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Tencent Games Strategy 2019

China Games Market Intelligence: Games Strategy 2019

Tencent Games Strategy 2019

Tencent is a Chinese technology conglomerate founded in 1998. It is one of the top 10 public corporations globally, by market cap, and is one of the world’s largest and investment firms. Tencent’s is at least partially attributable to WeChat and QQ, which are two of the largest social messaging platforms globally (despite being used primarily in ). It is also the largest gaming company in the world by revenue, having generated games revenue of $19 billion in 2018.

China’s games market was rocked by a temporary game license approval freeze between April 2018 and December 2018, which led to Tencent reporting its first profit decline ever. Despite this, the company has been able to weather the storm and maintain its leadership position. This report describes the bold strategy for games that Tencent has disclosed.

Tencent’s earnings and outlook for Q2 2019

Tencent reported Q1 2019 revenue of $12.69 billion, up 16% YoY, primarily driven by an increase in Payment, Cloud and Advertising revenue. Operating Profit was $5.46 billion, up 20% YoY with operating margin increasing to 43% from 42% last year. Total gaming revenue declined slightly to $5.2 billion, down 2.2% YoY. The decline was due to lower revenue from both Tencent’s and PC game segments.

Mobile game revenue declined 2.3% YoY, primarily due to fewer titles being launched during the quarter when compared to the same period last year. There were 8 new mobile games launched in Q1 2018 compared to just 1 in Q1 2019 (when licensing was just getting back underway). Perfect World Mobile, which received a license at the beginning of the year, was the only new game to launch during the quarter, generating revenues of over $100 million in its first month. Perfect World Mobile is an RPG game for smartphones that has been adapted from the PC game of the same name. The title is developed by Perfect World Entertainment themselves and published by Tencent.

Existing (legacy) titles continued to perform well with (known as in the West) remaining the #1 grossing mobile game in China during Q1 2019. Tencent saw an increase in DAU across its mobile game portfolio and paying users increased quarter on quarter, thanks to Chinese New Year promotions and the introduction of season passes and subscriptions across PUBG Mobile, Honor of Kings, CrossFire Mobile and QQ Speed Mobile. Season passes in F2P games were popularized by Fortnite’s battle pass last year and Tencent is currently experimenting with this monetisation method in its hit legacy games.

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China Games Market Intelligence: Tencent Games Strategy 2019

PC revenue declined 2.1% YoY, due to the lack of new title launches. remains Tencent’s hit PC game with user engagement and spend increasing over 2018. We credit high user demand to the success of League of Legends with Chinese team Invictus Gaming winning the League of Legends World Championships. Dungeon & Fighter has also been a top performer with paying users increasing quarter on quarter after the Chinese New Year update.

Tencent’s overseas games and earnings from investments also played a part as PUBG Mobile reached 100 million monthly active users outside China and has now generated lifetime revenue of nearly $400 million overseas. Tencent owns a majority stake in Supercell, who have published another hit in . The company owns minority stakes in and who have found success with Fortnite and Free Free, respectively.

Q2 2019 Outlook is Positive

We expect games revenue to see a notable increase year over year as the company plans to release Peacekeeper Elite, : Winter is Coming, JX Online 3 Mobile, Once Upon a Time, Fairy Tale Mobile, Ace Force Warrior and The Rhythm of The Clouds and Dreams. We expect Peacekeeper Elite, which is Tencent’s new battle royale title, to be the standout game during the quarter as players from the recently closed down PUBG Mobile migrate over and spend in the game. The large portfolio of games set to launch during the quarter is also a positive sign for the industry that Chinese game companies are returning to a healthy release schedule.

Peacekeeper Elite will be Tencent’s key title for 2019

Peacekeeper Elite launched on May 8, 2019 as Tencent’s new self-developed by Tencent’s Lightspeed & Quantum Studio, published by Tencent Games. The title launched with zero marketing or announcement prior to launch yet is already set to become one of Tencent’s most successful games ever. The game is essentially a carbon copy of PUBG Mobile with a few slight changes, and conveniently launched the moment that PUBG mobile was shuttered.

