Tencent: Worth more than it seems (SOTP valuation)

High earnings visibility and long runway makes Tencent attractive as a hedge in portfolios

Introduction to Tencent’s business

For those who are unfamiliar with Tencent’s business, I will briefly introduce its different business segments and strategy.

As one of China’s largest technology companies, Tencent is a conglomerate with a diversified portfolio spanning gaming, social media, fintech, advertising, and cloud computing.

The largest business segment is Value Added Services, or VAS. VAS makes up 50% of revenues as of 1Q25 and it consists of 3 sub-segments: Social Networks, Domestic Games and International Games.

The gaming business, both domestic and international gaming businesses, are Tencent’s cash cow and it is the world’s largest gaming company by revenue.

Popular games include titles like Honor of Kings and PUBG Mobile.

The Social Platforms business includes WeChat (Weixin) and QQ. WeChat, in particular, remains integral to user engagement and monetization via mini-programs, ads, and services.

The second segment is the online advertising segment, which has been renamed to the marketing services segment. This makes up 18% of revenues as of 1Q25.

Within the segment, the main channels here are WeChat Moments, mini-program ads, video ads on Tencent Video, and mobile news apps.

After a post-COVID dip and regulatory drag, the segment is rebounding, aided by AI-driven targeting and better monetization of WeChat’s ecosystem.

Lastly, we have the fintech and business services segment, which makes up 31% of revenues as of 1Q25.

The fintech business is anchored by WeChat Pay, which is one of China’s top two mobile payment platforms.

This segment also includes Tencent’s cloud computing business.

Tencent’s cloud computing business aims to rival Alibaba Cloud but remains a lower-margin business.

First quarter results

Tencent’s revenues grew 13% from the prior year to Rmb180 billion, beating expectations by 3%, which was largely contributed by the strong results produced by the gaming segment.

Gross margin came in at 55.8%, 1.8 percentage points higher than consensus expectations of just 54% and growing 3.2 percentage points from the prior year.

This was a sustained demonstration of the favorable mix shift towards higher margin self-developed games, Video Accounts and Search, and fee-based income (like wealth management, e-commerce technology fee), as well as improved cost efficiency in cloud and payment.

Operating expenses came in in-line with expectations growing 28% from the prior year.

Sales and marketing grew just 4%, 12% lower than expectations due to more prudent spending on new game launches despite the additional cost for traffic acquisition for AI application.

The higher operating expenses were mainly due to higher AI-related R&D and staff costs.

Operating profit and net profit grew 18% and 22% from the prior year to Rmb69.3 billion and Rmb61.3 billion, both beating consensus expectations by 4% mainly on higher-than-expected GPM.

Business segment results

Gaming

Gaming revenues grew 24% from the prior year, which beat consensus expectations by 8% for both domestic and international games.

Domestic gaming revenues grew 24% from the prior year, on solid performance in flagship titles Honor of Kings and Peacekeeper Elite, as well as Dungeon & Fighter Mobile and Delta Force.

International gaming revenues accelerated to 22% in the first quarter, up from 15% in the fourth quarter of 2024, on robust Brawl Stars and PUBG performance.

The strong first quarter growth in excess of 20% from its existing and new games demonstrate Tencent games longevity, alleviating investors' worries about tougher comparisons in 2H25.

During 1Q, Honor of Kings and CrossFire (now 3rd largest mobile game in China) achieved record grossing, while PUBG saw mid-teens year-over-year increase and Valorant doubled its grossing year-over-year.

Coupled with a robust pipeline, this positions Tencent’s gaming segment well for 2025.

Longer term, Tencent continues to refine its gaming strategy by assembling the right teams, introducing innovative game modes like the first-person shooter mode, and Peacekeeper Elite's popular extraction shooter mode, and leveraging AI to enhance user engagement, underpinning upside longer term.

For the marketing services segment, revenue grew 20% from the prior year, beating consensus expectations by 3%.

Marketing Services

Within the marketing services segment, the beat was due to broad-based improvement across verticals despite the soft macro.

On top of incremental ad inventory from Video Accounts, Mini Programs and Search, as well as ad tech upgrade, the improving close-looped transactions within Weixin ecosystem should have also helped.

Both ongoing enhancements in ad tech and additional inventory from Video Accounts, Mini Programs and Search should help the marketing services segment grow faster than the industry in 2025.

Fintech and business services

For the fintech and business services segment, revenue grew 5% from the prior year to Rmb 55 billion, coming in in-line with expectations.

Fintech services revenue grew by low single digits percentage year-over-year, driven by growth in consumer loan and wealth management services.

Management stated that they are using AI in the business, integrating HunYuan and DeepSeek large language model capabilities into the financial assistant chatbot.

Business services revenue returned to teens year-over-year growth this quarter due to higher cloud services revenue and higher technology fees generated from more e-commerce transaction volumes.

Gross margins for the business services segment grew this quarter due to improved efficiencies.

Within Tencent Cloud, AI-related revenue grew rapidly from the prior year as the customer demand for GPUs, APIs and platform solutions accelerated.

Management also suggested that Tencent Cloud’s AI-related revenues were constrated by limited GPU availability.

AI investment and monetization

With all business segments continuing to generate high quality revenue and free cash flows, this enables Tencent to have the ability to reinvest into the AI opportunity.

Tencent has mentioned in prior earnings calls that it will be accelerating investments in the AI space, which will lead to higher capital expenditures and operating expenses.

We have seen operating expenses increase in the earlier section, and below, you can see capital expenditures growing 91% from the prior year.

Tencent has sufficient free cash flows generated from its businesses such that even with the substantial growth in capital expenditures, its free cash flow still remains rather stable.

These investments into GPUs are already helping Tencent generate revenues, through improved ad targeting which helps increase ad revenue, or through improved content recommendation, which results in longer time spent on Tencent’s applications and platforms and in turn, lead to higher ad revenues.

For longer term opportunities, management is managing investor expectations here by emphasizing that there may be some lag in revenues coming in even after costs go up in the near-term, but they expect in the longer term that these AI projects will bring significant value for shareholders.

In the longer term, management is adding AI features to multiple products like Weixin Search, Yuanbao as a Weixin contact, with positive feedback.

Based on the average daily user engagement on Weixin, which is 1.5 hours as reported by QuestMobile, the extensive user base of 1.4 billion, diverse user applications, and most critically, user retention, I expect that Tencent has considerable opportunities for AI monetization.

Management is confident that while the while the import of high-end GPU remains fluid, they can navigate this situation in a compliant manner.

In the near-term, management is prioritizing chips for internal businesses that offer higher ROI, enhancing training efficiency, and utilizing inventory of high-end chips acquired previously.