China’s $370 billion tech giant Tencent could post its first revenue decline on record

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 behemoth 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 from 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.

While Tencent has said in the past that minors only account for a tiny fraction of its revenue, some of the effects are being seen.

Regulators also froze the approvals of new games in China from last July and only begun giving the green light for new titles in April again. In China, games need to be approved by regulators in order to be monetized. China has heavy censorship on the contents of games.

Analysts at China Renaissance said in a note published last month that Tencent launched just three mobile games in the second quarter so there will be “limited contribution” to revenue from new titles. The analysts are forecasting “flattish” online gaming revenue in the second quarter with domestic gaming revenue to fall 3% and international game revenue to rise 8% year-on-year.

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.”

Investors will be keeping their eye on a few more areas of Tencent’s business.

On Tuesday, Reuters reported that Tencent is planning to divest most of its $24 billion stake in food delivery giant Meituan. A source with knowledge of the matter told CNBC that Tencent has no plans currently to sell its stake. Investors will be hoping to hear from Tencent’s executives on its plans in this area.

Tencent’s fintech and cloud business are also important areas for the company. Tencent runs one of China’s biggest mobile payment platforms called WeChat Pay. China Renaissance said it forecasts just 2% year-on-year revenue growth for fintech due to the Covid resurgence.

Growth of the cloud business could also be hampered due to “project delays and softness in offline activities” because of the pandemic, Jefferies said.