Tencent’s reorganisation points to where it sees its future

Tencent
A pedestrian walks past Tencent Holdings Ltd.'s new under-construction headquarters in Shenzhen, China, on Monday, Aug. 22, 2016. Photographer: Qilai Shen/Bloomberg

Tencent Holdings Ltd has curious timing. And it’s not a day too early.

The social-media giant announced a reorganisation smack in the middle of a long weekend in Hong Kong and the beginning of China’s October Golden Week. The cadence isn’t unusual, being once every six or seven years (previous reorgs happened in 2005 and 2012).

While Tencent is cutting the number of business groups to six from seven, the company is actually adding to its structure.

The first key change is one that’s surely overdue. The company will combine three existing units – the social-networks group, mobile-internet group and online-media group – under a new platform and content group. This appears to nod to the fact that, with WeChat at the core of much of its business, the line between various content channels such as news, video and payments is being blurred.

I see this as recognizing and tying together the transformation at Tencent that’s occurred since 2012.

At the same time, the formation of a new business points to where the company sees its future.

According to Tencent, the cloud and smart industries group will include healthcare, education, security and location-based services. This doesn’t mean the old social and gaming businesses are done with, but shows where management wants to start building new revenue.

As noted Tencent and WeChat consultant Matthew Brennan pointed out, the company telegraphed its move into a greater B2B focus almost a year ago.

Tencent feels it’s time to upgrade from a consumer internet to an industrial internet, according to its statement. This is more than just marketing speak. The past 20 years of internet history have focused on how consumers interact with information, with corporations and with each other.

The coming implementation of faster 5G mobile networks and the introduction of more devices that connect to the internet without human involvement (aka Internet of Things) suggest a future where machines will be a bigger part of the online environment than people.

For Tencent, the timing of this change is important.

Back in March, when many were lauding the company’s solid earnings, I foreshadowed structural weakness at the social-media giant that couldn’t be papered over by one-off gains from the IPO of its portfolio companies. Operating margin had declined; and while the company was boosting its marketing budget by a larger proportion than its R&D spending, user growth was slowing. Put simply, Tencent wasn’t experiencing the benefits of scale that WeChat’s one billion users ought to provide, and investors were about to feel that pain.

Tencent’s shares have since reflected that reality, falling as much as 19 percent since a March high. They’re now 16 percent off that mark.

By leveraging a large user base to drive its artificial-intelligence efforts – and then combining that with businesses like healthcare, transport, security and retail – Tencent can bring in more industrial users and machines to feed into the cycle of data and analytics.

To get there, though, the company will need to boost R&D – probably to levels not seen since 2014 when the figure briefly passed 10 percent of revenue. That means reversing a recent trend of what looks like sacrificing research spending for greater marketing muscle. To be sure, both figures are rising but marketing exceeded R&D for the past three quarters.

Management also needs to think more carefully about its acquisition strategy, spending more time and money buying companies that build the stuff under the hood than those offering consumer-facing businesses.

If Tencent truly believes it is facing a change from consumer to industrial internet, it will have to show it can go beyond the one billion users it has today and focus on the ten billion machines it can connect in the future.

Also read:

Tencent announces a restructuring plan as challenges rise

Bloomberg