Tencent Stays in Beijing’s Sights Even After $490 Billion Drop

(Bloomberg) — Bigger job cuts. A fintech revamp. A drought of new games. If China’s crackdown on its giant tech sector is finally easing up, Tencent Holdings Ltd. has yet to feel it.

Most Read from Bloomberg

Tencent has lost about $490 billion in market value since its 2021 peak even as it’s consistently played down the impact of Beijing’s heightened scrutiny over industries from entertainment and media to finance. While signs are increasing that China’s campaign is relenting, it’s difficult to make the case that the gaming and social behemoth is out of the woods.

China’s second-largest company is expected to unveil its slowest pace of growth on record when it reports earnings Wednesday. On top of a set of results that will likely do little to assuage investor concerns, Tencent is coping with challenges that have yet to show up on its quarterly print. Regulators are considering requiring Tencent to bundle WeChat Pay into a financial holding company, Bloomberg reported last week, part of an overhaul of its giant fintech arm that could undermine the appeal of its entire social media business. And like its biggest rivals, Tencent is readying deeper job cuts than in prior years at a time when President Xi Jinping pushes for the end of a “disorderly expansion of capital.” Tencent’s trailing 12-month price-to-earnings ratio of about 15 compares with Electronic Arts Inc.’s 44, according to data compiled by Bloomberg.

“China’s internet firms are trading at historic lows. They enjoyed premium valuations during past years of rapid expansion, but the selloff has popped the bubble entirely,” said Citic analysts led by Wang Guanran in a March 16 note. “Tencent’s earnings will face pressure over the short term but its core businesses remain competitive.”

China’s tech corporations have resigned themselves to a new era of cautious expansion, nearly two years into Beijing’s bruising internet crackdown that quickly engulfed everything from e-commerce to ride-hailing and online education. Alibaba Group Holding Ltd. this month reported a 10% sales increase, the slowest pace of growth on record, and pledged to prioritize user retention over acquisition. Streaming hubs iQiyi Inc. and Bilibili Inc. – big spenders of past years – now aim to reach break-even more quickly, after their user growth slowed down.

Tencent has thus far largely escaped Beijing’s direct scrutiny, but the sheer size of its internet empire – with a billion-plus WeChat users at its heart – has left it vulnerable to macro and regulatory headwinds. Hammered by China’s weak economy during Covid-19 lockdowns, its online advertising business is expected to have contracted for the first time on record in the fourth quarter. A freeze on new titles in the world’s largest mobile gaming market is now entering its eighth month, forcing Tencent to increasingly turn outward with renowned properties like the League of Legends franchise. Its nascent fintech and cloud segment – the only division projected to post double-digit growth – has yet to meet requirements from the financial regulators, and faces intensifying competition from the likes of Alibaba and Huawei Technologies Co.

Tencent and its chief foes have gyrated widely as investors switched their bets. Just last week, Chinese officials led by Vice Premier Liu He vowed to stabilize financial markets, stipulating that the “rectification” of major tech platforms should end “as soon as possible.” His remark spurred a 30% rebound in the Hang Seng Tech Index in two days. Tencent and Alibaba gained roughly $200 billion in market value during that period, easing a $1 trillion yearlong meltdown from their peaks.

Several unresolved issues remain. Regulators are now weighing whether Tencent should include WeChat Pay in a newly created financial holding company, a year after they told the tech giant and 12 other firms to cordon off financial services from their main businesses. While similar requirements are imposed on Jack Ma’s Ant Group Co., ring-fencing Tencent’s financial business could be more difficult because it’s an integral part of WeChat’s one-stop-shop convenience and relies on back-end support from different divisions within the company.

Tencent’s fintech and business arm – which includes cloud computing – is its fastest growing part, contributing roughly 30% of sales, the biggest revenue source after gaming. Tencent executives have said a fintech shakeup should have little impact on operations, and WeChat Pay is first and foremost a transactional platform, instead of a lender, which has higher risks. The Wall Street Journal reported last week that Tencent faces a record fine after Chinese authorities found WeChat Pay had violated anti-money laundering rules.

But it’s in gaming – which yields the lion’s share of Tencent’s revenue and global clout – that the greatest uncertainty persists. Regulators have imposed strict curbs on playtime for minors, and are finalizing more restrictions on in-game purchases. That’s partly why Beijing’s media watchdog hasn’t approved the launch of a single title since the end of July.

It’s deja vu for Tencent, which in 2018 saw its first profit drop in at least a decade during a months-long gaming approval hiatus. While aging hits like Honor of Kings remain Tencent’s biggest cash cows, the company is delving deeper into the global market, including through a new publishing division set up in Amsterdam and Singapore. For the September quarter, Tencent’s domestic games sales grew just 5%, a fraction of the 20% increase in its international division.

“Tencent has many approved games in the pipeline, despite having no concrete timetable. We believe it has delayed these launches to avoid regulators’ attention in the near term,” Daiwa analysts including John Choi said in a note. “We expect its collaborations with international game houses and investments in overseas game studios to drive Tencent’s expanding influence globally.”

Tencent’s investment arm – which in the past bankrolled expansion for the likes of Meituan and ride-hailing platform Didi Global Inc. – has entered stealth mode. The company recently reduced its stake in Singapore’s Sea Ltd. and handed out almost all of its JD.com Inc. stock as a one-time dividend – spurring speculation it’s exiting or sidelining similar investments across the industry.

Meanwhile, WeChat is the glue that ties Tencent’s sprawling internet businesses together, for everything from a Call of Duty purchase to a TikTok-style video feed and meal delivery. Last year, China’s tech-industry overseer warned internet firms against blocking rival services, prompting WeChat to start allowing external links to apps run by the likes of Alibaba and ByteDance. That process remains in the works.

Most Read from Bloomberg Businessweek

©2022 Bloomberg L.P.