Ladies and gentlemen, thank you for standing by and welcome to the Tencent Holdings Limited 2014 second quarter result announcement conference call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question and answer session. If you wish to ask a question, you will need to press star one on your telephone to join the question queue. Your name will be announced when it is your turn to ask a question. If you wish to cancel your question, please press the pound or hash key. I must advise you that this conference is being recorded today. I would now like to hand the conference over to your host today, Ms. Catherine Chan from Tencent. Please go ahead, Ms. Chan.
Thank you, operator. Good evening. Welcome to our annual conference call for the second quarter of 2014. I'm Catherine Chan from the IR team of Tencent. 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 that may not be realized in future for various reasons. Information about general market conditions is coming from a variety of sources outside of Tencent. This presentation also includes some unaudited non-GAAP financial numbers that should be considered in addition to, but not as a substitute for, measures of the company's financial performance prepared in accordance with IFRS. For a detailed discussion of the risk factors and our non-GAAP measures, please refer to our disclosure documents downloadable on www.tencent.com/ir. Let me introduce the management team on the call tonight.
We have our chairman is Pony Ma, President Martin Lau, Chief Strategy Officer James Mitchell, Chief Financial Officer John Lo. Pony will kick off with a short overview. Martin will discuss the strategic highlights. James will stick to business review, John will go through the financials before we take your questions. I'll now turn the call over to Pony.
Thank you, Catherine. Good evening, everyone. Thank you for joining us. In the second quarter of 2014, we continued to deepen user engagement on our mobile platforms. We have further enriched our offline-to-online offerings through recent strategic investments in category leaders, including NavInfo, a mapping service provider, and 58.com, a local listing platform. In terms of revenue, both our smartphone games business and our online advertising business registered rather significant growth. Now let me highlight the financial numbers for you. Total revenue was CNY 19.7 billion, up 37% year-on-year. Value-added services was CNY 15.7 billion, up 46% year-on-year, of which social networks revenue was CNY 4.6 billion, up 47% year-on-year, online games revenue was CNY 11.1 billion, up 46% year-on-year. Online advertising revenue was CNY 2.1 billion, up 59% year-on-year, e-commerce transactions revenue was CNY 1.3 billion, down 40% year-on-year.
Non-GAAP operating profit was CNY 7.7 billion, up 53% year-on-year. Non-GAAP net profit was CNY 5.9 billion, up 42% year-on-year. Touching on some of our key online platforms. On our core communication and social platforms, total MAU for QQ was 829 million, within which smart devices MAU grew 45% year-on-year to 521 million. PCU increased 19% year-on-year to 206 million, over three-quarters of which were mobile users. Weixin and WeChat achieved combined MAU of 438 million, up 57% year-on-year. Total MAU for Qzone was 645 million, of which smart devices MAU rose 37% year-on-year to 497 million. Our online games platform continued its leadership on both PC and mobile. Our integrated media platforms achieved strong growth in active users and traffic on QQ.com, Tencent News app, and news plugins within Mobile QQ and Weixin. Our video platform also registered strong growth with the daily video views doubling year-on-year.
That's all from me tonight. I will invite Martin Lau to discuss strategic highlights.
Thank you, Pony Ma, good evening, good morning. I will give you some update on how we are leveraging on our mobile franchise to further develop our advertising business as this quarter's strategic highlight. I will divide it into sort of three different platforms. Number 1, for our news platform, we have further reinforced our leadership via mobile news service, which include news plugins within Mobile QQ and Weixin, as well as our Tencent News app that runs on smartphones. As at the quarter end, our news services achieved 180 million daily active users on mobile, and this refers to the people who actually read a piece of news. That's actually double our daily active users on PC previously achieved. Within this large number of daily active users, we have also added quite a lot of high-end users to our overall demographics compared to the PC era.
Our total daily page views across mobile and PC has also increased over 100% year-on-year. That's mainly driven by growth in mobile. The new mobile ad formats within our Tencent News app and news plugin have won initial recognition from brand advertisers. Revenue generated from our mobile news services has more than doubled quarter-on-quarter from a relatively low base. That's an encouraging sign. In order to develop this amazing market, we're going to introduce new ad formats and continue to educate advertisers, especially those high-end advertisers who like our broad reach and also our attractive demographics. Number 2, for our video platform, our mobile video traffic has increased significantly in the quarter and has reached approximately half of our total videos viewed. Unlike the news platform, which requires experimentation with new ad formats, mobile video ads are more straightforward.
As currently more than 90% of the mobile videos were viewed either via Wi-Fi or via download, it enables us to quite naturally extend the prevailing pre-roll ad format from PC. On the other hand, mobile currently only represents a low teen percentage of our total video ad revenue, and as a result, we see growth potential in this area. We will continue to invest aggressively in video content and also streaming technologies to strengthen our video platform. We will gradually capitalize on mobile monetization while balancing the overall user experience. Now finally, in terms of our social platform, our performance advertising business on mobile has been growing rapidly. It contributed to approximately 30% of our total performance advertising revenue in the second quarter. With respect to Qzone, which has over 75% of the total MAU for mobile, we have received strong demand for advertisers, especially application developers, for our feeds ads.
We are continuing to enhance our targeting technology, as well as expanding our advertiser base. On Weixin platform, we are beta testing task-linked ads to help advertisers, such as O2O merchants, to grow followers to their official accounts. During the quarter, we invited about 100 pilot accounts to join the experimentation, and we received positive feedback. We plan to expand the test to include more official accounts in the coming months. We believe overall we are in the early stage of the development of mobile performance ads business. With better-educated advertisers and with further build-out of our O2O, e-commerce, and content ecosystem, we will gradually unlock the potential of this market while keeping a strong focus on the overall user experience. With that, I will pass to James to talk about the business review.
