Tencent Holdings Ltd
HKEX:700
Earnings Call Analysis
Q3-2023 Analysis
Tencent Holdings Ltd
In the third quarter of 2023, the company reported a robust performance with a 10% year-over-year revenue increase, reaching RMB 155 billion, and a significant jump in non-IFRS net profit attributable to equity holders by 39% year-over-year and 20% quarter-on-quarter. The growth is described as high-quality, bolstered by an evolving mix of revenue streams that are higher margin and strategically refocused away from less scalable activities.
The user base has continued to expand, with Weixin and WeChat's combined monthly active users (MAU) growing to RMB 1.3 billion. The consistent increase in daily users and daily messages sent through Weixin demonstrates the platform's importance as a core communication tool in China, further augmented by social networking functionalities and customer support services.
The company has reinforced its leadership in competitive multiplayer games and is investing in the creation of future hits across various gaming genres. Additionally, significant advancements are being made in cloud services, with upgrades to the proprietary AI foundation model, 'Tencent Hunyuan', which is now being incorporated into services like Tencent Meeting and Tencent Docs.
The company has strategically shifted focus from maximizing revenue at all costs to nurturing high-quality and sustainable growth. This pivot is driven by innovative features such as Weixin's Video Accounts and Mini Programs, enhancing user engagement. Video Accounts in particular are contributing to a significant margin expansion due to their low ad load and high-margin nature. Cumulatively, these features have enabled Weixin to command a larger slice of user time spent, indirectly leading to increased advertising revenue, and optimizing revenue streams within the platform have yielded more lucrative and quality revenue compared to traditional models.
A significant shift has occurred in the company's financial structure, moving towards a model that promises greater operating leverage. The firm attributes this to a healthy mix of new revenue streams and scaling back less efficient activities. By optimizing costs, such as reducing non-core business commitments and unnecessary marketing spend, along with a heightened focus on cost discipline, the company has managed to increase its operating profit growth rate substantially relative to revenue growth.
Looking forward, the company boasts a strong pipeline of new games under development, including expansions of current game IPs and new titles that promise to strengthen both the consumer offerings and value provided to enterprise customers and the broader society.
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Good day, and good evening. Thank you for standing by. Welcome to Tencent Holdings Limited 2023 Third Quarter Results Announcement Webinar. I'm Wendy Huang from Tencent IR team. After management's presentation, there will be a question-and-answer session. [Operator Instructions] And please be advised that today's webinar is being recorded.
Before we start the presentation, we would like to remind you that it includes forward-looking statements which are underlined by a number of risks and uncertainties and may not be realized in the future for various reasons. Information about general market conditions is coming from a variety of reasons outside of Tencent.
This presentation also contains some unaudited non-IFRS financial measures that should be considered in addition to, but not as a substitute for measures of the Group's financial performance prepared in accordance with IFRS. For a detailed discussion of risk factors and non-IFRS measures, please refer to our disclosure documents on the IR section of our website.
Let me now introduce the management team on webinar tonight. Our Chairman and CEO, Pony Ma, will kick off with a short overview. President, Martin Lau, will discuss strategy review. Chief Strategy Officer, James Mitchell, will provide a business review. Chief Financial Officer, John Lo, will conclude with financial discussion before we open the floor for questions. I will now pass it to Pony.
Thank you, Wendy. Good evening. Thank you, everyone, for joining us. During the third quarter of 2023, we achieved a solid and high-quality revenue growth, notable margin expansion and structural operating leverage. Relatively new services such as video account and mini games contribute higher-margin revenue streams while we refocused away from less scalable activities.
We are increasing investment in our AI models, providing new features to our products and enhancing our targeting capabilities for both content and advertising. We aspire to position our leading AI capability, not only as a growth multiplier for ourselves, but also as a value provider to our enterprise customers and the society at large. Now let me go through the headline financials for the third quarter.
Total revenue was RMB 155 billion, up 10% year-on-year and 4% quarter-on-quarter. Gross profit was RMB 77 billion, up 23% year-on-year and 8% quarter-on-quarter. Non-IFRS operating profit was RMB 56 billion, up 36% year-on-year and 11% quarter-on-quarter. Non-IFRS net profit attributable to equity holders was RMB 45 billion, up 39% year-on-year and 20% quarter-on-quarter.
Turning to our key services for communication and social networks. Combined MAU of Weixin and WeChat grew both year-on-year and quarter-on-quarter RMB 1.3 billion. For games, we reinforced our leadership in competitive multiplayer games while investing to develop future hits in content-driven and casual games.
For cloud, we upgrade the size and capabilities of our proprietary foundation model, Tencent Hunyuan. We are making Hunyuan available on a limited basis to the public and to customers and deploying Hunyuan in Tencent Meeting and Tencent Docs. I will now hand over to Martin for a strategic review.
Thank you, Pony, and good evening, everybody. In the past few years, the Internet industry in China has gone through structural challenges leading to strategic changes. A major strategic change is a shift away from seeking to maximize revenue at all costs toward delivering high-quality and sustainable growth.
Today, I would like to share with you the progress we have made towards high-quality revenue streams and how this shift is translating into improved operating leverage and strategic position. To start with, let me walk you through the evolution of our Weixin platform and how it continues to improve its position by enhancing its value to users.
The original Weixin experience was messaging, and the franchise is stronger than ever as messaging remains the highest daily user frequency service in China. Weixin chat's DAU and daily messages sent per user are consistently increasing, driven by the evergreen need for communications among friends, family members and colleagues. Meanwhile, Weixin chat meets social networking needs through group functionalities and moments, and also enables new forms of connections such as customer support services.
Subsequently, we supplemented messaging with open platforms, which connect users with a range of external services. These include official accounts, which enable brands and content creators to reach their followers with text and image content and Mini Programs, which allow users to transact with merchants and service providers offline and online.
