Tencent Holding's (TCEHY) CEO Pony Ma on Q2 2014 Results - Earnings Call Transcript

Aug.13.14 | About: Tencent Holding (TCEHY)

Tencent Holding Ltd. ADR (OTCPK:TCEHY) Q2 2014 Earnings Conference Call August 13, 2014 8:00 AM ET

Executives

Catherine Chan - Head, IR

Pony Ma - CEO

Martin Lau - President

James Mitchell - CSO and SEVP

John Lo - CFO and SVP

Analyst

Dick Wei - Credit Suisse

Eddie Leung - BofA Merrill Lynch

Philip Wan - Morgan Stanley

Cynthia Meng - Jefferies

Alex Yao - JPMorgan

Jiong Shao - Macquarie Capital Securities

Wendy Huang - Standard Chartered Bank

Alan Hellawell - Deutsche Bank

Chao Wang - Nomura Securities

Alicia Yap - Barclays Capital

Chi Tsang - HSBC

Thomas Chong - Citigroup

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Tencent Holdings Limited 2014 second quarter results announcement conference call. (Operator Instructions). I must advise you that this conference is being recorded today.

I would now like to hand the conference over to your host, Miss Catherine Chan from Tencent. Please go ahead, Miss Chan.

Catherine Chan

Thank you, operator. Good evening. Welcome to our analyst conference call for the second quarter of 2014. I'm Catherine Chan from the IR team of Tencent.

Before we start the presentation, we would like remind you that it includes forward-looking statements which are underlined by a number of risks and uncertainties that may not be realized in future for various reasons. Information about general market conditions is coming from a variety of sources outside of Tencent.

This presentation also includes some unaudited non-GAAP financial numbers that should be considered in addition to, but not as a substitute for measures of the Company's financial performance prepared in accordance with IFRS. For a detailed discussion of the risk factors and our non-GAAP measures please refer to our disclosure documents downloadable on www.tencent.com/ir.

Let me introduce the management team on the call tonight. We have Chairman & CEO, Pony Ma; President, Martin Lau; Chief Strategy Officer, James Mitchell and Chief Financial Officer, John Lo. Pony will kick off with a short overview. Martin will discuss the strategic highlights. John will speak to the -- James will speak to the business review and John will go through the financials before we take your questions.

I'll now turn the call over to Pony.

Pony Ma

Thank you Catherine. Good evening everyone. Thank you for joining us.

In the second quarter of 2014, we continued to deepen user engagement on our mobile platforms. We have further enriched our offline to online offerings through -- with strategic investment in category leaders, including Navinfo, a mapping service provider and 58.com, a local listing platform.

In terms of revenue, both our smartphone games business and our online advertising business registered rather significant growth.

Now let me highlight the financial numbers for you.

Total revenue was RMB19.7 billion, up 37% year on year.

Value added services was RMB15.7 billion, up 46% year on year, of which social networks revenue was RMB4.6 billion, up 47% year on year and online games revenue was RMB11.1 billion, up 46% year on year.

Online advertising revenue was RMB2.1 billion, up 59% year on year and eCommerce transactions revenue was RMB1.3 billion, down 40% year on year.

Non-GAAP operating profit was RMB7.7 billion, up 53% year on year.

Non-GAAP net profit was RMB5.9 billion, up 42% year on year.

Touching on some of our key online platforms. On our core communication and social platforms, total MAU for QQ was 829 million, within which smart devices MAU grew 45% year on year to 521 million.

PCU increased 19% year on year to 206 million, over three quarters of which were mobile users.

Weixin and WeChat achieved combined MAU of 438 million, up 57% year on year.

Total MAU for Qzone was 645 million, of which smart devices MAU rose 37% year on year to 497 million.

Our online games platform continued its leadership on both PC and mobile.

Our integrated platforms achieved strong growth in active users and traffic on QQ.com, Tencent news app and news platform within mobile QQ and Weixin.

Our video platform also registered strong growth with the daily video views up year on year.

That's all from me tonight. I will turn to Martin to discuss the strategic highlights.

Martin Lau

Thank you Pony and good evening and good morning. I'll just give you some update on how we are leveraging on our mobile franchise to further develop our advertising business as this quarter's strategic highlight and I will divide it into three different platforms.

Number one, for our news platform, we have further reinforced our leadership in the mobile news services which include news platforms within mobile QQ and Weixin as well as our Tencent news app that runs on smartphones.

As at the quarter end, our news services achieved 180 million daily active users on mobile and this refers to the people who actually read a piece of news. And that's actually double our daily active users on PC previously achieved. And within this large number of daily active users, we have also added quite a lot of high end users to our overall demographics combined to the PC era.

Our total daily page views across mobile and PC has also increased over 100% year on year and that's mainly driven by growth in mobile.

The new mobile ad format within our news app and news have won initial recognition from brand advertisers. Revenue generated from our mobile news services has more than doubled quarter on quarter from a relatively low base, so that's an encouraging sign.

In order to develop this nascent market, we're going to introduce new ad formats and continue to educate advertisers, especially those high end advertisers who like our broad reach and also our attractive demographics.

Number two, for our video platform, our video -- the mobile video traffic has increased significantly in the quarter and has reached approximately half of our total videos viewed. Unlike the news platform which requires experimentation with new ad formats, mobile video ads are more straightforward. As currently more than 90% of the mobile videos were viewed either via Wi-Fi or via download, it enables us to quite naturally extend the prevailing frugal ad format from PC.

On the other hand, mobile currently only represents a low teen percentage of our total video ad revenue and as a result we see growth potential in this area. We continue to invest aggressively in video content and also streaming technologies to strengthen our video platform. We'll gradually capitalize on mobile monetization while balancing the overall user experience.