Thank you, Martin, and good evening, everyone. During the second quarter of 2014, we achieved total revenue growth of 37% year-on-year or 51% year-on-year excluding e-commerce transactions. Value-added services generated 80% of our revenue, of which online games contributed 56% and social networks 24%. Online advertising increased to 10% of our revenue, breaking into double digits for the first time in our recent history. E-commerce transactions represented 7% of revenue. Diving into value-added services, segment revenue was CNY 15.7 billion, up 46% year-on-year and up 9% sequentially. Our social network revenue was CNY 4.6 billion, up 47% year-on-year and 15% sequentially. Increased item sales on our mobile platforms contributed to both the year-on-year and quarter growth rates. As we add more mobile privileges into our subscriptions packages, the number of subscriptions we provide stabilized, and so our subscription revenue grew slightly in the second quarter.
Online game revenue was CNY 11.1 billion, up 46% year-on-year and up 7% sequentially, boosted by smartphone games. For PC client games, revenue was stable sequentially and increased year-on-year. Looking at our social network products, for Mobile QQ, we reinforced our historic strength in communities via our new nearby groups and interest tribes functions. We upgraded Mobile QQ Wallet to enable CNY transactions for both virtual goods and O2O services. For Mobile Qzone, we added privileges such as skins and background themes within mobile to personalize the user interface, helping our subscription revenue. For Weixin, we upsized group chats to allow up to 400 users per group and added the cash balance feature, enabling users who have not bundled a bank card to still use Weixin Pay payment. We have been integrating Weixin with some of our partner companies.
For example, enabling users to view JD.com products via a direct access point and allowing users to access content inside official accounts via Sogou search results. Moving to PC client games, for advanced casual games, our average concurrent user accounts increased 20% year-on-year to 7.1 million, and our paying user accounts in ARPU also improved. We launched two sports games, "FIFA Online 3" and "Freestyle Football," in May, just ahead of the FIFA World Cup. Two new shooting games, "Call of Duty Online" and "War Thunder," entered closed beta testing in June. Our battle arena game, "League of Legends," continues to expand both domestically and internationally. For massively multiplayer online games, our average paying user accounts declined 9% year-on-year to 2 million. Revenue grew moderately year-on-year as contributions from new titles offset maturity of older games.
Within the action game genre, we launched an expansion pack for DNF and started closed beta testing for two new games. For role-playing games, we launched an expansion pack for Legend of Yulong that increased the game's user base, and we delayed Blade & Soul's expansion pack until August. At the quarter end, we operated 21 smartphone games integrated with Mobile QQ and Weixin, of which we categorized about two-thirds as casual and one-third as mid-core. Generally speaking, mid-core games achieve higher ARPUs on smaller user bases than equivalent casual games, thereby boosting the portfolio's overall paying user accounts and ARPU. Due to both new games and the changing mix of games as well as in-game promotions during the quarter, our net revenue increased to about CNY 3 billion.
According to App Annie, we ranked the number one smartphone game publisher in China as measured by free downloads and revenue for each of the first seven months of 2014. Seven of our games ranked in the top 10 grossing chart in China's iOS App Store in June. Our second quarter smartphone game revenue was actually substantially higher than we ourselves expected. During the second half of 2014, we'll focus on user experience, expanding our game portfolio and platform enhancement. Consequently, it's possible that our smartphone game revenue will be more or less stable around current run rates for the next couple of quarters. Turning to online advertising. Segment revenue was CNY 2.1 billion, up 59% year-on-year and 75% quarter-on-quarter. Excluding our discontinued search and marketplace businesses, our advertising revenue grew 75% year-on-year. Our brand advertising revenue was CNY 1.4 billion, up 72% year-on-year and 88% quarter-on-quarter.
Within which our online video advertising revenue more than doubled year-on-year. Sequentially, advertising revenue grew strongly due to seasonality, increased online video traffic, the FIFA World Cup event, and traffic contributions to JD.com from our portal. Our top five advertiser industries were food and beverage, automobile, online services, personal care, and real estate. Our performance advertising revenue was CNY 700 million, up 79% year-on-year and 55% quarter-on-quarter. The increase flowed primarily from the insertion of news feeds ads into Mobile Qzone that Martin discussed, though also from traffic contributions to JD.com from Qzone. Our e-commerce transactions revenue was CNY 1.3 billion, down 40% year-on-year and down 48% quarter-on-quarter. The decline primarily reflected our sending traffic to JD.com, hence reducing sales volume at our principal operations at Yixun. To a lesser extent, the decline reflected a full-quarter impact of the consolidation of our marketplace businesses.
Consistent with our new strategy of focusing on our partnership with JD.com, we expect e-commerce segment revenue and costs to continue dropping rapidly in the coming quarters. With that, I'll pass to John to walk through the financials.
Thank you, James. Hello, everyone. For the second quarter of 2014, our total revenue was CNY 19.7 billion, up 37% year-on-year or 7% quarter-on-quarter. We recorded net other gains of CNY 691 million versus CNY 1.6 billion last quarter. Operating profit was CNY 7.8 billion, up 72% year-on-year or 1% quarter-on-quarter. Share of profit of associates and joint ventures was CNY 23 million compared to CNY 44 million last quarter. Income tax expense was CNY 1.7 billion. Effective tax rate for the quarter was 22.4%. GAAP net profit attributable to shareholders was CNY 5.8 billion, up 59% year-on-year. This sequential decrease of 10% was against a high base in the first quarter, where we recognized disposal gain of CNY 1.9 billion relating to our strategic partnership with JD.com. Non-GAAP net profit attributable to shareholders was CNY 5.9 billion, up 42% year-on-year or 13% Q-on-Q.