Tencent closed PUBG Mobile in China on May 7, 2019 as the game, which had been on the market since January 2018, had still not received a license that allowed Tencent to monetise the game in China. Meanwhile, Peacekeeper Elite did receive a license to monetise in April 2019 and Tencent decided that it’d be easier to close down PUBG Mobile and migrate all 150 million monthly active users to the new game where they could be monetised, rather than continue to operate PUBG Mobile with no way to monetise it.

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China Games Market Intelligence: Tencent Games Strategy 2019

Whilst an official reason was never given as to why PUBG Mobile was not awarded a license to monetise, we note that an unofficial ban on Korean game IP and rules surrounding battle royale games in China may have been contributing factors, because the original PC version of PUBG is a battle royale game developed in Korea. A statement from China’s Audio-Video and Digital Publishing association in October 2017 noted that battle royale games should strive to remove as much violence as possible, incorporate Chinese values and take into account the health of minors (who were spending many hours on such games).

As the game can be monetised, Peacekeeper Elite already has a store that sells skins, weapons and other items. We expect Tencent to add additional monetisation options such as a battle pass and more options in the future. It’s clear to us that Tencent took a number of steps to self- develop a battle royale game based on “domestic IP”, that did not utilise a Korean IP and explicitly followed content regulations, such as removing blood splatter, in order to obtain a license. Great news for Tencent, as they can now monetise a mobile battle royale game in China, yet not the best of news for PUBG Corp who may not see any of the profit from Peacekeeper Elite’s operation in China.

The game hit #1 on the iOS game revenue chart in China on day 1 (May 8th) and we note that the game has remained at the top of the charts since launch, alternating between the #1 and #2 positions. We estimate that the game could generate gross revenues of over $150 million in its first month and has the potential to gross nearly $1 billion by the end of the year, making the title one of Tencent’s most successful games. Coupled with PUBG Mobile overseas, we believe that the battle royale genre will be a key of growth for Tencent this year.

We note that Tencent has been able to launch battle royale games such as PUBG Mobile overseas and Peacekeeper Elite in China whilst also adding battle royale modes to existing games such as Honor of Kings and Online which has helped boost engagement and spend in the games. However, Tencent is still looking to obtain licenses for Fortnite, H1Z1 Battle Royale, Ring of Elyssium and Call of Duty Mobile Battle Royale to monetise these games in China. If Tencent is able to receive licenses for these games, the company will be able to grow and enhance its presence in the popular battle royale genre.

A growing pipeline of diversified titles will drive revenue growth in 2019

Tencent has taken a number of steps to grow and diversify its game portfolio to ensure that it can have a presence across all gaming genres and create games for underserved segments of the market. The company is carrying out this initiative by self-developing new games, licensing third

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China Games Market Intelligence: Tencent Games Strategy 2019

party games and by investing in and acquiring developers who can augment Tencent’s existing game pipeline. This will give Tencent a greater presence across all gaming genres and segments, allowing them to quickly respond to new trends and reduce any negative impact from new regulations.

This is one of the ways that Tencent was able to weather the storm last year during a temporary game license approval freeze when China’s gaming regulator stopped approving new licenses for games whilst it restructured and reformed between April 2018 and December 2018. Despite being unable to obtain new licenses for games, Tencent was still able to release more than 30 games during this period as they already had a large number of games far along in development that had been awarded a license prior to April 2018. This helped Tencent grow its gaming revenue 8.9% YoY, which was down compared to 41.5% growth in the prior year, but it’s worth noting the situation could have been much worse.

Domestic games

On March 24, 2019, Tencent held its annual UP conference where it showed 20 titles to demonstrate how the company was enhancing its game pipeline and diversifying its - up. Whilst a number of the titles were traditional RPG’s and Shooters, Tencent introduced new Sandbox, simulation, survival, rougelike, and interactive games that are set to launch this year. The company also focused on global games which are titles that the company plans to develop and publish in China and overseas.

Key titles showcased during the event include:

Dragon Raja – A mobile MMORPG game adapted from Jiang Nan’s novel of the same name. The game is said to be Tencent’s next generation RPG and will be developed on Unreal Engine 4 with ultra-realistic graphics, an and more. Players will be able to explore the semi-futuristic world of the novels and solve mysteries to save the world. The game is developed by Loong Entertainment and will be published by Tencent. We note that the game has over 9 million pre- registrations.

