Chinese teenagers have a lot of time on their hands. Or so it would seem – their obsession with online games has made Tencent China’s biggest internet company by market value ($50bn). Idle youths also helped Tencent report earnings over one quarter higher last year at Rmb10bn. That pushed up its shares by 4 per cent on Thursday. Not bad for a company which has quadrupled in value in the last three years.
Tencent now trades at 23 times this year’s earnings. The problem for investors in deciding whether this is fair, however, is that there are no real comparables. Tencent has a lot of social network functions similar to Facebook, but it also makes money from online games similar to Zynga. More than 90 per cent of its sales come from fees from users – for 10 yuan you can have a virtual pet. Advertising makes up the rest. That model helps it to produce more than twice the revenues of Facebook and four times those of Zynga each year.
But it is hard to keep teens engaged for long. Sales growth from subscription fees and virtual items on Tencent’s social networking platforms slowed to a fifth year on year in its fourth quarter, from 25 per cent during the same period in 2010. As a result, Tencent depends even more on its online games to support sales. And this translates into higher spend on advertising to capture gamers. The doubling in marketing costs last year dragged operating margins down by 7 percentage points to 43 per cent.