Diluted EPS was CNY 0.627 for the quarter. We booked net other gains of CNY 691 million in the second quarter, of which deemed disposal gain relating to JD.com was CNY 676 million and DIM disposal gain relating to Mobile QQ was CNY 141 million. These were partially offset by a donation of CNY 100 million to Tencent Charity Foundation and impairment provision made for invested companies at CNY 325 million. On non-GAAP basis, operating profit was CNY 7.7 billion, up 53% year-on-year or 19% quarter-on-quarter. Net profit attributable to shareholders was CNY 5.9 billion, up 42% year-on-year or 13% quarter-on-quarter. Let's turn to segment gross margin. Gross margin for value-added services was 70%, up 6 percentage points year-on-year and flat quarter-on-quarter. The year-on-year margin improvement mainly reflected high proportion of revenue generated from self-developed products.
Gross margin for online advertising was 45%, down 9 percentage points year-on-year or up 10 percentage points quarter-on-quarter. The year-to-year decrease mainly reflected the accelerated amortization of media content costs, while the sequential recovery was due to revenue growth in the system now strong second quarter. Gross margin for e-commerce transactions was -7%, down 13 percentage points year-on-year or 11 percentage points quarter-on-quarter. Both year-on-year and quarter-on-quarter decline were due to inventory provisions and discounts. Moving on to operating expenses. Selling and marketing expenses was CNY 2 billion, up 60% year-on-year or 6% quarter-on-quarter. The year-to-year increase primarily reflected cash subsidies relating to taxi booking apps, online game promotions, and marketing of our mobile products. In the second quarter, we scaled back cash subsidies relating to taxi booking app and step-up game promotional expenses for key titles. It grew 6% sequentially.
G&A expense was CNY 3.4 billion, up 44% year-on-year or 18% quarter-on-quarter. Higher R&D expenses and staff costs contributed to both year-on-year and quarter-on-quarter increases. Included under G&A, research and development expense was CNY 1.9 billion, up 52% year-on-year and 24% quarter-on-quarter. As a percentage of quarterly revenue, selling and marketing expense was 10% and G&A 17%. R&D represented 10% of quarterly revenue or 54% of G&A expense. Share-based compensation was 3% of quarterly revenue. As at quarter end, we had approximately 25,000 employees, down 2% year-on-year and 7% quarter-on-quarter, mainly due to headcount moving from our e-commerce business to JD.com. Let's look at the margin ratios for the second quarter. Gross margin was 61.6%, up four percentage points from the first quarter, mainly due to the big shift to our high-margin VAS business.
Excluding e-commerce transactions, revenue and COGS, gross margin would be 66.6%, underlying the strength of our core businesses. Non-GAAP operating margin was 38.9%, up 3.7 percentage points from the first quarter, mainly as a result of improved gross profits. Excluding e-commerce transactions, revenue and COGS, it would be 42.2%. Non-GAAP net margin was 29.8%, up 1.5 percentage points from the first quarter, mainly as a result of improved operating profit, partly offset by increased finance costs and higher income tax expense. Excluding e-commerce transactions, revenue and COGS, it would be 32.5%. For the second quarter, total CapEx was CNY 917 million, down 37% year-on-year and 19% quarter-on-quarter. Operating CapEx was CNY 581 million, down 20% year-on-year and 36% quarter-on-quarter. Non-operating CapEx was CNY 336 million, down 54% year-on-year or up 43% quarter-on-quarter. Free cash flow was CNY 6.3 billion, up 59% year-on-year or 15% quarter-on-quarter.
As at quarter end, net cash position was CNY 22.5 billion, down 33% year-on-year and 34% quarter-on-quarter, mainly due to subscription of JD.com IPO shares and strategic investment to expand our O2O ecosystem. In this connection, I would like to highlight that the fair market value of our listed associates and available-for-sale investments amounted to CNY 65 billion, indicating our balance sheet is still strong and liquid. This concludes our presentation. Thank you.
Thank you. Operator, we shall take the first question, please.
Thank you. We will now begin the question and answer session. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key. Your first question comes from the line of Dick Wei from Credit Suisse. Please ask your question.
Hi. Thank you for taking my questions. I have two questions. The first question is on the other revenue line. Looks like we have a pretty strong growth for the other revenue to CNY 645 million from CNY 284 million, and there's no real increase in costs for that line. Wondering what is the growth contributed to and what is the outlook going to be like for the next couple of quarters? I have a follow-up. Thank you.
Yeah. I would like to sort of trim down your excitement over this item. Basically, the main reason for the increase was actually reclassification of the virtual items, virtual e-commerce items that sort of used to be in our e-commerce business, but now have been moved over to our others revenue as a result of the internal restructuring of our e-commerce business.
Would it be like a pretty stable-
The increase in number is actually moving one from e-commerce to this line item. It's not really growth per se.
I see.
Okay.
It's not particularly payment related?
No.
Okay. I see. Good. Then for the second question is, I think Martin mentioned about that we got a pretty good performance ad over on the mobile side. Wondering if you can maybe share some thoughts on what's the outlook over the next couple of quarters as well? Thank you.
