On May 14th, Tencent Holdings released its financial report for the first quarter of 2024. The report indicates that Tencent's revenue for the first quarter was 159.501 billion yuan, a year-on-year increase of 6% and a sequential increase of 3%. The net profit (Non-IFRS) was 50.265 billion yuan, a year-on-year increase of 54% and a sequential increase of 18%.

In the main business segments, the revenue from value-added services was 78.629 billion yuan, a year-on-year decrease of 0.9%. The revenue from online advertising was 26.506 billion yuan, a year-on-year increase of 26%. The revenue from financial technology and business services was 52.302 billion yuan, a year-on-year increase of 7%. These three business segments accounted for 49%, 17%, and 33% of the total revenue, respectively.

Gross Margin Rises

Gaming, which constitutes about 30% of Tencent's revenue, falls under the value-added services category. In the first quarter, international gaming market revenue grew by 3% to 13.6 billion yuan, while domestic gaming market revenue decreased by 2% to 34.5 billion yuan. Behind this, the revenue of "Honor of Kings" and "Peacekeeper Elite" both declined in the first quarter, affected by the high base of last year's Spring Festival and weaker commercial content, while "Jinchanchan Zhizhan" recorded growth. Tencent's domestic games have seen a slight decline in revenue for two consecutive quarters, while international market gaming revenue has seen growth for several consecutive quarters.

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Both domestic and international gaming market turnover growth rates in the first quarter were better than revenue performance. Specifically, international market gaming turnover grew by 34% year-on-year, and domestic market gaming turnover increased by 3%, but both were affected by revenue delays.

The performance of Video Account was quite impressive. According to the financial report, the total user engagement time of Video Account grew by more than 80% year-on-year. In the first quarter, revenue from Video Account's live broadcasting, advertising, and merchant technical service fees increased, positively impacting Tencent's online advertising business, business services, and social networking revenue within value-added services.

The increase in gross profit from businesses including Video Account has raised the overall gross profit performance. The financial report shows that the gross profit and operating profit growth from WeChat Video Account and search advertising, mini-games platform service fees, and Video Account merchant technical service fees exceeded the revenue growth rate. The cost-effectiveness of long video and cloud services has also improved. Tencent's gross profit for the first quarter increased by 23% year-on-year, with the gross margin rising from 45% in the same period last year to 53%. The gross margins for value-added services, online advertising, and financial technology and business services increased from 54%, 42%, and 34% in the same period last year to 57%, 55%, and 46% in the first quarter of this year, respectively.

The online advertising business was also driven by mini-programs, search, and AI-driven advertising technology platforms. In the first quarter of this year, advertising spending in the gaming, internet services, and consumer goods industries saw significant growth. In addition, business service revenue increased by more than 10% year-on-year, cloud service revenue recorded growth, and financial technology was strongly influenced by the growth in wealth management service revenue.

Popular self-produced TV dramas and animations such as "Fanhua" and "Lie Bing" released by Tencent Video have driven the growth of long video paying members by 8% year-on-year, reaching 116 million. The number of registered accounts for Tencent's paid value-added services increased by 12% year-on-year, with the combined monthly active accounts of WeChat and WeChat reaching 1.359 billion, a 3% year-on-year increase.

However, the revenue from music and game live broadcasting declined in the first quarter, dragging down the social networking revenue, which decreased by 2% to 30.5 billion yuan. The financial technology business was affected by the slowdown in offline consumer spending and the reduction in cash withdrawal revenue, with revenue growing by a single-digit percentage year-on-year. The monthly active accounts of QQ mobile terminals decreased by 7% year-on-year, to 553 million.Financial reports indicate that by the end of the first quarter, Tencent's employee count stood at 104,800, a decrease of 1,434 compared to the same period last year, and a reduction of 630 from the end of the previous year. The reports also reveal the company's commitment to continue investing in AI technology and to execute its plan to repurchase shares worth over HKD 100 billion by 2024. In the first quarter, Tencent repurchased 51.04 million shares at a total cost of approximately HKD 14.8 billion, which have been subsequently canceled.

On May 14th, Tencent's share price closed at HKD 381.8 per share, up by 0.95%, marking the highest price in nearly a year, although still some distance from the previous peak of over HKD 450 per share in February 2022.

The market is still awaiting a killer AI application.

In the first quarter of this year, Tencent saw an increase in gross margin, with both online advertising and cloud business revenues growing. During the earnings call following the release of the financial report, investors and investment institutions were particularly interested in the topics of what kind of gross margin level Tencent can maintain and whether the advertising business can continue to grow.

"The current external environment is mixed, and the sentiment in the advertising market is also quite complex, making the advertising business still challenging. We expect the advertising business to continue growing, but the growth rate in the following quarters may not be as high as in the first quarter," said Tencent's management.

Tencent's management also mentioned the role of AI in advertising. They stated that AI has been very helpful to the advertising business, as it can simplify and automate the advertising process, and media companies can provide better advertising results to advertisers through AI. Social media companies have an advantage in providing a better advertising experience to advertisers, as these platforms have more user engagement and participation. Many competitors are vigorously promoting AI. "We have spent a lot of time researching AI and thinking about how to promote business development. After deploying AI in the advertising business, there may be a structural change in click-through rates, and some products that originally had low click-through rates can achieve good results after being empowered by AI," said the management.

Regarding the state of AI applications, when investors asked whether the introduction of more AI features by other manufacturers in the industry made Tencent nervous, the management stated that the company has platforms like WeChat, with a large user base and high user engagement, and the introduction of AI can realize more possibilities. "At present, there are still many unknowns about AI, and everyone is trying different directions. No company has yet made a killer application, and it will take some time to see the answers," said the management.

Regarding the growth of cloud business, the management stated that many SaaS products have always been offered as free services, developing from a low starting point, and more validation is needed. In China, many enterprises are unwilling to pay for related software, which is different from the situation in mature markets like the United States. In this regard, the current market development is quite good and will continue to grow, but it has not yet reached the real turning point, which will come at some point in the future.

In the first quarter of this year, Tencent's net profit (Non-IFRS) showed a significant year-on-year increase that was higher than the revenue growth rate. On this basis, will the gross margin remain at a high level in the future? Tencent's management stated that there are many factors behind the gross margin, including the competitive environment and the macroeconomic environment. One important point is that companies need to focus on the long term. The company has seen some positive changes in the fields of advertising, financial technology, and enterprise services, which can turn low profits from revenue into high profits. These areas should be able to achieve a sustainable high gross margin.

Tencent's share price has reached its highest point in a year. Regarding the pace of the repurchase plan, the management stated that the repurchase is not dependent on the share price. The current share price has risen significantly compared to when the plan to repurchase over HKD 100 billion was announced, but the company will still promote the repurchase in an orderly manner.