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

Nov. 16, 2016 12:35 PM ETTencent Holdings Limited (TCEHY)
SA Transcripts profile picture
SA Transcripts
132.62K Followers

Tencent Holding Ltd. ADR (OTCPK:TCEHY) Q3 2016 Earnings Conference Call November 16, 2016 7:00 AM ET

Executives

Catherine Chan - IR

Pony Ma - Chairman & CEO

Martin Lau - President

James Mitchell - Chief Strategy Officer

John Lo - CFO

Analysts

Eddie Leung - Merrill

Piyush Mubayi - Goldman Sachs

Alan Hellawell - Deutsche Bank

Alicia Yap - Citigroup

Wendy Huang - Macquarie

John Choi - Daiwa

Alex Yao - JP Morgan

Chi Tsang - HSBC

Evan Zhou - Credit Suisse

Natalie Wu - CICC

Operator

Thank you for standing by and welcome to Tencent Holdings Limited 2016 Third Quarter Results Announcement Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [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 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 conditions 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 on business review; and John will go through the financials before we take your questions.

I'll now turn the call over to Pony. Thank you.

Pony Ma

Thank you, Catherine. Good evening and thank you for joining us. In the third quarter of strong financial performance for our core businesses. In particular, our smartphone games and social performance advertising businesses, we parted across industry with new gross rate and continue to have healthy margins. Four key infrastructure patents supporting our ecosystem, specifically payment and cloud services, we saw significant progress in adoption and usage. We will continue to make investment in these strategic areas. Get me give you the headline numbers and to 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 locked in their smart devices. Combined 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 to expand use of bases. Our PC client games’ sustained leadership in several genres, retaining many loyal gamers who 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 the China Music Corporation. We believe the combined company can help shift China Digital Music ecosystem to more sustainable business models. In mobile utilities, our mobile security service continued its momentum. Our mobile browser partnered with 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.

And now I invite Martin to discuss strategy highlights.

Martin Lau

Thank you, Pony, and good morning, good evening to everybody. Tencent not only conduct businesses but also invest heavily into developing technologies that may not generate revenue directly but are important for our ecosystems. One of the technologies is our security technology. In the course of the past few years, we have made 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 vulnerability discovery contest this year, winning the number one title in Pwn2Own. Several months ago, engineers in our Keen Security Lab in the efforts to enhance security for Internet enabled cars had discovered vulnerabilities that conceded direct manipulation of Tesla's control system and that was a very significant event in the entire industry.

Follow international standards’ practices, we shared our findings with Tesla who implemented the patency immediately. We continue to be a leader in fundamental security technologies such as scanning viruses, releasing memory as well as boosting speed of handsets. We are also the leader in anti-fraud technology for smartphones; we own the most adopted detection systems for Sony PlayStations. We also own the largest database of fraud phone numbers and industry leading protection 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 infrastructural service with an ecosystem of our own applications as well as our partner services. The Tencent apps will protect user ID, passwords, personal information and virtual property. Our security app mobile manager will 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 capabilities help to detect fraudulent web pages and phone calls. For online finance, the security technology is in particularly important because it allowed us to provide users a save 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 higher value financial transactions on their smartphones. For our partners, we integrate our security capabilities into our cloud services to protect enterprise ID systems, defend against DDoS attacks and safeguard their products and services. For developers, we help 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’ll pass to James to talk about our business review.

James Mitchell

Thank you, Martin. In the third quarter of 201, 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 product. In the third quarter, 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 with strong performance in key PC titles contributed to the year-on-year revenue growth. Sequentially, PC games benefited from positive seasonality. Some of our big smartphone game such as Honor of Kings and JX Mobile delivered strong operating performances as well. Turning to social networks, for QQ, we added creative and fun features to enlighten patent community experiences. Specifically, we launched cmShow, a mobile QQ product 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 augmented reality torch relay campaigns for the Rio Olympics games and over 100 million mobile QQ users participated in the 22-day event.

For Weixin, we beta tested a new function called mini programs, users would enjoy a native app like experience conveniently without needing to leave the Weixin interface, consequently they can reduce their phone 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 seven times here year-on-year to almost 700,000. In September, we added Weixin Checkout, a feature that helps merchant simply 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 still manages to manage billing activities efficiently.