Now finally, in terms of our social platform, our performance advertising business on mobile has been growing rapidly. It contributed to approximately 30% of our total performance advertising revenue in the second quarter.

With respect to Qzone, which has over 75% of the total MAU for mobile, we have received strong demand for advertisers especially application developers for our feed ads. We continue to enhance our targeting technology as well as expanding our advertiser base.

On Weixin platform, we are beta testing [indiscernible] ads to help advertisers such as O2O merchants to grow followers to their official accounts. During the quarter we invited about 100 accounts to join the experimentation and we received positive feedback. We're trying to expand the test to include more official accounts in the coming months.

We believe overall we are in the early stage of the development of mobile performance ads business. With better educated advertisers and with further build out of our O2O, eCommerce and content ecosystem; we'll gradually unlock the potential of this market while keeping a strong focus on the overall experience.

So with that, I'll pass it to James to talk about the business review.

James Mitchell

Thank you, Martin and good evening everyone.

During the second quarter of 2014, we achieved total revenue growth of 37% year on year or 51% year on year excluding eCommerce transactions.

Value-added services generated 80% of our revenue, of which online games contributed 56% and social networks 24%.

Online advertising increased to 10% of our revenue, breaking into double digits for the first time in our recent history. eCommerce transactions represented 7% of revenue.

Diving into value added services; segment revenue was RMB15.7 billion, up 46% year on year and up 9% sequentially.

Our social network revenue was RMB4.6 billion, up 47% year on year and 15% sequentially. Increased item sales on our mobile platforms contributed to both the year-on-year and quarter-on-quarter growth rates.

As we add more mobile privileges into our subscriptions packages, the number of subscriptions [indiscernible] stabilized and our subscription revenue grew slightly in the second quarter.

Online game revenue was RMB11.1 billion, up 46% year on year and up 7% sequentially boosted by smartphone games.

The PC client games revenue was stable sequentially and increased year on year.

Looking at our social network products, for mobile QQ we reinforced our historic strength in communities via our new nearby groups and Interest Tribes functions. We upgraded mobile QQ Wallet to enable renminbi transactions for both virtual goods and O2O services.

For mobile Qzone we added privileges such as skins and background themes within mobile to personalize the user interface, helping our subscription revenue.

For Weixin, we upsized group chats to 400 users per group and added the cash balance feature enabling users who have not bundled a bank card to still use Weixin payments.

We've been integrating Weixin with some of our partner companies. For example, enabling users to view JD.com products via direct access point and allowing users to access content inside official accounts via Sogou's search results.

Moving to PC client games, for advanced casual games, our average concurrent user accounts increased 20% year on year to 7.1 million and our paying user accounts and ARPU also improved.

We launched two sports games, FIFA Online 3 and Freestyle Football in May just ahead of the FIFA World Cup. Two new shooting games, Call of Duty Online and [indiscernible] went into closed beta testing in June. Our backlog unit game EBITDA continue to expand both domestically and internationally.

For massively multiplayer online games, our average user accounts declined 9% year on year to 2 million. Revenue grew moderately year on year with contributions from new titles offsetting maturity of the older games.

Within the action game genre we launched an expansion pack for GMF and started closed beta testing for two new games.

For role playing games, we launched an expansion pack for Legend of Yulong and increased the game's user base and we delayed Blade and Soul's expansion pack until August.

At the quarter end, we operated 21 smartphone games, integrating with mobile QQ and Weixin of which we categorized about two thirds as casual and one third as mid-core. Generally speaking mid-core games achieve higher ARPUs on smaller user bases than equivalent casual games thereby boosting the portfolio's overall paying user accounts and ARPU.

Due to both new games and the changing mix of games as well as in game promotions during the quarter, our net revenue increased to about RMB3 billion. According to App Annie, we ranked the number one smartphone game publisher in China as measured by free downloads and revenue for each of the first seven months of 2014. Seven of our games ranked in the top ten grossing chart in China's iOS app store in June.

Our second quarter smartphone game revenue was actually substantially higher than we ourselves expected. During the second half of 2014, we'll focus on user experience expanding our game portfolio and platform enhancement. Consequently it's possible that our smartphone game revenue will be more or less stable around current run rates for the next couple of quarters.

Turning to online advertising, segment revenue was RMB2.1 billion up 59% year on year and 75% quarter on quarter. Excluding our discontinued search and marketplace businesses, our advertising revenue grew 75%

year on year.

Our brand advertising revenue was RMB1.4 billion, up 72% year on year and 88% quarter on quarter. Within which our online video advertising revenue more than doubled year on year.

Sequentially, advertising revenue grew strongly due to seasonality, increased online video traffic, the FIFA World Cup event and traffic contributions to JD.com from our portal. Our top five advertisers industries were food and beverage, automobile, online services, personal care and real estate.

Our performance advertising revenue was RMB700 million, up 79% year on year and 55% quarter on quarter. The increase was primarily from the insertion of news feeds apps into mobile Qzone as Martin discussed although offset from traffic contributions to JD.com from Qzone.

Our eCommerce transactions revenue was RMB1.3 billion, down 40% year on year and down 48% quarter on quarter. The decline primarily reflected our sending traffic to JD.com, hence reducing sales volume from our principal operations at Yixun. So in that circumstance the decline reflected a full quarter impact of the consolidation of our marketplace businesses.

Consistent with our new strategy of focusing on our partnership with JD.com, we expect eCommerce segment revenue and costs to continue dropping rapidly in the coming quarters.

And with that I'll pass to John to walk through the financials.

John Lo

Thank you, James. Hello everyone.

