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BEIJING/SHANGHAI (Reuters) - Tencent Holdings, China's largest Internet company by revenue, is betting that one-upmanship between friends playing addictive mobile games will boost revenue from WeChat, a social messaging app used by over half of all Chinese smartphone users.
The company, led by billionaire CEO and Chairman Pony Ma, last week released an update to WeChat, or Weixin, hoping the addition of games, paid-for emoticons, or stickers, and a mobile payment system will help it cash in on a client base of more than 300 million people.
Tencent doesn't charge users to download and play WeChat's 'freemium' games such as Tiantian Ai Xiaochu, which is similar to "Candy Crush Saga", the world's top grossing app, according to Think Gaming. Instead, WeChat's social networking features encourage friendly competition between players and their contacts by sharing scores. By paying for in-game upgrades - such as buying extra lives - users temporarily get one-up on their friends, and Tencent gets their money.
In looking to monetize its mobile platform, Tencent is following the likes of South Korean firm Kakao Inc's KakaoTalk and Japan's NHN Corp's Line. Three months after Kakao released Kakao Game last August, its monthly revenue soared ninefold to $35.3 million. Tencent has a 13.8 percent stake in Kakao.
To achieve similar success Tencent needs games, and is willing to pay top dollar to bring in talent, not just in China, but globally.
"We're going to buy into high-end game developers and start developing free-to-play content for developing markets," Steve Gray, the executive in charge of game development at Tencent, told Reuters at a gaming industry panel in Shanghai last month.
Investors in Tencent, which is more than 30 percent owned by South African media group Naspers Ltd, hope WeChat's hook into game players will boost revenue. The company's shares have risen around 48 percent so far this year, the best performer on the Hang Seng index, valuing Tencent at around $88 billion.
The company on Tuesday denied a newspaper report that it plans to list WeChat as a spin-off company in Singapore.
Unlike rivals Baidu Inc, the owner of China's biggest Internet search engine, and Alibaba Group, the country's leading e-commerce company, whose first-quarter revenue of $959 million and $1.38 billion, respectively, depended mostly on advertising, Tencent's quarterly revenue of $2.18 billion was fuelled by computer games such as its popular "League of Legends".
For 2014, WeChat will account for 2.95 billion yuan ($482 million) of Tencent's revenue, Barclays estimates, and mobile games could make up 73 percent of that. Last year, Tencent made no money from mobile gaming, but reported revenue of $338 million from that segment in January-March this year.
Tencent announces its second-quarter results later on Wednesday.
The fastest way for Tencent to fill its game development pipeline is to buy existing developers, but that's not cheap, said Gray, noting some target firms can be priced at 50-60 times their annual revenue - far more than the 20-30 times companies typically pay for web browser game developers.
The potential profits from mobile games can make these high valuations worthwhile, but not always. "(A company can) have a breakout hit and everybody's like 'Whoah, they can do this!' Then it turns out they just got lucky," said Gray.
Other companies eager to push into the very profitable mobile arena are taking a more cautious approach.
"We're looking to buy smaller studios," said Jazy Zhang, chief financial officer at Chinese video game company Giant Interactive Group, adding the company's strategy is to start with a minority stake then scale up if the games do well. Like Gray, Zhang expressed dismay at the high multiples being asked for mobile games developers, which she compared with Giant's single-digit multiple valuation.
Developers from overseas, meanwhile, are looking to tap China's developer talent pool and lower costs to break into the rapidly growing market. "There's a lot of great engineering talent here," said Michael Li, general manager of Kabam, a U.S.-based mobile games developer with rights to games for popular franchises like "The Hobbit" and "Fast and Furious".
Not only is it cheaper to develop in China, but the industry is already accustomed to the free-to-play gaming market, part of the reason Kabam has focused on buying Chinese developers as it grows. Large companies like Tencent and Giant are only now getting into mobile seriously, said Kabam's Li, making the landscape for developers increasingly competitive.
WeChat's new function as a platform for games distribution could help solve another issue for developers: China's highly fragmented Android appstore market. The Google Inc smartphone operating system dominates China, with more than two-thirds market share in April-June, according to Kantar Worldpanel, but its Google Play appstore has been muscled out by local third-party players, data from iResearch shows.
WeChat's reach of more than 300 million users across both Android and Apple Inc's iOS means developers will be able to avoid the challenge of getting their games on to as many stores as possible, as they can simply partner with Tencent instead. In turn, less competitive third parties may die out.
For now, Tencent's focus is on ensuring WeChat's games are good enough that customers spend money on them. "User acquisition is not free, but it is absolutely critical to everything," said Gray.
At the same time, increasingly popular smartphones and tablets are becoming more powerful, development costs are rising, and laptop and PC sales are flattening. Market tracker IDC predicts China's smartphone market will be worth close to $118 billion by 2017, up from a forecast $80 billion this year.
"The technologies are different, the challenges are different, and for teams that have done it on mobile, probably there's a higher premium," said Kabam's Li, referring to the price of buying game developers.
"That said, I think these numbers are ridiculous."
Editing by Ian Geoghegan