To The Moon

$TENCENT(00700)$

Tencent’s second quarter of 2025 arrived with the kind of print investors have been waiting for: double-digit top-line growth, expanding gross margins, and clear evidence that artificial intelligence is starting to show up in the numbers—not just in slide decks. Revenue climbed 15% year over year to RMB 184.5 billion, with gaming, marketing services (advertising), and AI-related cloud activity all contributing, while non-IFRS operating profit rose 18% and free cash flow improved. Just as importantly, management struck a disciplined tone on AI spending, emphasizing “spend smartly” rather than “spend at any cost.”

Shares responded briskly in Hong Kong, closing up roughly 4–5% on the day of the release, as the market recalibrated expectations around monetization of Weixin traffic, improving game pipelines, and early but tangible AI use cases across advertising and cloud.

The 30-Second Take

• Beat and broaden: Revenue +15% YoY to RMB 184.5B; IFRS net profit RMB 56.0B; non-IFRS net profit to equity holders RMB 63.1B. Gross margin expanded to 57%.

• Engines of growth: Domestic games +17% YoY, international games +35%, marketing services +20%, fintech & business services +10%. AI features boosted ad performance and supported content velocity in games.

• Cash + discipline: Free cash flow RMB 43.0B; capex RMB 19.1B (up 119% YoY but moderated sequentially vs late-2024); buybacks ~HKD 19.4B in Q2.

• AI stance: Tencent will pursue prudent AI investment after the beat, with adequate chip inventory and multiple deployment paths amid U.S.–China chip uncertainty.

Performance Overview & Market Feedback

Headline numbers. Tencent reported RMB 184.5B in revenue (+15% YoY). On an IFRS basis, operating profit reached RMB 60.1B (+18% YoY), and net profit came in at RMB 56.0B (+16% YoY). On a non-IFRS basis, operating profit rose to RMB 69.2B (+18% YoY), while non-IFRS net profit to equity holders was RMB 63.1B (+10% YoY). Gross profit surged 22% YoY to RMB 105.0B, lifting gross margin to 57%.

What moved the stock. The beat—particularly the quality of growth in gaming and advertising—reassured investors that Tencent’s AI work is improving monetization across core surfaces. Hong Kong-listed shares finished the session up ~4.7%, with broader China tech sentiment buoyed alongside U.S. rate-cut hopes.

User and platform scale. Weixin + WeChat combined MAUs reached 1.411B, while QQ mobile MAUs stood at 532M. Content ecosystems remained massive: 114M paid video subscribers and 124M music subscribers, underlining the company’s cross-surface monetization optionality.

What Drove the Quarter

Gaming: Evergreen IP + New Hits, Now With AI Assist

• Domestic games revenue rose 17% YoY to RMB 40.4B, led by Honor of Kings (HoK), Peacekeeper Elite, VALORANT, and the breakout of Delta Force. Tencent highlighted AI tools that accelerate content production and enhance gameplay via smarter NPCs and virtual teammates—features that support engagement and monetization.

• International games grew 35% YoY to RMB 18.8B on stronger performance from Supercell titles and PUBG Mobile, plus the launch of Dune: Awakening, which topped Steam revenue during launch.

Why it matters: Tencent’s multiyear thesis—long-lived, service-based mega-franchises periodically boosted by new releases—remains intact. AI’s role in content velocity and user acquisition is increasingly visible, potentially raising the ceiling on live-ops productivity and marketing ROI over time.

Marketing Services (Advertising): AI-Upgraded Adtech

Marketing services revenue climbed 20% YoY to RMB 35.8B, with Tencent explicitly attributing the step-up to AI-driven improvements in creation, targeting, recommendation, and performance analytics. Closed-loop commerce inside Weixin (Video Accounts, Mini Programs, Weixin Search) benefited as advertisers chased measurable conversions. Management called out ~50% YoY revenue growth in Video Accounts and Mini Programs marketing services, and ~60% in Weixin Search.

Why it matters: This is the flywheel investors wanted to see—Weixin engagement + merchant activity + AI adtech = better ROAS, which attracts more advertiser budgets, which deepens the commerce ecosystem.

FinTech & Business Services: Recovery Meets AI Demand

Segment revenue increased 10% YoY to RMB 55.5B. Commercial payment volumes turned positive YoY as offline spending stabilized, while AI-related cloud demand—notably GPU rental and API token usage—lifted Business Services growth to the teens. International cloud revenue also accelerated as Tencent leaned on migration tooling and database capabilities.

Fundamental Analysis and Cash Flow

Profitability & efficiency. With gross margin at 57% and non-IFRS operating margin at ~38%, Tencent continues to demonstrate operating leverage from higher-margin advertising and scaled gaming. The revenue mix shift toward marketing services and international gaming—both supported by AI—helped expand profitability.

Free cash flow & balance sheet. Free cash flow reached RMB 43.0B (+7% YoY). Total cash stood at RMB 468.4B and net cash at RMB 74.6B, preserving strategic flexibility for AI infrastructure, content investments, and capital returns. Capex was RMB 19.1B (+119% YoY), reflecting data center and AI infrastructure build-outs—but crucially down from late-2024’s peak cadence, consistent with management’s “prudent” stance.

Capital returns. Tencent repurchased ~38.9M shares in Q2 for ~HKD 19.4B, continuing a multi-year shareholder return program alongside dividends. Buybacks remain a key pillar given robust FCF generation and a net cash position.