For the second quarter of 2014, total revenue was RMB19.7 billion up 37% year on year for 7% quarter on quarter.

We recorded net other gains of RMB691 million versus RMB1.6 billion last quarter.

Operating profit was RMB7.8b up RMB72% year on year or 1% quarter on quarter.

Share of profit of associates and joint venture was RMB23 million compared to RMB44 million last quarter.

Income tax expense was RMB1.7b. Effective tax rate for the quarter was 22.4%.

GAAP net profit attributable to shareholders was RMB5.8b up 59% year on year. This sequential decrease of 10% was again the high base in the first quarter where we recognized disposal gain of RMB1.9 billion relating to our strategic partnership with JD.com.

Non-GAAP net profit attributable to shareholders was RMB5.9 billion, up 42% year on year or 13% Q-on-Q.

Diluted EPS was RMB0.67 for the quarter.

We booked net other gains of RMB691 million in the second quarter of which deemed disposal gain relating to JD.com was RMB676 billion and deemed disposal gain relating to Cheetah Mobile was RMB141 million. This was positively offset by a donation of RMB100 million to Tencent Charity Fund and impairment provision made for investing companies at RMB325 billion.

On non-GAAP basis operating profit was RMB7.7 billion up 53% year on year or 19% quarter on quarter.

Net profit attributable to shareholders was RMB5.9 billion, up 42% year on year or 13% quarter on quarter.

Let's turn to segment gross margin. Gross margin for value-added services was 70% up 6 percentage point year on year and flat quarter on quarter. The year-on-year margin improvement mainly reflects the higher proportion of revenue generated from self-developed products.

Gross margin for online advertising was 45%, down 9 percentage points year on year or up 10 percentage points quarter on quarter.

The year to year decrease mainly reflected the accelerated amortization of video content costs, while the sequential recovery was due to revenue growth in the seasonally strong second quarter.

Gross margin for eCommerce transactions was minus 7%, down 13 percentage points year on year or 11 percentage points quarter on quarter. Both year-on-year and quarter-on-quarter decline were due to inventory provisions and discounts.

Moving on to operating expenses. Selling and marketing expenses was RMB2 billion up 60% year on year or 6% quarter on quarter. The year-to-year increase primarily reflected cash subsidies relating to taxi booking apps, online game promotions and marketing of our mobile products.

In the second quarter, we scaled back cash subsidies relating to taxi booking app and stepped up game promotional expenses for key titles. It grew 6% sequentially.

G&A expense was RMB3.4 billion up 44% year on year or 18% quarter on quarter. Higher R&D expenses and staff costs contributed to both year-on-year and quarter-on-quarter increases included under G&A.

Research and development expense was RMB1.9 billion, up 52% year on year and 24% quarter on quarter.

As a percentage of quarterly revenue selling and marketing expense was 10% and G&A 17%. R&D represented 10% of quarterly revenue or 54% of G&A expense. Share based compensation was 3% of quarterly revenue.

At the quarter end, we had approximately 25,000 employees down 2% year on year and 7% quarter on quarter mainly due to headcount moving from our eCommerce business to JD.com.

Now let's look at the margin ratios for the second quarter.

Gross margin was 61.6%, up 4 percentage points from the first quarter mainly due to a big shift to our high margin VAS business. Excluding eCommerce transactions revenue and cost, gross margin would be 66.6% underlying the strength of our core businesses.

Non-GAAP operating margin was 38.9%, up 3.7 percentage points from the first quarter mainly as the result of improved gross profit. Excluding eCommerce transactions revenue and cost, it would be 42.2%.

Non-GAAP net margin was 29.8%, up 1.5 percentage points from the first quarter mainly as a result of improved operating profit partly offset by increased finance costs and higher income tax expense. Excluding eCommerce transactions revenue and costs it would 32.5%.

For the same quarter, total CapEx was RMB917 million, down 37% year on year and 19% quarter on quarter.

Operating CapEx was RMB581 million, down 20% year on year and 36% quarter on quarter.

Non-operating CapEx was RMB336 million, down 54% year on year or up 43% quarter on quarter.

Free cash flow was RMB6.3 billion, up 59% year on year or 15% quarter on quarter.

As at quarter end, net cash position was RMB22.5 billion, down 33% year on year and 34% quarter on quarter, mainly due to the subscription of JD.com IPO shares and strategic investments to expand our O2O ecosystem.

In this connection, I would like to highlight that the fair market value of our listed associates and available for sale investment amounted to RMB65 billion, indicating our balance sheet is still strong and liquid.

This concludes our presentation. Thank you.

Catherine Chan

Thank you. Operator, we shall take the first question please.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Your first question comes from the line of Dick Wei from Credit Suisse. Please ask your question.

Dick Wei - Credit Suisse

Hi and thank you for taking my questions. I have two questions.

The first question is on the other revenue line. It looks like we have a pretty strong growth for the other revenue to RMB645 million from RMB284 million and there's no real increase in COGS for that line. Wondering what is the growth contributed to and what is the outlook going to be like for the next couple of quarters? And I have a follow up. Thank you.

James Mitchell

I would like to sort of trim down your excitement over this item. Basically the main reason for the increase was actually reclassification of the virtual items, virtual eCommerce items that used to be in our eCommerce business but now has been moved over to our others revenue as a result of the internal restructuring of our eCommerce business.

Dick Wei - Credit Suisse

And would it be like -- be stable?

James Mitchell

The increase in number is actually moving one from eCommerce right to this line item not to the -- it's not really grown per se.

Dick Wei - Credit Suisse

I see. So it's not particularly payment related.

James Mitchell

No.

