Tencent's (TCTZD) CEO Pony Ma on Q3 2016 Results - Earnings Call Transcript

| About: Tencent Holdings (TCTZD)

Tencent Holdings Ltd. (OTCPK:TCTZD) Q3 2016 Earnings Conference Call November 16, 2016 7:00 AM ET

Executives

Catherine Chan - Investor Relations

Pony Ma - Chairman and Chief Executive Officer

Martin Lau - President

James Mitchell - Chief Strategy Officer

John Lo - Chief Financial Officer

Analysts

Eddie Leung - Merrill Lynch

Piyush Mubayi - Goldman Sachs

Alan Hellawell - Deutsche Bank

Alicia Yap - Citigroup

Wendy Huang - Macquarie

John Choi - Daiwa

Alex Yao - JPMorgan

Chi Tsang - HSBC

Evan Zhou - Credit Suisse

Natalie Wu - CICC

Operator

Thank you for standing by and welcome to the Tencent Holdings Limited 2016 Third Quarter Results Announcement Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today. I will then turn the conference over to your host today, Ms. Catherine Chan from Tencent. Please go ahead, Ms. Chan.

Catherine Chan

Thank you, operator. Good evening. Welcome to our results conference call for the third quarter of 2016. I am Catherine Chan from the IR team of Tencent. Before we start the presentation, we would like to remind you that it includes forward-looking statements which are underlined by a number of risks and uncertainties and may not be realized in future for various reasons. Information about general market condition is also coming from a variety of sources outside of Tencent. This presentation also contains some unaudited non-GAAP financial measures 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 non-GAAP measures, please refer to our disclosure documents on www.tencent.com/ir.

Now, let me introduce the management team on the call tonight. We have our Chairman and 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 strategic highlights. James will speak to business review. And John will go through the financials before we take your questions.

I will now turn the call over to Pony. Thank you.

Pony Ma

Thank you, Catherine. Good evening. Thank you for joining us. During the third quarter of 2016, we have delivered a strong financial performance for our core businesses. In particular, our smartphone games and social performance advertising businesses reported above industry revenue growth rate and continued to generate healthy margins for key infrastructure platforms supporting our ecosystem. Specifically, payment and cloud services, we saw significant progress in adoption and usage. We will continue to make investments in these strategic areas.

Let me give you the headline numbers and give further discussion to the financial section. Total revenue was RMB40 billion, up 52% year-on-year and 13% quarter-on-quarter. Non-GAAP operating profit was RMB15 billion, up 43% year-on-year and 2% quarter-on-quarter. Non-GAAP net profit to shareholders was RMB11.7 billion, up 42% year-on-year and 4% quarter-on-quarter.

Moving to our online platforms, total MAU for QQ increased 2% year-on-year to 877 million, with 647 million of monthly active users logging via smart devices, combined with MAU of Weixin and WeChat increased 30% year-on-year to 846 million. For Qzone smart devices, MAU increased 1% year-on-year to 584 million. In games, we launched several successful smartphone games, including low paying games which help us expand user basis. Our PC client games sustained its leadership in several genres, retaining many loyal gamers through a range of immersive in-game and less intense game-related activities. In media, we saw healthy growth in users and traffic for our news and video platforms. Digital content subscriptions for music and video services increased.

In the third quarter, we merged our online music business with China Music Corporation. We believe the combined company can help shape China digital music ecosystem to more sustainable business models. In mobile utilities, our mobile security service continued its momentum. Our mobile browser partnered with the China Reading Corporation to promote authorized content distribution. We continue to improve search, discover and download experiences in our app store, YingYongBao via deep linking. I now invite Martin to discuss strategic highlights.

Martin Lau

Thank you, Pony and good morning, good evening to everybody. Tencent’s not only conduct our businesses, but also invest heavily into developing technologies that may not generate revenue directly, but are important for our ecosystems. One of these technologies is our security technology. In the course of the past few years, we have made a significant advancement in our online security technology which has enabled us to become a leader in the market.

In mobile security, QuestMobile ranked us number one in MAUs since 18 months ago, with a widening lead. In PC security, our market share exceeded 30% according to iResearch. These achievements were supported by our core security technologies. For example, we scored excellent results at the Global Hacking and Maneuverability Discovery Contest this year, winning the number one title in [indiscernible]. Several months ago, engineers in our Keen Security Lab, in their efforts to enhance security for Internet-enabled cars, has discovered vulnerabilities that consider direct manipulation of Tesla’s control system and that was a very significant event in the entire industry. Following international standard practices, we shared our findings with Tesla, who implemented the patches immediately.

We continued to be a leader in fundamental security technologies, such as scanning viruses, releasing memory as well as boosting speed of Tencent. We are also the leader in antifraud technology for smartphones. We own the most adopted detection system for phony base stations. We also own the largest database of fraud phone numbers and industry leading prediction technologies based on big data analytical capabilities. As an evidence of our leading position, we became Apple’s official partner in anti-spam services supporting iOS users to identify report and block nuisance caused in China.

With best-in-class security capabilities, we are providing a superior infrastructure service with its ecosystem of our own applications as well as our partner services. For Tencent apps, we protect user ID, passwords, personal information and virtual property. Our security app Mobile Manager would automatically ensure a virus-free terminal environment by scanning the mobile phone, Wi-Fi access as well as in app links. Our cloud-based security capability helped to detect fraudulent webpages and phone calls.