As I said in the strategic highlights section, we have a number of different initiatives going on right now. It spans across the news platform, which is sort of the traditional portal type of advertising business, branded ads, as well as the video ads on mobile platform, as well as the performance ads that's running on our social network on the mobile platform. Each one of these initiatives are still relatively early stage in terms of their development. We do need to make sure that the user experience is well respected in each one of these platforms when we put in the ads. That's why we felt it will be a continuous effort, it will be a consistent effort, and I believe there's actually a lot of potential in this area.
We'll do it relatively cautiously and in a measured way so that we continue to place the user experience at the foremost of our attention, and we will continue to grow these platforms. That will be sort of the horse in front of the cart, and over time, the cart will actually follow the horse.
Great. Thank you very much, Martin.
Thank you. Operator, next question, please.
Thank you. Your next question comes from the line of Eddie Leung from Merrill Lynch. Please ask your question.
Good evening. Thank you for taking my questions. Just two questions. The first one is about your mobile game outlook. Could you elaborate a bit more on your comment about having a stable revenue stream in the upcoming couple of quarters? Are we seeing a bigger trade-off between user engagement and monetization on mobile games than PC games? I remember during the initial growth stage of PC games, it seems like you didn't have to manage the monetization of your PC games in order to grow your user engagement. That's my first question. Secondly, just for housekeeping purposes, could you share with us the ARPU range of your ACG, MMO, and mobile games? Thanks.
Sure. In terms of the mobile game outlook, the negative trade-off you're concerned about between game usage and game monetization is not something that we've experienced or we necessarily expect to experience. This is very much just a decision we've made on our side that we have a set of priorities, and we feel that we've actually very substantially over-delivered already on financial targets for the games, and therefore, while we'll continue to monetize the games, we'll also put even more energy into improving the platform infrastructure, improving the user experience. We also want to drive more traffic and more support toward the third-party games that will be coming onto the platform. As you may know, for those third-party games, we actually book revenue on a net basis, net of the developer share.
All else equal, if the total user spending on our platform increases, but the majority of the increase is driven by third-party games, then that would be less beneficial to net revenue versus the same amount of spending on first-party games. I wouldn't be concerned about the negative trade-off that you raised.
In relation to the ARPU for advanced casual games, because of the ARPU, it is within CNY 85-CNY 220. For MMOG, it is between CNY 240-CNY 320. In relation to platform games, mobile games, if you look at the portfolio, it will be within CNY 100-CNY 110 per quarter.
Thank you. Very helpful.
Thank you.
Next question, please.
Your next question comes from the line of Philip Wan from Morgan Stanley. Please ask your question.
Hi, good evening. Thank you for taking my question. I have two questions. My first one is also a follow-up on the mobile game sales outlook. Is it because the slowdown of a new game launch in your pipeline, or have you observed any particular change in gamer behavior that would lead to a flattish sequential growth in second half? Second question is also partly related to this. Have you seen any cannibalization between your gaming service and also other service you are starting to introduce in your WeChat platform in terms of user time spent on user engagement? Thank you.
I think with regard to the first question, the short answer would be no to all of the above. On the first question, slowdown in game launches, I think we actually intend, or we have been accelerating the pace of new game launches from one to two per month, closer to four per month. That's certainly not a factor. In terms of the game user behavior, that continues to move in a positive direction. When we first launched Weixin, people weren't accustomed to playing games on top. We launched some very casual games which people played, but they wouldn't spend money. More recently, we've been launching some games which people play, and they do spend money in. We feel that the behavior is moving pretty much as we would want it to move.
With regard to the cannibalization factor, we don't see that happening, and logically, we don't see why that ought to happen. The user need for reading news headlines and the user need for playing games are very different user needs, we don't see one of them negatively impacting the other.
Well, in fact, I would say the games, because they are really independent apps leveraging on our platform. The more games we have, they actually add to the total engagement time that we have with respect to the users, right? Take example of our running game. Basically, if you put that in comparison with the apps in China, our running game is probably ranked in the top five of all mobile apps in China. Just to give you an idea of how these different games actually add to the overall amount of time that's spent in our ecosystem.
A quick follow-up. You mentioned that you are starting to put in more resource on the third-party game. As you mentioned before, the self-developed mobile game enjoy higher margin. How would that affect the margin outlook for your platform? Thank you.
Well, consistent with my earlier comment that we actually report revenue for the third-party games on a net basis. The margin you would see if you do a simple calculation of operating profit over revenue would be pretty good for both first-party and third-party games. The cash margin we collect as a percentage of the cash the user spends would be a little bit lower for third-party games. That shows up in a lower revenue line, not in a lower margin percentage. Irrespective, if it's a successful game, whether it's third-party or first-party, it can be a very profitable business for both us and the developer of the game.
Yeah. I do want to emphasize that we see mobile gaming as a big opportunity, and that's why it's important for us to build it out for the long term. That's why, as James mentioned, we are going to spend a lot of development effort in terms of making sure that the platform actually supports better user interaction and user experience. At the same time, we do want to have a very strong ecosystem of games that include a lot of third-party games for the future. That's why despite the fact that on a cash-on-cash basis, we actually captured less of the revenue, we do believe that at this point in time, it's actually very important to direct more traffic and put much more effort in terms of grooming a very big ecosystem of third-party games on our platform.
Okay, thank you. That's very helpful.
Thank you. Next question, please.
Thank you. Your next question comes from the line of Cynthia Meng from Jefferies. Please ask the question.
