Tencent's path forward
Everyone knows Tencent.
From social media, to digital payments, to esports, to even being a shareholder in Tesla, Tencent is a behemoth of a business. The history of the company is well known and covering it in real depth is beyond the scope of this short thought piece, but in order to understand the future we need to understand the past.
A quick history of Tencent
An abridged version of Tencent’s recent experience as a listed equity instrument goes something like this:
As China rapidly digitised over the past decade, thanks as always to policy from the very top, 2 companies rose above all others – Alibaba and Tencent. In the beginning they each carved out their own more specialised dominions, with Alibaba taking ecommerce and Tencent taking social media and gaming. And for the first stage of accelerated Chinese internet adoption, they largely left each other alone as the gift of the Chinese consumer just kept on giving.
The race for space
These two “national champions” first began to butt heads towards the middle of the last decade, as China reached a point where finance and payments were ready to go digital. This was the real prize and it loomed large in the eyes of the two contenders. It was also around this time that close observers noticed the government becoming more directly involved. This was no coincidence, as for the state to allow “private” companies to wield such power over the payment rails of the nation would be unthinkable.
From that moment, Alibaba (Alipay) and Tencent (Wepay) went at each other in a colossal battle for control of the consumer wallet. The distinction between digital and physical quickly became blurred (see Alibaba’s new retail concept, Hema aka Freshippo) and a race for space began as the two giants acquired shopping malls, clothing retail, food retailers and everything from panelbeaters to sports retailers. The key objective of this race for space was to onboard as many customers as possible to their incumbent digital wallets in order to build scale in the most lucrative of all opportunities: financial services.
A fall from grace
This battle, which had intensified over the past 5 years or so, resulted in many bruises and broken limbs (read additional costs and many inefficient investments which even now continue to weigh on earnings). In essence it was, and still is, a clash between the two best fighters in the world’s most gladiatorial competitive arena, one in which there are no rules. That said, this battle was only one of the reasons why Tencent fell from grace in the eyes of equity investors worldwide.
The other reasons, with hindsight, are even more instructive.
Coming into 2018, Tencent had a series of decade-long tailwinds which were reflected in their earnings, valuation and, correspondingly, a frenzied upward move in its share price that peaked in January 2018.
The takedown came firstly from the state itself.
Apart from having to deal with combat with Alibaba in the payments space, Tencent also saw the Chinese government place a moratorium on monetising new gaming title releases in late 2017, seemingly as superstar games (largely distributed by Tencent) such as PUBG and League of Legends (at the time) were too popular - almost addictive. This dealt a major blow to a company who’s earnings momentum was chiefly driven by gaming - particularly, in-game spend.
In another negative development, the government also placed limits on the gaming time allowed for young adults and children to play games. Using advanced facial recognition, the system simply threw you out if you exceeded your time limit. Then as 2018 rolled in, the trade war erupted and China fell dramatically out of favour with global investors as an investment destination.
The way we see it, this was the perfect storm for Tencent:
A historic multi-decade bull run backed up by secular trends, government policy and of course earnings, resulting in a peak share price in January 2018.
Off this high base, we saw a number of shocks to Tencent’s key earnings driver, gaming, from moratoria on monetising new games to limitations on gaming time for children and young adults
To compound this, we saw the trade war, the narrative around which was that the Americans were punishing the Chinese and were, more importantly, winning.
All of this has resulted in poor stock price performance. At time of writing, Tencent’s share price was flirting with taking back the HK$400 handle, still roughly 20% shy of January 2018’s previous all-time high.
As of Friday’s market close, Tencent had already squarely retaken the 400 handle, closing at a tidy HK$409 à share.
Here, now and next
So, back to the present – and the future.
The most recent development for Tencent involves its 100% owned subsidiary, Riot Games, which owns League of Legends, the most successful multiplayer online battle arena game of all time (and arguably THE most successful of all games to date). League of Legends stands head and shoulders above any challenger. At least it did, until last week, when it was challenged by a brand-new first-person shooter game called Valorant.
What's fascinating is that Valorant is also created by Riot – it is only the second major game produced after a decade-long hiatus since League of Legends was released in October 2009 (notwithstanding some smaller releases in the LoL world more recently).
In its closed beta last week, Valorant attracted 1.73 million concurrent viewers on Twitch - almost a record. This has only been bested by League of Legends itself, which hit 1.74 million concurrent viewers in the recent world championship final. It did however break the single day Twitch viewership record with 34 million hours watched on Twitch!
This is fascinating for 2 reasons.
First, it was the closed beta version which broke the record. The closed beta was only released to cherry-picked players and influencers to stream on their Twitch feeds, as well as some lucky lottery-style participants.
Second, while critics may say that the number is inflated as people who wanted to get access to the closed beta needed to watch the streams to stand a chance to get a code to participate themselves - this could well be true - the point that’s more relevant is Riot may have come up with a new tactic for future textbooks on marketing strategy.
Ultimately, the popularity of the stream of a closed beta, not even a public launch, and the resulting publicity suggests that the ends do justify the means.
