Tencent Holdings Ltd. is planning to spin off its e-book business as it boosts spending on payments and content to lure users and keep them glued to its WeChat service.
An initial public offering of the Kindle-like business is planned for Hong Kong, the Shenzhen-based company said Wednesday after posting quarterly earnings that trailed analyst estimates. While net income surged 47 percent to 10.5 billion yuan ($1.5 billion), that trailed the 11 billion yuan expected by analysts.
Chairman Ma Huateng is prepared to wear the hit to profit margins that comes from investing in areas such as video and mobile payments, which he sees as critical to retaining users for WeChat and QQ. Keeping customers engaged underpins its strategy to grow advertising and game sales, with the company recently unveiling “mini programs” that provide access to everything from ride-hailing to food delivery without leaving China’s most popular instant message service.
While revenue in the quarter climbed 44 percent to 43.9 billion yuan, costs jumped 60 percent to 20.2 billion yuan — almost half its overall sales.
“The payments service is treated as an infrastructure, that’s why even as user numbers grow fast, bank fees grow as well, so what we generate is similar to what we invest,” Ma told reporters in Hong Kong. “A lot of our cloud business is also in the investment phase, that’s why costs in the short term will be high.”
Shares of Tencent fell 1.6 percent to HK$225.20 in Hong Kong before its earnings were announced. The stock has gained 19 percent this year, compared with a 20 percent gain for New York-listed rival Alibaba.
China Reading Ltd., as Tencent’s literature unit is known, is said to have asked bankers to pitch for a role arranging an IPO that could raise about $500 million. President Martin Lau said it would also consider other spinoffs without identifying targets. The company also operates a music and video-streaming service.
While Tencent’s services have a massive reach in China, growth is slowing as it nears saturation in its home market. In addition to new games, it’s funding blockbusters including “Kong: Skull Island” and “Warcraft” and sitting atop a plethora of intellectual property for anime and online novels distributed via its websites. The company has aspirations to eventually create a Marvel-like movie empire, as it competes with Alibaba Group Holding Ltd. for users.
While losses from the video business surpassed that of the cloud division, and will grow in the medium term, Tencent isn’t focused on making it profitable this year, the company said.
That’s driving it to find ways to keep people engaged with WeChat, the messaging service that some 889.3 million monthly users employ to make payments, buy goods and catch up with the news. “Mini programs” are stripped-down versions of popular mobile apps that not only keeps users in WeChat but could pit it against Android and Apple Inc. app stores, by obviating the need to download full versions of apps.
“One of the more important reasons we started mini programs was to boost interaction between online and offline,” said Lau. “The service can help solve pain points for offline merchants who have access to customers but want to bring them to their online services.”
For now, it still gets most of its revenue from online games, where it competes with local giants including Netease Inc. Revenue from Value Added Services, which includes online games and messaging, jumped 27 percent to 29.2 billion yuan, while online advertising sales climbed 45 percent to 8.3 billion yuan.
While games have underpinned Tencent’s rise, it risks getting drawn into a political spat between China and South Korea.
The company hosts games from South Korean developers and could run afoul of a Chinese boycott of goods from its Asian neighbor, retaliation for hosting a controversial U.S. missile-defense system. Martin Lau said that could affect approval of new games, which need to be cleared by the government, although existing titles wont be affected.
“Tencent is directing its energies into these growth segments with the right rationale — each segment presents a long runway for growth and all three are impressive market opportunities in their own right,” Bhavtosh Vajpayee and Bill Liu, analysts for Sanford C. Bernstein, wrote in a research note. “Yet, the blow of content cost inflation for video, ramp costs for cloud and the price for share gains in payments also need to be factored into a prognosis for the stock over the next 12-18 months.”