To The Moon

After the Hong Kong stock market closed on August 13, $TENCENT(00700)$ released its Q2 2025 financial report. Following a significant beat of expectations in Q1 driven by its dual engines of gaming and advertising, Tencent continued its double-digit growth trend in both revenue and profit, with standout performance in international gaming, Video Account advertising, and cloud services. The core highlight lies in AI technology fully realizing its commercial potential, driving profit margin improvements across the three key business segments of games, advertising, and enterprise services. The company continues to increase investments in AI foundational models, game content generation, and advertising placement, with capital expenditures and R&D spending remaining at high levels. Against the backdrop of a gradually improving macroeconomic environment, this Q2 performance reflects that Tencent has entered a new phase characterized by a "high-margin structure + AI-enabled growth." The market had optimistic expectations for Tencent ahead of its earnings report, with the stock price reaching new highs for the year in the second quarter. The surprise factor of the Q2 earnings report was no less than that of Q1, but the market also had high expectations. The earnings benefited from the core growth logic remaining intact, especially the continued acceleration of advertising and international games, which also ensured stable performance. The current valuation still has room for upward movement. Performance characteristics Revenue maintained double-digit growth, and gross margin improved again. Overall revenue for Q2 was 184.5 billion yuan, up 15% year-on-year and 2% quarter-on-quarter, slightly exceeding market expectations. Gross profit was 105 billion yuan, up 22% year-on-year and 4% quarter-on-quarter, with gross margin improving to 57% (56% in Q1), a new high in recent years, reflecting the continued increase in the proportion of high-margin businesses. Non-IFRS net profit attributable to shareholders was RMB 63.1 billion, up 10% year-on-year and 3% quarter-on-quarter; if fluctuations in joint venture profit sharing are excluded, the adjusted year-on-year growth rate could reach 20%. Gaming sector: International market booms, domestic market faces pressure during off-season. VAS revenue reached 91.4 billion yuan, up 16% year-on-year and down 0.8% quarter-on-quarter. Domestic game revenue reached 40.4 billion yuan, up 17% year-on-year and down 6% quarter-on-quarter, with a seasonal decline after the Spring Festival. "Delta Force" and "Honor of Kings" continued to contribute significantly to revenue; mini-game revenue increased by 20% year-on-year. International game revenue reached 18.8 billion yuan, up 35% year-over-year and 13% quarter-over-quarter, driven by revenue from "PUBG MOBILE," Supercell-series products, and "Dune: Awakening." Social network revenue reached 32.2 billion yuan, up 6% year-on-year and down 1% quarter-on-quarter, driven by growth in live streaming on Video Accounts and paid music membership. Previously, Tencent Music's financial report showed unexpectedly strong advertising revenue, supporting both revenue and growth. Advertising business: AI-enabled continuous growth The entire marketing services segment generated revenue of RMB 35.8 billion, representing a year-on-year increase of 20% and a quarter-on-quarter increase of 12%, exceeding market expectations with two consecutive quarters of high growth. The utilization rate of advertising inventory on Video Accounts, Mini Programs, and Search has improved, and AI-driven creative generation and ad placement optimization have significantly enhanced advertisers' ROI. The gross margin for marketing services reached 58% (up 2 percentage points year-on-year), signaling important progress in business structure optimization. Financial Technology and Enterprise Services: AI Cloud Drives Margin Improvement Total revenue was RMB 55.5 billion, up 10% year-on-year and 1% quarter-on-quarter. Among these, fintech (payments, wealth management, consumer loans) resumed growth amid a recovery in consumption, while enterprise services accelerated growth driven by GPU leasing, AI API calls, and merchant technical service fees. Gross margin was 52% (up 4 percentage points year-on-year) and up 2 percentage points quarter-on-quarter. Investment Highlights and Logic Game business internationalization and new product cycles proceed in parallel, with AI joining to empower monetization. Delta Force entered the top five in terms of daily active users and the top three in terms of revenue among domestic FPS games, demonstrating Tencent's ability to break into new markets. In the international market, Supercell and PUBG MOBILE achieved record-high revenue, and the pace of content updates accelerated. The high growth rate of overseas revenue partially offset the seasonal fluctuations in the domestic market, validating the sustainability of Tencent's dual-drive model of global distribution and independent research and development. At the same time, the upgrade of the mini-game ecosystem within the WeChat ecosystem (engine