Each day, several 100 million unique user visits and interact with over 1 million unique Mini Programs. Mini Programs facilitated over RMB 1.5 trillion of GMV in the third quarter. Merchants and service providers developing and managing their own Mini Programs provides growth and innovation for our ecosystem. Mini Games, which is a successful vertical use case for Mini Programs, has become the largest casual game community in China. We monetize these open platforms primarily through payment take rates and a very light advertising load resulting in a wide gap between the value we deliver to participants versus the revenue we generate ourselves.
More recently, Weixin launched Video Accounts, which is a major new addition to the Weixin ecosystem. Video Accounts are growing usage fast, and that usage is incremental to our messaging and open platform time spent, uplifting Weixin's overall time spend. Video Accounts also differ from chat and open platforms in that they enable us to participate in high-margin monetization activities such as in-feed advertising and e-commerce technology service fees.
Going into Weixin's new services monetization a bit more. Our newer services innovation are generating revenues at higher incremental margins than our company average. Specifically for Video Accounts, monetization generates high incremental margins because, first, we are already incurring Video Accounts platform cost during the bid-off phase prior to monetization.
Second, once video accounts attain critical mass, our developers can start streamlining operating costs such as bandwidth, service and content costs. Consequently, Video Accounts advertising revenue is high margin and offers a long runway for growth ahead, given increase in video views, low ad load compared to peers and continued the deployment of AI technology to enhance ad click-through rates. video Accounts e-commerce technology service fees, which we book on a net basis are also high margins in nature for similar reasons.
Additionally, we are cultivating more high-quality revenue stream opportunities within Weixin. For example, Mini Games, which we discussed last quarter, had quite a bit of length, contribute to platform fees and advertising revenues to Tencent. From a reporting perspective, we also book platform fees on a net basis such that Mini Games revenue carries higher margins than app-based games. And for Weixin Search, the increasing volume of transactions within Weixin is driving rapid growth in our commercial curate volume and marketing search keywords on our own existing traffic generates high margin inherently.
As a result, we believe we have moved into a high-quality revenue growth model. Under this model, we can now deliver greater operating leverage than in the past. Prior to 2021, our gross and operating profit typically grew at similar or slower rates versus our revenue. While in 2021 and '22, slowing revenue growth translated into even slower profit growth or in some certain quarters, profit declines.
However, entering 2023, solid revenue growth rates have translated into substantially faster growth and operating profit growth rates. There are 3 drivers in this significant change, two sustainable ones colored in blue on the right and onetime driver colored in gray, the biggest driver of this change, which we view as structural in nature is a positive revenue mix shift, i.e., the growth of new high-quality revenue streams and the scale back of certain low-quality in activities. This positive mix shift is the primary reason for gross profit growth exceeding revenue growth.
A second driver, which we view as less recurring, is that we optimize costs by exiting certain noncore business and cut back excessive spending on operations subsidies and marketing activities during the tough time. This driver helps explain why operating profit growth has exceeded gross profit growth, partly and we view it as a lever for pooling at certain times, but not at all times.
The third driver, which we view as ongoing, is our heightened focus on cost discipline. We're seeking to continuously improve operational efficiency, thoughtfully allocate headcount and effectively manage marketing expenses so as to maintain a focused organization and lean cost structure for the future.
Lastly, I'll also share with you how we think about our position in the games market. We maintain a strong and defensible franchise in competitive multiplayer games due to the ongoing popularity and performance of our flagship evergreen games, such as Honour of Kings, League of Legends and Peacekeeper Elite. But we also supplement our success by cultivating new competitive multiplayer games, such as Fights of Golden Spatula, Arena Breakout and VALORANT, which have the potential of becoming evergreen titles in the future.
Looking across the market, we've seen increased interest in casual games and renewed excitement around content-driven games. These trends have not negatively impacted our competitive multiplayer games in terms of audience and monetization. On the other hand, we see these as new opportunities for us to capture and we are investing to benefit from these trends.
For content-driven games, we have attained some success, including Naruto Mobile, Lost Ark and NIKKE. But we aspire to create even bigger hits in the future. For casual games, we already operate the largest casual game platform in the model of Mini Games. We are also seeking to operate blockbuster app-based casual games with user-generated content capabilities.
Looking forward, we have a substantial pipeline of new games in development, including games that expand our own game IPs such as Honour of King World, Valorant Mobile and Delta Force, mobile games that utilize well-loved licensed IPs such as Monster Hunter Mobile, Assassin's Creed Mobile and One Piece Mobile and new games with new IPs in high-potential genres such as Dream Stars in casual games, Nightingale in survival open world crafting and Ash Echos in [ RPG ]. We're taking more time than before in developing these games because we want to ensure the quality of these games and because our improved financial structure described in the previous slides, offer us the ability to do so.
Now with that, I will pass to James to talk about business review.
Thank you, Martin. For the third quarter of 2023, our total revenue increased 10% year-on-year. VAS represented 49% of our revenue, within which the social network subsegment was 19%, domestic games 21% and international games, 9%. Online advertising was 16% of our revenue, and FinTech and Business Services was 34%.
For value-added services, segment revenue was RMB 76 billion, up 4% year-on-year. Social networks revenue was RMB 30 billion, flat year-on-year, as revenue from music-related and game-related live streaming services sharply decreased, while revenue from music subscriptions and Mini Games substantially increased. Profitability improved as we book entertainment live streaming revenue on a gross basis, creating revenue sharing as content cost, whereas we book Mini Game revenue on a net basis, netting the game developers revenue share out of our revenue.
Long-form video subscription revenue increased 2% year-over-year, benefiting from higher ARPU. Video subscriptions declined slightly year-on-year, though grew quarter-on-quarter to 117 million accounts. Our exclusive drama series, Lost You Forever, ranked first industry-wide by video views across all online platforms in China during the quarter. Music subscription revenue increased 42% year-on-year. Tencent Music optimized user operations, enriched membership privileges and deepened collaborations with labels and artists, resulting in music subscriptions up 21% year-on-year to 103 million accounts and ARPU increasing 17% year-on-year.
