First quarter revenue decline forecast

Tencent could post its first year-on-year revenue decline on record when it reports second-quarter earnings on Wednesday, according to analysts, as a Covid-induced slowdown in the Chinese economy and continued challenges in the domestic gaming market could prove to be strong headwinds for the company.

The Chinese gaming and social media behavior is expected to report June quarter revenue totaling 132.2 billion yuan ($19.5 billion), a more than 4% year-on-year decline, according to consensus forecasts from Refinitiv. Net income is forecast to fall nearly 30% to 23.8 billion yuan.

Tencent, which runs China’s biggest messaging app WeChat, makes a large amount of revenue from gaming and advertising, two areas which are likely to have taken a hit in the second quarter.

“We factor in more conservative assumptions to online games and advertising revenue in 2Q due to global macro-headwinds and the outbreak of the pandemic. We expect the headwinds to lead to softness in overseas gamers spending,” Jefferies analysts said in a note published last month.

During the April to June quarter, China saw a resurgence of Covid-19 that led to the lockdown of major cities, most notably the financial metropolis of Shanghai, as authorities continue with the country’s “Zero Covid” policy.

China’s economy grew just 0.4% in the second quarter, missing analyst expectations. Macroeconomic headwinds are likely to lead to slower consumer spending plus a cutback in advertising, two areas Tencent relies on.

For the April to June quarter, e-commerce giant Alibaba reported flat revenue growth for the first time on sluggish consumer spending.

Jefferies forecasts that Tencent’s online ad revenue declined 29% year-on-year in the second quarter to 16.3 billion yuan. That’s a sharper drop than what was reported in the first quarter.

“We expect the softness to have come from the outbreak of the pandemic and uncertainties in the macro environment, as well as the high base of certain industry categories (including education and gaming),” Jefferies said.

Gaming revenue, which accounts for about a third of Tencent’s total sales, will be in focus for investors.

China’s gaming sector continues to face challenges. Last year, Chinese regulators said children below 18 years old will only be allowed to play online games for up to three hours a week and only during specific times.

Tencent and its rival NetEase have looked toward international gaming expansion as the domestic market has slowed, acquiring developers or opening new studios.

Jefferies analysts are bullish on the future potential of Tencent’s overseas drive.

“Overseas, Tencent has a solid pipeline of about 30 titles that are to be released in the next few years,” they said. “On top of mobile games, Tencent also has console games in the pipeline. It pursues multi-pronged strategies in overseas expansion such as setting up local operations teams, self development as well as publishing.”