For online finance, the security technology is, in particular, important, because it allowed us to provide users a safe environment for payment and financial transactions. Based on data analytics, we can identify and control dubious transactions before they are conducted. By ensuring security, we can speed up the adoption of online financial transactions and make users comfortable with conducting high-value financial transactions on their smartphones. For our partners, we integrate our security capabilities into our cloud services to protect enterprise IT systems, defend against DDOS attacks and safeguard their products and services. For developers, we helped them to screen applications for security vulnerabilities before release. All-in-all, our security capabilities has allowed us to develop a healthy ecosystem for our businesses.

So with that, I will pass to James to talk about our business review.

James Mitchell

Thank you, Martin. In the third quarter of 2016, our total revenue grew 52% year-on-year. Value-added services represented 69% of our revenue, within which online games contributed 45% and social networks 24%. Online advertising was 19% of total revenue. The other segment which includes payment-related and cloud services accounted for 12% of total revenue.

Looking at value added services, segment revenue was RMB28 billion in the third quarter, up 36% year-on-year and up 9% quarter-on-quarter. Social network revenue was RMB9.8 billion, up 58% year-on-year and up 15% quarter-on-quarter. Strong performance of game-related item sales and digital content sales drove the year-on-year and quarter-on-quarter revenue growth. In the third quarter, the consolidation of China Music Corporation contributed over RMB800 million to sequential revenue growth, of which over RMB700 million was booked on to the social network category.

Our online game revenue was RMB18.2 billion, up 27% year-on-year and up 6% quarter-on-quarter. New smartphone games and strong performance of key PC titles contributed to the year-on-year revenue growth. Sequentially, PC games benefited from positive seasonality. Some of our big smartphone games such as Honor of Kings and JX Mobile delivered strong operating performances as well.

Turning to social networks, for Q2, we added creative and fun features to enlighten community experiences. Specifically, we launched CM Show, a Mobile QQ product that provides users with animated personal avatars. With these avatars, users can interact with their friends inside the chat box or connect items from friends to unlock new features. We conducted an augmented-reality torch reader e-campaign for the Rio Olympic Games and over 100 million Mobile QQ users participated in the 22-day event.

For Weixin, we are beta testing a new function called Mini Programs. Users will enjoy a native app like experience conveniently without needing to leave the Weixin interface. Consequently, they can reduce their phone’s CPU usage and phone memory storage requirements. For Weixin Pay, we significantly increased merchant adoption. On August 8, we launched our annual Cash-Free Day in many Tier 1 and Tier 2 cities. The total number of stores participating in this promotional campaign increased by over 7x year-on-year to almost 700,000. In September, we added Weixin Check Out, a feature that helps merchants simplify payment integration and reduce registration process time. By scanning a unique QR code assigned to each store, consumers can check out and pay quickly, while store managers can manage billing activities efficiently.

Looking at PC client games, revenue grew 10% year-on-year and 9% quarter-on-quarter. Daily active user accounts were down 9% year-on-year and stable quarter-on-quarter, while average concurrent user accounts for advanced casual games were down 18% year-on-year and average concurrent user accounts for online games were down 11% year-on-year.

Let’s put some color around these trends. Increasingly, fast broadband speeds are enabling more PC gamers to enjoy real-time player versus player games, such as League of Legends and Free for Online, in which they alternate high engagement competitive sessions with low intensity practice review and game-related trap sessions. Consistent with this migration in behavior, we are shifting our engagement focus away from maximizing users’ time spent in game and toward broadening overall user engagement by game-related activities such as eSports and tournaments, video streams and popular gamers and game-specific interest tribes within QQ and Weixin. This shift in focus results in users spending less time passively sitting inside the game plan, which naturally translates into fewer average concurrent users, since the average concurrent user metric measures total active users multiplied by average time spent in the game client per user. However, the shift is not necessarily reducing user engagement with our games or willingness to spend money on game items with our PC game revenue increased despite the decline in average concurrent users. Ultimately, we believe this broader engagement model should result in healthy and more sustainable gamer relationships with our key products.

Our smartphone games revenue reached RMB9.9 billion, up 87% year-on-year and up 3% quarter-on-quarter. We were the #1 ranked publisher in the iOS App Store top grossing chart globally and also #1 publisher in Android app stores inside China. In the third quarter, we published 2 new casual gains and 3 new mid-core games. Our player versus player competitive games and role playing games continues to provide the key metrics. Honor of Kings recently surpassed 40 million daily active users, which we believe is a usage record for mid-core games in China. Our recently launched role-playing games, JX Mobile, Hudong [ph] Mobile and Zero Mobile contributed materially to sequential revenue trends. And we are participating in eSports car chips and mobile games to high-profile tournaments for titles such as Crossfire Mobile and Honor of Kings.

Moving on to online advertising, segment revenue was RMB7.4 billion, up 51% year-on-year and up 14% quarter-on-quarter. Brand advertising revenue was RMB3.1 billion, up 21% year-on-year and up 9% quarter-on-quarter. Revenue grew year-over-year and quarter-on-quarter due to mobile news adds in the Rio Olympics. About 700 million unique visitors part of the Olympic Games in on our news video platforms cementing our position as the online leader in terms of sports related traffic and revenue. Our top 5 brand advertising categories are food and beverage, automobile, online services, personal care and consumer electronics.