JX Online 3 Mobile – A 3D martial arts MMORPG game that is adapted from the PC game of the same name. The game has a new unique art style that takes advantage of traditional Chinese culture and art to immerse the player in the game world. Martial arts combat in PVE and PVP modes is available and a new counterattack system will be introduced. The game is developed by Seasun and will be published by Tencent in the second quarter of 2019. We note that the game has over 12 million pre-registrations.

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China Games Market Intelligence: Tencent Games Strategy 2019

Ace Force Warrior – A hero shooter that combines shooter + MOBA + RPG elements with cartoon style graphics. Players can choose to play from nearly 30 heroes in the game, each with unique skills and weapons. The game also contains multiple game modes such as Assault, base occupation and more. The game is similar to Overwatch in terms of gameplay and style. The game is self- developed by Tencent’s More Fun studio group and is set to be published in the second quarter of 2019. We note that the game has over 8 million pre-registrations.

Game of Thrones: Winter is Coming – A simulation game based on the world of HBO’s popular TV show, Game of Thrones. As the game is officially licensed by HBO, it utilises official character portraits and storylines. In the game, players must plan, build, explore and battle opponents in a real time strategy game to claim the iron throne. The game is developed by Yoozoo and will be published by Tencent at the end of June in China.

ReEvolve – A sandbox game with stylistic graphics that contains both a PVE and PVP mode. In the game, players must decide whether to save the world or end the world by exploring an immersive open world where they will mine natural resources, craft new items and build defences. We note that the title borrows a number of gameplay mechanics from already existing games such as Minecraft and to create a unique experience. The game is developed by Perfect World and will be published by Tencent.

Code: Live – An open world co-op survival game with Shooter and RPG elements. The game has a realistic art style and contains zombie hordes, similar to Days Gone and State of Decay. In the game, players must survive together by building defences and fighting off zombies. The game is a self-developed title from Tencent’s LightSpeed and Quantum studios.

Tencent has been self-developing titles since 2003 and some of the company’s most popular games, such as Honor of Kings and League of Legends are developed by Tencent’s internal game studios (Tencent purchased 100% of in 2015). Tencent also acts as the operator for overseas game developers who want to bring their games to China as a Chinese law states that foreign developers cannot operate an online game in China themselves and must work with a local partner. A trend that we have seen accelerate recently is Tencent publishing titles that have been developed by fairly large domestic game developers, even those that have their own publishing unit.

Recent games developed by domestic Chinese developers and published by Tencent include Perfect World Mobile and The Rhythm of Clouds and Dreams from Perfect World Entertainment, The World of Legend and Dragon Nest from Shanda Games, Game of Thrones from Yoozoo, Dragon Oath from Changyou, JX Online 3 Mobile from Kingsoft/Seasun and Blue Moon Legend from Kingnet. Despite having game publishing capabilities, themselves, more domestic game

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China Games Market Intelligence: Tencent Games Strategy 2019

companies are choosing to allow Tencent to distribute their game due to the company’s experience, distribution channels and advertising reach.

Tencent has an advantage in China due to more than 20 years of experience operating social networks in the country. QQ and WeChat have more than 1 billion users in China and are also used as a distribution and advertising channel for games. Games that are published by Tencent are able to use these social networks to their advantage, not just to distribute and advertise about the game, but to fully integrate at every level including account log ins and payment. Chinese domestic developers are discovering that working with Tencent to publish their game in China would allow them to reach a larger audience than they ever could and allow them to earn more overall than if they were to self-publish.

Foreign Games and Global Strategy

Tencent is a strong partner for foreign publishers due to its experience in development and publishing. The strategy also includes investments in gaming companies that augment its existing games and pipeline, picking up on trends for growth areas globally. Tencent leverages its partners expertise when launching its own games and assists partners with game development and localisation for the China market.