Booking of 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 users accounts for advanced casual games were down 18% year-on-year and average concurrent users accounts for [indiscernible] online games were down 11% year-on-year. To 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 FIFA Online in which they also made high engagement competitive sessions with low intensity practice, review and game related chat sessions. Consistent with this migration in behavior, we’re shifting our engagement focus away from maximizing user time to spent in-games and somewhat broadening overall user engagement by game-related activities such as eSports and tournaments, video streams of popular gamers and game specific interest stripes within QQ and Weixin.

This shift in focus results in users spending less time passively sitting inside the game, which naturally translates into fewer average concurrent users since the average concurrent user metric measures total active users multiplied by average time spent in get client per user. However, the shift is not necessarily reducing user engagement with our games or willingness to spend money on game items. And our PC game revenue increased despite the decline in average concurrent users. Ultimately, we believe this broader engagement model should result in healthier 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 number one ranked publisher in the iOS app store top grossing chart globally and also number one publisher in Android app stores inside China. In the third quarter, we published two new casual games and mid-core games. Our player versus player competitive games and role-playing games continued to drive key metrics. Honor of Kings the 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 such as [indiscernible] contributed materially to sequential revenue trends. And we’re participating in eSports [indiscernible] mobile games through high profile tournaments for titles such as CrossFire mobile and Honor of Kings.

Moving onto 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-on-year and quarter-on-quarter due to mobile newsfeed ads and the Rio Olympics. About 700 million unique visitors followed the Olympic Games in our news and video platforms, cementing our position as the online leader in terms of sports related traffic and revenue. Our top five brand advertise categories were food and beverage, automobile, online services, personal care and consumer electronics. Performance advertising revenue was RMB4.3 billion, up 83% year-on-year and up 18% quarter-on-quarter. Weixin advertising including Moments and efficient accounts inventories was the biggest contributor to the year-on-year and quarter-on-quarter growth.

In September, we launched neighborhood apps that enabled local merchants to promote their services and products to the most relevant users within 4,000 business hubs in major cities. A number of Weixin Moments advertisers increased by over 100% quarter-on-quarter. In response to advertiser demand, we’ve been shifting some mobile newsfeed inventory from setting on a cost per time brand model to setting on a cost project performance model. This had the effect of reducing our brand advertising revenue and increasing advertising revenue during the period.

And now I’ll 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 and increased from RMB292 million in the second quarter. On a non-GAAP basis share of losses of associates and JV reduced sequentially from RMB206 billion to RMB107 million. Income tax expense was RMB2.5 billion, up 57% year-on-year or down 11% quarter-on-quarter. 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 adjustments to non-GAAP, operating profit was RMB15 [ph] 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 revenue mix shift to in-house games. Sequentially, it dipped 1.5 percentage points reflecting increased content amortization costs relating to our premium video subscription businesses and the consolidation of China Music Corporation. Gross margin for online advertising was 6.3%, down 12.6 percentage points year-on-year and 9 percentage points quarter-on-quarter, increased investment in video content was the primary reason behind the margin contraction.

Moving onto 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 grow mobile apps preloads to drive mobile payment adoption and to promo across 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 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 outsourced 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 shared-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 declined and bigger contribution from others segment 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 where 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 you 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 crowd-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 land used 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 on engaged 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 primarily relating to the acquisition of Supercell which we were funding investment with a combination of cash and debts. In July, we made a cash pre-payment of US$3.7 billion or approximately RMB24.7 billion and subsequently we recouped approximately US$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 of quarter-end. Thank you.

We shall now open the floor for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Eddie Leung from Merrill. Please ask your question.

Eddie Leung

I have a question on some of your cost items. Just wondering if you could share more color on the trend of our sales and marketing expenses as well as headcounts 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, would be great if you could update us on, number one, your mobile game pipeline and number two, the ARPU of different types of games. Thank you.

Pony Ma

Thanks Eddie. In terms of sales and marketing, I think certainly we continue to invest pretty heavily in a number of 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 are 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 MMORPGs there needs to be sort of 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 DAU apps and as a result we actually sort of continued to market these apps especially sort of in working with handset 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're spending in the marketing expenses.

Now in terms of headcounts and our human expenses, I think sort of 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 competitors notably 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

And also in terms of the headcounts, perhaps you might view that 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 consolation of China Music as well as converting some of our outsourcing functions such as our customer support to be handled by our own, permanent staff. In relation to the ARPUs, for MMOG, it’s between 310 to 450 of unscheduled games was between 85 to 370, and the smartphone games is between 145 to 155.

Catherine Chan

Next question please.