Domestic Games revenue grew 5% year-on-year to RMB 33 billion. The increase was driven by new launches, VALORANT and Lost Ark, as well as evergreen titles such as Honour of Kings and Dungeon & Fighter. International games revenue increased 14% year-on-year or 7% in constant currency terms to RMB 13 billion. The recovery of PUBG Mobile and sustained contributions from NIKKE, VALORANT and Triple Match 3D drove the growth and offset a tough comparison from Tower of Fantasy's launch quarter in the third quarter of 2022.
For communications and social networks, Weixin Video Accounts video views increased over 50% year-on-year, thanks to a thriving creator community and growing user mindshare. Original content that is uploaded directly to Video Accounts now contributes to the large majority of our video views, demonstrating the services content creation and consumption flywheel. We're enhancing our recommendation algorithms and traffic support programs to more actively surface original content within the video accounts.
Inside QQ, we're adding capabilities to QQ Channels, which enable users with shared hobbies activities on memberships to operate interest-based communities using software tools such as voice chat and event management. QQ now hosts over 700,000 active channels covering categories including colleges, games, knowledge-based content and music.
Moving to domestic games. The 19th Asian Games held in Hangzhou included esports as official medal events for the first time, reflecting interesting competitive gains from the general public and endorsement from governments. We published 4 out of the 7 games selected for the Asian Games: Arena of Valor, Peacekeeper Elite, League of Legends and FC Online.
During the quarter, we extended our leadership in competitive multiplayer games. Honour of Kings remained the first place mobile game across all genres in terms of DAU, time spent and gross receipts, while we've also grown Wild Rift's audience in monetization such that Wild Rift now ranks among the top 10 mobile games by gross receipts, too.
Between our 3 big battle arena games, Honour of King, Wild Rift and League of Legends, we serve different player needs and innovate in multiple directions within the battle arena genre. Similarly, for FPS games, we're launching new titles that appeal to different fair interest and capture new gameplay concepts, such as the PC tactical first-person game, VALORANT and the mobile hero first-person game, Hyper Legends.
While it typically takes several years to grow individual FPS game since their potential audience and monetization, VALORANT has already become one of the leading PC games in China in terms of users and of revenue.
Martin spoke about our aspiration to size up in content-driven and casual games. For content-driven games, in August, we launched MapleStory: The Legends of Maple, which we ranked fourth across all mobile games like gross receipts in its first 30 days. For casual games, we opened our mobile party game, Dream Stars, up for preregistration in September, and the game has accumulated over 27 million preregistrations so far. We're making a substantial investment around Dream Star's upcoming launch.
Turning to international games. Among our competitive multiplayer games, after a post-COVID consolidation period, PUBG Mobile returned to year-on-year and quarter-on-quarter increases in DAU and gross receipts, benefiting from appealing content and themed events such as the Dragon Ball collaboration. Call of Duty Mobile, which we released back in 2019, achieved record high monthly gross receipts in July, driven by new season content, including a top tier operator and a new arena mode.
Among our content-driven games, NIKKE maintained robust DAU and gross receipts via content updates, such as a collaboration with Square Enix's NieR:Automata. For online advertising, our revenue increased 20% year-on-year to RMB 26 billion, with notable growth contributions from Video Accounts, mobile ad network and Weixin search. Advertiser categories, such as fast-moving consumer goods and local services, increased spending while automobiles were weaker.
Our advertising revenue year-on-year growth rate slowed versus the previous quarter because as e-commerce has become a much bigger contributor to our ad revenue in recent periods, our advertising revenue seasonality has changed with the second and fourth quarters of each year seeing more positive seasonality while the first and third quarters see weaker seasonality, reflecting the wasting of e-commerce promotional activities towards the second and fourth quarter of each year.
In addition, we began monetizing video accounts via in-feed ads through the third quarter of last year. We have expanded our AI models with more parameters to increase their ad targeting and attribution accuracy contributing to our ad revenue growth. We're also starting to provide generative AI tools to advertiser partners, which enables them to dynamically generate ad visuals based on text fronts and to optimize ad sizes for different inventories, which should help advertisers create more appealing advertisements with higher click-through rates boosting their transactions in our revenue.
Closed loop advisements, which linked directly to a transactional user action within the app where the advertisement appears, provide users and advertisers with a shorter impression to transaction funnel and enhance the effectiveness and measurability of advertising spend. Advertisers are increasingly linking their ads within Weixin to transactions or actions inside the advertisers Mini Program, Video Account, official accounts or WeCom landing page. And such closed loop ad revenue increased over 30% year-on-year during the quarter, now accounting for more than half of Weixin's ad revenue.
Video Accounts' ad revenue grew notably quarter-on-quarter, driven by increases in video views and time spent on a stable ad load percentage. On the content side, our long-form video ad revenue increased moderately year-on-year, and our music ad revenue maintained robust year-over-year growth.
Looking at FinTech and Business Services. Segment revenue was RMB 52 billion, up 16% year-on-year. FinTech services revenue sustained a teens year-on-year growth rate, benefiting from increased commercial payment activity and wealth management aggregated customer assets. The commercial payments, daily active users and transaction per user both increased year-on-year. Enhanced merchant solutions boosted Mini Program transactions in categories such as retail, travel and transportation and dining services, and Mini Program transactions have notably increased as a proportion of our overall commercial payment volume. For Business Services, revenue grew at a double-digit rate year-on-year in the third quarter, accelerating versus the second quarter, and the business services gross margin improved significantly year-on-year.
Our cloud services revenue growth benefited from the restructuring undertaken in prior periods as well as from higher spending by industries such as finance and automotive. Video Accounts e-commerce transaction GMV increased quarter-on-quarter and the technology service fees we collect on these transactions contributed to the Business Services revenue and margin uplift.
