Tencent (Minutes): Management confirms that high growth in core business benefits from AI

The following are the minutes of the FY25 Q2 earnings call for$TENCENT(00700.HK) compiled by Dolphin Research. For earnings interpretation, please refer to《Spending and Earning! Is Tencent's Meta Moment Coming?》

I. Review of Core Financial Information

1. Capital Expenditure:

◦ Operating capital expenditure was RMB 17.9 billion, up 149% year-on-year, mainly due to increased investment in GPUs and servers to enhance AI capabilities.

◦ Non-operating capital expenditure was RMB 1.2 billion, down 20% year-on-year.

◦ Total capital expenditure was RMB 19.1 billion, up 119% year-on-year.

2. Cash Flow:

◦ Free cash flow was RMB 43 billion, up 7% year-on-year, primarily driven by growth in gaming revenue.

◦ Free cash flow decreased by 9% quarter-on-quarter, due to the seasonal decline in gaming revenue post-Chinese New Year.

◦ Net cash was RMB 74.6 billion, down 17% quarter-on-quarter (i.e., RMB 15.6 billion), mainly due to the payment of FY2024 dividends amounting to RMB 37.5 billion.

3. Shareholder Return Plan:

◦ Diluted earnings per share were RMB 6.793, up 13% year-on-year, outperforming non-IFRS net profit growth, mainly due to a reduction in share capital following stock repurchases.

◦ The weighted average number of shares used to calculate diluted earnings per share decreased by 2% year-on-year.

◦ A final dividend of RMB 37.5 billion for FY2050 has been paid.

4. Personnel Adjustment Plan:

◦ As of the end of the quarter, the total number of employees was approximately 111,000, up 5% year-on-year and 2% quarter-on-quarter, mainly driven by the onboarding of new graduates.

5. Guidance:

◦ The company achieved double-digit growth in revenue and non-IFRS operating profit in Q2 2025, thanks to investments in and utilization of AI.

◦ The company will continue to focus on enabling more use cases within WeChat, promoting the use of AI-native application "Yuanbao," and upgrading the "Hunyuan" foundational model capabilities to bring broader AI benefits to consumers and enterprises.

◦ The company is rapidly enhancing the functionality of the AI-native application Yuanbao and plans to share more details on increasing daily active users (DAU) later this year.

◦ "Valorant Mobile" will be launched in China next week, expanding the game's reach from PC, PlayStation, and Xbox to mobile platforms.

◦ Overseas subsidiary Funcom has a substantial content reserve to support and expand the "Dune: Awakening" game content.

◦ The company will continue to increase investment in GPUs and servers to enhance AI capabilities.

II. Detailed Content of the Earnings Call

2.1 Key Information from Executive Statements

1. Overview of Q2 2025 Performance:

In Q2 2025, the company achieved revenue of RMB 185 billion, up 15% year-on-year; non-IFRS operating profit of RMB 69 billion, up 18% year-on-year. Executives noted that this growth was driven by investments in and utilization of AI. Gross profit was RMB 105 billion, up 22% year-on-year. Excluding the contribution from associate companies, potential net profit would have increased by 20% year-on-year.

2. Core Business Progress:

a. Communication and Social: The monthly active accounts of WeChat and WeChat reached 1.4 billion, achieving both year-on-year and quarter-on-quarter growth. Mini Programs, as a platform connecting users with merchants and content providers, drove GMV to achieve double-digit growth. Mini-game total revenue grew by 20% year-on-year.AI features have been applied to public account articles, video account comments, and mini-store customer service.

b. Digital Content: TME consolidated its leadership in music streaming, with music subscription revenue up 17% year-on-year, and total subscribers reaching 124 million. Long video subscription revenue fell by 2% year-on-year, with 114 million subscribers, and the self-produced drama "Long Wind Breaking Waves" performed outstandingly.

