How Much Money Is Tencent Really Making From Games?

Tencent reported its third quarter results this week, surpassing analyst expectations. It is hardly news that Tencent is going from strength to strength in terms of its games-related revenues. However, the way it reports financials still underestimates just how important games are to its money-making efforts.

Tencent’s most important revenue segment, value added services (VAS), reached RMB 42.1 billion accounting for 65% of its total revenue in Q3 2017. VAS consists of two key revenue components: Online Games (RMB 26.8 billion) and Social Networks (RMB 15.3 billion). Tencent’s results state that Social Networks grew faster (56%) than its online games segment (48%).

While this intuitively suggest a healthy growth in both segments, a closer examination reveals that the social networks revenue and its growth is in fact significantly subsidised by Tencent’s games-related revenues. And this can be attributed to Tencent’s distribution of its smartphone games revenue (RMB18.2 billion) within its financials. Even though the names of the revenue segments (Online Games and Social Network) intuitively suggest that one is a games-related segment and the other is not, it is not the case in reality. A portion of Tencent’s Smartphone Games revenue is booked under Online Games, while the remainder is tallied under Social Network revenues. This was confirmed by Tencent’s IR in Q1 2017.

So how big of a role does games revenue really play in Tencent’s Social Networks revenue segment? In short, approximately RMB 6.1 billion, or a significant 40% of the Social Network revenue segment.

Although Tencent doesn’t break this down, we are able to get to the number with just a few simple calculations.

Tencents reported that Smartphone games revenue was RMB 18.2 billion. It also reported that PC client games revenue (all of which is under Online Games) was 14.6 billion. The remaining PC Web and Console Games segment is negligible (estimated RMB 0.1 billion or so). Putting them together (18.2+14.6+0.1=32.9) exceeds the reported Online Games revenue (RMB 26.8 billion) by RMB 6.1 billion. This is the portion booked under the Social Networks revenue line.

So, 40% of Tencent’s revenue reported under Social Networks in fact comprises of games income.

Secondly, though Social Networks revenue was reported to have grown faster than Online Games, the pace is significantly helped by the games revenue component within it:

Social networks grew 56% to RMB 15.28 billion, i.e. approximately RMB 5.49 billion was added. However, Smartphone Games (approximately a third of which is booked under Social Networks) grew by 84% to RMB 18.2 billion, meaning RMB 8.3 billion was added. We now know that approximately 33.5% of Smartphone Games revenue is booked under Social Networks, so approximately RMB 2.8 billion of the growth in Smartphone Games was added to the Social Networks revenue line. This is more than half of the whole social network growth. Without it, Tencent’s social network would show an increase of just RMB 2.7 billion, instead of the reported RMB 5.49 billion.

From this, we can deduce that Tencent is trying to make its revenue mix look less dependent on games than it really is and, or, that it wants to show stronger growth in its social network segment. Doing so is a favourable narrative to Wall Street, and consequently Tencent’s stock price. It allows Tencent to be analysed through a tech company lens, rather than a games company lens, where volatile factors like games reviews and launches can play a large role in analyst attitudes towards the company.

Of course, Tencent has built a robust ecosystem using synergies of games, social networks, digital item sales and advertising, but in its VAS revenue terms, it is a gaming company more than anything else. Here is how much money Tencent really made from gaming in VAS:

As a final note, bear in mind that Supercell’s revenue, which is likely in excess of RMB 3.8 billion is not included in Tencent’s revenue lines. Rather Supercell’s performance is included under dividend income in ‘Other Gains’, due to the fact that the acquisition was made via a consortium controlled by Tencent, rather than Tencent itself. Therefore, officially, Supercell is not a 100% subsidiary of Tencent, which means Tencent does not have the obligation to include Supercell revenues in its financial statements.