We have upgraded our proprietary foundation model, Tencent Hunyuan. We have made Tencent Hunyuan bot initially available to a smaller but expanding number of users via a Mini Program. Hunyuan is also now powering meeting summarization in Tencent Meeting and content generation in Tencent Docs. And externally, we're enabling enterprise customers to utilize our large language model via APIs or model as a Service solutions in our cloud for functions such as coding, data analysis and customer service automation.
And now I'll pass to John for the financial review.
Thank you, James. Hello, everyone. For the third quarter of 2023, total revenue was RMB 154.6 billion, up 10% year-on-year. Gross profit was RMB 76.5 billion, up 23% year-on-year. Operating profit was RMB 48.5 billion, down 6% year-on-year. Finance costs were RMB 2.8 billion, up 43% year-on-year due to reduced ForEx gains and to a lesser extent, higher interest expenses. Share of profit of associates and JVs was RMB 2.1 billion compared to a share of loss of RMB 3.7 billion for the third quarter of 2022.
On a non-IFRS basis, share of profit was RMB 4.8 billion, improving from share of profit of RMB 2.4 billion last year. This was driven by better profitability of certain domestic associates, thanks to the revenue growth and improved cost efficiency, along with the successful game released by an overseas investee.
Income tax expense increased by 55% year-on-year to RMB 11 billion, driven by pretax profit growth and increased withholding tax provision. IFRS net profit attributable to equity holders was RMB 36.2 billion, down 9% year-on-year. Diluted EPS was RMB 3.752, down 9% year-on-year. Now I'll share our non-IFRS financial figures.
Operating profit was RMB 55.5 billion, up 36% year-on-year. Net profit attributable to equity holders was RMB 44.9 billion, up 39% year-on-year. Diluted EPS was RMB 4.657, up 41% year-on-year.
Moving on to gross margins. Overall gross margin was 49.5%, up 5.3 percentage points year-on-year. By segment, gross margin for VAS was 55.5%, up 3.8 percentage points year-on-year. This was due to higher mix of high-margin games revenue, including Mini Games, and lower mix of low-margin music and games related live streaming revenue, along with our cost control measures.
Gross margin for online advertising increased to 52.3%, up 6 percentage points year-on-year. This was mainly driven by high incremental profits generated from Video Accounts ad revenue as well as our efficiency improvement. Gross margin for FinTech and Business Services was 40.9%, up 7.6 percentage points year-on-year. This was driven by margin improvement for in-cloud business restructuring, emerging high-margin revenue from Video Accounts, e-commerce, technology service fees, structural shift towards certain high-margin products within fintech services and our operational efficiency initiatives.
On operating expenses, selling and marketing expenses were RMB 7.9 billion, up 11% year-on-year, due to more spending on promotion advertising and the total represented 5.1% each -- 5.1% of revenues. R&D expenses were RMB 16.5 billion, up 9% year-on-year, mainly because of higher staff hours on research and development projects. G&A excluding R&D were RMB 9.8 billion, down 14% year-on-year, mainly due to lower staff hours, including reduced surveillance payments. At quarter end, we had approximately 105,000 employees, down 3% year-on-year or up 1% quarter-on-quarter.
Let's look at our operating and net margin ratios. For the third quarter of 2023, non-IFRS operating margin was 35.9%, up 6.7 percentage points year-on-year. Non-IFRS net margin was 29.6%, up 5.8 percentage points year-on-year. To conclude, I'll highlight some cash, key cash flow and balance sheet metrics.
Total CapEx was RMB 8 billion more than triple year-on-year. Within total CapEx, operating CapEx was RMB 6.6 billion, up more than 5x year-on-year driven by increasing investment in GPUs and servers. Nonoperating CapEx rose by 6% year-on-year to RMB 1.4 billion. Free cash flow was RMB 51.1 billion, up 85% year-on-year, mainly driven by higher receipts from various businesses and timing difference in the settlement of certain accounts payables. Net cash position was RMB 36.4 billion, up 106% quarter-on-quarter, reflecting strong free cash flow generation, partially offset by cash outflow for share repurchases and strategic investments. Thank you.
Thank you, John. We shall now open the floor for questions. [Operator Instructions] The first question comes from Kenneth Fong from UBS.
Congrats for another solid quarter of quality growth. I have 2 questions. The first is on Mini Games. Could management share with us more about the future strategy of Mini Games given Tencent's strong franchise. We will be just staying at a platform for distribution? Or we can actually use Mini Games to rejuvenate some of our existing titles, which are late in their product cycles?
Also going forward, any shift in our strategy on the game launch between app-based versus Mini Games in our games going forward? And I have a follow-up question on the AI strategy. We have successfully launched the Hunyuan AI model, and we send out versus our peers with our use cases. Can management share with us how would the U.S. take spend impact our AI strategy, including product launch monetization and also area of focus?
Kenneth, thank you for your question. So I'll take the Mini Game question. Martin will handle the AI question. For the Mini Games, we view the Mini Game opportunity for Tencent primarily as a platform opportunity. And there are many thousands of game development studios that you now focus on creating Mini Games. We're very happy to nurture that ecosystem and we don't want to squeeze or unduly pressure that ecosystem. You asked about whether we would seek to rejuvenate existing titles, which are late in their product cycle, by releasing Mini Games.
And the reality is that our game strategy is not built on titles that have a product cycle that age and then require heavy rejuvenation. Our game strategy is built around what we hope will become evergreen games, and it's built around making those evergreen games as popular and successful as they can be, and then adding further evergreen games that would also be popular and successful. So we don't hugely focus on taking smaller games that have a product cycle and then seeking to rejuvenate them through Mini Games or anything else.
In terms of Hunyuan and the overall AI strategy, I would say we have been pretty far along in terms of building up Hunyuan, and we feel that we are one of the leaders within China, and we are also continuously increasing the size of the model and preparing for the next generation of our Hunyuan model, which is going to be a mixture of experts architecture, which we believe will further improve the performance of our Hunyuan model.