Our performance advertising revenue was RMB4.3 billion, up 83% year-on-year and up 18% quarter-on-quarter. Weixin advertising, including Moments and Official Accounts inventories, was the biggest contributor to the year-on-year and quarter-on-quarter growth. In September, we launched neighborhood ads that enabled local merchants to promote their services and products, so the most relevant users within 4,000 business hubs in major cities. The number of Weixin Moments advertisers increased by over 100% quarter-on-quarter.

In response to advertiser demand, we have been shifting some mobile news feed inventory from selling on a cost per time brand model to setting on a cost project performance model. This is how the effect of reducing our brand advertising revenue and increasing our performance advertising revenue during the period.

And now I will pass to John to talk through our financials.

John Lo

Thanks, James. Hello, everyone. For the third quarter of 2016, our total revenue was RMB40.4 billion, up 52% year-on-year or 13% quarter-on-quarter. Gross profit was RMB21.8 billion, up 40% year-on-year or 7% quarter-on-quarter. Share of losses of associates and joint venture was RMB619 million, an increase from RMB292 million in the second quarter. On a non-GAAP basis, share of losses of associates and JV reduced sequentially from RMB206 million to RMB107 million. Income tax expense was RMB2.5 billion, up 57% year-on-year or down 11% quarter-on-quarter. The effective tax rate for the quarter was 18.6%.

Net profit to shareholders was RMB10.6 billion, up 43% year-on-year or down 1% quarter-on-quarter. After adjustment to non-GAAP, operating profit was RMB15 billion, up 43% year-on-year or 2% quarter-on-quarter. Net profit attributable to shareholders was RMB11.7 billion, up 42% year-on-year or 4% quarter-on-quarter.

Let’s turn to segment gross margin. Gross margin for VAS was 65.2%, up 1 percentage point year-on-year, reflecting a revenue mix shift to in-house games. Sequentially, it dipped 1.5 percentage points, reflecting increased content amortization costs relating to premium video subscription businesses and the consolidation of China Music Corporation. Gross margin for online advertising was 36.3%, down 12.6 percentage points year-on-year and 9 percentage points quarter-on-quarter. Increased investments in video content, was the primary reason behind the margin contraction.

Moving on to operating expenses, selling and marketing expense was RMB3.3 billion, up 60% year-on-year or 39% quarter-on-quarter. The year-to-year jump reflected our aggressive marketing efforts to promote mobile ad-free loads to drive mobile payment adoption and to promote our cloud services. Sequentially, marketing expenses for games, mobile news and video services were the main drivers. Total G&A expense was RMB5.9 billion, up 34% year-on-year or 11% quarter-on-quarter. Within which R&D expense was RMB3.2 billion, up 29% year-on-year or 15% quarter-on-quarter. The year-to-year and sequential increase reflected staff costs relating to our organic businesses. We had just over 38,000 permanent employees at quarter end. University recruitment, CMC consolidation and one-off recruitment of some manpower who previously engaged in our customer support work contributed to the sequential increase in headcount. As a percentage of quarterly revenue, selling and marketing expense was 8% and G&A was 15%. R&D represented about 8% of quarterly revenue, while share-based compensation was approximately 3%.

Looking at margin ratios for the third quarter, gross margin was 54%, down 4.6 percentage points year-on-year and 3.3 percentage points quarter-on-quarter. The combined effect of online advertising gross margin decline and bigger contribution from other segments drove year-to-year margin decline. Sequentially pull-through from lower VAS and online advertising gross margin as well as bigger contribution from other segments, were the main reasons.

Non-GAAP operating margin was 37.2%, down 2.3 percentage points year-on-year or 4 percentage points quarter-on-quarter. Non-GAAP net margin was 29.5%, down 2.3 percentage points year-on-year and 2.7 percentage points quarter-on-quarter.

Finally, let me provide a few key financial numbers for your reference. Total CapEx was RMB3.7 billion, up 121% year-on-year or 143% quarter-on-quarter. Operating CapEx was RMB2 billion, up 76% year-on-year and 97% quarter-on-quarter. We purchased more servers and network equipments to support business growth such as cloud-based services. Non-operating CapEx was RMB1.6 billion, up 228% year-on-year and 245% quarter-on-quarter. We added RMB1.2 billion for non-news rights. Free cash flow was RMB14.1 billion, up 113% year-on-year or 45% quarter-on-quarter, reflecting strong cash flow generated from our operations, especially online games during the positive season in the third quarter.

Our net cash position at quarter end was RMB8.4 billion, down 61% year-on-year and 65% quarter-on-quarter. The decline was primary relating to the acquisition of Supercell which we were funding investment with the combination of cash and debts. In July, we made a cash prepayment of $3.7 billion or approximately RMB24.7 billion and subsequently, we recouped approximately $1.2 billion in October, which is approximately RMB8 billion. Fair market value of our listed associates and AFS financial assets amounted to approximately RMB94 billion as at quarter end.

Thank you. We shall now open the floor for questions.

Question-and-Answer Session

Operator

Yes, thank you. [Operator Instructions] Our first question comes from the line of Eddie Leung from Merrill Lynch. Please ask your question.