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China Games Market Intelligence: Tencent Games Strategy 2019

Tencent Games Investments / M&A (Foreign game publishers only)

Company Name Majority/Minority shareholder Stake (%) Riot Games Majority 100% Sharkmob Majority 100% Supercell Majority 84.3% Mini Clip Majority Undisclosed Majority 80% Epic Games Minority 48% SEA (Garena) Minority 39.7% Blizzard Minority 5% Bluehole Minority Undisclosed CJ Games () Minority 28% Minority 9% Glu Mobile Minority 21.5% Pocket Gems Minority 38% Kakao Games Minority 13.5% Minority 5% Pati Games Minority 20% Robot Entertainment Minority Undisclosed Minority 5% Milky Tea Minority Undisclosed Minority 36%

Tencent is the top partner of choice for game localisation in China, with foreign publishers such as Actiivision, , Take Two, Ubisoft, Nexon and others working with Tencent to localise and publish their IP in China. Tencent has recently started to deepen its partnerships with foreign game publishers, obtaining a license to develop and publish new and unique versions of foreign game IP.

PUBG Mobile is the greatest example of this, with Tencent’s internal studios having developed the game and published it outside China. The game has been a hit for Tencent on the global stage and has generated gross revenues of nearly $400 million. Tencent recently obtained a license for the Call of Duty franchise from Activision and is developing Call of Duty Mobile for a global audience. Street Fighter Online is another self-developed title where the IP has been licensed from Capcom.

One other way that Tencent is aiming to grow its overseas presence is through the acquisition of foreign game developers to create new games which will be published in China and overseas. This

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China Games Market Intelligence: Tencent Games Strategy 2019

strategy has worked for Tencent in the past with the acquisition of Riot Games and minority investment in Epic Games, which allowed the company to become the largest PC game publisher with League of Legends and Fortnite, as well as the acquisition of Supercell, which allowed Tencent to become the largest mobile game developer with . Tencent is currently looking into acquiring Nexon, the publisher of Dungeon & Fighter, as the company is currently for sale.

Tencent recently acquired Sharkmob, a Swedish game development studio that was founded by a group of ex Ubisoft employees that worked on The Division. Sharkmob is currently developing an online game with an immersive social experience for large groups of gamers across multiple platforms that Tencent will publish in China and overseas. Tencent also announced a joint venture partnership with that will see both companies create AAA titles based on new IP, create games based on existing IP and bring Square Enix titles to China. We hold a positive view of Tencent’s overseas gaming strategy but note that there is still a long way to go before Tencent becomes a household name in the West.

Tencent’s investment in Buy to Play helps them reach a niche segment

WeGame

Tencent currently dominates the free to play (F2P) PC and Mobile games market but has not had a large presence in the Buy to Play (B2P) space on PC, Mobile and Console. This is primarily because B2P has not been a big segment in China before and the investment was not worth it. Niko Partners tracked the B2P market when games were sold as packaged discs for PC in the early 2000’s. These games were usually single player only, sold at retail and very expensive. Piracy rates were extremely high for these games and it made the B2P market completely unviable for all game publishers.

Over the past few years we have seen the rise of the B2P games market as , higher disposable incomes, DRM software to combat piracy and the growth of PC online game distribution platforms in China has led to publishers being able to successfully monetise games both at launch and post launch. has been a key platform behind the rise of B2P games in China, offering gamers localised games, local payment methods and a variety of popular foreign AAA titles such as 2, Grand Theft Auto V and Playerunknown’s Battlegrounds. Today, Steam has more than 40 million active users in China and Valve is currently working with Perfect World to create a China only version of Steam.

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China Games Market Intelligence: Tencent Games Strategy 2019

It’s important to note that the international version of Steam currently operates in a grey area as none of the games on the platform have received a license from China’s gaming regulator to launch and monetise in the country, yet the platform remains open and operable. This is also true for other B2P game stores such as Ubisoft’s uPlay store, EA’s store and Epic Games own store. Today, B2P games on PC generate more than $600 million in China each year, accounting for approximately 5% of total PC games revenue.

Tencent launched its own B2P PC game distribution platform in September 2017 called WeGame, with the aim to distribute both domestic and foreign titles to gamers in China and take market share away from competing platforms such as Steam. Unlike Steam, Tencent is playing by the rules in China and requires each and every title to be approved by the gaming regulator before launching the game on its platform. This means that Tencent offers a more stable platform for publishers, but also requires foreign game developers to make changes to their titles to comply with content regulations before they can request a license to publish in China. This process is long and cumbersome which means many smaller developers will opt to publish games on Steam where none of this is currently required.

