Games: Alibaba's New Tie-Up, Tencent's Candy Crush

|
 |  About: Tencent Holding Ltd. ADR (TCEHY), BABA
by: Doug Young

A year after entering the ultra-competitive online gaming market, e-commerce leader Alibaba is boosting its drive into the space through a major new tie-up with Kabam, a fast-growing American designer of free online games. The move looks squarely aimed at archrival and leading Chinese game operator Tencent (OTCPK:TCEHY), which has just made its own major advance in the space with the launch of an officially licensed version of the wildly popular "Candy Crush" game in China.

The bigger story behind these 2 moves is the rapid growth in China's online game market, particularly in mobile games. The space is especially attractive to Tencent and now also Alibaba, as it's one of a handful of areas with a proven track record for generating revenue. Highlighting that potential, Tencent gaming executive Wang Bo said over the weekend that mobile games will generate a whopping 37 billion yuan ($6 billion) in China next year, with Tencent and its partners aiming to take around 10 percent of the market. (Chinese article)

It's no coincidence that we're getting a flurry of gaming news right now, since many of the industry's top executives were attending ChinaJoy, the nation's top trade show, in Shanghai over the weekend. Among the big announcements was Alibaba's new tie-up that will see it invest $120 million for an undisclosed stake of Kabam, a fast-growing San Francisco-based start-up. (company announcement) A separate report said the funding values Kabam at about $1 billion, meaning Alibaba's stake would be around 12 percent.

Under the deal, Alibaba will become a China-based operator for many of Kabam's games, which are free and already available on a wide number of platforms in other markets. Kabam already has a Beijing office and has developed a number of its games there. The company's revenue doubled to $360 million last year and is expected to grow by another two-thirds to about $600 million this year. It has also been profitable for 2 years. Some media are speculating the Alibaba tie-up could portend an upcoming New York IPO for Kabam, which would give investors an interesting Chinese-American hybrid to bet on in the crowded gaming market.

Meantime, separate media reports are saying Tencent began offering an Android-based, Chinese-language version of "Candy Crush Saga" in its online app stores on July 31. (English article) The game also became available the same day on Tencent's popular WeChat and QQ platforms, which collectively boast hundreds of millions of users. Tencent is also expected to introduce a Chinese version for Apple's (NASDAQ:AAPL) iPhones and iPads soon, the reports say.

Like many of the world's most popular titles, Candy Crush is mostly a game for individuals to play alone with no social elements. But the WeChat and QQ versions will add a few social features, including the ability for players to compare scores and send in-game gifts. The latter could be a potential revenue generator for Tencent in the future, and I'm sure it will also find other ways to convince Chinese gamers to pay for other services based around the game.

Tencent also has its own equity relationship with a major global game developer, after it purchased an undisclosed stake in Activision Blizzard (NASDAQ:ATVI) last year as part of a management-led buyout of the company. (previous post) Such tie-ups are attractive to both sides, providing game developers with strong Chinese partners who often get preferential access to some of the world's most popular titles.

While such tie-ups benefit big companies like Tencent and Alibaba, they are far less desirable for other smaller players like Sungy Mobile (NASDAQ:GOMO), The9 (NASDAQ:NCTY) and Perfect World (NASDAQ:PWRD), which often find themselves forced to license new titles from lesser known developers. The second-tier game operators have already been declining for the past few years due to intense competition, and I expect these new tie-ups from Tencent and Alibaba will further accelerate their declines.

Bottom line: Alibaba and Tencent's new online game moves represent their aggressive acceleration into the space, which will further marginalize second-tier players.

Disclosure: None

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.