A world first
Valorant may emerge as the first major game to be a complete cradle-to-grave eSports title: a game that was conceived and launched with eSports in mind from the very start.
Essentially every top eSports personality participated in this event, which meant immediate reach for Riot to the masses. We have previously written about an eSports team called 100 Thieves and linked to this highly recommended article. We believe 100 Thieves is an emerging blue chip brand that has already captured the imagination of the community (nevermind the best players). They are all over Valorant with their players and social media streams and the game has only just had its closed beta. In fact, they hosted the 100 Thieves Valorant Invitational on Thursday this past week, attracting some of the top eSports players. Note the sponsors of this particular “thank you” image include Cash App, Square’s mobile payment service, clearly indicating the young target demographic. This is a whole new world opening up in front of our eyes!
That this game has been treated as eSports royalty from inception is remarkable. It also just so happens that the gameplay has a no blood option – one of the key censorship requirements to scale in China. Furthermore, lest we forget, Tencent owns both Chinese eSports streaming platforms too; Douyu and Huya.
As Valorant has only just recently been released in closed beta it is certainly too early to get over-excited and there is a very long road ahead. But in today’s world, games like this are not released like they used to be in years gone by - the new rules of social marketing apply fully.
What would make a title like this succeed? Well to start in one word: influencers. As touched upon above, this game came out of the blocks fast, with the world's top players, influencers and teams supporting it heavily. Not via Facebook, Instagram and Twitter (although of course via these channels too) but via Twitch, Youtube and Discord, ground zero for gaming attention. This is why Valorant is so interesting. It is the first major title to be launched into a fully fledged eSports ecosystem and we may look back on this opening playbook as one that others will seek to replicate.
Enter the Metaverse
Furthermore, as many readers will know, one of the major trends we are following is that of the Metaverse. If you haven't read our musings before on the metaverse then read this. As we have written before, the metaverse currently has 3 main candidates – Fortnite (owned by Epic Games, which is itself 40% owned by Tencent), Roblox (still private, though recently Andreessen Horowitz led a series G round valuing it at $4 billion) and finally Minecraft (owned by Microsoft).
Parents of teenage (and younger) kids will know these names, as their kids are likely inseparable from them. The concept of the metaverse is, very simplistically, a complete virtual world where people live and thrive, working and interacting with each other more and more seamlessly as technology evolves.
The idea is widely credited to Neil Stephenson’s seminal book, Snow Crash, and further developed by creations like Ready Player One. The reason it is so lucrative is this: imagine one entity owns an entire world with virtual real estate and real commerce, where people can even earn a living. We have seen pockets of these activities in some of the above contenders already, but imagine a fully fledged ecosystem and what it could offer! Again, Matthew Ball writes far more expertly on this concept than we do so we reiterate that this article of his is compulsory reading.
Our interest from an investment angle focuses on Tencent and Epic games through Fortnite. Fortnite is the closest thing we’ve seen to what the metaverse may look like (caveat: it's seriously early and there have been merely snippets). Epic owns its own world class, open sourced, world building engine called Unreal (named after its original inception in the game of the same name launched back in 1998, and whose most recent product is the remake of Square Enix’s all-time classic, Final Fantasy VII) which it uses for Fortnite (and many other things), and that allows continuous development. As an aside, one of the reasons we are so optimistic on the fortunes of Polish gamer, CD Projekt, is their extremely sophisticated gaming engine, which has been used to build the upcoming Cyberpunk 2077 game in September.
Our key question.
This is all very cool, but here is our key question:
If there ever was to be a mature metaverse which one company dominates, would the Americans allow China (via Tencent) to own it?
If the metaverse proceeds as it might (over the next decade or so) it is no exaggeration to say that it could become the most important asset in the world, or certainly one of the most strategically important.
It's no secret that China has pursued global influence through soft loans and infrastructure projects, but far less appreciated is the fact that Tencent (and hence China) owns an interest in many, if not most, of the key gaming platforms worldwide (nevermind Hollywood, but that is another story). Besides Riot (League of Legends, Valorant) and Epic (Fortnite), Tencent has a small stake in both Activision Blizzard (Call of Duty) and Ubisoft (Assassin's Creed). It owns the majority of Supercell (Clash of Clans etc) too. This is just the tip of the iceberg as Tencent owns a stake in many other gaming companies worldwide, like a series of small call options on future success. How much would you invest for a shot at influencing the minds of the next few generations? Especially when no one else has figured it out yet. One would certainly not be shocked to see Tencent announce a stake in Roblox at some point (assuming also that Microsoft wouldn't be interested in dealing on Minecraft).
So, to complete the loop, Tencent has many exciting things going on right now, from Valorant’s launch to the evolution of the metaverse. And arguably most importantly, the stock price has been churning along for many years finding its new normal. As we always like to say, there are still multiple paths along which the story can unfold, but it's increasingly possible to us that the base case has shifted once more.
And with that, it could just be time for Tencent to take its place in the throne room once again.