And by building up Hunyuan, we actually have really build up our capability in general AI across the board. Because Hunyuan, the transformer-based model include -- involves the handling of a large amount of data, large amount of training data, large size of computing cluster and a very dedicated fine-tuning process in terms of improving the AI performance.
And by going through the process right now, we have also built up a lot of our AI capability, which is not transformer-based, but can be applied in many of our other businesses. So if you look at Hunyuan itself, right, right now, we see it very good at generating text messages. And that actually is quite useful for a lot of SaaS applications to improve the capability of the SaaS service.
For example, in Tencent Meeting, we can actually leverage Hunyuan to provide summary of meetings and help people to catch up on meetings if they have missed the first half of the meeting and so on and so forth. And in Tencent Docs, we can actually provide a whole set of tools for people to create documents in a much more efficient way. And these services are already offered to outside customers. And we also have a whole set of productivity enhancement tools such as the customer service APIs, which are now being tested by a lot of customers and enterprise customers who have the need to interact with the customers.
In terms of cogeneration, it's actually sort of providing very good results and tools for our programmers as well as our outside customer programmers to improve on their coding efficiency. And it's also helping in terms of content creation for both of our advertising business, helping advertisers to create more ads, more targeted ads which can be used to improve the click-through rates of the advertising as well as in the game production process, especially related to the artwork. We are actually leveraging AI to actually help us to create this artwork in a more efficient and cost-effective way.
Look -- so that's for Hunyuan. And the general AI capability is actually helping us quite a bit in terms of the targeting technology related to advertising and our content provisioning service. So in short video, by improving our AI capability, we can actually ramp up our Video Accounts at the faster clip. And in terms of the advertising business, by increasing the targeting capability, we are actually increasing our ad revenue and by delivering better results to the -- to our customers. So they are generating -- so our AI capabilities are generating tangible result at this point in time.
And we actually look into the future. Hunyuan can actually provide a lot of tools for enterprise customers. It can further improve our advertising business efficiency by, in the future, really merging the advertising stage and the selling stage, right. If we can actually provide very good customer service capability, then a lot of merchants can actually combine the advertising and sales process into one.
And we also feel that further in the future, when there's actually a consumer-facing product that is more like a smart agent for people right now, that is further down the road, but it actually carries quite a bit of room for imagination. Now in terms of the chip situation, right now, we actually have one of the largest inventory of AI chips in China among all the players. And one of the key things that we have done was actually we were the first to put in order for H800, and that allow us to have a pretty good inventory of H800 chips. So we have enough chips to continue our development of Hunyuan for at least a couple more generations. And the ban does not really affect the development of Hunyuan and our AI capability in the near future.
Going forward, we feel that the shipment does actually affect our ability to resell these AI chips to -- through our cloud services. So that's one area that may be impacted. And going forward, we will have to figure out ways to make our -- the usage of our AI chips more efficient. We'll try to see whether we can offload a lot of the inference capability to lower-performance chips so that we can retain the majority of our high-performance AI chips for training purpose. And we also try to look for domestic stores for these training chips.
Thank you. We will take the next question from Gary Yu from Morgan Stanley.
Congratulations for another solid quarter. My first questions is also related to the games business. I think 2 years ago, we also identified games as the key investment area for future growth. I think at that time, we were expecting a kind of 2 to 3 years production cycle. We commented that because of the improving financial performance, we now had the last show to take a longer time for production cycle. So where are we right now at the kind of production cycle? And how should we look at these investments translating into games pipeline in different genres and also financial performance in the next couple of years?
And then I have a follow-up questions related to our capital management. I think last year, we increased dividends. We have also stepped up share buyback. How should we look at the opportunities in our investment portfolio, similar to what we did on JD and [indiscernible] distribution in the past 2 years?
Gary, so on the game question, then in general, we have chosen to elongate our game production cycles sometimes by 6 months, sometimes by 18 months. And there's a couple of reasons for that. One is that we can see empirically that there's bigger opportunities now for the best games, especially if the development studio is patient about investing at the time the resources to make the best games be or that they can be. And of course, we want to capitalize on that and release the best games.
And then secondly, as you alluded to, with the high-quality revenue growth model in place, we feel we now have the luxury where our business, because of Video Accounts, because of Mini Games, because of search, because of e-commerce, is actually capable of sustaining quite healthy earnings growth rates even without releasing a big game in a given 3-month period.
And therefore, with the -- both of those in place, we think that for us, it makes -- has made sense for us to play the long game and really focus on making the games in our pipeline be what that they can be. And Martin highlighted 9 games in our pipeline. One of those games will be released in the coming weeks. The others will be released in the coming few months. And those will be the test cases of how effectively we're executing in that direction.
But overall, we feel that we now have this luxury of playing the long game because of the high-quality revenue growth model provides us with earnings growth irrespective of whether we're launching a game in a quarter or not.
In terms of shareholder return and capital management, I would say a few points, right? Number one, we are very focused on shareholder return, and we'll try a different ways to improve it. And secondly, we do have a very strong cash flow alongside with a very large investment portfolio, half of which is actually in liquid stocks. So we do have the flexibility of using different tools to increase shareholder return.
And if you look at the tools that we have, right. Obviously, you mentioned their share buyback, there's a dividend. There is also a distribution of investee shares that we have executed before. And there's also divesting investments so that we generate cash so that we can actually do more of share buyback and dividend. So we will use these tools dynamically and also at different times in different combination to improve and return -- improve the shareholder return and return capital to our shareholders.
But I would say at this point in time, if you look at the market, the valuation in the market for China in net stock is almost at historical lows, right? So I would say, at this point, buyback will be a more favorable means for our shareholders than other means.
Thank you. We will take the next question from William Packer from BNP.
Congrats on the strong quarter. My question is around the sustainability of gross margin improvement across the key, VAS ads and fintech segments of your portfolio. Are the gains we've seen year-to-date sustainable into 2024 and beyond? And is there further upside from mix shift? And my follow-up question was around domestic gaming. Gross has been volatile in recent years, as you've digested the impact of lockdowns, rectification, et cetera, we now seem to settle into a more normalized period. How should we think about the medium- to long-term growth algorithm for the segment? And to what extent are you reliant on new hit content within that segment?