Eddie Leung

Good evening. Thank you for taking my questions. I have questions on some of your cost items. I am just wondering if you could share more color on the trend of our sales and marketing expenses as well as our headcount going into the future. Particularly, if you are investing more for certain opportunities, what are some of the key areas that you pay extra attention to? And then just a housekeeping question, it will be great if you could update us on, number one, your mobile game pipeline, and number one, the ARPU of different types of games? Thank you.

Pony Ma

Yes. Thanks, Eddie. In terms of sales and marketing, I think we continued to invest pretty heavily in a number of our strategic products. Obviously, the first one is around games, right, because games is our largest business segment and the marketing of games, actually especially sort of new games can generate good ROI if the games of good quality. The sales and marketing pattern is more around sort of the launch of new games. But in certain areas such as sort of new MMOGs, right, there needs to be continued marketing to attract the core users. The other large area of sales and marketing really sort of goes into our payment business as well as our app, mobile app installation, because we now own a large number of high BAU apps. And as a result, we actually sort of continued to market these apps, especially sort of in working with Tencent manufacturers as well as app stores to get these apps distributed to the users. And the other one that I think John mentioned in his prepared remarks is on the cloud business, which we are really opening up a new market segment, which is around enterprises and that’s why we are spending in the marketing expenses. Now, in terms of headcount and our human expenses, I think the overall approach is that we tried to control the number of our people, but we continue to enhance the quality of our overall team as well as we continue to pay competitively in the market and reward our employees when the company is actually sort of achieving great results. So, that’s the overall philosophy.

John Lo

Yes. And also in terms of the headcount perhaps you might view that the increase was so significant this quarter versus last quarter, but as I mentioned before, this is a special quarter, because we have the new fresh graduates. We have the consolidation of China Music as well as collaborating some of our outsourcing functions such as you know our customer support to be handled by our own permanent staff. In relation to the ARPUs, for MMOG, it’s between 310 to 450 advanced casual games was between 85 to 370 and the smartphone games is between 145 to 155.

Eddie Leung

Thank you.

Catherine Chan

Next question please.

Operator

Thank you. Our next question comes from the line of Piyush Mubayi from Goldman Sachs. Please ask your question.

Piyush Mubayi

Thank you. We observed that Supercell games have risen back to the top of the charts, displacing games that were popular a quarter ago. From a Tencent perspective, when and how does Supercell impact the P&L? And also, is there going to be specific strategy you will deploy for Supercell games as and when that get launched in China? And second is related to the tripling in the cloud number that you have reported this quarter. Could you give us a sense of what the numbers are looking like as well as what percentage of the dip in gross margins can be attributable to potentially the cloud business or the payment side? Thank you.

Martin Lau

In terms of Supercell games, well, thanks for your observation. I think, yes, we are very glad to see that the games of Supercell actually returned to the top of the chart. And I think it’s actually consistent with our long-term view of Supercell, which has created very exciting games that actually can be played by people, large number of people for long time. And I think sort of – part of it is also as we continued to exchange knowledge about sort of how to design the commercialization of the games and how to actually sort of attract more people to pay for the games. They have actually sort of achieved better monetization on the games. Now, with respect to the accounting, right, Supercell is going to be accounted for – with a dividend method. So for this year, I don’t think sort of there is going to be any dividend distributed. So, that’s why it’s not going to make meaningful contribution to our earnings for a while.

Now with respect to the cloud business, I think so if you look at the others category, right, you can see sort of the gross margin has improved quite significantly. It’s around sort of 18% now, but we have also talked about the fact that we are investing very heavily in the marketing of the services for both payment and cloud. And there is also sort of a large team of people who are actually working on these products. So, if you can lean the overhead, if you can lean the marketing expenses, I think these expenses are very significant compared to the gross profit. So, that continues our theme around these services, which is we view the payment business, the cloud business as infrastructure businesses services for our overall ecosystem. It’s beneficial for our own services. It’s beneficial for our partners’ services. So, that’s why we are willing to take a very long-term view and to continue to invest in these businesses despite the fact that it may not be profitable for the time being. We felt that they are very beneficial for our ecosystem going forward and can enhance the value of our overall business portfolio. So, that’s sort of the kind of philosophy that we are attaching to these businesses for the time being.

Piyush Mubayi

Thank you, Martin.

Catherine Chan

Thank you. Next question please.

Operator

Thank you. Our next question comes from the line of Alan Hellawell from Deutsche Bank. Please ask the question.

Alan Hellawell

Great, thank you very much. Just a follow-up question on payment, I was wondering if you could offer some more color on the GMV mix between non-monetizing payments and B2C payments and how that mix if I could have shift over time. And if we referenced some of the publicly listed pure-play payments companies which seem to have operating margins in the low 20s. I will take onboard Martin’s comments that this is a strategic part of the company. But how do we think about profitability emerging if we have those mile markers already? And then I would love a little more detail on the quarter-on-quarter decline in advertising margin. And I guess related to that, any color on how the video market is evolving, particularly as if it’s different to original expectations? Thank you.