c. Gaming: Domestic gaming revenue grew by 17% year-on-year, mainly due to contributions from "Delta Force" (with DAU exceeding 20 million in July, ranking top three in revenue), "Honor of Kings," "Valorant" (China version Q2 average DAU reached a new high), and "Peacekeeper Elite" (average DAU grew by over 30% year-on-year). International gaming revenue grew by 35% year-on-year, driven by games from Supercell, "PUBG Mobile" (with record monthly revenue in April), and "Awakening" (the highest-grossing paid game on Steam globally). AI is increasingly important in game content production, player engagement, and monetization.

d. Cloud Business: Tencent Cloud has been recognized by Gartner as one of the world's top communication platform as a service (cPaaS) solutions for three consecutive years. Enterprise service revenue achieved double-digit growth, with accelerated growth in cloud service revenue, benefiting from providing GPUs and API tokens for customer AI needs. International cloud revenue also grew significantly.

3. AI Investment and Strategy: The double-digit growth in company revenue and non-IFRS operating profit was driven by investments in and utilization of AI. The company is continuously committed to enabling more use cases within WeChat, promoting the use of AI-native application "Yuanbao," and upgrading the "Hunyuan" foundational model capabilities to bring broader AI benefits to consumers and enterprises. AI plays an increasingly important role in driving growth in game content production, player engagement, monetization, and marketing. AI-driven advertising platform upgrades have effectively improved advertiser click-through rates and ROI. Cloud service revenue has also accelerated due to AI demand.

4. Value-Added Services (VAS): Revenue was RMB 91 billion, up 16% year-on-year, accounting for 50% of total revenue. Gross profit was RMB 55 billion, up 23% year-on-year; gross margin was 60%, up 3 percentage points year-on-year, mainly due to the increased proportion of high-margin domestic gaming revenue and the expansion of music subscription service gross margin.

5. Marketing Services: Revenue was RMB 36 billion, up 20% year-on-year, accounting for 19% of total revenue. Gross profit was RMB 21 billion, up 24% year-on-year; gross margin was 58%, up 2 percentage points year-on-year. AI-driven advertising technology upgrades have effectively increased advertiser click-through rates, conversion rates, and ROI. Video account marketing service revenue grew by about 50% year-on-year, and advertising revenue related to mini-games and short dramas in mini-program ads grew by 50% year-on-year. WeChat search ad revenue grew by 60% year-on-year.

6. Fintech and Business Services: Revenue was RMB 56 billion, up 10% year-on-year, accounting for 30% of total revenue. Gross profit was RMB 29 billion, up 21% year-on-year; gross margin was 52%, up 5 percentage points year-on-year. Fintech services were mainly driven by commercial payments and consumer loans, with commercial payment transaction volume returning to positive growth year-on-year. Enterprise service revenue achieved double-digit growth, with cloud service revenue accelerating due to providing GPUs and API tokens for customer AI needs.

2.2 Q&A Session

Q: Regarding the advertising business, can management elaborate on the potential of marketing services in the coming quarters and years, and the key factors driving advertising revenue growth, particularly in terms of traffic, click-through rates, and ad load rates?

A: The company's advertising revenue has a long and continuously extending growth runway, expected to grow at a healthy rate.

Specifically, in terms of the priority of driving factors, in the just-concluded second quarter, our 20% year-on-year growth mainly came from CPM improvement. In the Chinese market, this was mainly due to two aspects: (1) AI leading to higher click-through rates; (2)more complete closed-loop transaction activities brought by WeChat mini-stores and mini-games, thereby increasing revenue per click.

The secondary driving factor was increased ad impressions, mainly due to traffic growth in video accounts and WeChat search. Ad load rate was not a major growth driver this quarter.

Future major growth variables include: (1) Higher click-through rates enabled by AI, achieving more clicks through optimized targeting; (2) Traffic growth in video accounts, search, and AI-native experiences, increasing exposure; (3) Generative AI enhancing ad creativity and promoting e-commerce closed-loop transactions, thereby increasing revenue per click.