So on the margin question, we talked about how there's 3 drivers of the uplift in margins in recent quarters. And 2 of them, we view as sustainable and recurring in nature, one of them, which is the headcount adjustments, restructuring and so forth is more episodic in nature. And looking forward, in general, the revenue streams that are growing fastest in our business are the revenue streams with the highest margins. So we believe that the current level of margin -- of gross margin is sustainable, and we believe that there is room for margins to improve further.
If you look at the advertising segment, for example, the gross margin has improved from 30% to around 50%. Our closest global comparable is running an advertising gross margin of 18%. So that's on the margin side. With regard to the games, then we believe that the existing evergreen games provide a certain quantum of growth. And then on top of that, we have new games in the pipeline. And depending on when we release those and the success of those new games, those can provide additional growth on top. Thank you.
Thank you, William. Next question comes from John Choi from Daiwa.
I have just a quick 1 question on the gains, as you mentioned. I think you guys mentioned that domestic you're more comfortable with the more launches. But as we go into the international side, can you kind of elaborate like what kind of investments that we have to do further as we continue to invest? I do understand that we have, first, I think Call of Duty Mobile, you mentioned that after despite being launched 4 years ago, where you had a record July. So I wanted to know like what are -- like kind of how do you elongate or revive some of the old titles while you balance the new launches?
And just a quick follow-up on your CapEx and headcount plan. Can you kind of share us what -- I think this quarter, we did see elevated CapEx this time and also headcount did see a sequential improvement. So as you go into 2024, could management share some color on this area?
So on the international games, we've already been running a very substantial investment in international game development through our P&L. If you take our studios such as Riot, Supercell, Miniclip, [indiscernible] and on and on and on, then we're actually one of the biggest game developers in the world, executing our China business. And of course, our big China studios such as Timi and Quantum add many thousands more of developers who are creating games that are targeting in international as well as domestic market.
So we feel that we have the teams in place now to create big budget, high production value and ultimately successful games for the international market, and we'll be bringing those games to release in the quarters to come. So that's on the game side. CapEx, John, please?
Yes. Operating CapEx represents about 3.5% of total revenue, 3% to 3.5% in 2023. And for 2024, I think it would be at similar level. And if we are able to get more GPUs to add on and the 1% on top of that 3% to 3.5% in. For nonoperating CapEx every year on the construction side, we spent roughly USD 1 billion in the past few years. That's excluding any land acquisition. If we add on land acquisition, it shouldn't be more than additional $1 billion on top of that construction cost.
In terms of headcounts, we believe most of the efficiency optimization have been done, and we have the right size of a workforce for our existing business. We are hiring selectively to grow our new businesses. But also, it's actually very important for us to recognize that big teams are actually not very good for focus and efficiency execution of businesses.
So in the past, I think we and maybe many other companies that actually sort of built teams up too quickly and built too large a team. And so going forward, consistent with what we talked about in our new high-quality revenue growth model. One of the key thing is actually cost discipline and the cost discipline is -- part of it is trying to keep our teams smaller but with better people so that we can actually help our team to focus on the real value-added things to work on. And that turns out to usually be a value creation exercise for our business and make ourselves, our business strategically stronger.
Thank you. We will take the next question from Alicia Yap from Citi.
Okay. All right. Also congrats on the solid profit beat. Two questions. First is on the Video Accounts advertising revenue as we started to laps out the lower base. And although we're going to still have the close looped e-commerce transactions to benefit and support that solid ad growth for the Video Account. Just wondering what could be the steady state of the growth rate for the overall online ad revenues going forward?
And then a follow-up is on the Hunyuan model. I think management did mention potentially sometimes down the road, there will be a commercial product for consumer ad. So just wondering when we can see, for example, the AI system to be integrated into retail in Q2. And when that is ready, would that be potential also a commercial service charge, for example, like the subscription?
So on your first question about video account advertising revenue. We're not super focused on whether there's a low base or a higher base because actually, we have 4 discrete growth drivers we see supporting our advertising revenue growth, not just this year, but for many years to come. The first of them is traffic. So the number of video views today is substantially greater than 50% higher than it was when we began monetizing Video Accounts just over a year ago. And so that's an immediate uplift and an ongoing uplift because we believe video accounts traffic will continue to grow.
Second, there's the ad load. Today, the ad load we operate at on Video Accounts is less than 3%. the ad load that our domestic peers operate at is over 10%. And so we have room to very substantially multiply our ad load over the years to come versus where it is today.
Thirdly, there's the ability to uplift our click-through rates using artificial intelligence. Today, a typical click-through rate might be around 1%. As you deploy large language models, then you can make more use of the thousands of discrete data points that we have potentially for targeting and bring them to bear and turn them into reality. And you can get pretty substantial uplifts in click-through rate and therefore, in revenue, which is what the big U.S. social networks are now starting to see.
And fourth, there's the closed loop opportunity. And if you look at our domestic peers in the short video space, they have been very focused and very effective at maximizing closed-loop transactions because those generate the most information, those enable the greatest future targeting, forward targeting abilities. And given our Mini Programs, given our WeCom landing pages, given Video Accounts, and given the Tencent payment infrastructure, we feel we're in an ideal position to further ramp up our own close-loop capabilities. So with those 4 drivers in place, obviously, the macro environment is out of our control, but we have 4 important drivers of growth within our control.
Now in terms of the Hunyuan and in the future, the potential of an AI assistant, I think it's fair to say it's still in a very, very early stage of concept design. So definitely not at the stage of product design yet and definitely not at the stage of thinking about monetization yet.
But of course, right, if you look at any of these generative AI technology at this point in time, inference cost is a real variable cost, which needs to be considered in the entire equation. And that, to some extent, add to the challenge of the product design, too. So I would say, at this point in time, it's actually very early stage. There is a promise and imaginary room for opportunity for the future. But it's too early to talk very concretely about it for now.
