TENCENT (Minutes): AI will be prioritized for high-return advertising and top-tier games

Below is the earnings call summary for $TENCENT(00700.HK) Q1 FY25. For earnings analysis, please refer to《Tencent: Aggressive Investment Without Hesitation, the King of Stocks is Already "Addicted" to AI!》

1. Key Earnings Highlights

1. Evergreen Games Continue to Shine, Exceeding Expectations: Q1 gaming revenue grew 24%, a strong performance even excluding expectations. Besides incremental contributions from DNF Mobile and Delta Force: Operation Zero Hour, evergreen titles like Honor of Kings and Peacekeeper Elite also delivered solid revenue during the Spring Festival thanks to content updates and operational events. Overseas revenue growth was driven by PUBG Mobile and classic games from Supercell.

Deferred revenue growth exceeded historical norms, potentially supporting Q2 performance. However, Q2 will inevitably face a high base effect from DNF Mobile. The current pipeline includes heavyweight titles like Honor of Kings: World, though most are still awaiting official release dates, making it uncertain whether they can launch this year.

Under such growth pressure, reliance on evergreen games will increase. In Q2, Honor of Kings continues to collaborate with popular IPs (e.g., Nezha), while Peacekeeper Elite will receive a major update this summer, including AI-enhanced content experiences.

2. Advertising Remains Strong, Accelerated by E-commerce: Q1 ad revenue grew 20%, exceeding expectations despite a high base. The company previously highlighted increasing WeChat Channels' ad load rate as the core driver for ad growth amid macroeconomic uncertainty. Currently, WeChat Channels is the second-largest ad revenue source within WeChat, with a load rate of only 4%, lagging behind short-video peers.

However, increasing the load rate requires advertiser support, and e-commerce merchants are the biggest ad spenders. The recent establishment of an e-commerce product team under WeChat Group signals clear intentions.

3. FinTech Recovery as Expected: Driven by policy tailwinds, though full-year growth may remain slow due to consumer uncertainty. However, e-commerce growth could also boost payment volumes, particularly in Tencent's weaker area—online physical goods payments.

4. AI and E-commerce Drive Enterprise Services: Growth stems from AI cloud demand and e-commerce commissions. Last quarter, the company mentioned insufficient AI cloud supply. With accelerated chip deployment, revenue growth is expected to exceed 10%. However, internal demand prioritizes compute resources, limiting aggressive cloud growth expectations for this year.

E-commerce initiatives may also generate incremental tech commission revenue, though Tencent could waive fees to attract merchants, focusing instead on long-term ad value.

5. Operational Efficiency Boosts Margins: Q1 margins expanded alongside revenue growth, driven by improved monetization efficiency (higher gross margins) and stable, low operating expense growth. Despite intensive in-game events, sales expenses remained flat, showcasing the efficiency of evergreen games' built-in marketing. As the leader in evergreen titles, Tencent holds a natural advantage.

Non-IFRS net profit rose 22%, with margins reaching 24%. Excluding a one-time 4 billion RMB equity compensation from Ubisoft's restructuring, the profit beat was even larger. Dolphin Research's core operating profit metric (excluding Ubisoft) also grew 22%, defying the high base.

6. AI Investments Unabated: Cash flow and capital allocation focus on capex and buybacks. Q1 operating cash flow hit a record 76.9 billion RMB, driven by gaming and ads. Capex of 27.5 billion RMB exceeded expectations, possibly due to preemptive chip purchases amid export controls. Buybacks were minimal in Q1 due to shorter quiet periods between earnings releases.

Net cash rose by 13 billion RMB sequentially to 90.2 billion RMB at quarter-end.

2. Earnings Call Details

2.1 Management Highlights

1. Q1 FY25 delivered high-quality revenue growth, with AI enhancing performance ads and evergreen games. Accelerated investments in Yuanbao (AI assistant) and WeChat AI are funded by existing revenue, with long-term value creation potential.

2. Core Business Updates:

a. Social: WeChat + WeChat merged MAU reached 1.4 billion, with growth in user time spent on WeChat Channels and GMV in mini-program stores.

b. Digital Content: Subscribers grew for Tencent Video and Tencent Music.

c. Games: Domestic evergreen titles hit record revenue (Honor of Kings’ Year of the Snake event boosted paying rates; Peacekeeper Elite’s new modes lifted DAU and revenue). Delta Force: Operation Zero Hour peaked at 12 million DAU, ranking as China’s top new game in three years. Overseas, PUBG Mobile grew double-digits via themed events, while Delta Force PC beta gained traction on Steam.

d. Cloud: Tencent Cloud’s video solutions lead China for seven consecutive years.

3. AI Strategy: Continued investments are yielding returns (e.g., ad targeting, content recommendations, game engagement). Long-term projects may have extended payback periods but will create user and shareholder value.

4. VAS: Revenue rose 17% YoY to 92 billion RMB, driven by social networks, music subs, and games.

5. Ads: Upgraded generative AI capabilities boosted ad performance; WeChat Channels ad revenue surged 60%+, while mini-program ads benefited from short dramas and games.

6. FinTech & Enterprise: FinTech grew modestly (consumer loans, wealth management); enterprise revenue expanded double-digits (cloud + e-commerce tech fees).

2.2 Q&A

Q: WeChat’s Agentic AI prospects and differentiation? Monetization strategies (ads, transactions, GPU leasing, subscriptions)?

A: Prospects: Agentic AI handles complex tasks and APIs. Two products: (1) Native WeChat AI (e.g., Yuanbao, Ema) is building general capabilities; (2) WeChat-embedded AI leverages unique social graphs and ecosystems (e.g., Mini Programs). Monetization: Ads (already impactful), transactions (ad-linked), GPU leasing (low priority), subscriptions (not mainstream in China).

Q: E-commerce reorganization progress? Mini-program store strategy?

A: WeChat’s e-commerce team is now independent but remains under existing leadership. No further details.

Q: User trends post-Yuanbao integration? Synergies with WeChat ecosystem?

A: Early-stage adoption shows rising usage frequency for Q&A and content analysis. Deeper WeChat integration is experimental; systematic updates expected in coming quarters.

Q: Balancing AI investment vs. revenue?

A: Focus remains on demand growth; no near-term pressure to balance.

Q: Structural drivers behind domestic gaming strength?

A: Beyond post-2023 recovery, growth is structural: (1) Optimized operations (e.g., Honor of Kings’ AI-guided tutorials); (2) Rising FPS penetration (Delta Force, CrossFire Mobile); (3) New modes (e.g., extraction shooter in Peacekeeper Elite).

Q: App store regulatory impact?

A: Global reforms are shifting value to content creators (e.g., games). China leads this trend.

Q: User behavior changes with AI? Yuanbao’s future?

A: Yuanbao’s user base and retention are growing. Chatbots are key but not the ultimate AI form—future lies in scenario-based assistants within WeChat’s ecosystem.

Q: WeChat e-commerce KPIs? Shelf-based plans?

A: No rigid KPIs; focus is long-term ecosystem building. Mini-program stores will evolve organically, avoiding traditional shelf models.

Q: Payment volume dip in Q1?

A: Primarily due to pricing pressure, not strategy. April showed recovery signs.

Risk Disclosures: Dolphin Research Disclaimer