Martin Lau

Yes. In terms of payments, I think it will be – we can’t sort of give you the exact GMV. But I would say we look at it from both angles, right? We are looking at it from sort of the number of transactions. We do handle sort of hundreds of millions of transactions a day. And out of that, I would say a big proportion of it is actually sort of in the category of social payments, which include wrap package, which also include the transfers among consumers. But at the same time, we are seeing also sort of a significant amount of transactions that are business-oriented and these transactions will include our own sort of transactions, for example, game transactions. It includes a lot of the online merchants transactions, that will include DD and JD [indiscernible] as well as sort of new people who use our platform to top up their cell phone. And then there is an increasing number of transactions which are actually sort of conducted by offline merchants. So you have the KFCs, the McDonald’s and sort of the supermarkets and the convenience stores who are actually sort of now receiving payments through WeChat and QQ Wallet. And at the same time, we are also seeing even smaller merchants, right they can actually send a QR code and get paid and so they can use our face-to-face payments to effect transactions. So I would say, there is a large number, still a sort of predominant number of person-to-person social payment. But in terms of growth rates, the commercial transaction is actually growing faster in terms of growth rate. I think James will talk about our video and the advertising business.

James Mitchell

So for the advertising gross margin, there are positive factors and negative factors in this quarter that the negative factors are more obvious. On the positive side, there is the growth in social performance advertising, which tends to be relatively high gross margin because it’s on our own social properties and thus the rapid growth more recently of our news app advertising, which is also relatively higher margin. On the negative side, there is a specific kind of cost heavy events during the quarter for video, notably, that the Voice of China or Sing China competition and the Olympics. And then there is a more general trend of video content costs increasing extremely rapidly to issue a relatively competitive environment. You asked whether the video environment is evolving as we would have thought or differently from what we would have thought, I think it’s evolving pretty much as we would have thought, but perhaps even more swiftly in terms of the shift from being a primarily advertising funded model toward consumers being willing to pay for subscriptions. And our video team recently disclosed, we have about 20 million people now paying for subscriptions, up from 100 million a couple of years ago. Now that shift overall we think is positive in the long-term, but it does – it’s not without its costs. And one of the costs is that it’s more and more users pay for premium video service. In China, there is a history where once you pay for these premium video services, as well as having access to premium content, such as Western movies or Chinese TV series, you also don’t watch ads. And so the increased take-up of premium video subscriptions has a negative impact on the industry’s total advertising inventory load. So that’s what’s happening in the online video market in terms of competition, margins and the shift from an ad funded to an ad-plus subscription funded promotion.

Pony Ma

Yes. And I think that…

Alan Hellawell

Yes, sorry. I know that – as I recall, I think there was a quintupling in the number of either P4P or WeChat based advertisers in the June quarter over March, could you guys also update us on what kind of growth you have seen in the number of P4P advertisers quarter-on-quarter?

James Mitchell

I think we disclosed the total number of Weixin Moments advertisers more than doubled quarter-on-quarter and that would have been driven primarily by what you referred to as kind of the kind of P4P advertisers.

Alan Hellawell

Thank you.

Pony Ma

Yes. I actually missed sort of answering your question about sort of payment margins. I think what you are seeing in the listed sort of payment companies is, actually sort of operating in the U.S., I suppose and the environment is actually sort of very different. Payment is actually sort of quite new there, quite local practices, also the regulation driven business in the sense that if you look at credit cards in the U.S. you get paid 300 basis points or thereabout, but in China right, your credit cards get paid sort of a fraction of that. And I would say, in China, the situation for online payment is similar in the sense that it’s actually a more competitive market. If we are dealing with sort of new captive business, for example, you have a captive e-commerce business, then the kind of margin is different. But then sort of if the commercial transaction is actually sort of out there competing, by having two large payment platforms, I think sort of the pricing is actually sort of very competitive, marketing is actually competitive. So that’s why I sort of I view that we should be looking at sort of in the medium-term of our payment business as more like an infrastructure business for the entire ecosystem rather than sort of a business that will generate profit.

Alan Hellawell

Understood. Thank you.

Catherine Chan

Thank you, Alan. Next question please.

Operator

Thank you. Our next question comes from the line of Alicia Yap from Citigroup. Please ask your question.

Alicia Yap

Hi, good evening management. Thanks for taking my questions. I have two questions. Number one is related to the overall mobile games industry for the third quarter, so I wanted to get a sense what’s the revenues that you achieved, meeting your internal expectation, was there any seasonal effect for the industry as a whole for the 3Q, is there any lack of new games launched or was that other social activity that might have taken away some of the user time spend and in related to that, for mobile games, if you could share with us some of your user analysis. For example, on average, how many games a single user usually play the same period and if you have data, for example on percentage of gamers who play two to three games, gamers who play maybe only one game and maybe gamers that play more than three games?

James Mitchell

So I think in terms of the mobile game business performance versus our expectations in the industry, we disclosed our mobile game revenue grew of 80% year-on-year, so you can assume that we are fairly happy with 80 something percent year-on-year revenue growth. From a quarter-on-quarter perspective, the trends get bounced around by the timing of specific new games, the timing of monetization events within games and so forth, but we tend to look more longer time periods and have year-on-year comparisons rather than very short time comparisons, because otherwise, we can continue be chasing our tails. In terms of the user analysis, one appealing trend about our mobile game position this year has been that we have seen quite a nice up-tick in the number of people playing our mobile games. It’s measured by DAU, for example. We have well over 100 million daily active users for our mobile games, that amount has increased quite substantially yesterday, so we think that it puts us in a very strong position in the industry, but the shift in revenue is balanced by actually a wider leadership in terms of usage. I think that the sort of median would be that the users would be paying – playing two games or so on a regular basis, although that’s obviously a high degree of discussion around that media.