compatibility, loading optimization) enables complex mobile games to be directly converted into mini-games, which will have a long-term positive impact on monetization efficiency. In addition, the company mentioned this season that it is using AI tools to accelerate game production, launch more realistic virtual teammates and NPCs (the AI virtual teammates in Honor of Kings simulate real human operations through reinforcement learning, and the NPC behavior library covers 2 million strategy combinations, resulting in a 12% increase in player retention rates), thereby attracting user activity. AI-enabled game operations have transitioned from technical exploration to full-scale commercialization, redefining the value chain across three key areas: content production, gameplay design, and operational efficiency. This includes the 3D asset generation system powered by the Huanyuan large model (reducing R&D costs) and other innovations. The advertising business is entering a period of AI dividends. Tencent Advertising's AI transformation has progressed from model upgrades to full-chain implementation across ad creation, placement, and performance analysis, driving two consecutive quarters of high ad revenue growth. Compared to Bilibili and Kuaishou, Tencent Advertising has achieved faster improvements in unit ROI, benefiting from WeChat's closed-loop ecosystem's transaction conversion capabilities. Video account ads enjoy TikTok-style user engagement growth dividends, while also leveraging AI-generated content and live-streaming e-commerce scenario expansions, leaving significant room for ad inventory expansion. New growth curve for enterprise services and AI cloud Enterprise-level AI computing power leasing and API calls have become measurable revenue streams, with some customers locked in for long periods, improving revenue visibility. Compared with Alibaba Cloud and Huawei Cloud, Tencent's AI services are more differentiated in vertical fields such as gaming, social networking, and entertainment, and are expected to penetrate more industries in the future. In the financial sector, benefiting from the low interest rate environment, wealth management revenue continues to maintain its advantage. High costs are related to AI In terms of expenses and investments, the high level of AI-related expenditures remains evident, while marketing expenditures for games continue to remain at a high level. However, the overall expense ratio remains under control. Total sales and marketing expenses reached 9.4 billion yuan, up 3% year-on-year and 20% quarter-on-quarter, driven by the promotion of new game titles. In terms of management expenses, general administrative expenses amounted to 31.9 billion yuan, up 16% year-on-year, with R&D and AI-related human resource costs being the primary drivers of growth. Additionally, R&D expenses reached 20.25 billion yuan, also growing year-on-year, and were one of the few expense categories that exceeded expectations. On the other hand, capital expenditure was 19.1 billion yuan, maintaining a high level of investment, slightly below market expectations, mainly due to supply-side issues. Joint venture and investment income contracted, with joint venture profits totaling 4.5 billion yuan, down from 7.7 billion yuan in the same period last year. This was mainly due to a decline in profits from a single large joint venture, such as Q1 $PDD Holdings Inc(PDD)$ s performance falling short of expectations, as well as a pullback in the travel and hospitality businesses in Q1. The decline in joint venture performance this period is attributed to seasonal fluctuations, though it is also related to Tencent's confidence in its Q2 performance, leading to adjustments in certain accounting items. Valuation Discussion Based on the closing price, the NTM PE ratio for 2025 is approximately 19 times, which is below the median level of large-cap technology stocks in the US stock market. The market remains skeptical about the sustainability of growth in international games and advertising. If the third quarter peak season meets expectations, there will be considerable room for valuation recovery. Variables to watch The impact of changes in domestic game regulatory policies on cash flow patterns; The sustainability of Video Number advertising ROI; Order conversion rates and customer renewal rates for AI cloud services; Can the profit sharing of joint ventures stop falling and rebound? Outlook The Q2 financial report continued Tencent's steady growth in revenue and profits, with a further consolidation of its high-margin structure. AI-enabled advertising and international games became the most impressive growth engines. Although domestic games were affected by seasonal factors, new products and internationalization provided a hedge. If the peak season in the second half of the year unfolds as expected, coupled with the accelerated commercialization of AI advertising platforms and AI cloud services, the current valuation still has room for upward revision. In the short term, attention should be paid to fluctuations in the profits of joint ventures and the policy environment for domestic games.