Tencent held a WeGame developers conference on May 10, 2019 where it confirmed that the platform now has 300 million registered users and 70 million monthly active users. Whilst these numbers are certainly impressive, we do note that WeGame also hosts popular F2P games from Tencent such as League of Legends which inflates the numbers. B2P game sales increased 56% YoY in 2018 with standout titles such as Stardew Valley, Icey and Oxygen Not Included becoming top sellers. Tencent also noted that there has been a rise in domestic B2P games as Chinese developers have experimented with the business model. More than 5 million units of Chinese developed games were sold on WeGame in 2018.

Tencent faces a number of challenges with WeGame due to content regulation laws and approval times in China. The platform has more than 200 titles to choose from, but this pales in comparison to the more than 5,500 games on Steam that have been localised into Chinese. In August 2018, Tencent launched Capcom’s Monster Hunter World on the WeGame store. The title achieved more than 1 million pre-orders, but every user was refunded after one week after regulators ordered Tencent to remove the game as it did not comply with content regulations. The game has yet to relaunch on the platform nearly one year later, likely because the game was resubmitted for approval during the temporary game license approval freeze and has not been reviewed yet.

To combat these challenges and bring more compliant games to the platform, Tencent has extended its Wings Developer Program to both overseas and domestic developers. WeGame will now aim to partner with developers that are creating unique and content compliant games to provide them with resources and support to help develop the game and launch it on WeGame.

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China Games Market Intelligence: Tencent Games Strategy 2019

Tencent is also improving the platform itself with a better review system, improved voice chat capabilities and a new customer support program. As Tencent uses WeGame to distribute F2P PC games too, we believe that the discoverability for B2P games on the platform is high and expect sales of these games to increase as more titles come to the platform.

Nintendo Switch

Tencent confirmed on April 26th, 2019 that it would be the exclusive distributor of Switch hardware and software in China, marking an official entry into the console market for the company. Consoles have not been a focus for Tencent in the past due to the console ban which lasted from 2000 through to 2014. Whilst grey market consoles were popular during the console ban, it is clear to us that the ban had a notable impact on the potential size of the market as console games and brands were not localised or promoted in the country. Even with the ban overturned, the console market only accounts for approximately 1% of total games revenue in China.

Tencent has attempted to launch console hardware in China before, based on Windows and Android, with zero results as they were expensive and failed to offer anything unique. Whilst the can still be considered expensive for China, it will likely be priced cheaper than its competitors and will offer a unique gaming experience that is different from its competitors. Nintendo has already taken steps to increase the appeal of the device in China by removing region lock, localising software into Simplified Chinese and published games that take advantage of the portable and tabletop gaming modes which play into the social gaming culture in China. We note that grey market sales of the Nintendo Switch have been particularly strong which is a positive sign for the official launch.

The Nintendo Switch can be successful in China, especially due to Nintendo’s strong first party IP such as Mario and Pokemon which are also known in China. Tencent has already released Arena of Valor on Switch and we expect them to bring other games and perhaps even services such as WeChat or even Tencent Instant Play to the Switch in order to support the launch and pitch the console as a HD dedicated gaming device to compliment already existing PC and Mobile game hardware on the market. Nintendo has a chance to surpass PlayStation as the market leader in China, but we should note that the console market in China will always remain niche due to the high barriers to entry.

The Nintendo Switch has already been approved for sale by the Guangdong Ministry of Culture but requires further approval from the State Administration of Press and Publication and a China Compulsory Certificate before it can be distributed in the country. Software for Nintendo Switch will also require individual approval from the State Administration of Press and Publication before

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China Games Market Intelligence: Tencent Games Strategy 2019

they can receive an official release in China. It’s currently unclear when hardware will receive all approvals and so far, no software has been approved by the gaming regulator. Therefore, we do not expect to see more news on the Nintendo Switch launch until this happens which we estimate to be towards the end of 2019 or beginning of 2020.

Whilst Nintendo and Tencent have partnered to distribute the Switch in China, we note that the partnership may extend to other areas such as Nintendo’s mobile game business. None of Nintendo’s mobile games have yet to launch in China and we expect Tencent to localise and publish these titles as well as work with Nintendo to adapt its console IP to mobile devices. Whilst the console business may remain niche, we would expect a Tencent and Nintendo mobile game partnership to be much more fruitful for both companies.