(4) Additionally, the ad load rate for short videos is currently in the low single digits, with significant room for improvement compared to peers. In terms of the priority of driving factors, the main contributions are from click-through rate improvements brought by AI deployment and revenue per click increases from closed-loop transactions, followed by traffic growth, while ad load rate is not a major driving factor.

Q: After integrating AI features into mobile internet applications and launching native AI applications like Yuanbao, what observations does the company have on consumer usage behavior? Do these behavioral changes impact the existing mobile internet ecosystem, such as AI search potentially leading users to bypass traditional web pages?

A: Management believes it is still in the early stages of observing user behavior. Initial observations show that users are more satisfied when using AI features, and efficiency in content creation and information acquisition has significantly improved, overall enhancing the user experience.

As for whether AI-assisted search will directly display content rather than guide users to pages, thereby harming the traditional search and content ecosystem, the company has not seen a significant impact. Many page views do not come from search but are based on user subscriptions to creator content. Therefore, the impact on specific content creators is currently minimal.

Q: Considering the higher delivery cost of consumer-facing AI features compared to traditional mobile internet services, will this harm the company's cost structure? Is management considering directly monetizing these AI features in the next year or two? If so, which AI features or services have the most monetization potential?

A: The company is managing AI costs in a refined manner, using smaller models as much as possible to reduce costs, and continuously improving inference efficiency through software upgrades to keep costs under control. Management believes that some AI features will eventually be monetized, but given the market environment in China, the prevalent user payment model is difficult to implement. In the future, advertising-supported monetization methods may be explored. Meanwhile, AI has already promoted growth and monetization of existing businesses in various ways, in a sense, the growth of our other businesses can provide a practical subsidy for the costs incurred by providing free AI services to users.

Q: Regarding the Chinese AAA game market, how does management view its growth potential, especially on PC and console platforms? Is the rise of such games opening up a new market or replacing existing market share?

A: Management is optimistic about both AAA games (such as the paid buyout game "Black Myth: Wukong") and online service games (such as "Delta Force"). The current and future market in China is still dominated by long-term service games (Live Service Games).

Demand for AAA games is growing, and if the product is excellent, it can achieve solid profitability, but the entry barrier is high. Given that players are accustomed to free games, AAA games will still be a minority in China, but they provide a profitable opportunity for "passion projects." The company believes that AAA games and long-term service games are complementary rather than cannibalistic, similar to the complementary model of Tencent Music's subscriptions and digital albums. Most users who purchase AAA games also play and spend on online service games.

Q: Regarding the AI capital allocation strategy, why not consider investing more capital to create new leading "top-of-the-funnel" products like Yuanbao and IMA, but instead take a more gradual approach?

A: The company has invested a considerable amount of AI capital and will continue to increase it, but emphasizes that spending needs to be wise and paced. For innovative products like IMA, it is still in the stage of exploring the best product form and use cases, so it is not advisable to invest too much in marketing expenses.

Yuanbao, as a more mature product, has already seen significant promotion in the first quarter, with a significant increase in the user base. The focus in the second quarter was on product improvement and user retention, and more promotion will be intensified in the future. Promotion will fully utilize existing platforms for integration, which is an important advantage.

Q: Regarding the new advertising regulations effective in July, which require an additional 25% tax on sales and marketing expenses exceeding 15% of revenue, how is this expected to impact the company's advertising revenue, especially for mini-games that rely on traffic acquisition?

A: Management expects the impact of the new advertising regulations to be minimal. The company's advertising business is broad, and despite the adverse impact in the second quarter from increased subsidies by food delivery and e-commerce companies, reducing advertising spending, advertising revenue still grew by 20% year-on-year. Therefore, the company believes that fluctuations in individual categories are normal and not the most important variable.

For our advertising business, how we continue to deploy AI technology to improve advertising efficiency and performance is more important.

Q: This quarter's accelerated growth in enterprise service revenue benefited from increased demand for GPU leasing and API Tokens. Will the company further allocate GPU resources to support external enterprise customer demand? Can enterprise service revenue continue to accelerate growth in the coming quarters?