Thank you, management, congratulations for a good set of results. I have two questions. Number one, can you further elaborate on how the strategic cooperation with JD helps fuel the strong advertising revenue growth this quarter? It was mentioned in the written statement. Number two is, can you please give us more color as to how the partnership with 58.com is going to fit Tencent's overall O2O strategy layout? Thank you.
Sure. In terms of the advertising revenue, we mentioned that the cooperation with JD.com is one factor that helps our advertising revenue. It wasn't the largest factor. The performance advertising on Mobile Qzone, the growth in online video advertising, were both larger factors. FIFA World Cup was also a moderate-sized factor during the quarter. It's one of several factors benefiting our online advertising revenue. I'll pass over to Martin for the cooperation question.
Yeah. In terms of 58, I think it fits our overall strategy of leveraging our social and communication platform to connect different entities in the ecosystem. If you look at our overall communication platform, in the initial phases, it was about connecting people. Over time, we would like to connect people with services, we want to connect people with goods, we want to connect people with businesses, and that's where different strategic investments come into play. If you look at JD, it's about connecting people with goods, and if you look at Dianping, it's about connecting people with O2O services. In this case, with 58.com, it's about leveraging our platform to connect our users with a lot of services, life services, things that would help them to manage their movement from one city to another, that help them to rent an apartment on a short-term basis.
There are a lot of these sort of lower frequency, but very necessary services that are available on the 58.com, which over time we would like our users to be able to be connected to, I think that's the overall theme. Over time, with our traffic, with our user base, and with the fact that we also know different people by sort of the logins, we can actually add to the overall trustworthiness of the 58.com community as well. I think it's mutually beneficial.
Great. Thank you.
Thank you. Your next question comes from the line of Alex Yao from JPMorgan. Please ask your question.
Hello. Good evening, everyone. Thank you for taking my question. Can you guys give us an update on the internet banking strategy now that you guys will get a banking license? What will this banking license allow you guys to do? And can you share with us the latest thinking in this area? Thank you.
Yeah. In terms of the internet banking license, we have gotten a license and I would say we're in the early stage of building out the service and mapping out our business plan, leveraging the license. I think there are still a lot of things to do with respect to the license, because the license doesn't really enable us to roll out our business on a completely national basis in terms of physical location. It's a license that's in process, I would say. Over time, we'll work with the regulators and try to develop innovative services that will leverage the license, to help us to address an increasingly large user base.
Now, with respect to the initial thinking around what we were going to do with this banking license, I think the future direction of this bank, and this overall banking initiative is going to be, number one, it will not be a direct competition to the current banks in terms of their businesses. What I mean is that, what we will try to do within this banking and credit initiative is really to serve the underserved segment within the credit market, i.e., consumer credit, i.e., the credit which are very difficult for banks to identify within their cost structure, as well as within the current availability of data. Because of our large data, because of our consumer touch points, we believe we are in advantage of identifying a credit that existing banks are not in a position to serve, and we'll be in a better position to serve.
I think we're digging up the unmet demand within the credit system is one of the important thing that we'll be doing. Second thing is, when we look at our future bank, it will be a bank that really cooperates with a lot of other different banks. Because of its positioning of digging up the underserved demand, what we will do is actually we will work with a lot of banks who has deposits. We're not going to compete with other banks for deposit. Rather, we'll work with them. A lot of banks, they have deposit, but they want to find attractive borrowers, and we are in the best position to do that. In the future, we'll be working with a lot of different banks to deliver this kind of market to them. I think that's what we envision for our future banking initiative.
Because we need the flexibility of working with these different banks, we need also the access to a lot of credit information facilities. By having this banking license, it will help us a lot in this process.
Very helpful. Thank you. Second question is on the profitability side. From Q1 to Q2, the revenue contribution from mobile game within the VAS increased from 12% to about 20%-21%. Why was the VAS profitability broadly stable in the past two quarters?
You mean the games, on the game side?
The VAS gross margin.
Alex, can you repeat the last part of your question?
Yes.
Yeah. Sure. I think your VAS gross margin was flat-ish from Q1 to Q2 at about 70%. Clearly the revenue mix was moving towards the higher margin mobile game side. What was the reason behind that? Is that some other low-margin business, the carrier or do you just want to get a little color on the overall VAS gross margin trends?
I think historically, our VAS gross margin tends to tick up in Q1 and Q3 because that's when the desktop game business is more healthy. Our VAS costs tend to increase in line with basic social network communications user growth. Historically, the costs increase quarter on quarter through the year, whereas the revenue is more bumpy toward Q1 and Q3, and that causes the gross margin to sometimes be a little bit weaker in Q2 than Q1. This year, the mobile game phenomenon that you have identified would have acted as an offset to that. We can look into it and come back to you offline in more detail, I think that's the most plausible.
Well, helpful. Thank you very much.
Right. Thank you, Alex. Operator, next question please.
Thank you. Your next question comes from the line of Xiong Xiao from Macquarie. Please ask the question.
Thank you for taking my questions. My first question is about the e-commerce. It's been a couple of months since your partnership with JD officially started on Weixin. I was wondering, would you be able to elaborate a bit on what are some of the early results you have seen in terms of the traffic conversion rate, et cetera, for this partnership? Related to that, you highlighted earlier on our call that you are seeing a lot of momentum in the public accounts from the O2O merchants on Weixin. What's your plan for the next step in terms of converting perhaps some of those merchants into some sort of a marketplace for B or for the smaller Bs? My second question is about the video-
Sorry, why don't we address these questions together? Wait.
Alex, we'll address you first.
