

Gary, on Dungeon & Fighter Mobile and triangulating it versus our historically 2 biggest games as well as other games that are in the market, then this is probably stating the obvious, so I apologize. But as a narrative rather than systems-based game, one would naturally expect a lower daily active user base for DnF Mobile, then one would for more systems-based games, such as Honour of Kings or Peacekeeper Elite. On the other hand, as a narrative, not system-based games, one would expect a substantially higher ARPU for Dungeon & Fighter Mobile than for those system-based games.

In addition, because Dungeon & Fighter Mobile is sort of building on 16 years of legacy, and specifically of many people who played in DnF PC 16 years ago when they were in college and are now working and quite affluent, but only have time to play games on mobile phones, the spending power of those users is also greater than it would be for new games that appeal to more of a 20-something user base. And so both the nature of the game being more narrative-based as well as the nature of the audience being a more mature audience are conducive to higher ARPU.

Now that said, if you compare Dungeon & Fighter Mobile with other narrative-based games in the China market, then the user base, the number of DAUs is dramatically larger. The game actually has a big audience for a narrative-based experience. And we believe that will continue given the nature of the game, given the high retention rates I talked about earlier. And while the ARPU is higher than it is for our biggest systems-based games, it's lower than for many narrative-based games in China, we think the monetization is fair and sustainable. Again, especially in light of the nature of the audience for Dungeon & Fighter Mobile.

[Chi Ping Lau, executive]

In terms of macro, I would say what we saw is actually pretty consistent with the official consumption number, which is the second quarter is actually a slowdown from the first quarter. So I think that's the current trend. We felt with the government rolling out more proactive policies and more expansionary policies then over time, given the resilience of the overall industry as well as entrepreneurial environment in China, then we should, over time, see a recovery in terms of the economy as well as consumer consumption. So that's what we believe in. But the -- it's not a matter of whether, right, it's a matter of when. And we just sort of have to wait a little bit to see when the inducive policies would actually start yielding results.

Now in terms of games, I would say, for our games, which are essentially large DAU, long engagement games, we have pretty low spending per unit at the time. And as a result, we felt this is actually quite resilient in the overall macro environment. And if we are to see any issue, it probably would be in the low-DAU, high-ARPU games, which are not necessarily Tencent Games, and you might want to look at those games as proxies.

And overall, we felt, of course, part of the gaming industry is actually driven by macro environment, which we felt given sort of the low spending per unit time, there are probably still some headroom before we hit that.

The more important driver is actually innovation, as I've continually repeated a couple of times. So when there is continued innovation in the gaming industry, then we felt the market would expand even if the macro environment is actually challenging.

[Wendy Huang, executive]

Thank you, Martin. We are now ending the webinar. Thank you for joining our results today. If you wish to check out our press release and other financial information, please visit the IR section of our content website at www.tencent.com. The replay of this webinar will also be available soon. Thank you, and see you next quarter.