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Credit FAQ: Has Tencent Cleared China's Regulatory Hurdles?

Changes have been coming fast and furious for Tencent Holdings Ltd. The China internet giant has faced rapid regulatory change and uncertainty, and shifting market fundamentals. Many of these structural shifts hit amid the shocks of COVID-19. So how has Tencent managed the transition?

Reasonably well, given the circumstances. As growth matures at its traditional franchises, such as games and messaging service Weixin, it has launched new apps and functions. Some of these newer businesses could turn into significant revenue drivers.

The company will need to continue investing and executing on its new initiatives to stay ahead of competition and shifts in consumer behavior. It has plenty of room to maneuver here considering its annual free operating cash flows (including purchase of intangibles) of about Chinese renminbi (RMB) 110 billion-RMB120 billion (US$15.8 billion-US$17.3 billion).

In this this report, we address the most common questions we hear from investors.

Frequently Asked Questions

How has the business and regulatory environment changed for Tencent and other Chinese internet companies?

It's better now, with, for example, approvals for new games filtering back through after a painful pause. Conditions remain difficult compared with pre-2020. Consider for example:

  • Starting in 2020, China began stringently enforcing its Anti-Monopoly Law, requiring Chinese internet companies to register acquisitions with the State Administration for Market Regulation (SAMR). The following year, the regulator blocked Tencent's proposed merger of China's two largest video-game streaming companies Huya Inc. and DouYu International Holdings Ltd. This was first time China blocked a merger between two domestic companies.
  • The review process for approving online game licenses (or "banhao") changed significantly, slowing matters. Sometimes many months went by without new approvals.
  • China introduced new restrictions that severely limit the amount of time minors can play online games.
  • SAMR ordered Tencent Music Entertainment Group to end its exclusive music agreements.

Some unrelated policy decisions and industry shifts also took a toll:

  • COVID-related lockdowns and regulations on education and real estate significantly reduced advertising spending and;
  • Online users in China are increasingly gravitating to newer social media formats from text and pictures to short-form videos.

As a result of these changes and trends, Tencent's revenue declined across most of its business segments. Total revenue growth slowed from 20%-30% at the beginning of 2020 to single-digit declines in 2022.

Chart 1


What do these changes mean for Tencent's future?

2023 could bring a meaningful recovery for Tencent. This is partly because of a low base effect after a particularly difficult year for advertising in 2022. Another driver of better performances is new growth platforms such as Mini Programs and Weixin Video Accounts. More clarity around government regulation and policy direction also supports growth for online games and fintech.

There is less visibility in 2024 and beyond. Online entertainment such as domestic online games, music, and video will expand in line with China's GDP growth, in contrast to faster growth of past years. The company is also pursuing new growth areas; however, some of the new markets are crowded or intensely competitive.

More stability for most of the traditional domestic franchise.  Tencent's domestic games, third-party payments, online music and long-form video are likely to expand roughly in line with China's economic growth rate. This is considering high penetration rates (of online games and payments) or growing competition from competing online entertainments (music and video).

Downside risk is contained by the company's large share of user activity. While competition is increasing in some of these niches, overall Tencent has limited direct competitors in these segments. Combined, we estimate these traditional segments account for over 60% of Tencent's revenues.

International games, Video Accounts (e-commerce opportunity), Mini Programs, other fintech services (consumer lending, insurance, etc.), and cloud have potential to take off.  We see potentially significant growth in revenue from the short-form video function Video Accounts--indeed, this is key to our forecast for Tencent's social advertising revenue growth of mid-teens over the next two years.

At the same time, competition in these newer segments are much more intense. And for some segments, Tencent's share is far behind the market leader (including cloud and short-form video). Moreover, these businesses tend to be less profitable and benefit less from working capital in-flows when compared with online games.

Chart 2


Overall, we expect Tencent's credit quality to remain stable. This considers its likely single-digit growth (assuming no large acquisitions), and potentially even slower EBITDA and cash flow growth, partially offset by improving diversification. EBITDA could outperform our forecasts (see table 1 at bottom of report), if Video Accounts, Mini Program, and cloud can materially improve their profit margins through scale and efficiency gains.

Chart 3


What is the outlook for Tencent's games business?

Tencent's domestic games revenue, accounting for 20% of revenues and a higher percentage of profits, is likely to recover over the next two years after a 4% decline in 2022. However, growth is likely to be modest considering a more mature online games market (the user base for online games has remained flattish over the past several years), government initiatives to control online game play, and competition from other entertainment options such as short-form video.

Easier comparisons in 2023 and a resumption in game license approvals are key drivers for domestic game revenue growth in 2023 and 2024 at about 3% and 5% respectively, up from a decline of 4% in 2022. Tencent's gaming revenue growth has some correlation with new game approvals, sometimes with a bit of a delayed effect.

Chart 4


The lack of new game approvals in 2021 and 2022 also resulted in a decline in the number of users and time spent on games. Without new games and content, it is likely that users shifted to other forms of entertainment.

QuestMobile, a data provider, indicated that total user-time spent on online games declined 3% in 2022, in line with Tencent's domestic game revenue decline of 4%. This compares with double-digit growth in average user time on short-form video platforms--where users now spend on average 2.5 hours per day, making up 28.5% of total user time spent online. Users spend more time on short-form video apps than any other category of online apps by a large margin (instant messaging accounts for 20.7%).

Upside to our domestic online game revenue forecasts for 2023 and 2024 hinges on new games.  If they turn out to be hits, games in the pipeline could entice new gamers or lure back users that left for other entertainment options.

