[Reuters Breakingviews] Tencent provides a timely AI reality check

By Robyn Mak

HONG KONG, Aug 14 (Reuters Breakingviews) - Tencent's 0700.HK latest financial results will bolster the case for both artificial intelligence optimists and sceptics. The $683 billion Chinese video-games group delivered an impressive 15% year-on-year jump in revenue in the June quarter thanks to new technology turbo-charging advertising sales. But the impact on its bottom line is less transformative, and its much-hyped business selling AI services to companies is its slowest growing.

Boss Pony Ma's conglomerate goes to some length to detail how it is deploying AI in its existing businesses. New tools in advertisement creation, placement, recommendation and more helped lift sales in that unit by a fifth to 36 billion yuan ($5 billion) in the quarter year-on-year. That trounces the forecast 6.4% marketing revenue growth at e-commerce giant Alibaba 9988.HK and 15% decline at search-engine operator Baidu 9888.HK over the same period, per Visible Alpha.

Elsewhere, the company is using AI to accelerate content production in its cash-cow video-games unit, as well as creating more realistic non-player characters. Across Tencent's ubiquitous all-in-one messaging app, its ChatGPT-like assistant lets users create text and images, analyse articles and more. In sum, these should all result in better user experiences and engagement across Tencent's stable of games and apps.

How that helps Tencent's bottom line, though, is less obvious. Advertising accounts for just 20% of the company's top line. Having more AI features in games might give it an edge in a notoriously hit-driven and fickle industry, but rivals like NetEase 9999.HK are doing the same. Higher spending on AI infrastructure R&D, as well as rising depreciation costs, will offset some of those gains too. Tencent's net profit is forecast to grow just 14% and 13% in 2026 and 2027, per Visible Alpha, down from 41% last year.

Worse, the company admits that charging users for its expanding range of AI tools and functions will be a long slog. On a call with analysts, Tencent President Martin Lau cautioned that "in China, in reality, it's actually very hard to use the user-paid model" popular in the U.S., including at ChatGPT-owner OpenAI.

Against this backdrop, it will be more important for Tencent to convince companies to pay up as a way to monetise its AI initiatives. In 2018, Tencent announced a "strategic upgrade" to focus on its cloud computing and enterprise-facing services. Yet revenue from that business, which also includes its fintech and payments division, grew just 10% in the recent quarter. Tencent's Hong Kong stock, though up 42% this year, remains 16% below its 2021 peak. Evidence of more AI gains could help it cross that level.

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CONTEXT NEWS

Chinese video-games group Tencent on August 13 reported revenue of 184.5 billion yuan ($25.7 billion) in the three months to June 30, a 15% increase year-on-year. Operating profit rose 18% to 69.2 billion yuan, as the operating profit margin rose to 38% from 36% in the same period last year.

Tencent's Hong Kong shares opened up 2.4% on August 14 to HK$600.

Tencent's earnings growth is forecast to fall