Alicia Yap

I see, very helpful. My next question is related to payment, I think you mentioned on the press release that you attract that 700,000 merchants to participate on that promotion day in August, just could you elaborate a bit of the background of these merchants, for example, the industry vertical, the size of that business and also maybe, average numbers of payment transaction that they received during that day of the promotions. And in related to that, also noticed, you have gradually introducing various payment scenarios for the Hong Kong retail payment features, so wondering if management could share your strategies and thoughts about expanding your payment service into the overseas markets? Thank you.

Martin Lau

Yes. In terms of the cash less there, I think this is a way for us to raise the awareness among the merchants on getting their customers to use a Weixin payment and the QQ Wallet. And the 700,000 merchants are actually sort of pretty widely distributed sort of across different industries. That includes, as I said, convenience stores and sort of food and beverage outlets and supermarkets, to name a few of those. And I would say the result is actually sort of quite good, despite the fact that we just spent quite a bit of money in terms of subsidizing some of these payments. But what we actually usually look at is how many of the converted users actually sort of continued to use the mobile payment services afterwards, right. And we found that sort of there is a pretty high rate of users, ones adopting this payment solution then sort of continued to use it on ongoing basis. So, we are very pleased with that result. Now, in relate to the Hong Kong expansion, I would say, it’s obviously sort of important long-term strategy for us to serve different markets. I think that the first group of users that we definitely want to serve is actually the people who are traveling, China people who are traveling outside of China, right? They are traveling overseas. We actually want to allow them to be able to pay with Weixin payment and QQ Wallet. And then we will look at expansion into selected local markets, I think on a much more cautious basis. The Hong Kong is a market, which served both purposes, right? One is, there are lot of Mainland Chinese who are traveling to Hong Kong on a continuous basis. And a lot of Hong Kong merchants actually sort of welcome the adoption of coverage of Weixin payment. And at the same time, we have a pretty large user base in Hong Kong for WeChat. And as a result, we would like to be able to serve them with our payment services.

Now having said that, I think sort of the regulatory environment as I said sort of for each one of the markets, right, is actually very different and sort of the practices of financial institutions are actually quite different. So right now, for example, in the Hong Kong, there are only a limited number of banks who can actually allowed us to have the kind of experience in China where you can just bind a banking card to the WeChat and QQ account. And if you actually have to use credit card for the payment, right then a lot of the social payment actually is very difficult, because the transaction cost is actually high. And also sort of the credit card companies do not like to move cash. So, I think Hong Kong will continue to cover our services, but the kind of dynamic is actually quite different from China.

Alicia Yap

Okay, great. Thank you.

Catherine Chan

Thank you, Alicia for your questions. And next question operator, please.

Operator

Sure. Our next question comes from the line of Wendy Huang from Macquarie. Please ask the question.

Wendy Huang

Thank you. So currently you are lumping the payment in cloud revenue together in others. So, can you give us some color which part contributed to the bigger portion of the other revenue? And also the gross margin, 18% you reported for this segment, is this margin expansion more driven by the payment or more driven by the cloud? Related to that, I also noticed that there is a accounting change on your restricted cash, which I believe is related to the around RMB125 billion on your WeChat payment platform. And you mentioned in your press release, this is because some of the operating environment changing the PRC. So, can you maybe share what kind of operating environment change in payment or internet finance space trigger you to make this change? Yes, that’s my first question on the payment account. Thank you.

Pony Ma

Let me answer the question regarding the restricted cash first. I think there has been – from time-to-time, there has been guidance being promulgated by authorities in relation to cash on who are behalf of your customers. And I think during the third quarter, there has been some guidance that talks about that. So, as a result, we make some changes to the customer agreement in terms of the payment business. And as a result the related asset which is the restricted cash as well as the liabilities at the making of balance sheet. Anyway, it hasn’t got any impact on the net asset as a whole, because anyway we have the corresponding liabilities in there beforehand. I think for this we have made clearer that the restricted cash does not belong to us.

Martin Lau

Yes. So, in terms of others, right, payment is the bigger portion. And in terms of the pickup in gross margin, so the payment is also sort of the higher contributor and a part of it is sort of our charge on peoples with growing cash, right, start to really come into full force. And the other one is that as you see sort of when we launch a lot of promotions in terms of cash-free dates and actually induce a lot of transactions on the offline merchants and sort of for those we actually generate revenue as well as some gross profit, but of course, accompanying that is actually sort of an increased amount of marketing expenses.

Wendy Huang

Thank you. My second is…

Martin Lau

Maybe we should leave this to others.

Catherine Chan

Wendy, we will put you back on the queue for the second round of questions, okay?

Wendy Huang

Sure. Thank you.

Martin Lau

Thank you.

Catherine Chan

Yes. Next question, operator please.

Operator

Sure. Our next question comes from the line of John Choi from Daiwa. Please ask the question.

