UPDATE 2-Tencent in rare profit miss, new forays shrink margins

Wed Nov 14, 2012 6:53am EST

* Q3 net profit up 32 pct on strength in online games

* But falls short of market estimates as costs soar

* Tencent shares up 72 pct this year as new forays welcomed (Adds analyst quote)

By Melanie Lee

SHANGHAI, Nov 14 (Reuters) - Tencent Holdings, China's biggest online gaming and social networking company, surprised with a rare earnings miss, as efforts to expand into new businesses hit margins and the number of fee-paying users for its Internet services fell.

Searching for fresh revenue streams, Tencent has steadily expanded into e-commerce and online video but the highly competitive and cost-heavy nature of both these industries has meant that Tencent has had to spend in order to boost sales growth.

"The bottom line was a bit of a miss compared to our numbers and the Street and it's largely due to Tencent's margins," said Hong Kong-based Nomura analyst Jin Yoon.

"Margins will have to continue to go down if this company continues to invest in these negative margin businesses," Yoon said.

Net profit for the third quarter climbed 32 percent to 3.2 billion yuan ($514 million) from a year earlier, helped by strength in its core online gaming business.

But it fell short of an average estimate of 3.5 billion yuan in a Reuters poll of nine analysts as cost of sales soared 80 percent. Tencent's e-commerce business had the lowest margins, as costs were equivalent to 96 percent of that segment's sales, followed by online advertising, where costs were equivalent to 50 percent of that segment's revenue.

Its e-commerce revenue rose 32 percent from the previous quarter to 1.1 billion yuan.

Tencent, which is more than 30 percent owned by South African media group Naspers Ltd, is a relatively new player in China's e-commerce industry which was worth $45 billion in the second quarter. In the second quarter, Tencent had 4.5 percent of the market, behind 360buy and Alibaba Group's Taobao platforms.

The forays into new businesses have, however, found favour with investors this year, driving its shares 72 percent higher, compared with a 16 percent climb for the Hang Seng Index.

MOBILE PAIN

Tencent said the number of fee-paying subscribers for value-added Internet services fell 4.8 percent in the quarter after it initiated a drive to improve its subscriber base by cutting out user accounts where fee-collection was unlikely.

The company also said the consumer shift to mobile devices was bringing some pain and might pose a risk to its traditional business model -- where users buy virtual currency and virtual items to personalise their accounts. Tencent's value-added Internet service business contributes more than 72 percent to its total revenue.

Tencent also noted that a slower Chinese economy may have hurt its online advertising business, which online video is a part of.

Online gaming continued to drive much of quarterly profit growth, with Tencent's new game "League of Legends" gaining traction in the market to join stalwarts "Cross Fire" and "Dungeon & Fighter" as China's most-searched-for games.

Overall third-quarter revenue jumped 54 percent from a year earlier to 11.6 billion yuan, matching analysts' estimates, with online gaming revenue climbing 44 percent to 6 billion yuan.

Tencent said that Weixin or WeChat, its highly popular mobile chatting app that has been a particular focus for investors, had taken good steps forward and had more than 200 million users as of end-September.

"Several of our investment initiatives, such as open platform, Weixin and online video, made progress in driving user engagement or monetisation," Tencent's Chief Executive Pony Ma said in a statement.

"Our focus remains on building our user base and enhancing our user experience, particularly during this period of rapid mobile Internet growth," Ma said.

Shares of Tencent ended 0.9 percent lower on Wednesday before its results were announced, versus a 1 percent rise for the Hang Seng. ($1 = 6.2265 Chinese yuan) (Reporting by Melanie Lee; Editing by Edwina Gibbs)

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