A: The growth in enterprise service revenue is not only due to GPU and API Token leasing but also shows broad growth in foundational business. Over the past 2-3 years, we have effectively "de-bugged" the cloud business, reducing or even exiting some low-profit, low-value business activities.

Currently, the cloud business is built on a more sustainable foundation, with improved supply chain cost competitiveness. The company is refocusing on achieving revenue growth at a faster pace without overly relying on GPU supply conditions. If there are enough GPUs available for external leasing, the company will actively provide them, but the cloud strategy does not rely entirely on GPUs, and also focuses on growth in CPU, storage, database, CDN, and other areas.

Q: Considering the continuous improvement in conversion rates and eCPM driven by large model upgrades and AI capability expansion, and the company's relatively low ad load rate, is the 20% year-on-year growth rate in marketing service revenue likely to be the lower limit for growth in the coming quarters?

A: The company is satisfied with the current advertising growth rate and has not changed its focus on extending the growth runway. Management believes that unless the cost of deploying AI (including GPU depreciation) suddenly increases significantly and becomes too burdensome, there is currently no need to accelerate advertising monetization. This indicates that the company's current strategy is to balance growth and investment rather than pursue short-term aggressive monetization goals.

Q: As the evergreen game category expands and the product line becomes increasingly robust, is the overall gaming business moving towards platformization, thereby reducing the volatility of individual games and enhancing stability? How should the normalized growth rate of the overall gaming business be viewed in the future, including market share, player numbers, and ARPU potential?

A: Management confirms that as the game portfolio expands and the platform nature strengthens, the volatility of overall game revenue growth is expected to decrease. Although individual games still have quarterly fluctuations, top-tier games can rebound even if they perform weakly through nurturing and support. For example, "Brawl Stars" and "Clash Royale" have both achieved strong recoveries after years of calm.

The company regularly releases new games, some of which are expected to become evergreen games, further expanding the product portfolio and consolidating platform stability. This indicates that the company, through diversification and long-term operation strategies, has enhanced the gaming business's risk resistance and sustainable growth potential.

Q: Regarding the "Hunyuan" model family, what is the focus of its next development steps? Especially as the gap between Chinese models and global leading models narrows, how is the company investing in multi-modal, 3D, and Agent capabilities, and how does it view the potential of Agents in "Hunyuan" and WeChat?

A: The next focus of the "Hunyuan" model family is continuous improvement in multiple dimensions:

• Large Language Model (LLM) itself: Improve data quality, pre-training efficiency and effectiveness, post-training and reinforcement learning processes, and optimize infrastructure to enhance training and inference efficiency, reducing service costs. The improved LLM will serve as the foundation for all AI services, especially enhancing search and productivity tools.

• Multi-modal capabilities: Enhance the functionality of multi-modal applications like Yuanbao, supporting diverse user needs such as voice and text conversion.

• Coding and Agent capabilities: Continuous improvement will provide a better coding environment for the company and enterprise customers, and achieve stronger Agent and instruction-following capabilities. Agent capabilities are particularly important for the future development of WeChat, aiming to create personalized assistants for WeChat users.

Q: What impacts has the company observed from the government's efforts to combat involution? How are these changes expected to affect major business lines? Additionally, with the commercial payment volume growth turning positive in the second quarter, is this growth trend sustainable and accelerating?

A: Management noted that the most significant impact of the government's efforts to combat involution is reflected in the improvement of commercial payment business trends. This improvement is mainly driven by a reduction in the decline rate of the amount per transaction. Commercial payment volume is a function of transaction quantity and the amount per transaction, and while transaction quantity continues to grow healthily, the amount per transaction has been declining; the current improvement is a slowdown in its decline rate. Management believes that part of the driving factor is the government's anti-involution measures.