Yeah. I think you have two questions already, let's sort of address that first before we lose track. The first one with respect to JD.com, I think, we'll let JD elaborate on the details, right? I think what I would say is, we are in this sort of early stage of integration, right? I think a lot of the effort in the very initial stage was really sort of just making sure that the actual sort of logistics of the strategic partnership gets done. JD was very focused on getting their IPO done as well. I think as far as sort of the early results of the integration, I would say, on the QQ side, a lot of the traffic has already been directed to JD's mall. Also, the conversion rate has actually increased compared to before.
That's, I think, pretty natural because there's a bigger selection of products, the conversion rate actually increased. Now, in terms of the mobile integration, we have launched the level 1 access point in Weixin, recently we have actually sort of also launched it in Mobile QQ. What I would say is, it is generating meaningful GMV, we believe this overall effort is still early stage. Because right now the user experience is rather simple. It's basically just sort of one click into a normal mall. Where over time, I think there's going to be more innovations that we can do with respect to the access point, with more customization, with sort of more exciting experience for the consumers, make it differentiating. I think that would take time for us to sort of explore and experiment.
The other thing I would say is, for the overall e-commerce infrastructure within Weixin and QQ, I think it's also in an early stage of development because the more payment users, right, Weixin Pay or the QQ Wallet users, which we sort of just recently launched, the more likely for users to click into the access point and be able to convert into buying users. Likewise, the more advertising infrastructure that we can actually provide within Mobile QQ and within Weixin, then that would actually sort of also benefit the build-out of this e-commerce ecosystem. I think overall, it's still sort of relatively early stage, and we'll continue to work with JD.com to sort of further explore and develop these synergies. I did lose track of your second question, which is like O2O.
I did sort of lose track of your second question about sort of O2O and sort of marketplace. I apologize on that.
Oh, no. Sorry. No, I was just wondering, it's actually the second part of the first question. Now you have a bunch of the public accounts from these merchants on Weixin. They're a little bit sort of spread out through the whole ecosystem infrastructure. Down the road, do you think that it is conceivable you may be putting together a marketplace, sort of B2C marketplace or C2C marketplace within the Weixin ecosystem?
Well, I would say this, right? Number 1, we'll continue to build out those sort of e-commerce enhancing infrastructure, as I said, right? The payment as well as the advertising, which will deliver more traffic to these O2O or e-commerce public accounts. The other thing which I would say is, if we are going after the centralized e-commerce model, rather than sort of work with JD.com, right? We can actually direct traffic to the stores that these merchants actually open up in JD.com's mall. I think that's a more effective way to really sort of help them to generate traffic from a centralized model.
Okay.
Thank you. Operator, next question please.
Thanks.
Thank you. Your next question comes from the line of Wendy Huang from Standard Chartered Bank. Please ask the question.
Thank you. I have two questions. First one, I think in the past six months, you have invested in different kinds of e-commerce assets, but some of them are actually flash sale e-commerce type of platforms. We actually have seen the flash sale usually enjoyed higher mobile penetration rates. Going forward, will you consider to add maybe flash sale e-commerce business model or this kind of sales format to your overall e-commerce ecosystem? My second question is about your WeChat international expansion. Currently, you have over 200 million users outside China already. When do you expect to monetize this overseas traffic, and also, how do you view the competition in the overseas markets online and flash sale? Thank you.
Okay. In terms of flash sale, I think it's a very interesting model. Again, what we would be doing is we would be doing it alongside with JD. Within the level 1 access points, there could be sort of different ways to curate the presentation of the products, and one of the presentation could be flash sale. That's something which we'll sort of test out with JD.
I think in terms of WeChat, on the monetization side, our games are already available in Malaysia, for example. They're quite popular, and they are monetizing in Malaysia, but it's obviously a much smaller market than our home market. The focus continues to be growing the user base and then growing the engagement for WeChat internationally. Some of the activities or services such as games would serve to both boost engagement and monetize. For us, the primary value in the near term would be around the engagement rather than the monetization. We're not monetizing internationally, but the focus is on engagement first, and then the monetization should be a happy byproduct of that. With regards to competitive landscape, I think that it is extremely competitive, especially in Western markets, still very competitive in Asian markets, although we have stronger positions in some of the Asian markets.
I think the strongest competitor we've faced so far in the most markets is a company you didn't mention, which is WhatsApp. That's the competitive landscape.
Okay. Thank you.
Yeah. Thank you. Next question, please.
The next question comes from the line of Alan Hellawell from Deutsche Bank. Please ask your question.
Thank you very much. I was hoping to maybe ask two questions. Could you give us an assessment of how recent regulatory announcements may have impacted products such as Weixin and Mobile QQ, if at all, and what we might expect going forward?
Well, I think the impact is actually relatively minor. First of all, if you look at the requirements to have real name, our Weixin service basically sort of already asks people to bind their cell phones. It's real name in nature. A lot of the regulation is actually around the public account, which, one, it's sort of subsidiary to our overall communication experience, and two, most of the traffic on our public account actually sort of already comply with all the regulations. I think it doesn't really affect our platform.
This recent cresting of scrutiny, you think we've possibly seen the worst of it for the time being? Okay.
It's not certainly a net negative.
Right. Okay. I'm just curious, would we expect much more M&A activity, and related to that, even further incremental mobile functionality rolled out over the next year? Would you regard the next year as being devoted to basically just expanding these existing offerings, further integrating some of your successful external investments? Can you comment on that?
Yeah. I wouldn't characterize our activity as sort of that passive way. I think we are in an industry in which sort of innovation is the key to success. That's why I think, while we sort of will continue to work on the initiatives which are seeing great traction, we'll continue to sort of look out for new opportunities as well as sort of engaging in innovations, especially when you're talking about functionalities within our mobile platforms. There will be more and more functionalities, definitely. I think that's actually one area of focus rather than saying sort of just working on existing initiatives.