Chart 5


Chart 6


We see room for higher growth in Tencent's international games, despite a recent slowdown. This could come via:

  • cross-platform games boosting Tencent's penetration into other game platforms;
  • more online game spending in emerging markets outside of China; and
  • further share gains in mobile gaming in overseas markets.

These opportunities are somewhat offset by slowing global game spending, China developers' already large share of overseas mobile revenues, and Tencent's lack of console games. We forecast Tencent's international games revenue will expand by percentages in the low- to mid-teens over 2023 and 2024.

Chart 7


Chart 8


How big of a threat are short-form video platforms Douyin and Kuaishou and how well can Tencent's Video Accounts defend against it?

The threat could be meaningful. Short-form video platforms are growing dramatically, at the expense of other online entertainment such as online music, long-form videos, and online games. Such platforms now account for the largest chunk of users' time spent online (see chart 7 above).

Tencent launched Video Accounts--a short-form video service built within its Weixin messaging app--in response to the short-form video threat. This app rapidly took off in the two years since it was launched two years ago. It had 813 million monthly active users (MAU) as of June 2022, according to QuestMobile. Its success, despite competing with well-established competitors, may stem in part from its unique content.

However, such uniqueness may have its disadvantages. For example, its differentiated value proposition may in fact limit Video Account's ability to defend loss of users and their time spent within Tencent's ecosystem. This is because rather than being a substitute product to Douyin and Kuaishou (and therefore winning back users), Video Accounts could be complimentary to the other two platforms.

Chart 9


Signs of this includes differences in usage patterns and a surprisingly large overlap between Video Accounts users and Douyin and Kuaishou--60% of Video Accounts users use Douyin and about a third use Kuaishou, based on data from QuestMobile. Video Accounts users also spend less time and use the app less frequently than Douyin and Kuaishou, according to some third-party reports and Tencent. This could suggest that the content on Video Accounts is different from Douyin and Kuaishou and hence the differences in user behavior.

Chart 10


On the other hand, momentum from Douyin and Kuaishou may also be moderating. Growth of users and time spent on the platform are slowing, especially as users are already spending on average more than two hours per day on such platforms.

Chart 11


Chart 12


Does Video Accounts have to be a significant revenue driver?

Yes. We estimate that advertising revenues alone from Video Accounts could increase by at least 3x-4x over the next few years, from RMB1 billion per quarter now. By way of comparison, Kuaishou's current advertising revenue is about 10x that of Video Accounts. And Kuaishou has a smaller MAU base. Granted, Kuaishou has a similar scale of daily active users (DAU), who spend more time on this dedicated short-form video platform relative to Video Accounts.

We estimate that Video Accounts can reach RMB15 billion in annual advertising revenues over the next three to four years, representing 18% of online advertising revenue as of Dec. 31, 2022. The upside reflects an increase in ad load and the potential to expand user-time spent on its platform.

Chart 13


Our estimates do not consider live-streaming revenues, which can be significant. Kuaishou's live-streaming revenues totaled RMB35 billion in 2022, which is equivalent to roughly 12% of Tencent's value-added services revenue. Nor does it consider any potential revenues from e-commerce.

Notwithstanding significant differences between Video Accounts and other short-form video platforms, particularly around content, user behavior, and ecosystem, we see potential for large upside to Video Account's revenues. Even if its revenue scale may not catch up to the incumbents, Video Accounts is still key to our forecast for Tencent's social advertising revenue growth of mid-teens over the next two years

Why did we change the downside trigger on our outlook for the Tencent issuer credit rating?

We did this because a significant portion of Tencent's investments are monetizable and can be used for debt reduction, if necessary. Such investments are also relatively liquid, are not essential to the company's strategy or operations, and are sizable enough to reduce its net debt-to-EBITDA ratio by more than 0.5x--a dramatic amount relative to our forecast for 2023 of about 0.6x.

In estimating investments, we apply a 50% discount on the fair value of its listed non-associate investments and 15% discount on its long-term treasury and deposits. The discounts account for market volatility, a small portion of investments that are held in non-wholly owned subsidiaries, and transaction costs (including any potential tax liabilities, which are likely to be minimal).

To reflect Tencent's flexibility to use its large investment portfolio to reduce debt leverage, we increased the net debt-to-EBITDA downside trigger to 2.0x from 1.5x. This assumes that Tencent's investment portfolio will remain large enough to reduce its net debt-to-EBITDA by more than 0.5x should its leverage ratio exceed 1.5x. (see "Tencent Holdings 'A+' Rating Affirmed; Outlook Stable; Downside Trigger Revised On Large Investment Portfolio", published on RatingsDirect on, May 5, 2023).

Chart 14


Table 1

Tencent Holdings Ltd (A+/Stable/--)
Key Metrics
2021a 2022a 2023f 2024f
Revenue growth (%) 16.2 (1.0) 10.0 8.0
EBITDA margin (%) 30.3 29.3  31.0 30.0
Capital expenditure (bil. RMB) 29.3 22.7 24.0 26.0
Total investment spending (net of disposals and including acquisition of intangibles) (bil. RMB) 143.4 55.0  110.0 117.0
Debt to EBITDA (x) 0.6 0.7 0.6 0.5
All figures adjusted by S&P Global Ratings. a--Actual. f--Forecast. RMB--Chinese renminbi.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Clifford Waits Kurz, CFA, Hong Kong + 852 2533 3534;
Secondary Contact:Cathy Lai, Hong Kong (852) 2533-3569;
Research Assistant:Sam Lee, Hong Kong

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