Dick Wei - Credit Suisse

Okay, I see. And then the second question is I think Martin mentioned about it that we got pretty good performance ad over on the mobile side. Wonder if you can maybe share some thoughts on what's the current outlook over the next couple of quarters as well? Thank you.

Martin Lau

Well, I think as I said in the strategic highlight section that we have a number of different initiatives going on right now expanded across the news platform which is sort of the traditional portal type of advertising business, branded ads as well as the video ads on mobile platform as well as the performance ads that's running on our social networking on the mobile platform. I think each one of these initiatives are still relatively early stage in terms of their development.

Now we do need to make sure that the user experience is well respected in each one of these platforms when we put in the ads. So that's why we felt it will be continuous effort, it will be a consistent effort and I believe there's actually a lot of potential in this area. But we'll do it relatively cautiously and in a measured way so that we continue to place the user experience at the foremost of our attention. And we will continue to grow these platforms and that will be the horse in front of the cart. And over time, the cart will actually follow the horse.

Operator

Thank you. The next question comes from the line of Eddie Leung from Merrill Lynch. Please ask your question.

Eddie Leung - Merrill Lynch

I just have two questions. The first one you talked about your mobile game outlook. Could you elaborate more on your comment about having a stable revenue stream in the upcoming couple of quarters? Are you see a bit of trade-off between user engagement and monetization on mobile games and PC games? Because I remember during the initial growth stage of PC games, it seemed like you didn't have to -- tough like manage the monetization of your PC games in order to grow your user engagement. So that's my first question.

And then secondly, just for housekeeping purposes could you share with us the ARPU range of your ACG, MMO and mobile games? Thanks.

James Mitchell

Sure in terms of the mobile game outlook the negative trade-off you're concerned about between game usage and game monetization, it's not something that we have experienced or necessarily expect to experience.

This is very much just a decision we've made on our side that we have a set of priorities and we feel that we've actually raised substantially, over-delivered already on financial targets for the games. And therefore while we'll continue to monetize the games we'll also put even more energy into improving key platform infrastructure, improving the user experience.

And we also want to drive more traffic and more support towards these third party games that will be coming on to the platform. And as you may know, for those third party games we actually book revenue on a net basis, net of the developer's share. So all else equal, if the total user spending on our platform increases, if the majority of the increase is driven by third party games then that would be less beneficial to net revenue versus the same amount of spending on first party games. But I wouldn't be concerned about the negative trade-off that you raised.

John Lo

In relation to the ARPU for advanced casual games in terms of the ARPU, it's within RMB85 to RMB220. For MMOG it's between RMB240 to RMB320. And in relation to platform games or mobile games if you look at the portfolio it will be within RMB100 to RMB110 per quarter.

Operator

Your next question comes from the line of Philip Wan from Morgan Stanley. Please ask your question.

Philip Wan - Morgan Stanley

I have two questions. My first one is also a follow up on your mobile games sales outlook. As you're seeing -- is it because of slowdown of a new game launch in your pipeline or have you observed any particular change in gamer behavior that will lead to a flattish sequential growth in the second half?

And then the second question is also partly related to this. Have you seen any cannibalization between your gaming service and also other service you're starting introducing in your WeChat platform in terms of user time spent or user engagement? Thank you.

James Mitchell

With regards to the first question I think the short answer would be no to all of the above. So on the first question slowdown in game launches I think we actually intend or we have been accelerating the pace of new game launches from one to two per month. So close to four per month. So that's certainly not a factor.

In terms of the game user behavior, that continues to move in a positive direction. When we first launched Weixin people weren't accustomed to playing games on top. Then we launched some very casual games which people played, but they wouldn't spend money. And more recently we've been launching some games which people play and do spend money. So we feel that the behavior is moving pretty much as we would want it to move.

With regard to the cannibalization effect, we don't see that happen and logically we don't see why that ought to happen. The user need for reading news headlines and the user need for playing games are very different user needs. And so you don't see one of them negatively impacting the other.

Martin Lau

Well, in fact I would say the games they are really independent apps leveraging on our platforms. So the more games we have they actually add to the total engagement time that we have with respect to the users.

Take the example of our running game. Basically if you put that in comparison with the apps in China, our running game is probably ranked in the top five of all mobile apps in China. So just to give you an idea of how these different games actually add to the overall amount of time that's spent in our ecosystem.

Philip Wan - Morgan Stanley

A quick follow-up. You mentioned that you're starting to put in more resource on the third party games. As you mentioned before the self-developed mobile games enjoy higher margins. So how would that affect the margin outlook for your platform? Thank you.

James Mitchell

Well, consistent with my earlier comment that we actually report revenue for the third party games on a net basis, the revenue you would see -- the margin you would see if you do a simple calculation of, I think operating profit over revenue would be pretty good for both first party and third party games.

The cash margin we collect as a percentage of the cash the user spends will be a bit lower for third party games. But that shows up in a lower revenue line not in a lower margin percentage.

But irrespective, if it's a successful game whether it's third party or first party, it will be a very profitable business for both us and the developer of the game.

Martin Lau

Yes, I do want to emphasize that we see mobile gaming as a great opportunity and that's why it's important for us to build it up for the long term. So that's why as James mentioned we are going to spend a lot of development effort in terms of making sure that the platform actually supports better user interaction and user clearance.

And at the same time we do want to have a very strong ecosystem of games that include a lot of third party games for the future. So that's why we, despite the fact that on a cash on cash basis we actually capture less of the revenue, we do believe that at this point in time it's actually very important to direct more traffic and put much more effort in terms of building a very big ecosystem of third party games on our platform.

Operator

Thank you. The next question comes from the line of Cynthia Meng from Jefferies. Please ask the question.