Financial Highlights and Valuation

Selected Q2 2025 highlights (YoY unless noted):

• Revenue: RMB 184.5B (+15%)

• Gross profit: RMB 105.0B (+22%), Gross margin: 57%

• IFRS op. profit: RMB 60.1B (+18%); IFRS net profit: RMB 56.0B (+16%)

• Non-IFRS op. profit: RMB 69.2B (+18%); Non-IFRS net to equity holders: RMB 63.1B (+10%)

• FCF: RMB 43.0B; Capex: RMB 19.1B; Net cash: RMB 74.6B; Total cash: RMB 468.4B.

Market context & price levels. Post-print, Tencent’s Hong Kong shares advanced ~4.7% and are approaching the upper end of their 52-week range, a reflection of improved earnings quality and a better macro tone for China tech. The 52-week band spans roughly HKD ~317 to ~614.

Valuation framing (qualitative). While headline P/E depends on IFRS vs non-IFRS and investee mark-to-markets, the combination of:

1. accelerating high-margin ad monetization,

2. durable games cash generation with AI-enhanced live-ops, and

3. emerging AI infrastructure revenues (GPU, token usage, enterprise cloud), implies multiple support even after the post-earnings move. With cash returns ongoing, incremental upside will hinge on sustained ad ROAS, steadier China consumption, and continued international games outperformance.

Industry Dynamics & Competitive Pressures

Advertising & short video. Tencent’s Weixin surfaces compete for both time spent and transaction intent against platforms like Douyin and Kuaishou. The shift to closed-loop commerce is a structural advantage—reducing leakage and giving Tencent end-to-end visibility to improve targeting via foundation models. But competitive ad auctions remain intense, and ROAS improvements must persist to keep share gains.

Gaming landscape. At home, content approvals have normalized versus the 2022 shock, yet regulatory unpredictability remains a known variable. Globally, Tencent is pushing deeper into PC/console with studios like Supercell and Funcom, while mobile live-ops remain the cash engine. The AI-enabled production toolkit is a potential moat—but publishers worldwide are racing to do the same.

AI infrastructure & models. Tencent’s HunYuan family (including 3D) is advancing, with the 3D model topping a Hugging Face leaderboard for quality metrics. The company is also pragmatic: integrating third-party models where it makes sense, and it has flagged chip-import uncertainties amid evolving U.S.–China rules—a macro risk partially mitigated by current inventory and flexible deployment options.

Detailed Market Sentiment & Management Guidance

Sentiment snapshot. The beat on both growth and margins catalyzed a relief rally, supported by a better global risk backdrop. Coverage from major outlets emphasized the role of AI in boosting ad yields and content velocity, while calling out measured capital intensity ahead.

Management tone. Tencent indicated it will be cautious and disciplined on AI outlays, focusing on sustainable monetization and “smart” spending. On the supply side, management acknowledged uncertainty in U.S. AI chip import rules but noted sufficient inventory and multiple pathways to keep advancing AI services. Tencent does not issue granular quarterly revenue guidance, but the narrative implies continued investment in:

• AI-powered Weixin features (citations, customer service, video summarization)

• Ad foundation models to drive CTR/conversion

• AI-assisted game development and marketing

• Cloud services tied to GPUs and API tokens All of which should support mid-teens type growth in the current mix—conditional on macro stability.

Risks

• Policy & regulation: Content and platform rules in China can evolve quickly; ad and gaming ecosystems remain exposed to policy shifts.

• Macro sensitivity: Advertising and fintech payment volumes correlate with consumer sentiment.

• AI supply chain: Export controls and chip availability may constrain model training or inference economics, though Tencent indicates near-term buffers.

• Competition: Short-video platforms for ad dollars; global AAA publishers in games; hyperscalers and local peers in cloud/AI services.

Verdict & Entry Price Zone

Verdict: Buy on constructive pullbacks (long-term). Tencent’s Q2 2025 report showcased broad-based, margin-accretive growth, with clear AI monetization levers now contributing in advertising, gaming live-ops, and cloud demand. With a net cash balance sheet, strong FCF, and ongoing buybacks, the setup is favorable for multi-year compounding if management sustains disciplined AI spend and execution.

Entry price zone (HK shares): After a ~5% post-print move and given the 52-week range (~HKD 317–614), long-only investors looking to optimize entries could target HKD 540–565 on pullbacks (roughly a 4–8% retrace from the post-earnings area), scaling toward core positions if fundamentals stay intact and ad/games KPIs continue to trend. Position sizing should reflect policy and chip-supply risks.

Conclusion & Key Takeaways

1. AI is monetizing, not just mesmerizing. Ad yields improved, content pipelines accelerated, and cloud demand for GPU and API tokens increased—each a revenue driver in Q2.

2. Games remain the cash engine. Evergreen franchises plus new hits like Delta Force delivered, with AI enhancing both development and engagement. International momentum is a second growth leg.

3. Prudent capital allocation. Rising—but moderating—capex, robust FCF, and steady buybacks point to thoughtful investment intensity rather than a blank-check AI cycle.

4. Macro and policy still matter. A firmer consumer backdrop helps fintech and ads; chip-import policy remains a watch item, though Tencent has buffers.

5. Long-term path: With unmatched social distribution via Weixin, a high-ARPU gaming base, and pragmatic AI deployment (first-party + third-party models), Tencent is positioned to translate model quality into monetization quality—the ultimate arbiter of durable value creation.

On balance, Buy on pullbacks for long-duration investors who can tolerate China policy noise and AI supply-chain uncertainty. Execution across adtech, live-ops, and cloud AI will determine whether today’s double-digit growth can sustain into a compounding decade.