Operator

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

Piyush Mubayi

Thank you. We observe the 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 if there are going to be a specific strategy you'll deploy for Supercell games as and when they get launched in China. And second is related to the tripling in the cloud number that you've 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 sort of have been created very exciting games that actually can be played by people large number of people for a long time. And I think part of it is also as we continue to exchange knowledge about 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 the dividend method, so for this year, I don't think 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, if you look at the others category, you can see sort of the gross margin has improved quite significantly, it’s around 18% now. But sort of we have also talked about the fact that we are investing very heavy in the marketing of the services for both payment and cloud and there's also sort of a large team of people who are actually working on these products. So if you count in the overhead, if you count in the marketing expenses, I think sort of 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 infrastructural businesses services for our overall ecosystem. It’s beneficial for our own services, it's beneficial for our partners or services so that's why we're willing to take a very long-term view and to continue to invest in this business is 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.

Catherine Chan

Thank you. Our 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

Just a follow-up question on payments, was wondering if you could offer some more color on the GMB mix between non-monetizing payments and B2C payments and that mixes like to shift over time. And if we reference some of the publicly listed pure-play payment companies which seem to have operating margin is the low 20s, I'll take on board, Martin commented 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 would love a little more detail on the quarter-on-quarter decline in advertising margins and I guess related to that any color on how the video market is evolving particularly if it's different to original expectations. Thank you.

Martin Lau

In terms of payments, I think sort of it will - we can sort of give you the exact GMV, but I would say we look at it from both angles, we’re 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 that package which also include the transfers among consumers. But at the same time we're seeing also sort of a significant amount of transactions that our business oriented and these transactions include our own transactions. For example, game transactions, it includes a lot of online merchants, transactions that we include [indiscernible] as well as sort of people who use a platform to top up their cell phone.

And then there's an increasing number of transactions which are actually sort of conducted by offline merchants. So, you have to KFCs and McDonalds and sort of the supermarket and the convenience stores who are actually sort of now receiving payment through WeChat and QQ Wallet. And at same time we're also seeing even smaller merchant [indiscernible] use our face to face payments to effect transactions. So I would say, there is a large number, still sort of predominant number of person to person social payments, but in terms of growth rates, the commercial transactions are actually growing faster in terms of growth rate. I think James will talk about our video and advertising business.

James Mitchell

So for the advertising gross margin, there are positive factors and negative factors. In this quarter, the negative factors are obvious. On the positive side, there is growth in social performance advertising, which tends to be relatively high gross margin, because it’s on our social properties and that’s rapid growth more recently of news advertising, which is also relatively higher margin. On the negative side, there is specific kind of cost heavy events during the quarter for video, notably 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, due to 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 [ph] 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.

So, any one of the costs is that it’s more and more uses pay for the premium video service in China. That's 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 markets in terms of competition, margins and the shift from an ad funded to an ad plus subscription funded.

Alan Hellawell

Yeah. 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’ve seen in the number of P4P advertisers quarter-on-quarter?

Pony Ma

I think we disclosed the total number of Weixin Moments advertised has more than doubled quarter-on-quarter and that would have been driven primarily by what your approach was, the kind of the P4P advertisings.

John Lo

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

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 wanted to get a sense of what 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 launch or what's that, other social activity, that might have taken away some of the user time spent? And 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 during 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?

Pony Ma

So, I think in terms of the mobile game business performance versus our expectations in the industry, we disclosed our mobile game revenue grew over 80% year-on-year. So you can assume that we're very 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 for a longer time period, year-on-year comparisons rather very short term comparisons, because otherwise, [indiscernible]

In terms of the user analysis, one appealing trend about our mobile game position this year has been that we've seen quite a nice uptick 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 of our mobile games and that number has increased quite substantially year-to-date. So we think that puts us in a very strong position in the industry, our leadership 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 playing two games or so on a regular basis. So that’s obviously a very high degree of discussion around that median.

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 their business and also maybe average numbers of payment transaction that they received during that day of that promotions? And related to that, also noticed you are gradually introducing various payment scenarios for the Hong Kong retail payment feature. So wondered if management could share your strategies and thoughts about expanding your payment service into the overseas markets? Thank you.

John Lo

Yes. In terms of the cash less, I think this is a sort of way for us to raise the awareness among the merchants on getting their customers to use ways in payment and QQ Wallet and the 700,000 merchants are actually sort of pretty widely distributed across different industries that include, as I said, convenience stores and 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 did spend 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 continue to use the mobile payment services afterwards, right, and we found that there's a pretty high rate of users, ones adopting this payment solution, then sort of continue to use it on an ongoing basis. So we are very pleased with that result.