Cynthia Meng - Jeffries

I have two questions. Number one, can you further elaborate on how the strategic cooperation with JD helps to fuel this strong advertising revenue growth this quarter? It was mentioned in the written statement.

Number two is can you please give us more color as to how the partnership with WUBA and 51.com is going to fit Tencent's overall O2O strategy layout? Thank you.

James Mitchell

Sure in terms of the advertising revenue we mentioned that the cooperation with JD.com is one factor that helps our advertising revenue. It wasn't the largest factor. The performance advertising on mobile, Qzone, the growth in online video advertising are all those larger factors and moderate sized facts during the quarter. So it's one of several factors benefiting our online advertising revenue. I'll pass over to Martin for the cooperation question.

Martin Lau

Yes, in terms of 58, I think it fits our overall strategy of leveraging our social and communication platform to connect different entities in the ecosystem. So if you look at our overall communication platform, in the initial phases it was about connecting people. But over time we would like to connect people with services, we want to connect people with goods; we want to connect people with businesses. And that's where different strategic investments come into play.

If you look at JD, it's about connecting people with goods. And if you look at VMPA it's about connecting people with auto services. In this case about 58.com, it's about leveraging our platform to connect our users with a lot of services that -- life services, things that will help them to manage their movement from one city to another, that help them to rent an apartment on a short-term basis. There are a lot of these lower frequency but very necessary services that are available on the 58.com which all the time we would like our users to be able to be connected to. And I think that's the overall theme. And over time, with our traffic, with our user base and with the fact that we also know different people by sort of lockings, we can actually add to the overall trustworthiness of the 58.com community as well. So I think it's mutually beneficial.

Operator

Thank you. Your next question comes from the line of Alex Yao from JPMorgan. Please ask your question.

Alex Yao - JPMorgan

Thank you for taking my questions. Firstly can you guys give us any update on the Internet banking strategy that you drives with the banking license what were the potential other things about you have to do and can you share with us maybe thinking in this area? Thank you.

Martin Lau

In terms of the Internet Banking license, right, we have gotten a license and I would say we are in the early stage of building up the service and mapping out our business plan, leveraging the license. I think there are still a lot of things to do with respect to the license. The license doesn't really enable us to roll out our business on a completely national basis in terms of physical location. So it's a license that's in process, I would say. Over time we'll work with the regulators and try to develop innovative services, but we'll leverage the license to help us to address and increase any large user base.

Now, with respect to the initial thinking around what we're going to do with this banking license, I think the future direction of this bank and this overall banking initiative is going to be, number one, it will not be a direct competition to the current banks in terms of their business as -- what I mean by that -- what I mean is that what we will try to do within this banking and credit initiative is really to serve the under-served segment within the credit market, i.e. consumer credit, i.e. the credit which are very difficult for banks to identify within their cost structure as well as within the current availability of data. Because of our large data, because of our consumer touch points, we believe we have an advantage of identifying credit that existing banks are not in a position to serve and we'll be in a better position to serve. So picking up the un-met demand within the credit system is one of the important things that we'll be doing.

And second thing is when we look at our future bank, it will be a bank that really cooperates with a lot of other different banks. Because of its positioning of picking up the under-served demand, what we will do is actually we will work with a lot of banks who has deposits. We're not going to compete with other banks for deposits; rather we'll work with them. A lot of banks they have deposits but they want to find attractive borrowers and we're in the best position to do that. So in the future we'll be working with a lot of different banks to deliver this kind of market to them. I think that's what we envision for our future banking initiative.

Now, because we need the flexibility of working with these different banks, we need also the access to a lot of credit information facilities. So by having this banking license it will help us a lot in this process.

Alex Yao - JPMorgan

Very helpful, thank you. Second question is on the probability side. From Q1 to Q2 the revenue contribution from the mobile game is it need to and increased it from 12% to about 20%, 21%, but why would there be a developing program stage in the past three quarters?

Catherine Chan

Alex, can you repeat the last part of your question?

Alex Yao - JPMorgan

Yes, yes. I think your VAS gross margin was flattish from Q1 to Q2 at about 70% but clearly the revenue mix is moving to the higher margin mobile game types. Is there something -- what is the reason behind the margin, [indiscernible]? Could you just maybe give a little color on the overall VAS gross margin trends?

James Mitchell

I think historically the VAS gross margin tends to pick up in Q1 and Q3 because that's when the game business is more healthy. Whereas VAS costs tend to increase in line with basically social network communications user growth. So historically the costs increase quarter on quarter through the year, whereas the revenue is more bumpy towards Q1 and Q3 and that causes the gross margin to sometimes be a little bit weaker in Q2 than Q1.

This year the mobile games that you've identified would have acted as an offset to that. We can look into it and come back to you offline in more detail, but I think that's the most [forceful] --

Operator

Thank you. Your next question comes from the line of Jiong Shao from Macquarie. Please ask your question.

Jiong Shao - Macquarie

Thank you for taking my questions. My first question is about the e-commerce, it's been a couple of months since your partnership with JD officially started Weixin. I was wondering would you be able to elaborate a bit on what are some of the early results you have seen in terms of the traffic, the conversion rate et cetera for this partnership.

And related to that, you highlighted on an earlier call that you have seen a lot of momentum in the public accounts from the O2O merchants Weixin. And what's your plan for the next step in terms of the converting perhaps some of those merchants into a marketplace for B or for the smaller Bs?

My second question is about the --

Martin Lau

That's two questions already so let's address that first before we lose track. The first one with respect to JD.com, I think we'll let JD elaborate on the details, right, but I think what I would say is we are in the early stage of integration. I think a lot of the effort in the very initial stage was really just making sure that the actual logistics of the strategic partnership gets done. And JD was very focused on getting their IPO done as well.