Got it. Forgive me, just the reason I ask is you could argue that there's been some behavioral fatigue on a lot of mobile platforms, that platform A serves wonderfully as a social networking platform, but its relevance or utility in branching out into other concentric circles is limited. What is your philosophy around Weixin? Do you feel like it's almost infinitely expansible, or have we kind of achieved the 80/20 of what it's going to do for us for the next couple of years?
I think what you said is right. If you do it in basically just accumulative way, I think that's sort of what you'll be getting. If you try to sort of blast the same experience to everybody, there's a limitation on what you can add. I think the beauty of mobile internet is that there are a lot of different instances in which a particular person will need a particular service. Being able to capture that moment, and then present it in a natural way, I think is the unique experience that we want to provide. If we can provide that, rather than basically just blasting everybody with the same user experience and then you can sort of, you take the third one, the fourth one, you may not need it, then that's the end of it.
If we can actually really find the right person, find the right service, find the right moment to present, I think that makes it much more expandable. I think that's what we try to focus on.
Thank you very much.
Thank you, Alan. Operator, next question, please.
Thank you. The next question comes from the line of Chao Wang from Nomura Securities. Please ask your question.
Hi. Thank you for taking my question. I have a follow-up one on mobile game. Could you update us on your mobile game Daily Active User? It was 120 million last quarter. How should we think about the user growth for rest of the year? They said that you tried to track your new goals. Thank you.
I think as we mentioned in the introductory remarks, the newer games we have added tend to be games which are a little bit more mid-core rather than casual, therefore they would tend to have potentially fewer DAUs, but more monetization than some of the games that we added six or nine months ago. If you extrapolate that to the platform as a whole, then for the platform as a whole, the number of DAUs would be stable to slightly increasing, but broadly stable.
Sure. How about the growth for the rest of the year?
How about what?
User growth for rest of the year.
I think-
For which? Sorry, Chao.
For mobile game.
Well, that's a function of many things. That's a function of Weixin user growth, that's a function of Mobile QQ user growth, that's a function of the conversion of those users to play games. Obviously we'd like all of those numbers to keep growing. It remains to be seen like just how fast they should grow.
Understood. Thank you. I have a follow-up question on video. Could you share with us your investment strategy on the content, both in-house content and third-party content? Thank you.
We have been, and we will continue to invest very aggressively in video content, both third party and first party. You can see in our results, both our traffic results with our DAU views doubling year-on-year and also our revenue results with our revenue substantially more than doubling year-on-year. That when we buy the right content or when we develop the right content, given our platform advantages, given our massive upstream traffic, given our login relationship with users, given our ability to virally market content through our social graph, if we have the right content, we can deliver very strong user growth, and if we have the users, we can deliver advertising revenue. We're very committed to increasing our investment in both third party and self-created content.
Thank you.
Thank you. Operator, in the interest of time, we take the last three questions, please.
Certainly. The next question comes from the line of Alicia Yap from Barclays. Please ask your question.
Hi. Good evening, everyone. Thanks for taking my questions. My first question is back on the PC games. While the PC games, as you mentioned, experienced healthy year-over-year growth is driven by a couple of the new games and also the LOL, I wanted to ask that, it seems like some of the legacy ACG games seems to be slowing down. Do you think that the trend of this slowdown for the advanced casual games such as the DNF and CrossFire will continue as these games are aging, or is there any potential that they will be rebounding or re-accelerate again? What is your expectation for the CrossFire? Thank you.
With regard to the maturation of legacy advanced casual games, I think you mentioned Dungeon & Fighter. We classify Dungeon & Fighter as a sort of action role-playing game. That wouldn't be included in the advanced casual game category. The other game you mentioned is CrossFire. That's a game that's been phenomenally successful over time. It's a game that we've been publishing now for five years or so. It's a game where over time, as it's become bigger and bigger, the revenue growth has naturally decelerated as you might expect. At the same time, we believe that the consumer demand for playing shooting games is still very buoyant demand. If you look at the U.S., if you look at Europe, shooting games are the biggest category and the biggest shooting game is the biggest game in those markets.
Over the past couple of years, we've brought a game called Assault Fire, which is a self-developed shooting game to be one of the most successful titles in our portfolio in terms of traffic, in terms of revenue, in terms of profitability.
While one particular shooting game may be more mature, the overall category has continued to exhibit growth. We think that with the right expansion packs and so forth, CrossFire itself seems good growth as well. Finally, Call of Duty Online, that is our version of Call of Duty, which is the most successful shooter franchise globally. As we mentioned, we've recently taken that into a later stage beta test. We'll see how that game proceeds going forward. The reason I dive into this in so much detail is not because I'm a shooting game fanatic, but more to illustrate the point that what you and I call advanced casual games is actually a collection of numerous game genres, with shooting games being one.
We take a game genre strategy, if one title in a game genre is slowing down, obviously we'd love to re-accelerate the growth and do things to re-accelerate the growth. We also might have other titles in that genre that serve slightly different needs. Sometimes the behavior of the overall genre can be different from the behavior of the individual title.
I see. My second question is regarding more on our strategies. We invested quite a few of the new investee companies over the past six months. What is our plan for these stakes? We intended to keep them as the current percentage of ownership or in the future, if there's more synergies happen down the road, is there any possibility that you may consider increasing the stake or may have full control on some of these stakes? Thank you.
