Just two years ago next month, Tencent Holdings Ltd. (700) introduced a mobile instant-message application called WeChat. It already has 200 million users, including Lai Jingkui, a teacher in China’s southern Zhuhai city, who uses the “Drift Bottle” function to find friends.
While Lai, 23, is still looking, Tencent has found a hit. WeChat’s user base could double to 400 million within three years, providing the chance for China’s biggest Internet company to boost revenue by adding mobile e-commerce and location-based advertising, Core Pacific-Yamaichi International (H.K.) Ltd. estimates.
That’s welcome news for Shenzhen-based Tencent, which this year faces its second-slowest annual profit growth since it listed on the Hong Kong Stock Exchange in 2004. The problem: a shift in Internet usage from personal computers to smartphones and tablets.
The trend is pulling users away from Tencent’s offerings toward competitors like Sina (SINA) Corp.’s Twitter-like Weibo microblog, which built a user base of 424 million as of September. Sina is projected by analysts to turn from a loss to a profit in 2012, and net income growth next year is estimated to be more than double Tencent’s.
Tencent is counting on WeChat to close the gap.
“Implementation of WeChat will help Tencent get into a new growth stage, as the company has traditionally relied on online games,” said Kevin Tam, an analyst at Core Pacific-Yamaichi in Hong Kong. “WeChat can replace online games as a growth driver in coming years.”
Tam projects the free WeChat app will begin contributing to sales in 2013. He hasn’t forecast the amount of sales yet.
Tencent, founded in Shenzhen in 1998 with an instant-messaging service called QQ, started its QQ Game Portal in 2003. For the past decade, online games such as “Dungeon & Fighter” and “Cross Fire” propelled Tencent’s growth and contributed 56 percent of revenue in 2011. Now, casual gaming on smartphones and tablets is eating into the growth of gaming on PCs.
Tencent’s net income is projected to increase 24 percent to 12.6 billion yuan ($2 billion) this year, according to the average of 19 analysts’ estimates compiled by Bloomberg. That’s down from 27 percent in 2011, and less than half the 56 percent profit growth in 2010. It would be the slowest pace since a 9 percent gain in 2005, according to data compiled by Bloomberg.
Meanwhile, Sina is projected to rebound from a loss and post a net income of $25.7 million in 2012, according to the average of 17 analysts’ estimates. In 2013, growth in profit will outpace Tencent’s projected 28 percent pace, rising 64 percent to $42 million, according to the estimates. Sina’s market capitalization is $3.1 billion, compared with Tencent’s $59.7 billion, according to data compiled by Bloomberg.
As people spend less time with their PCs, WeChat, known as Weixin in Chinese, gives Tencent a way to capture the explosive increase in the use of tablets and smartphones.
Despite its early lead in the mobile shift, Sina’s advertising-driven business model ultimately won’t keep pace with Tencent’s e-commerce capability, said Cynthia Meng, a Hong Kong-based analyst with Jefferies Group Inc.
“Sina’s mobile traffic is large, but we’re talking about positioning for mobile monetization,” Meng said. “The first opportunities in mobile will come from games and mobile commerce,” at which Tencent has a distinct advantage, she said.
Its core functions allow WeChat users to send text, image or audio messages. The audio message function is similar to an application from WhatsApp Inc. WeChat’s photo-sharing function called “Moments” operates with a timeline and cover-photo layout similar to that of Facebook Inc. (FB), which had more than 1 billion monthly active members as of Sept. 30, including 604 million mobile users. The app’s video conferencing ability is likened to Microsoft Corp. (MSFT)’s Skype.
Twitter Inc.’s messaging and social media service had more than 200 million monthly active users, the San Francisco-based company said on its website Dec. 18. Sites of Twitter and Facebook are both officially blocked in China.
WeChat goes beyond those functions for keeping up with existing friends, providing ways to connect with new ones. The “Drift Bottle” function lets a user throw or pick up a random audio or text message. The interface has a picture of a stretch of beach under a blue sky, where users can pick up a bottle as a virtual hot air balloon drifts overhead. The user can respond to the message or throw it back.
Lai said he likes to use “Drift Bottle” daily even though it hasn’t led to any meaningful new friendships yet.
“It’s very unlikely for me to keep in touch with people I meet using the ‘Drift Bottle,’” Lai said. “People usually just send back one response and the conversation ends there.”
While the bottles go at random to any user around the world, there’s also a way to meet people closer by with a function called “Look Around” that shows who’s using the app in the vicinity. Users who meet each other this way can exchange contacts wirelessly by shaking their phones.
“WeChat is a killer app,” said Alicia Yap a Hong Kong-based analyst at Barclays Plc. “WeChat seems to capture human behavior. Once people use it, and all their friends use it, they need to continue to use it.”
Right now Tencent is “much more focused” on building WeChat’s user base, rather than deciding how to make money from it, President Martin Lau said on a Nov. 14 conference call.
“Monetization from WeChat can come in a similar way as PC Internet,” Lau said on the call. “You can have certain elements of entertainment, you can have certain elements of advertising and you can have certain elements of transactions.”
The Internet company declined to make Lau available for an interview for this story. Tencent has “no plans for monetization in near term” for WeChat, it said in an e-mailed reply to questions from Bloomberg News.
Still, it will not take long for Tencent to begin deriving revenue from WeChat, and the company will probably begin when users reach about 300 million, said Thomas Chong, a Hong Kong-based analyst at BOCI Research Limited. Chong said he hasn’t included any revenue from WeChat in his estimates yet because it’s “too hard to quantify at this stage.”
Tencent could monetize WeChat in several ways, including in-app advertising, fee-based content and premium features, and indirectly through the integration of other Tencent services, said Justin Weiss, an analyst at JI Asia in Tokyo.
“The company recently said that it would add its TenPay online payment services into WeChat by the end of January,” Weiss said. “The move would open the door to a variety of e-commerce-related options.”
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