I think as far as the early results of the integration, I would say on the B2 side a lot the traffic has already been directed to JD's mall and also the conversion rate has actually increased when compared to before. And that's, I think, pretty natural because there's a bigger selection of products so the conversion rate actually increased.

Now in terms of the mobile integration, we have launched a level one access point in Weixin and recently we have actually also launched it in Mobile QQ. What I would say is it is generating meaningful GMV but we believe this overall effort is still early stage because right now the user experience is rather simply. It's basically just one click into a normal mall. But over time I think there's going to be more innovations that we can do with respect to the access point, with more customization, with more exciting experience for the consumers and make it differentiating. So I think that would take time for us explore and experiment.

The other thing I would say is for the overall e-commerce infrastructure within Weixin and QQ, I think that we're also in an early stage of development because the more you tailor users, right, the Weixin Payment or the QQ Wallet users which we just recently launched, the more likely for users to click into the access point and be able to convert into buying users. Likewise the more advertising infrastructure that we can actually provide within Mobile QQ and within Weixin, that would actually also benefit the buildup of this e-commerce ecosystem.

So I think overall it's still in reality in the early stage. And we'll continue to work with JD to further explore and develop this synergy.

I did lose track of your second question which is what -- I did -- lost track of your second question about for the O2O and for the marketplace, so I apologize on that.

Jiong Shao - Macquarie

I was just wondering -- it's actually the second part of the first question -- now you have a bunch of the public accounts from these merchants on Weixin. A little bit spread out through the whole ecosystem infrastructure. Down the road do you think it is conceivable you may be putting together a marketplace, B2C marketplace or C2C marketplace in -- within the Weixin ecosystem?

Martin Lau

What I would say is because right now -- number one, we will continue to build up those e-commerce enhancing infrastructure, as I said, right, the payment as well as the advertising, which will deliver more traffic to these O2O or e-commerce public accounts.

the other thing which I would say is if we are going after the centralized e-commerce model, we'd rather work with JD; we can actually direct traffic to stores that these merchants actually open up in JD's mall. And I think that's a more effective way to help them to generate traffic from a centralized model.

Jiong Shao - Macquarie

Okay.

Operator

Thank you. Your next question comes from the line of Wendy Huang from Standard Chartered Bank. Please ask your question.

Wendy Huang - Standard Chartered Bank

Thank you. I have two questions. First one I think in past six months you have invested in different kinds of e-commerce assets; [indiscernible] flash-sale e-commerce type of platforms. And we actually have seen the flash-sale actually usually enjoyed higher mobile penetration rates. So going forward actually would you consider to add maybe flash-sale e-commerce business model or this kind of sale format to your overall e-commerce ecosystem?

My second question is about your WeChat international expansion. So currently you have over 200 million users outside China already. When do you expect to monetize this overseas traffic and also how do you view the competition in the overseas market from [indiscernible] and Facebook. Thank you,

Martin Lau

Okay. In terms of flash, I think it's a very interesting model. Again what we will be doing is we'll be doing it alongside with JD, right. We're doing the level one access points. There could be different ways to rate the presentation of the products. And one of the presentations could be flash sale and that's something which we'll test out with JD.

In terms of --

James Mitchell

I think in terms of WeChat on the monetization side, our games are already available in Malaysia for example. They are quite popular and they are monetizing in Malaysia but it's obviously a much smaller market than our home market.

With regard -- sorry. The focus continues to be growing the user base and then growing the engagement for WeChat internationally. And some of the activities or services such as games would serve to both boost engagement and monetize, but for us the primary value in the near term would be around the engagement rather than the monetization. So we're not not monetizing internationally, but the focus is on engagement first and then the monetization should be a happy by-product of that.

With regard to the competitive landscape, I think that it is extremely competitive, especially in Western markets. It's still very competitive in Asian markets but we have a stronger positions in some of the Asian markets. So I think the strongest competitor we've faced so far in most markets is the company you mentioned, it's WhatsApp. So that's the competitive landscape.

Operator

The next question comes from the line of Alan Hellawell from Deutsche Bank. Please ask your question.

Alan Hellawell - Deutsche Bank

Thank you very much. I was hoping that [indiscernible] ask two questions. Could you give us an assessment of how recent regulatory announcements that may have impacted products such as Weixin and Mobile QQ at all and what we might expect going forward?

Martin Lau

Well you know the impact is actually relatively minor. First of all, if you look at the requirement to have a real name, our Weixin service basically already asked people to define their cell-phones, so it's real name in nature. And a lot of the regulation is actually around the public accounts which -- it's, one its subsidiary to our overall communication experience and, two, most of the traffic on our public account actually is already complied with all the regulations. So I think it doesn't really affect our platform.

Alan Hellawell - Deutsche Bank

Alright, got it. With this recent [indiscernible] scrutiny you can't be public [indiscernible] for the time being. Okay.

Martin Lau

It is not that negative.

Alan Hellawell - Deutsche Bank

Right, okay thanks. And I'm just curious, would you effect much more M&A activity and related to that even further incremental mobile functionality rolled out over the next year? Or would you regard the next year as being devoted to basically just expanding the existing offerings, further integrating some of your successful O2O investments. Can you comment on that?

Martin Lau

Yes. I wouldn't characterize activity as sort of new [indiscernible]. We are in an industry in which innovation is the key to success. And so that's why, I think, while we will continue to work on the initiatives which are seeing great traction, we will continue to look out for new opportunities as well as engaging in innovations, especially the one you're talking about, functionalities within our mobile platforms. There will be more and more functionalities definitely. That's actually one area of focus rather than saying just working on existing initiatives.