Q: Tencent has achieved great success with several FPS games, such as "Delta Force," "Peacekeeper Elite," and "Valorant." What are the key factors behind these successes? Looking ahead, how will upcoming FPS games (such as "Valorant Mobile") differentiate from existing titles, and is there any competition among them?

A: FPS games have historically been underrepresented in the Chinese market, but there is now a structural demographic shift in favor, with millions of college students entering the market each year who prefer such games, as evidenced by the surge in sales of gaming mice. At the same time, technological advancements have reduced latency, effectively combated cheating, and improved graphics quality, making these games perform better. Like in Western markets, Chinese FPS games, although similar, can differentiate and coexist in various ways without cannibalizing each other. Differentiation is reflected in modes (battle royale, extraction shooter, tactical shooter, arcade shooter), roles (hero or class), elimination time (positioning or marksmanship critical), and graphic styles (realistic or cartoonish), among others. Tencent is the clear market leader in this field, with the most extensive experience and skills.

Q: Besides FPS games, what other game genres will the company invest more in the future?

A: The company is broadly investing in various game genres. Historically, there has been a lack of content-driven games, but now it has successful products like "Naruto," "Ming Tide" (internal studio), and "Goddess of Victory: NIKKE," which have performed well in both the Chinese and international markets.

This is an important growth area, and its target audience is significantly different from traditional FPS players.

Additionally, it is worth noting that some new tactical FPS games and large content-driven games (such as "Ming Tide," "Love and Deep Space") have an average revenue per daily active user (per DAU revenue) far higher than industry-wide games, even up to 4 times higher. Therefore, as we explore these emerging user groups, we also enjoy the benefits of higher commercialization potential. Thank you.

Q: Given the current news about chip restrictions, what are the company's chip procurement options under the new rules, and how will this affect the company's capital expenditure and group profit margins?

A: Regarding chip procurement, especially the import of U.S. chips, there is currently no clear answer, and the company is waiting for the results of discussions between the two governments. However, the company states that existing chip reserves are sufficient to support the training and continuous upgrading of existing models, and there are multiple options for inference chips. At the same time, the company is executing a large number of software improvements and upgrades to improve inference efficiency, handling more workloads with the same number of chips.

For this year's capital expenditure target, the company is not making adjustments for the time being. Although AI-related depreciation costs are expected to rise, the company also continues to benefit from AI, with cost and benefit trends generally aligned.

Q: This quarter's performance in value-added service gross margin was outstanding. Is this mainly due to changes in international app store commission rates following the recent Epic ruling? Is this change an already effective driver or a potential growth source in the future? How is the company's progress with app store partners in the Chinese market?

A: The recent court ruling on App Store fees is not the main driver of the second quarter's value-added service gross margin. The company has increased the use of external payment links in the U.S., but rulings in other jurisdictions (such as Australia) took effect later, and game revenue costs are accounted for on an accrual basis, with a lag.

In China, the revenue sharing of Android app stores is moving in a more reasonable direction, benefiting developers and the overall software and hardware ecosystem, constituting a moderate positive. However, the improvement in the second quarter's value-added service gross margin is mainly due to changes in the product mix, specifically shifting from licensed games to self-developed games, with a more significant contribution from "Delta Force."

Q: Regarding the company's overall AI strategy, what key performance indicators (KPIs) does the company use to track AI development progress (from the model layer to application and Agent AI layer)? Also, how does the company address existing challenges, especially on the supply side?

A: The company closely tracks AI development progress using multiple indicators:

1. Efficiency improvements and growth contributions of AI to existing businesses (such as advertising, gaming, fintech).

2. Performance and quality of large language models.

3. User growth of AI applications (such as Yuanbao, browsers, and AI-driven search).

4. Progress in designing other AI-related innovative products within the ecosystem (such as WeChat AI Agent, Agents in productivity tools). On the supply side challenges, the company has sufficient chips for foundational model training and continuous upgrades. At the same time, it is utilizing various different chips for inference and extracting more performance from AI chips through infrastructure and software capability improvements.

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