How South Africa’s Naspers is making money from Chinese gamers

tencent headquarters

Undoubtedly, the single largest driver of the Naspers share price over the last few years is its 34% holding in Tencent.

The share price is up a phenomenal 548% in the last 5 years while the Tencent share price (in rands) is up 587%. Currently, Tencent derives over half of its revenue from the sale of games, commonly referred to as “gaming”. The world of gaming is constantly evolving and understanding how Tencent not only extracts revenue from the industry, but also how the company is positioned to continue benefiting from industry disruptions, is key to understanding this important earnings driver.

Gaming, as a branch of entertainment, has evolved over time and more recently at an accelerating pace. Starting back in the early 70s with arcade games in your nearest café, then moving onto “TV” games or console games in the early 80s. Shortly after the introduction of console games and with the increasing affordability of home computers, gamers started linking their computers to play multi-network games – arguably the advent of social networking. The internet opened up a whole new interactive gaming experience with an almost unlimited amount of players able to compete and interact on a social platform. Over the last five years, mobile gaming (games played on smartphones and tablets) has taken the world by storm. Recently however, virtual reality hardware and games, where the player wears a headset that allows him to have a 360 degree visual experience, have been released which could further disrupt the ‘traditional’ gaming fraternity over the next decade.

To truly understand how smartphones and tablets have transformed the gaming industry, it is imperative to delve into the demographic trends. A study from the Entertainment Software Association indicated that the average gamer is 35 years old, with a split of 56% male and 44% female. While a recent study by Reality Mine indicated that the age group 16-24 represented a meagre 14.2% of mobile gamers while the age group 45 and older made up almost 33% – trashing the traditional notion that gaming is predominantly a teen phenomenon. Globally, mobile gaming has resulted in an increased population of gamers with a staggering 1.1 billion people playing mobile games – five times the size of the traditional video games population.

Source: RMB Morgan Stanley

Source: RMB Morgan Stanley

Simplistically, there are three ways to generate revenue from the gaming Industry. Firstly, revenue can be generated from the hardware sold to play the game: Sony Playstation for example. Revenue can also be generated from developing the game itself like EA’s popular FIFA 2015 game. Lastly and specifically relevant for mobile gaming, is the significant revenue generation from the distribution platform for games. It is interesting to note in the graphic above that both industry giants, Apple (sixth place) and Google (seventh) have attained their gaming revenue market share from being the distribution platform (Apple’s App Store and Google’s Play Store) where games are purchased and downloaded. These distribution platforms earn on average between 20-30% of the revenue made from the game.

Understanding how Tencent generates its revenue in gaming sheds much light on their industry dominance. Tencent has not entered the traditional gaming hardware market (eg. Microsoft X-Box or Sony Playstation). Instead, their gaming revenue has traditionally been made from a software gaming development division and personal computer platform. Tencent has developed some of the most popular game titles in China and has an aspiration to not only become a relevant developer of games in China but globally as well. This is done through their complete ownership of Riot Games (the developer of League of Legends) and minority holding of Activison Blizzard Inc (fourth place). Activision Blizzard Inc, the developers of block buster games such as Call of Duty and Warcraft has also recently acquired King (tenth place). Gaming development, however, is only part of Tencent’s gaming revenue generation.

Mobile gaming and Tencent’s distribution platform WeChat, is at the forefront of Tencent’s gaming revenue evolution and scale. In China, WeChat (similar to Facebook’s WhatsApp but with more functionality) is the platform used to access the majority of mobile applications including games – the equivalent of the Apple App Store or Google Play Store. As an example of how relevant the distribution platform for games is, look no further than Apple where their App Store gets 74% of its revenue from gaming sales.

Due to Tencent’s gaming development expertise, together with their dominance in distributing games to the Chinese market, global game titles are queuing to partner with Tencent to access the Chinese gamer. Tencent “localises” the global title, changing the language and also making sure the overall feel remains relevant to a Chinese gamer and then helps distribute the title to their 697 million WeChat users. As the partner for development, developing its own games and being the platform used to buy the games, it is estimated that Tencent receives between 60-80% of all mobile gaming revenue in China.

Tencent is primed to continue its market share dominance of gaming revenue as gaming increases its share within the entertainment category together with an exploding mobile gaming population. As a result, gaming should remain a key driver of their continued growth over the medium term. Bear in mind that gaming revenue is not Tencent’s only growth driver. The company also plans on aggressively increasing revenues from on-line advertising and with their dominant mobile platform position, also growing their e-commerce offering of both goods and services. The read through for Naspers is positive and continues to warrant our favourable stance on the share.

This article was originally published by Ashburton Investments.