Thank you. We will take the next question from Thomas Chong from Jefferies. Okay. We will maybe come back to Thomas later. So we would...
Can you hear me? Sorry.
Yes, we can hear you now. Yes, we can hear you now.
Sorry. My question is about live streaming e-commerce. Given that the competitive environment is very intense and we are seeing Video Accounts is gaining very good traction, enjoying very fast growth. So I just want to get some color from a management perspective about our strategies and our goal in coming years? And in particular, how we should think about the internal advertising as well as the commissions growth trend or any market position that we want to achieve in coming years?
Well, in terms of live streaming e-commerce, I think the playbook is actually quite clear, right? Once you have the short video franchise, you actually sort of start taking that into the live streaming and build a franchise there. And then from live streaming, if you can actually establish the tools and the connection and a supply chain of merchants, then you can start building up the live streaming e-commerce.
So the playbook is actually well developed. What we are doing is actually we want to build it in a systematic way, step by step. And it does involve a process of many steps, including building a strong ops team so that we can ensure the quality of the products offered on our platform, building category teams to manage different categories, building tools and infrastructure to facilitate merchants to do more businesses, we need to have integration of the entire ecosystem into our ad system.
And also, we need to build up a KOL ecosystem so that the merchants can leverage the KOL to facilitate the live streaming e-commerce business, right? So I think this would actually, if played out step by step, right, would basically mirror the market share that we have on short video, right? When you have short video, you have the live streaming. And the live streaming, you actually sort of have the live streaming e-commerce GMV.
And I think if we execute all of those steps well within the playbook, then it would give us a fair share. But over and beyond, we believe we have some pretty unique capabilities or characteristics that we can bring to bear that may offer further upside that include we have a very strong Mini Program ecosystem, and there are a lot of merchants and brands who are already doing a lot of businesses on Mini Programs.
And if we can actually connect our live streaming e-commerce with the Mini Programs and the additional layer of integration and ability to do more business, we have social sharing within our ecosystem, right, and that would actually help merchants and products to be shared to many other friends and connections and as a result, can generate more sales. And we also have a pretty significant group of high-income and affluent customer base who are probably not that used to shopping on short video platform at this point in time. And if we can bring them to the entire live streaming and e-commerce ecosystem that could offer further upside. So that's the way we think about the live streaming e-commerce at this point in time.
Thank you. The next question is Alex Yao from JPMorgan.
Congrats on a good quarter. I have 2 questions. Number one, regarding the growth driver of advertising business. James, you mentioned Weixin Search as one of the driver. Can you share with us a little bit more metrics in terms of where the business is? For example, percentage of the Weixin DAU who use Weixin Search, et cetera, et cetera? And very importantly, I would like to understand how you think about the long-term monetization opportunity given search ads is a [indiscernible] model with many years of operational history in China Internet. So that's the first one on Weixin Search.
Second question is on the Mini Game. We noticed that some majority of the mid-core and hardcore game activities are still mostly take place in apps. What does it take for those mid-core and harder core game activity to migrate into mini game ecosystem? Is it currently constrained by technology or bandwidth? Or it's more of a user behavior issue?
Well, why don't I take the Mini Game question. So Sorry, Martin. So on the Mini Game question, there's a number of constraints. We believe the most important is the technical capabilities and the game development tools for making Mini Games that are comparable to app-based games.
And I say that, first of all, because if you look at similar concepts such as Roblox, and over time, there's been a steady broadening in the range of games available on Roblox or to graphically immersive more and more multiplayer, more and more fast-paced switch-based games. And we're seeing now something similar in Mini Games where the initial Mini Games were typically single player, then there were basic multiplayer card games.
Now we're moving into multiplayer role-playing games. And then going into the future, we expect to see multiplayer first-person action games. So as the handsets become more sophisticated, as the mini game architecture becomes more powerful as the developers become more expert in creating Mini Games then there should be a long-term convergence in terms of the capabilities and the experiences of Mini Games versus app-based games. And as that happens, then there's no intrinsic reason why people who are currently playing at base games wouldn't also start playing Mini Games.
Now in terms of Weixin Search. Right now, the penetration is actually quite high, right? So starting from people basically searching for in-app contact and content, basically, everybody does it on a very frequent basis every day, right?
But then in addition to that, everybody have to actually search something on the Open Web as well as in the ecosystem. So the content search, everybody has done some of that. But what we need to do is actually need to have people use it more frequently.
And the way through which we can actually make it more frequently used is, of course, one, the search technology, right? And within Weixin, we have been constantly building up the technology. And I think the search technology has improved consistently. And after we have acquired Sogou, the technology of search have also taken a step up.
The second is that actually the search user experience. Because Weixin is a tool which people communicate, so we actually need to have a user experience that allow people to find the content more quickly than normally if people open up browser and try to do searches. And I think that we have made progress, but there's still more work to be done.
And the third one is actually the ecosystem, right? So we have a lot of content within Weixin, and that's through official accounts. And there's also an increasingly large Mini Program ecosystem that's sitting on Weixin, and now there's also Video Accounts. The ability for us to leverage the Weixin Search and connect it to all the content within our ecosystem is actually something that we -- building over time. And once we have done that, right, we can allow people to search on the Open Web. We also have unique content that's uniquely available on Weixin and the Weixin Search value proposition and content will be even better.
So I think those are things that we have been doing in order to increase the frequency of usage by our users on Search. And we have seen encouraging signs on that because the VV and in general, VV on content have been increasing consistently over the past few years. And over time, we felt once we have built up that content search traffic within Weixin on a consistent basis, then we can actually overlay demonetization, right?
And right now, the ad load on our search is still very, very low. So that there's actually a lot of potential for us to increase it. But more important, I think the ability for us to build a transaction ecosystem within Weixin is actually very important for the future growth of Weixin Search. The more Mini Program transactions that we can generate, the more live streaming e-commerce that we can generate over time that would actually help us to increase the potential for Weixin search monetization. And we feel there's actually a very long runway in terms of growing this part of the business.