John Choi

Good evening and thanks for taking my question. My question is on your new initiative on the Mini Program, could you guys share with us the latest progress on the beta testing, including the developer’s feedback and when do you expect to launch and how you plan to monetize it? Is this going to be – is it fair to say this is – the major purpose is to increase the user engagement within the Weixin users? And secondly, a follow-on on your content side, content investment, what is the plan for next year on the investment side and how will this further impact your margins on the advertising side? Thank you.

Pony Ma

Yes. On Mini Programs, we are still in the beta testing. There are several hundred developers who are now developing Mini Programs and we are doing the testing. I think sort of in the next version of Weixin, it will support the Mini Program. Now in terms of the feedback, I think we have to see, right, but sort of from a technical perspective, I think the goal for us is actually for Mini Program to provide, to some extent, an upgrade experience from our Official Accounts. Official Accounts, as you look at it, it’s actually sort of a media and content type of a platform, whereas sort of mini programs actually provide much more flexibility for the developers to develop their services, right into the WeChat, the Weixin platform and it will help the service to actually run like a native app with much faster speed and it would actually sort of allow a lot of services which we believe sort of – are hard to induce people to download an app. These are sort a lot of times are infrequently used services, but if you have the Mini Program, the users, when they want to use the program, when they need to use the service, they can actually access the service very quickly. Some of these maybe sort of merchants offline, they can actually promote these Mini Programs and some of the developers maybe sort of online operators, but their services are infrequently used, but if users want to search for their services and then use it immediately, they can actually do that. So, that was the goal of Mini Program and we will have to see, right, how many developers would develop the programs and how would these be received by the users. But what we want to do is actually sort of provide a platform so that more creativity can be put into the Weixin platform.

James Mitchell

In terms of video content costs, I think it will not come as no surprise to you or anyone else that the industry is experiencing very rapid content cost inflation, particularly for certain categories of content such as high-profile TV drama series from both China and Korea. And we have accordingly been expecting modeling for a very sharp increase in our video content costs as we move from 2016 to 2017 and some of that would already be inopportune because of the need to pay for content ahead of screening. The increase in content costs naturally flows through into downward pressure on our video and our online advertising margins structure and the extent of that downward pressure naturally depends on how much we offset via video advertising growth and video subscription revenue growth.

Catherine Chan

Thank you. Next question please.

Operator

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

Alex Yao

Hi, good evening everyone. Thank you for taking the question. I have two questions, one is on gaming side, can you guys discuss where and how will you deploy augmented reality, AR technology to your gaming content and how should we think about the impact from introduction of AR gaming engagement and monetization. And secondly on the performance ads, can you comment on the path load of Moments in the Qzone, we understand that you guys are prioritizing on the harder part of ad infrastructures such as technology distribution, etcetera, what will make you comfortable to release more inventory and when would that be? Thank you.

Pony Ma

In terms of AR, I think sort of it’s actually very early technology, right. So the industry is actually sort of testing them out, both VR and AR, I think sort of we quite some time away from sort of this technology being used in sort of big user games. I think sort of with AR and VR, in particular VR, right, we felt sort of this is more like a deep immersive type of gaming experience. So it would appeal to people sort of who are now that console or PC game players who wants to have sort of how much more immersive experience. Now sort of then we need to have the developers who can develop these games, so I think it’s unlikely in the near future that we will see large DAU games coming in the form of either AR or VR. Now sort of Pokémon Go, you may say, it’s an AR game, but we all think sort of it’s core to the user experience. It’s more like an LBS type of game. So I think that will be sometime to go. Performance ad, maybe James, you want to add something?

James Mitchell

Yes. So as you are aware, we have I think a very moderate ad inventory load on Qzone and even more moderate one ad per day ad inventory load on Weixin Moments. I think our focus is less on increasing that ad load and more on providing better tools, providing better performance measurements and so on, so that we can utilize the existing ad inventory more efficiently. And if you look at the growth in our performance advertising revenue year-to-date, a great deal of it has been driven by us utilizing the existing Weixin Moments, ad inventory increasingly efficiently, particularly by allowing smaller advertisers, small local advertisers to buy more targeted slices of our consumer attention in third and fourth tier cities. So we have plenty of room to increase ad inventory at the right time. If you compare the ad inventory on our properties with those of our peers globally or even if you compare the ad inventory on our social properties with the ad load on news apps in China, there is a very substantial gap, but that’s something we can sort holding reserve for the future and for the present, we are really focused on the tools, the performance measurements and on increasing the number of advertisers who are participating in the performance bidding.

Catherine Chan

Thank you. Operator in the interest of time, we will take the last three questions please.

Operator

Our next question comes from the line of Chi Tsang from HSBC. Please ask your question.

Chi Tsang

Thank you very much. I wanted to ask you a little bit about brand advertising, what do you think the current demand outlook may be for brand advertising for next year and also, I wanted to know if you can add a little bit more color regarding the shift in the news feed revenue from CPT to pay for performance in terms of maybe the magnitude of that shift? Thanks so much.