Alan Hellawell - Deutsche Bank

Got it. Forgive me, just a -- the reason I ask is you could argue that there's been some behaviors at the -- on a lot of mobile platforms that platform A has -- serves wonderfully as a social networking platform but it's relevance to utility and branching out into other concentric circles is limited. What is your philosophy around Weixin? Do you feel like it's almost infinitely expandable or have we achieved with 80/20 what it's going to do for us for the next couple of years.

Martin Lau

I think what you said is right. If you view it basically in just accumulated play, that's what you will be getting, if you try to blast the same experience to everybody, where there's a limitation on what you can add. But the beauty of mobile Internet is that there are a lot of different instances in which a particular person would need a particular service. And being able to present that -- capture that moment and then present it in a natural way, I think is the unique experience that we want to provide, right. So if we can provide that, rather than basically just blasting everybody with the same user experience and then you can -- you take the third one, and the fourth one may not be needed and that's the end of it. But if we can actually really find the right person, find the right service; find the right moment to sell that will make it much more expandable. That's what we try to focus on.

Operator

Thank you. The next question comes from the line of Chao Wang from Nomura Securities. Please ask your question.

Chao Wang - Nomura Securities

Hi. Thank you for taking my questions. I have a follow-up one on mobile games. Could you update us on the mobile game daily active users? It was [indiscernible] in the last quarter. And how do really think about the user growth progress could be despite [indiscernible] growth. Thank you.

James Mitchell

I think as we mentioned in the introductory remarks, the newer games we have added tend to be games which are a little bit more [indiscernible] and casual and therefore they would tend to have potentially fewer DAUs but more monetization than some of the games that we added six or nine months ago. So if you extrapolate that to the platform as a whole and the platform as a whole the number of DAUs would be stable to slightly increasing, but broadly stable.

Chao Wang - Nomura Securities

Sure. And how about the growth for the rest of the year.

James Mitchell

How about what?

Chao Wang - Nomura Securities

User growth for the rest of the year.

Catherine Chan

For which? Sorry --

Chao Wang - Nomura Securities

for mobile games, mobile games.

James Mitchell

That's a function of many things. That's a function of Weixin user growth, that's a function of Mobile QQ user growth, that's a function of the conversion of those users to playing games. So obviously we'd like all of those numbers to kick around, but it remains to be seen how fast they can grow.

Chao Wang - Nomura Securities

Understood, thank you. I have a follow up question on JD. Could you share with us your investment strategy on content, both in-house content and third-party content thank you.

James Mitchell

We have been and we will continue to invest very aggressively in video content, both third party and first party. You can see in our results, both our traffic results where our DAV is doubling year on year and also our revenue results, with our revenue substantially more than doubling year on year. So when we buy the right contents or when we develop the right content, given our platform advantages, given our massive upstream traffic, given our log-in relationship with the users, given our ability to virally market content through our social graphs, if we have the right content we can deliver very strong user growth. And if we have the users we can deliver advertising revenues. So we're very committed to increasing our investment in both third-party and self-created content.

Operator

The next question comes from the line of Alicia Yap from Barclays. Please ask your question.

Alicia Yap - Barclays

Hi. Good evening everyone. Thanks for taking my questions. My first question is back on the PC games. So while the PC games, as you mentioned, experienced healthy year over year growth. It was driven by a couple of the new games and also the LOL. I wanted to ask that it seems that some of them like ACG games seems to be slowing down. So do you think that the trend of this slowdown for the advanced casual games such as D&F and Crossfire will continue as these games are ageing or is there any potential that there will be rebounding on the accelerator game. And then what is your expectation for the Call of Duty? Thank you.

James Mitchell

So with regards to the maturation of legacy advanced casual games, I think you mentioned Dungeon and Fighter. We classify Dungeon and Fighter as action role-playing games so that wouldn't be included in the advanced casual game category. The other game you mentioned it's Crossfire, that's a game that's been phenomenally successful over time. It's a game that we've been publishing out for five years or so and it's a game where over time, not figure on figure, the revenue growth has naturally decelerated as you might expect.

Now, at the same time, we believe that the consumer demand for [indiscernible] shooting games is still very buoyant demand. If you look at the United States, if you look at Europe, shooting games are the biggest category. The biggest shooting game, it's the biggest game in those markets. So over the past couple of years we've brought a game called Assault Fire which is a self-developed shooting game to be one of the most successful titles in our portfolio in terms of traffic, in terms of revenue, in terms of profitability. And so for us, while one particular shooting game may be more mature, the overall category has continued to exhibit growth, [particularly] we think with the right expansion packs and so forth. And Crossfire itself sees good growth as well.

And then finally Call of Duty Online, that is our version of Call of Duty which is the most successful shooter franchise globally. And, as we mentioned, we've recently taken that into a later stage beta test, so we'll see how that game proceeds going forward.

But the reason I dive into this in so much detail is not because I'm a shooting game fanatic, but more to illustrate the point that what you and I call advanced casual games is actually a collection of numerous game genres with shooting games being one. And then we take again genre strategy and if one title in a game genre is slowing down, then obviously we'll have to re-accelerate the growth do things to re-accelerate the growth, but we also may have other titles in that genre that serve slightly different needs. And sometimes the behavior of the overall genre can be different from the behavior of the individual title.

Alicia Yap - Barclays

I see, I see. And my second question is regarding more on our strategies. As we invested quite a few of the investment companies over the past six months, so what is our plan for these stakes? Are we intended to keep them at the current percentage of ownership or in the future, if there's more synergies happen, is there any possibility that you may consider increasing the stake or may have full control on some of these stakes. Thank you.