Thank you. We will take the next question from Charlene Liu from HSBC.
I have 2 questions. First is on advertising, which obviously has been a really strong year for Tencent as the platform has been gaining market share, considering e-commerce is becoming a bigger contributor. And obviously, there are seasonality factors that comes with that contribution from Weixin Search. And next year, obviously, we could see over [indiscernible] for Video Accounts after it has delivered very robust growth this year. Should we expect, I guess, growth to accelerate into the next quarter or 2024? Just generally how you're thinking about the outlook? And then I have a follow-up on international games.
Charlene, we missed some of the questions. I think it also may have overlapped a little bit with Alicia's question earlier. So I just refer back to that in the -- we see 4 discrete growth drivers for our advertising business, including traffic growth, increased ad load to converge with industry peers, deployment of AI to boost CTR and closed-loop advertising. And so those are all on the positive side, and then macro could be a potential negative. But candidly, this year hasn't been a spectacular year from a macro perspective anyway.
In terms of what that translates into -- for growth in next quarter or next year, we don't give guidance. And the theme we've been talking about this evening is not a high revenue growth model, it's high-quality revenue growth model. So we're less focused on maximizing the speed of our revenue growth in any given quarter. We're more focused on having a healthy sustainable revenue growth rate. And we believe with sustainable revenue growth rate, we can drive a faster earnings growth rate. So that's on the advertising question.
I guess separately on international games. I guess what factors should we be focusing on as we think about again the outlook? Obviously, we're reading a little bit more about layoffs in the industry. How should we think about contributing factors like user spending as well as development pace of new launches and consolidation within the industry, how would these things kind of play out, whether it will help a bit or help or benefit Tencent?
But I don't think there's a very simple single answer. It's a complex industry, and it went through a period of rapid headcount increase over the last 2, 3 years. Now it's going through a period of headcount consolidation. That's happened many times in the past. And unfortunately, it may happen again in the future, and it's just incumbent on us to navigate that effectively. But again, we have the benefit in that because we have a number of other businesses that are growing quickly, therefore, we don't feel pressure to maximize our international or our domestic game revenue growth in any single quarter.
If you are looking at Microsoft, then Microsoft doesn't feel, it has to release a new Halo game on December 31 rather than January 1 because people keep using Windows and Office and [indiscernible] as on all of the other Microsoft products that also generate profit growth. And I think we're now in that position where with the improving margins of our advertising business, with the improving margins of our fintech business, with the turnaround in our business services, the new contributions from e-commerce and so forth, then we have a multipronged growth model. And so as and when international games has a big new product and accelerates, that's great. But in the meantime, international games is not the primary determinant of whether we grow our earnings or not in any given quarter.
Thank you, Charlene. We will take the last question from [ Romel ] Kong from Goldman Sachs.
So my first question, I think on FBS. We haven't heard too much on the fintech's mid-teens growth and the cloud business so far. Just how should we think about the landscape on these 2 and the growth outlook? Should we expect a further recovery, particularly on the business services, excluding the e-commerce side of the cloud business in the competitive landscape and outlook? Maybe I'll ask the second question as well, just in one go.
So on our shareholder return policies, how should we think about our current investment portfolio in terms of the investment and the reinvestment piece this year? And any lessons or experience from the past 2 years of distribution that we have from my experience and how should we think about the shareholder return on the investment portfolio front?
In terms of the FBS, I think there are 2 parts of it, right? There is the fintech and there is the business services. Now in terms of the FinTech, I think what we have is a very significant platform in terms of payment. And on top of the payment, we actually offer financial services. And if you look at the business itself, it's actually growing quite nicely this year.
And there are a couple of drivers. Party is actually growing alongside with consumption, right? And you can see although there is some macro challenges on the economy side, but the consumption in China is still growing quite nicely and our overall Fintech business actually grow alongside with that. And then on top of it, we actually have been offering financial services such as lending, such as wealth management. And these are actually falling into the model of the high-quality revenue growth model in which these are businesses which generates high margins, and they ride on a payment network, which has the cost already paid for. So their growth actually generates additional incremental margins.
And at the same time, we actually manage these businesses in a very measured way because we want to make sure that we are very good in terms of risk management and we also try to grow them in a measured way so that we don't take on too much risk, and we can also pick the best customers that we want to serve.
So I think that's on fintech side. Over time, we actually sort of would like to find additional value-added services that we can actually bring value to the merchants that we serve. And for the value that we create, we charge a little bit on additional fees if they are really generating value. So I think that's the overall model that we're thinking with respect to fintech.
In terms of the business service, the cloud, right? I think right now, there's a lot of -- in the past 2 years, there's a lot of capacity readjustment within the industry, right? The excess capacities are being used up and a lot of businesses have been trying to manage their cost down. And I think we have also proactively got rid of some low-quality businesses, too.
When we look into 2024, we believe that the dynamics in the market is that the squeezing of unused capacity is probably over. So if macro stays the same, there will probably some modest growth in terms of the cloud usage. But there probably needs to be a higher economic growth in order for higher growth to return to the market. There will be some growth with respect to PaaS and SaaS, and that's, frankly, the area that we are focused on. We believe, going forward, again, we'll be more focused on the high-quality revenue model in which we'll be more focused on the PaaS and SaaS, which inherently will be generating more gross margins for us. So that's how we look at those 2 businesses. So James?
Yes. With regards to the investment portfolio, so we are quite active and agile on both additional investments, but also on divestments. Some of that activity is visible. A lot of it is not visible.
But given what we view as our share price dislocation, our primary use of cash has been buying back our own shares. And that remains the priority at this point in time.
Thank you all for joining the call today. We are now ending the webinar. If you wish to check out our press release and other financial information, please visit the IR section of our company website at www.tencent.com. The replay of this webinar will also be available soon. Thank you, and see you next quarter.