Tencent’s PC Games Revenue is Larger than Reports Reflect

According to Tencent’s Q1 2017 financial release dated 17 May 2017, total online games revenue in the first quarter was 22,800 million RMB ($3,360 million). That’s $3 billion in one quarter alone, just from online games! The financial report says that PC client-based games revenue was 14,100 million RMB ($2,070 million) and mobile games revenue was 12,900 million RMB ($1,900 million) – and clearly this does not add up to 22,800 million. This caused confusion among financial and industry analysts following the Chinese games market and major game publishers: 14,100+12,900=27,000 ($3,980 million), but the total was only 22,800 ($3,360 million). Where was the additional $620 million?

The Q3 2016 financial release stated that Tencent’s PC client-based games revenue had risen 10% year-on-year, but some industry observers doubted it, yet to Niko Partners, we thought it made sense because we had forecast the market to grow by 9% in 2016. In our quest to figure out what was going on with the “missing” $620 million, Niko analysts questioned whether PC online games revenue could simply be calculated by subtracting mobile games revenue from online games revenue as most analysts had been doing. We concluded that there had to be other revenue in other places of the financial statements because that simple calculation resulted in too low of a figure for PC online games compared to what we had forecast.

After closer analysis and confirmation with Tencent as detailed below, it turns out that we were correct: it is not accurate to do that simple calculation because some online games revenue (such as with Yingyongbao, Weixin and Mobile QQ) is categorized elsewhere in the financial statement as “social networks” revenue.

A) Previously generally accepted formula: Online games – Mobile games = PC games
B) Revised accurate formula: Online games – (Mobile games – Distribution mobile games revenue from social networks) = PC games

On 26 June 2017 Niko analysts discussed this matter via phone with the Tencent Hong Kong-based investor relations team, and the detailed discussion confirmed Niko’s estimate that Tencent’s PC games revenue is actually higher than the reports reflect and other analysts have believed, in line with what Niko Partners had forecast all along. We recognized that League of Legends (LOL) remains very popular, I-café usage is stable, and Niko’s gamer surveys show that mobile gaming is accretive to PC, not dilutive.

Tencent outlined where some of the revenue is categorized:

Mobile games distribution revenue through app store Yingyongbao, and social networks Weixin and Mobile QQ, is included in the “Social Networks” business line.
Roughly 1/3 of Social Networks revenues is comprised of such “mobile games distribution” revenue in Q1 2017 and 33-35% for 2016 (3^rd party distribution).
This distribution revenue includes Tencent’s game such as Honor of Kings and other 3^rd party games.
Tencent’s PC web-based game revenue is extremely small, and therefore PC online games revenue essentially equals PC client-based games revenue.

Tencent’s PC online games revenue is more than “online games minus mobile games”, and the Tencent data shown in the table at the end of this article, if taken in that level of simplicity, implies that PC online games revenue declined from Q1 2016 to Q4 2016 while mobile games revenue surpassed PC online games revenue in Q2 2016. Considering Tencent owns nearly half of the total games market revenue in mainland China, that perceived decline led many analysts to presume that the Chinese PC games market is in decline. But as Niko Partners surmised, that data does not tell the full story.

The fact is that the Tencent financial reporting structure lumps certain types of PC and mobile games revenue in other categories, which makes it look as though their PC games business generated lower revenue than it actually did. Niko’s detailed analysis shows that Tencent’s PC games revenue exceeded mobile games revenue until Q1 2017 (not Q2 2016). In 2016 total PC games revenue was 44,840 million RMB ($6,630 million), and “Online” games revenue was 83,000 million RMB ($12,260 million) – not 70,844 million RMB ($10,440 million) as their disclosure structure implies. Further, Niko Partners had previously forecast that the market (which is nearly half Tencent) would increase by 9% in 2016 over 2015. Most analysts forecast a decline in the market and a decline in Tencent PC games revenue.

Niko’s 9% growth forecast for 2016 proved to be too high, but not because of Tencent. We were accurate about that “half” of the market. Rather, other PC games companies contracted significantly and the web games market collapsed, and we had not forecast those two things to be so detrimental to the market. Still, with Tencent growing 9% last year (which is in line with what our market forecast was), it seems that if that trend continues there is still hope for further growth in PC games revenue in 2017 and beyond.

Tencent recognizes that Q1 2017 revenue of PC client-based games was stronger in part because of the Chinese New Year holidays and increased marketing promotion campaigns. In Q2 2017 the mobile games revenue will likely surpass PC client-based games because of the strong demand for Honor of Kings, the mobile hit.

In July 2017 China’s government called attention to the strong demand for Honor of Kings, especially by students who were on summer holidays. Tencent was the first games company to initiate a system solution for youth protection limiting playtime for children under age 18. This may impact MAU but not really revenue, because most paying gamers are over 18.

Tencent is fully committed to PC client-based games (and again, this is nearly 100% of their PC online games revenue as their web-games are practically non-existent). In 2017 beta tests have launched for Transformers Online, Rising Fire, Paragon, Paladins, MapleStory 2, and Orcs Must Die: Unchained. This shows how important PC client-based games are to Tencent’s business now and in the future.

According to Niko Partner’s “China Digital Games Market Data Report, 2017” (published April 2017), the size of China’s PC online game market in 2016 was $15.4 billion USD, of which PC client-based games were $12 billion. This implies that Tencent has 43% share of China’s PC online games market and 55% share of China’s PC client-based online games market (there are other companies still operating web-based games).

Now we await the August release of Tencent’s Q2 results, but with a much clearer view on what they mean.

Tencent’s Quarterly Financial Results, 2016-2017