Pony Ma

So on your second question about the magnitude of the shift, I mean we are quite conscious about what we caught out in the commentary, so you can assume that it was of sufficient magnitude to be felt in order to be called out. I think it reflects some interesting trends. One is the traditionally brand advertisers are increasingly adapting the performance mindset. A second is that the growth of news aggregator services like perhaps headlines [indiscernible] that monetize more aggressively than what we might have done in the past just illustrated that there is very great performance advertiser demands to either put their ads into a sort of a news-driven news feed environments. I think that’s partly because of the nature of smartphone screen versus PC screen. But on the smartphone screen, you are kind of trained to continually scroll, click, scroll, click, scroll, quick, and so that lends itself very well to performance advertising that’s paid on a cost per click basis in a way that it didn’t necessarily lend itself for homepage on the PC. So there has been a fairly substantial shift driven really by advertiser demand as opposed to our supply decisions away from branded toward performance advertising within particularly, our new SAP and also some of our other services. So that’s part of the reason why you have seen the divergence in growth rates between a very fast performance advertising revenue growth on the one hand and decelerating brand advertising revenue growth on the other. In terms of the brand advertising outlook for next year, historically, we don’t have a great deal of visibility until we enter the annual commitment process in December, January. But overall, it’s clearly a relatively weak economic environment and there are specific pockets of additional weakness, whether due to government regulatory policies such as real estate. I think for Tencent, we believe that the pattern of performance advertising growing faster than brand advertising will certainly continue in 2017, while brand advertising will have to grapple with these macro headwinds, as well as specific factors such as advertising inventory moving through branch performance and the trend I mentioned in video of consumers are paying for subscriptions and enable them to skip the brand advertising.

Chi Tsang

Thank you.

Catherine Chan

Thank you. Next question please.

Operator

Thank you. Our next question comes from the line of Evan Zhou from Credit Suisse. Please ask your question.

Evan Zhou

Hi, good evening. Thank you for taking my questions. My question is regarding our core products user engagement, I noticed that there is a slight decline quarter-over-quarter on QQ product and especially on the smart device and you also came down even larger than the overall revenue for QQ. And also, Qzone Q-on-Q and you went down as well, so I was wondering, is there any kind of any seasonality impact or any specific product feature changes that’s making this a move or what do you see as credit overall outlook for our relative speaking, more legacy product lines Q-on-Q? Thank you.

Martin Lau

Yes. I think on other social products, we look at it from two different angles. The first one is actually sort of your overall user base and engagement across our platforms because sort of there are sort of pretty significant number of people who are actually using both QQ and WeChat. And I think for us, as a company, we tend to look at sort whether we are increasing the total number of users using both QQ and WeChat and whether sort of the users are using our platform on a more frequent basis. I think that the answer to both of the two questions is actually yes. Now the second perspective that we looked at is actually sort of are we covering the different segments of our people with some kind of dedicated and specialized products. And I think if you look at the user base where sort of people use either QQ or WeChat, right, I would say, QQ now is actually increasingly popular among the young cohorts, the young users and obviously, QQ continues to be sort of very strong with users who are using sort of new office workers, right, when they are in office, right, when they are sitting right next to a computer, when they need to send their large files and communicate with other users, other workers, co-workers sort of QQ is the preferred product. So, with these two group of users, I think sort of QQ’s engagement is still very high. In particular, with respect to the young users, it’s actually sort of increasing the adopted by the young users at younger age. So, I think overall we are actually pretty happy to see that overall portfolio is actually engaging with more users with higher frequency engagement and at the same time, each product is actually sort of pretty successful in covering the differentiated user base as well.

Evan Zhou

Thanks, Martin.

Catherine Chan

Thank you, operator. We shall take the last question please.

Operator

Thank you. Our last question comes from the line of Natalie Wu from CICC. Please ask the question.

Natalie Wu

Hi, thank you for taking my questions. Just a quick question, what’s the split of brand ads from a performance based ad format in terms of mobile use revenue and what’s the current revenue split among [indiscernible]? Thank you.

Pony Ma

Well, right now, the revenue on the news side is actually predominantly Tencent news. Tencent Koudai is actually relatively new product. We actually sort of want to focus on improving the user experience. So, that’s why sort of as you look into the app, right, the ad load is actually relatively small. I think there is a potential to have sort of meaningful ad load on Tencent Koudai going forward, but sort of for the time being, I think we will be much more focused on the user experience.

James Mitchell

Natalie, sorry, I didn’t catch the first part of your question.

Natalie Wu

Yes, I think that for your mobile news revenue, you just split that into like brand advertising and performance based advertising, right. So, I just want to get some color about the split, see every light $100 you get from your mobile user, how many will you – how much will you be recognized into the brand advertising, and how much revenue…

James Mitchell

Roughly, I mean it’s been changing very quickly. As of Q3, it was roughly two-thirds brand, one-third performance, but the mix has been – if you go back 1.5 year ago, it would have been 90% brand, 95% brand. So, it’s influx. For the reasons I mentioned that the overall industry is changing. The advent of new news aggregator services have driven performance advertising very aggressively monetize very high rates and sort of unlock the door to performance advertisers being willing to advertise in much more news-driven newsfeed environment.

Natalie Wu

Understood. Thank you.

Catherine Chan

Okay. Thank you very much for your questions and thank you operator. We are closing the call now. If you wish to check our press release and all the financial information, please visit our company website at www.tencent.com/ir. A replay of this webcast will also be available soon. Thank you and see you next quarter.

Operator

That does conclude our conference for today. Thank you for participating Tencent Holdings Limited 2016 third quarter results announcement conference call. You may all disconnect now.

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