Trends to watch in 2019

Investment in Esports

Tencent is already a dominant force in China’s esports industry, operating hit esports titles such as League of Legends, Honor of Kings and PUBG Mobile. Tencent is building an esports ecosystem in China with a more than $1 billion investment in game live streaming platforms Douyu and Huya as well as undisclosed investment in esports tournament operator VSPN. The company is investing in its own games and introduced the franchise model for the League of Legends Pro League and King Pro League. At the UP conference on March 24th, Tencent rebranded its Tencent Games Arena (TGA) esports tournament to Tencnent Esports Games (TEG), with the new tournament covering 30 esports titles across 8 professional esports competitions.

In 2019, Tencent plans to operate more esports event this year at a much larger scale, especially after the success of Chinese teams in esports tournaments last year. Local governments in China are seeing the potential in esports and have signed agreements with Tencent to subsidise esports competitions and boost economic growth. We note that esports is currently seen as a way to increase engagement and spend within games and the main value being generated is the revenue from these games. As esports grows and is supported by more stable infrastructure, we would expect it to become a more material and profitable venture for Tencent.

New technology in games (AR+LBS+Blockchain)

Tencent is constantly investing in R&D to create new ways to play and engage with games. We’ve started to see new trends emerging such as Augmented Reality, Location Based Services Gameplay and Blockchain games. In April 2019, Tencent launched its new smartphone game ‘Let’s Hunt

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China Games Market Intelligence: Tencent Games Strategy 2019

Monsters’ to demonstrate how this technology could be implemented into video games. The game takes the AR+LBS elements from Pokemon Go and combines it with the Blockchain elements from Cryptokitties to create a social mobile game based on .

In the game, players can find and capture virtual monsters in the real world and then rear and trade digital kittens stored on a blockchain. Each kitten is unique and holds real world value as they can be traded on an official in game market. The core game itself has been received positively from players and the title is a top 10 grossing game on the iOS games chart in China. Whilst Let’s Hunt Monsters is no more than a tech demo and proof of concept at this point, it shows what can be possible in future games.

Growth of Mini Games

Mini games and super casual games are making a comeback thanks to social media apps such as WeChat and QQ in China. WeChat Mini Games are simple, social and contain a competitive element to keep players engaged and bring them back day after day. They are perfect for first time mobile gamers and current mobile gamers who are looking for a simple yet challenging experience. Tencent launched its WeChat Mini Games platform in December 2017 and games on the platform have reached more than 400 million players, half of which are female.

Tencent has enabled in game purchases and advertising for third party publishers on the platform and has now announced that it will be enabling mini games within its QQ Game Centre app which has 300 million users. Mini games are growing the gaming market by bringing in new gamers and lapsed gamers with simple, easy to play games. We expect players of WeChat mini games to migrate over to midcore and hardcore games over the next few years. Whilst Tencent is the leader in this category, many other tech companies such as Douyin and Tencent backed Kuaishou have launched their own mini game platforms on mobile.

Cloud Games and 5G

With 5G set to launch in China this October, the possibilities of cloud games have moved from concept to a finalised product in the form of Tencent Instant Play which is a service. Cloud gaming will allow games to be streamed from a remote server in the cloud to a user, removing the need for high spec hardware and allowing any game to run on any device. Tencent Instant Play promises that games will run in 1080p at 60fps across PC and Mobile devices with a response time of less than 40ms.

Tencent is currently testing this technology with a closed test for users in and Guangdong. Cloud gaming is an emerging trend in 2019 and will allow the gaming market to grow,

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China Games Market Intelligence: Tencent Games Strategy 2019

reach new gamers, and offer new ways to engage with games. Tencent already has a robust cloud business in China with 75% of the top mobile games in the country using Tencent Gaming Cloud already. We believe Tencent is uniquely positioned to become the leader in the cloud gaming market due to its experience in cloud and gaming, not to mention that it will not have to compete with other cloud gaming platforms such as Stadia due to Google services being banned in the country.

Outlook for 2019

With more than 20 titles showcased at Tencent’s UP conference, a commitment to esports and increased investment / M&A in the gaming space, it’s clear that Tencent is continuing to focus on gaming as a key driver of growth in 2019.

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