Last Wednesday, Tencent Holdings Limited (OTC: TCEHY) delivered a second quarter report that reflected the turbulent dynamics of the Chinese economy that hasn't bounced back from the COVID-19 turmoil as quickly as anticipated.
Tencent's core gaming business fell short of as the Chinese technology giant continues its recovery from a rough 2022, but it did deliver three straight quarters of revenue growth. Like its tech peers, Alibaba Group Holdings Limited (NYSE: BABA) and Baidu Inc (NASDAQ: BIDU), Tencent is betting heavily on AI to boost its business, but this time, its earnings came below expectations.
Second Quarter Highlights
For the quarter that ended on June 30th, revenue grew 11% YoY to 149.20 billion yuan, which amounts to approximately $20.45 billion, below Refinitiv's average estimate of 151.73 billion yuan. This is a slight change compared to the first quarter that reported a 10.7% rise, but then again during last year's comparable quarter, Tencent recorded its first-ever sales decline, that amounted to 1%, as the tech sector was hit with Beijing's regulatory crackdown.
Although domestic gaming revenue was pretty much flat at 31.8 billion yuan, which the company attributed to the release of "less-commercially impactful content", YoY growth is expected to return in the ongoing quarter. On the other hand, international gaming revenue rose 19% to 12.7 billion yuan, or 12% excluding the impact of currency movements.
This slowdown in gaming was offset by strong performance of online advertising whose revenue rose 34% to 25 billion yuan, topping Refinitiv consensus estimate of 22.85 billion yuan.
Fintech and business services rose 15% to 48.6 billion yuan, with the expansion being owed to both offline and online payment activities.
As a result, net profit rose 41% YoY to 26.17 billion yuan, under 33.41 billion yuan that analysts expected, according to Refinitiv.
Regulatory Environment Is Now More Supportive
This year, the regulatory pressures have eased for China's tech titans, such as Tencent, Alibaba and Baidu, as the authorities now aim to support the innovation these companies bring out, as they benefit the economy. As for the potential impact of China's cyberspace regulator's proposal to ban children from using smartphones for more than two hours a day, Martin Lau, Tencent's president, does not expect any material impact as the company already prohibited minors from using its services.
The AI Bet Promises To Be Among China's Best Models
Like Baidu and Alibaba, Tencent is preparing its self-developed foundation model that is set to launch later this year. Back in April, Alibaba already launched its large language model, Tongyi Qianwen, that allows AI content generation in English and Chinese. Alibaba developed different model sizes, including seven billion parameters and more complex ones. Alibaba even challenged Meta Platforms (NASDAQ: META) by open-sourcing the seven-billion-parameter model and version designed for conversational apps.
Lau highlighted AI as Tencent's key focus as this technology can be used in various applications. Tencent revealed that it has been testing this model internally across its businesses, including advertising and fintech, with positive progress reports showing it is among the top leading foundation models produced in the country.
China's Slower Than Expected COVID-19 Recovery
Although Tencent is seeing the benefits of cost-cutting initiatives it started last year by shutting down its non-core business and cutting down on marketing spending, its results also show that the world's second largest economy is taking more time than needed to bounce back from the COVID-19 downturn. First, Tencent needed to bid farewell to its Covid-19 "glory days" as lockdowns came to an end, dethroning gaming as the #1 activity, then it faced Beijing's regulatory crackdown and now, it suffered due to China's slugglish recovery from the COVID-19 turmoil. But, Tencent is udoubtedly going to fight for the AI crown, with favorable regulatory tides for a change.