Tencent Holdings Ltd.'s blowout second quarter saw the Chinese internet company report net income that beat estimates by 35 percent, the most on record.
Revenue climbed an impressive 59 percent and profit to shareholders expanded 70 percent to 18.2 billion yuan ($2.7 billion), which implies that the company is squeezing more profit for every dime of revenue.
It's true that Tencent continued to do well from its core business of selling games, related paraphernalia, and advertising. But actually, 5.1 billion yuan came from other gains such as revaluing its stakes in bike rental and fintech startups, and the IPO of South Korean games publisher Netmarble Games Corp. By comparison, it recorded just 911 million yuan in that same column a year earlier. Absent such one-off items, which it marks down under operating profit, earnings would have come in much closer to estimates.
Another way to strip away such gains is to look at gross profit. This isn't a perfect metric, but looking here we see that margins have been shrinking for the past three years, hitting a low of 50 percent this past quarter. A major reason is increasing expenses for content and payment services, and the price it must pay to distribute its smartphone games.
Relying more on external gains may not be a bad thing since the Tencent business model is predicated on building a platform and ensuring all manner of services are plugged into it. But given the continued decline in gross margin, and Tencent's own admission that the cost of conducting its core business is rising, investors must model their expectations accordingly.
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