Martin Lau

At this stage I think we're very focused on pursuing integration of the services so that, number one, where we can actually help these companies to grow and also benefit from our large user base; number two is to be able to deliver better services to our users. So I think that's -- we really focus on that. We don't have -- we don't think a lot about the stake itself. We think a lot about how to actually deliver value to our users and also value to our partners.

Operator

Thank you. Your next question comes from the line of Chi Tsang from HSBC. Please ask your question.

Chi Tsang - HSBC

Hello. Thanks for taking my question and good evening. I have two questions. Firstly just getting back to the engagement levels on WeChat, when you combine gaming, chatting, reading moments, shopping, what is the rough average time spent per day per user and what do you think is the natural limit on that figure. And then I've got a second question. Thank you.

Martin Lau

Well, I think it's actually not the appropriate way to look at it because I think for us, right, what we -- the communication and the social networking activity is actually within the app, but a lot of the other activities is actually using our platform as effectively a discovery as well a channel as well as a launch pad. So that the activity of games actually happen within the games itself rather than within WeChat. And with the reading a lot of times actually it happens when people click into the news and if it brings them our Tencent news app. So what we try to do is actually to divert the heavier users and heavier user experience toward the individual apps that can deliver that longer-time engagement. So I think that's the architecture of our overall platform strategy. And, as a result, it doesn't really get limited by the amount of time that people spend on the app itself, but it's really a function of the range of activities that people would do in their every day time.

Chi Tsang - HSBC

Great. And my second question is can you give us an update on Weixin Wallet? If you can give us just a sense of DAUs or MAUs and what type of spending habits you're seeing on Weixin Wallet? Thanks a lot.

Martin Lau

Well at this point in time we -- what we can say about Weixin Wallet is that, one, it's actually very light experience for users and as a result it actually is very easy for users to subscribe to this service. And number two is we have an increasing number of payments applications so that we -- those applications will help to pull in the users.

But I have to say that we're still in the early stage of developing this ecosystem, right. The more applications that we have, the more likelihood for us to be able to convert users. So I would say we have reasonable take-up. We're still in at the early stage of converting more and more users into Weixin Payment. I would rather not go into the specific numbers because of competitive reason.

Operator

Thank you. Your last question comes from the line of Thomas Chong from Citigroup. Please ask your question.

Thomas Chong - Citigroup

Hi. Thanks. Good evening. Thanks for taking my questions. I have two questions. The first one is about still the mobile games. Given you have to launch the smartphone games for a year already, what lessons have you learnt in the past 12 months and should we expect the smartphone games' revenue to resume quarter-on-quarter growth after you do some revamp in the user engagement? And then I have a follow up. Thanks.

James Mitchell

I think in terms of timing we don't give guidance, but earlier in the prepared remarks I realized I said that you might see us focusing more heavily on the non-financial metrics for a couple of quarters. So just to be clear, a couple when I say a couple I mean two exactly. I was really thinking about the balance of this year. Given how strongly we've outperformed financially in the first half year, the balance of this year the teams will continue to monetize but they'll also focus very much on our third-party games, focus very much on enhancing our platform, focus very much on improving the user experience. So my comment was really about the next couple meaning next two quarters.

With regard to lessons learnt. I think the other people will probably chime in and supplement me, but one thing that's been very clear to us is the more that we integrate the games with the unique social aspects of Weixin and QQ, the more popular they are, the more revenue generative they are. And so that's why in the early stages of the Weixin, QQ game center, the first-party games generated a very disproportionate chunk of the revenue, not because we wanted to actually favor first-party games, but because the internal studios picked up very quickly how to fully integrate the games with the Weixin and QQ social world and how to make best use of Weixin and Mobile QQ.

Now we're in the process of integrating those values to third-party games and making sure that third-party games can similarly benefit from very powerful integration. So I think that's one important takeaway.

A second important takeaway is if you look at the trajectory of other chat platforms around the world and how successful they've been in adding mobile games, some of them have been very successful at adding the casual mobile games; not so successful at adding the mid-core mobile games. Others have successfully transcended into mid-core and even hard-core mobile games as well. And I think our experience so far is that on Weixin and on Mobile QQ, we're very capable of generating casual games hits [indiscernible] DAUs. But we're also very capable of generating more mid-core hits with smaller numbers of DAUs. It's a very healthy revenue generation. That is a big part of the reason of why we generated substantially more mobile game revenue in 2Q than we expected.

Thomas Chong - Citigroup

I see. Thanks James. And my second question is about the use of cash. We see you have invested in China South City earlier this year. And given you rely on JD.com for the e-commerce, so should we still expect Tencent to spend money on logistics and warehousing going forward? Thanks.

Martin Lau

One of the go-to or the objective in investing in China South City was partly the land but it's not the main focus. I think, as we explained earlier a few quarters back, the most important thing was actually we believe China South City is building an interesting ecosystem of offline suppliers in their offline premise. And over time this large number of offline suppliers can actually move online. And that's actually the kind of opportunity that we are most focused on. So that's why on one hand, China South City we'd be working with Jingdong on some of their logistics-related stuff, but on the other hand they will be working with both us and Jingdong on building up the e-commerce service for their merchants. I think that's the bigger opportunity that we really target on when we do investment.

Catherine Chan

Okay. Thank you very much for all of you to join the call tonight. And we're winding up the call now. If you wish to check our press release and our financial information, please visit our corporate website at www.tencent.com/ir. We will also place a replay of this webcast on site shortly. Thank you and see you next quarter.

Operator

Thank you. That does conclude our conference for today. Thank you for participating Tencent Holdings Limited 2014 second quarter results announcement conference call. You may all disconnect now.

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