Well, at this stage, I think we're very focused on pursuing integration of the services so that number 1, we can actually help these companies to grow and also sort of benefit from our large user base. Number 2 is to be able to deliver better services to our users. I think let's really focus on that. We don't think a lot about the stake itself. We think a lot about how to actually deliver value to our users and also value to our partners.
Okay, great. Thank you.
Thank you. Next question, please.
Thank you. Your next question comes from the line of Chi Tsang from HSBC. Please ask the question.
Sure. Hello. Thanks for taking my question and good evening. I have two questions. Firstly, just getting back to the engagement levels on WeChat. When you combine gaming, chatting, reading moments, shopping, what is the rough average time spent per day per user? What do you think is a natural limit on that figure? Then I have a second question. Thank you.
Well, I think it's actually not the appropriate way to look at it, because I think for us, the communication and sort of the social networking activity is actually within the app. A lot of the other activities is actually using our platform as effectively a discovery, a channel as well as a launch pad, so that the activity of games actually happen within the games themselves rather than within WeChat. With the reading, a lot of times actually, it happens when people click into the news and then it brings them to our Tencent News app. What we try to do is actually to divert the heavier users and heavier user experience toward the individual apps that can deliver that longer time engagement. I think that's the architecture of our overall platform strategy.
As a result, it doesn't really get limited by the amount of time that people spend on the app itself, but it's really a function of the range of activities that people will do in their everyday time.
Great. My second question is, can you give us an update on Weixin Wallet? If you can give us just a sense of what the AUs or MAUs and what type of spending habits you're seeing on Weixin Wallet? Thanks a lot.
Well, at this point in time, what we can say about Weixin Wallet is that, one, it's actually a very light experience for users. As a result, it's very easy for users to subscribe to this service. Number two is, we have an increasing number of payment applications, so that those applications will help to pull in the users. I have to say, we're still in the early stage of developing this ecosystem. The more applications that we have, the more likelihood for us to be able to convert users. I would say we have a reasonable take-up. We are still in the early stage of converting more and more users into Weixin payment. I would rather not go into the specific numbers because of competitive reason.
Great. Thank you.
Thank you. Operator, the last question, please.
Thank you. Your last question comes from the line of Thomas Chong from Citigroup. Please ask the question.
Hi. Thanks. Good evening. Thanks for taking my questions. I have two questions. The first one is still about mobile games. Given you have launched the smartphone games for a year already, what lessons have you learned in the past 12 months? Should we expect the smartphone games revenue to resume quarter-on-quarter growth after you do some revamp in the user engagement? I have a follow-up. Thanks.
I think in terms of timing, we don't give guidance, but earlier in the prepared remarks, I realized I said that you might see us focusing more heavily on the non-financial metrics for a couple of quarters. Just to be clear, when I say a couple, I mean two. It's really thinking about the balance of this year, given how strongly we've outperformed financially in the first half of this year. For the balance of this year, the teams will continue to monetize, but then also focus very much on adding more third-party games, focus very much on enhancing the platform, focus very much on improving the user experience. My comment was really about the next couple, meaning next two quarters.
With regard to lessons learned, I think other people will probably chime in and supplement me, but one thing that's been very clear to us is the more that we integrate the games with the sort of unique social aspects of WeChat and QQ, the more popular they are, the more revenue generative they are. That's why in the early stages of the WeChat and QQ game center, the first-party games generated a very disproportionate chunk of the revenue, not because we wanted to practically favor first-party games, but because the internal studios picked up very quickly how to fully integrate the games with the WeChat and QQ social graph, how to make best use of WeChat and Mobile QQ. Now we're in the process of extending those learnings to third-party games and making sure that third-party games similarly benefit from very powerful integration.
I think that's one important takeaway. A second important takeaway is if you look at the trajectory of other chat platforms around the world and how successful they've been in adding mobile gaming. I'd say some of them have been very successful at adding the casual mobile games, not so successful at adding the mid-core mobile games. Others have successfully transcended into mid-core and even hard-core mobile games as well. I think our experience so far is that on WeChat and on Mobile QQ, we're very capable of generating casual games hits with tens of millions of DAUs, but we're also very capable of generating more mid-core hits with smaller numbers of DAUs at very healthy revenue generation. That was a big part of the reason why we generated substantially more mobile game revenue in Q2 than we expected to do.
I see. Thanks, James. My second question is about the use of cash. We see you have invested in China South City earlier this year, given you rely on JD.com for the e-commerce, should we still expect Tencent to spend money on logistics and warehousing going forward? Thanks.
Well, the objective investment in China South City was sort of partly the land, but certainly it's not the main focus. I think as we explained earlier, a few quarters back, the most important thing is actually we believe China South City is actually sort of building interesting ecosystem of offline suppliers in sort of their offline premise. Over time, this large number of offline suppliers can actually move online, that's actually the kind of opportunity that we are most focused on. That's why, on one hand, China South City would be working with Jingdong on some of the sort of logistics-related stuff. On the other hand, they will be working with both us and Jingdong on sort of building out the e-commerce service for their merchants. I think that's a bigger opportunity that we targeted when we made the investment.
I see. Thanks.
Okay. Thank you very much for all of you who joined the call tonight. We're winding up the call now. If you wish to check our press release and other financial information, please visit our corporate website at www.tencent.com/ir. We'll also post a replay of this webcast on site shortly. Thank you, and see you next quarter.
Thank you. That does conclude our conference for today. Thank you for participating. Tencent Holdings Limited 2014 second quarter results announcement conference call. You may all disconnect now.