Tencent, NetEase likely to lose young users after stricter online gaming rules

Chinese gaming companies Tencent Holdings Ltd. and NetEase Inc. will struggle to attract and retain young users after the introduction of new rules to restrict access to their platforms.

Tencent released a series of measures Aug. 3 to tighten young players' access to its mobile games to prevent gaming addiction. Tencent said it will cut the amount of time that players aged 18 years and under spend on its popular game, Honor of Kings, to an hour and a half per weekday and two hours on the weekend. The company added it will expand the measures to its other games at a later date.

Similarly, rival gaming company NetEase said it will restrict the time and money young players spend on their games and implement real-time authentication of gaming accounts, as part of its 2021 summer program.

"Game developers will likely lose the chance to breed future game players due to current restrictions on minor groups," said Jes Zhang, CEO and head analyst at iiMedia Research Group. The time restrictions imposed on young users will stunt the growth of game players in the long term, the CEO noted.

To boost the longevity of their games, both Tencent and NetEase have titles that aim to attract student players, who often turn into paying players when they start earning, Zhang said.

Tencent's Honor of Kings and NetEase's Fantasy Westward Journey are examples of popular games that have implemented this strategy and done well, Zhang added. As of August 2021, Honor of Kings was the highest-grossing game globally with $9.6 billion in revenue, while Fantasy Westward Journey was featured in the top nine highest-grossing games globally with $4.7 billion in revenue, according to data from mobile app marketing intelligence firm Sensor Tower.

Honor of Kings has been a globally popular game for six years, which is longer than the average lifespan of mobile games. "Mobile games are usually attractive to players for, [at] most, two to three years," Zhang said.

As of December 2020, minors aged under 18 accounted for 6% of Tencent's China online game gross receipts, among which, minors aged under 16 accounted for 3.2%, according to Tencent's 2020 annual report.

As a percentage of its online gaming revenue, minor players contributed less than 2% for Tencent, according to Ivan Su, senior equity analyst at Morningstar. NetEase does not provide a breakdown of its online gaming revenue by age.

Tencent and NetEase's move to change user player access, follows reports from Chinese state-backed media, Securities Times, which said Aug. 5 that online game developers should prepare to pay more in taxes. The publication is believed by industry observers to be an official outlet for Chinese securities, banking and insurance regulators.

Another Chinese state-backed publication, The Economic Information Daily, reported Aug. 3 that online games are "opium for the mind," and called for intensified crackdowns on online gaming time allowed for players under the age of 18.

Tencent's share price sunk nearly 9% to HK$424.6 post the report on Aug. 3. The stock closed Aug. 17 at HK$435. NetEase hit HK$134.9 per share on Aug. 3, down around 14% from its opening trading price of HK$157 on the day. NetEase closed Aug. 17 at HK$129.

"If taxation exemptions on these companies are removed, the pace of growth for the game companies will slow down," Su said.

Game developers are categorized as "high-tech" software companies in China, according to the Securities Times report. China has been granting exemptions on corporate and value-added taxes to software companies since 2011 to help with the development of so-called "high-tech" enterprises, according to a February government document. Select software companies can be exempted from a 25% tax for the first several years and pay half of the tax for an unspecified period of time later. The time and the amount of the tax exemption vary case by case, based on the companies' financial performance and specific products, according to the document.

If NetEase and Tencent lose their tax exemptions, the companies will risk dropping their annual online gaming profit, Su said.

For its entire business, Tencent's profit attributable to equity holders of the company was 159.85 billion yuan in 2020, up 71.3% year over year. NetEase's net income was 12.06 billion yuan in 2020, down 43.2% over the year. The companies do not provide a breakdown of their profit by business segment.

Su added that Tencent would be impacted less by any tax change due to its "diversified business model."

Tencent and NetEase declined to comment.

China has been looking to tighten the management of its gaming sector in recent years.

From October 2016, companies are prohibited from publishing games without a license from content watchdog, National Radio and Television Administration, or NRTA. The NRTA recently adopted a system to rate the games based on their "value guidance, originality, quality of plots, operation system development and cultural impact," according to local media reports. The full score is five points and games rated under three points will be unable to receive a license.

The NRTA and other four state ministries together published a list of critical companies for cultural export from 2021 to 2022, according to a July 27 release by the Ministry of Commerce. Some 68 out of over 300 companies are game developers, which include Tencent, NetEase, miHoYo Technology (Shanghai) Co. Ltd. and CMGE.

"The gaming sector will continue to be an important sector for China," said Tam Tsz Wang, Hong Kong and China equity research analyst at DBS Vickers Securities.

"But the values [illustrated through the] games and the themes they embody via their plots will continue to be under tight control," Tam said. "We can expect more [regulatory] moves in content-related sectors such as online gaming and video streaming."

As of Aug. 17, US$1 was equivalent to 6.49 yuan.