Now in relation to the Hong Kong expansion, I would say it's obviously important long-term strategy for us to serve different markets. I think 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. When they're traveling overseas, we actually want to allow them to be able to pay with Weixin payment and QQ Wallet and then, we would look at expansion into selected local markets I think on a much more cautious basis. The Hong Kong is a market which serves both purposes, right. One is there are a 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 a 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 the regulatory and as I said, for each one of the markets is actually very different and the practices of financial institutions are actually quite different. So right now, for example, in Hong Kong, there are only a limited number of banks who have actually allowed us to have the kind of experience in China where you can just bind and 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 the credit card companies do not like to move cash. So, I think, Hong Kong, we’ll continue to cover our services, but the kind of dynamics is actually quite different from China.

Operator

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 and 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 the segment, is this margin expansion more driven by payment or more driven by the cloud. Related to that, I also noticed that there is accounting change on your restricted cash, which I believe is related to the RMB125 billion on your WeChat payment platform and you mentioned in your press release, this is because some of the operating environment change in 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 payment and cloud. Thank you.

Martin Lau

Let me answer the question regarding the restricted cash first. I think that's been, from time to time, there has been guidance, being [indiscernible] behalf of your customers and I think during the third quarter, there have been some guidance and talks about that. So as a result, we made 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 have been made off balance sheet. Anyway, it hasn't got any impact on the net asset as a whole because anyway, we have the corresponding liability in there beforehand. I think for this, we have made clear that the restricted cash does not belong to us.

James Mitchell

Yes So in terms of others, right, payment is the bigger portion and in terms of the pickup in gross margins, payment is also sort of the higher contributor and part of it is our charge on people withdrawing cash, right, if it starts to really come into full force and the other one is that as you see when we launch a lot of promotions in terms of cash free days and actually induce a lot of transactions on the offline merchants and with those, we actually generate revenue as well as some gross profit. But of course, a company don’t actually sort of an increased amount of marketing expenses.

Maybe we should leave this to other.

Catherine Chan

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

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. A 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 developers’ feedback and when you expect to launch and how you plan to monetize it? Is this going to be able - is it fair to say the major purpose is to increase the user engagement within the Weixin users.

Ad secondly a follow-on on your content side and content investment, what is the path for next year on the investment side and how will this further impact your margins on the advertising side? Thank you.

John Lo

Yeah. Our mini programs, we're still in the beta testing. There are several hundred developers who are now developing mini programs and we're doing the testing. I think in the next version of the Weixin, it will support the mini program. Now in terms of the feedback, I think we have to see, right, but from a technical perspective, the goal for us is actually for mini program to provide to some extent and upgrade experience from our official accounts. Official accounts is looking at - it’s actually a media and content type of platform. Whereas mini programs actually provide much more flexibility for the developers to develop their services, right, into the WeChat, the Weixin platform.

And it would 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 are hard to induce people to download an app, these are a lot of times 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. 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'll 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 provide a platform so that [Technical Difficulty] Weixin platform.

James Mitchell

In terms of video content costs, I think you will note the comments no surprise to you or anyone else that the industry is experiencing a very rapid cost inflation, particularly for certain categories of content such as high profile TV drama series from both China and Korea. And we’ve 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 locked in because of the need to pay for content ahead of screening. The increase in content costs naturally flows through into downward pressure on video and our online advertising margin structure. And the extent of that downward pressure naturally depends on how much will be offset via video advertising growth and video subscription revenue growth.

Operator

Thank you. Our next question comes from the line of Alex Yao from JP Morgan. 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 the introduction of AR gaming engagement and monetization.

And secondly is on the performance apps, can you comment on the ad load of moments in the Qzone, we understand that you guys are prioritizing on the harder part of, as the infrastructure such as technology distribution, et cetera. What will make you comfortable to release more inventory and where would that be? Thank you.

Pony Ma

In terms of AR, I think it's actually very early technology, right. So the industry is actually testing it out, both VR and AR. I think we're quite some time away from this technology being used in user games. I think with AR and in particular VR, right, we felt this is more like a deep immersive type of gaming experience. So it would appeal to people who are now the console or PC game players who want to have a much more immersive experience. Now 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 new games coming in the form of AR or VR. Now, Pokemon Go, you may say, it’s an AR game, but we don’t think it’s call to the user experience, it’s more like an LBS type of game. So I think that will be sometime to go.

Performance ads, maybe James you want to talk about.

James Mitchell

Yes. So, as you’re aware, we have I think a very moderate ad inventory load on Qzone and an 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, more local advertisers to buy more targeted license of 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, that's a very substantial one. But that's something we can holding this up for the future and for the present. We're really focused on the tools, the performance measurements and on increasing the roll 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

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

Chi Tsang

Great. Thank you very much. I wanted to ask you a little bit about some brand advertising. What do you think the current demand outlook might 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 newsfeed revenue from CPT to pay for performance in terms of maybe the magnitude of that shift? Thanks so much.

John Lo

So on your second question about the magnitude of the shift, we’re quite conscious about what we call it out in the commentary. So you can assume that it was of sufficient magnitude that we felt it ought to be caught out. I think it reflects some interesting trends. One is that traditionally brand advertisers are increasingly adopting a performance mindset. Second is that the growth of these aggregator services that perhaps a headline today, monetize more aggressively than we might have done in the past. It illustrated that there is very great performance advertiser demand to put their ads in to a news driven news feed environment. I think that's partly because of the nature of smartphone screen versus PC screen.

But on the smartphone screen, you’ll have train to continually scroll, click, scroll, click, and so that lends itself very well to in performance advertising that's paid on a cost per click basis in a way that didn't necessarily lend itself on the PC. So there has been a fairly substantial shift driven really by advertiser demand as opposed to our supply decisions away from branding towards performance advertising within particularly news app and also some around the services. So that's part of the reason why you’ve seen the divergence in growth rates between 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 year to 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 relative to government regulatory policies such as real estate. I think for Tencent, we believe that the pattern of performance advertising grown 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 from branch performance and the train dimension in video of consumers paying for subscriptions and then it may enable them skip the brand advertising.

Operator

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

Evan Zhou

Hi. Good evening. Thank you for taking my questions. My question is guarding our core product user engagement. I noticed that there's a slight decline quarter-on-quarter on our QQ product and especially on the smart device, NAU also came down larger than the overall for QQ. And also Qzone Q-on-Q NAU went down as well. So I was wondering, is there any kind of seasonality impact or any specific product feature changes that’s making this move or what do you see as kind of the overall outlook for our relatively more legacy product lines as for Q2 and Q4?

John Lo

Yeah. I think on the social products side, we look at it from two different angles. The first one is actually sort of overall user base engagement across our platforms, because there are 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 of whether we are increasing the total number of users using both QQ and WeChat and whether the users are using our platform on a more frequent basis. I think so the answer to both of the two questions is actually yes.

Now, the second perspective that we looked at is actually, are we covering the different segments of people with some kind of dedicated and specialized products and I think if you look at the user base, where people use either QQ or WeChat, right, I would say, QQ now is actually increasingly popular among the young cohorts and the young users and obviously QQ continues to be very strong with users who are office workers, when they’re in office, when they are sitting right next to a computer, when they need to send very large files and communicate with other users, other workers, co-workers and QQ is the preferred product. So with these two group of users, I think QQ’s engagement is still very high, particularly with respect to the young users.

It’s actually increasing the adopted by the young users at the younger age. So I think overall, we're actually pretty happy to see the overall portfolio is actually engaging with more users with higher frequency of engagement and at the same time, each product is actually pretty successful in covering the differentiated user base as well.

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 question. Just quick question, what’s the split of brand ad and 4 million performance based ad in the mobile news revenue and what the current revenue split among Tencent News app and [indiscernible]. Thank you.

John Lo

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

Pony Ma

Natie, so I didn’t catch the first part of your question.

Natalie Wu

Yes. I think that for your mobile news ad revenue, you just split that into like brand advertising and performance based advertising, right. So just want to get some color about the split, say every line, dollar you get from your mobile user, how much will you be recognizing into the brand and how much?

Pony Ma

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 a year-and-a-half ago, it would have been 90% brand, 95% brand. So it’s in flux for the reasons I mentioned that the overall industry is changing. News aggregator services have driven performance advertising very aggressively, monetized very high rates, sort of unlocked the doors to performance advertisers being willing to advertise much more in a news driven newsfeed environment.

Catherine Chan

Okay. Thank you very much for your questions and thank you, operator. We're closing the call now. If you wish to check our press releases and other 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 in Tencent Holdings Limited 2016 third quarter results announcement conference call. You may all disconnect now.

Recommended For You

Comments

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.