Ladies and gentlemen, thank you for standing by and welcome to the Tencent Holdings Limited 2011 Second Quarter and Interim Results Announcement Conference Call. At this time, all participants are in the 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 * 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, ladies and gentlemen. Welcome to our conference call for the second quarter of 2011. I'm Catherine Chan from the IR team of Tencent. Before we start the presentation, we would like to remind you that inclusive forward-looking statements, which are underlined by a number of risks and uncertainties, may not be realized in the future for various reasons. Besides, information about general market conditions is coming from a variety of sources outside of Tencent. For a detailed discussion of the risk factors that may affect our businesses and operations, please read through the disclosure documents downloadable on www.tencent.com/ir. Having said that, let me introduce the management team on the call tonight. They are our CEO, Pony Ma, President Martin Lau, and Deputy CFO John Lo. Pony will brief you on the key highlights, as usual.
Martin will go through the business review and outlook, while John will walk you through the financials. We will move on to Q&A. Now, let me turn the call over to Pony.
Good evening, everyone. We're in the second quarter of 2011. It is called a solid growth in our operation and financial results. Our IVAS business grew despite weak seasonality in the second quarter. On the other hand, our online advertising business grew significantly from a weak first quarter. MVAS business grew slightly due to growth in mobile SNS and mobile games offsetting challenges in the factory environment. Let me run through the headline numbers for you. Total revenue was RMB 6.7 billion, an increase of 6% quarter- on-q uarter, or 44% year- on- year. IVAS revenue was RMB 5.4 billion, an increase of 3% quarter- on- quarter, or 50% year- on- year. MVAS revenue was RMB 794 million, an increase of 2% quarter- on- quarter, or 18% year- on- year. Online advertising revenue was RMB 512 million, an increase of 82% quarter- on- quarter, or 29% year- on- year.
Gross profit was RMB 4.4 billion, an increase of 6% quarter- on- quarter, or 38% year- on- year. Gross margin was stable at 65% for the quarter. Operating profit was RMB 2.8 billion, a decrease of 18% quarter- on- quarter, for an increase of 17% year- on- year. Net profit attributable to shareholders was RMB 2.3 billion, a decrease of 18% quarter- on- quarter, for an increase of 23% year- on- year. One of the major reasons behind the sequential decline was accounting for Riot G ames acquisition that took place in the first quarter. In order to give you an alternative perspective on the financial performance of our core operations, we also provide a set of non-GAAP figures for your reference. On a non-GAAP basis, operating profit was RMB 3.2 billion, an increase of 2% quarter- on- quarter, or 28% year- on- year.
Non-GAAP net profit attributable to shareholders was RMB 2.7 billion, an increase of 4% quarter- on- quarter, or 31% year- on- year. As for the margin ratios, GAAP operating margin decreased 12 percentage points to 41%. On a non-GAAP basis, operating margin decreased 2 percentage points to 47%. GAAP net margin decreased 11 percentage points to 35%. On a non-GAAP basis, non-GAAP net margin decreased 1 percentage point to 40%. We believe these non-GAAP figures will provide a good reference for the performance of our core operations going forward. As these non-GAAP figures take away the gains and change related to the strategic investment and acquisitions, we need to enhance the long-term competitiveness of the company. In addition, these non-GAAP numbers may also provide a better comparison with the peers in our industry, which have been disclosing such numbers for some time.
Now, I will give you an update on our operating platforms. On our core IM platform, active user accounts grew 4% quarter- on- quarter to 702 million. CCU was flat at 137 million. User growth on IM platform has been slowing due to its large base, as well as reflecting a slowdown in the growth of internet users in China. According to CNNIC, year-on-year growth in internet users for the first half was 16%, a decrease from 24% for the same period last year. For our social networking services, active user accounts of Qzone grew 5% quarter- on- quarter to RMB 531 million, while that for Pengyou grew 28% to RMB 129 million. QQ.com continued to record growth in both TV and UV. TCU of QQ Game Portal decreased by 3% quarter-o n- quarter to RMB 7.5 million due to weak seasonality.
Our wireless portal was ranked number one in China and saw continuous growth in traffic. That's all from me for the moment. I will hand over to Martin to talk about the business review and updates.
Thank you, Pony, and good evening and good morning, everybody. Let's first talk about our IVAS business, which made up 80% of our total revenue in the second quarter. Segment revenue was RMB 5.39 billion, an increase of 3% quarter- on- quarter, or 50% year- on- year. As students spend more time to prepare for exams, the second quarter is typically a weak season for our IVAS business, and in particular for online games. In terms of revenue breakdown, Community VAS contributed RMB 1.75 billion, or 32% to IVAS revenue. Quarter- on- quarter, community VAS revenue grew 4%, as revenue from QQ Membership monthly subscriptions, as well as item sales relating to Qzone third-party applications, increased. On a year-on-year basis, revenue grew 21%. Going forward, the revenue mix will be changing as we continue to add more third-party applications, and the contribution from these item-based revenue will increase over time.
Online games contributed RMB 3.64 billion, or 68% to IVAS revenue. Quarter- on- quarter, online games revenue increased 2% due to increased monetization from Dungeon & Fighter, QQ Speed, and mini casual games. On a year-on-year basis, revenue grew 70%. Going through the major community products, active user accounts of Qzone grew 5% quarter- on- quarter to RMB 531 million. Monthly subscriptions decreased slightly as a result of the maturity of QQ Farm and QQ Ranch, while item sales related to third-party applications increased as more applications were added. We have deepened our partnerships with application developers and extended cooperation with third-party websites through OpenID and similar initiatives. By quarter end, we had 57 applications mainly from third-party developers. Active user accounts of Pengyou, our real-name SNS, grew 28% quarter- on- quarter to RMB 129 million.
With the official launch of the Pengyou.com domain name, we have further gained market share in the white-collar and university student communities. By quarter end, we had 606 applications on this platform. Two weeks ago, Zynga Beta launched the Chinese version of CityVille on our open platform. For our microblog service, registered user accounts exceeded 233 million, which translated into 59% growth quarter- on- quarter. We'll continue to invest heavily in premium content and marketing to grow user base and increase our user interaction. In addition, we will leverage the integration of this service with our other SNS open platform and experiment with applications for microblog. For QQ Membership, monthly subscriptions increased as we continued to enrich functionalities and do cross-promotions. We're also expanding our loyalty program called Pengyou to link up with our growing e-commerce endeavors.
For QQ Show, we were focused on expanding user base through special promotions and free items. Moving on to online games, starting with the casual game, on the mini casual game front, we added two new applications during the quarter and brought the total number of games to 109. The combined PCU and ACU were 7.5 million and 3.8 million, respectively, compared to 7.7 million and 3.5 million last quarter. PCU decreased slightly, mainly due to weak seasonality, while monetization increased as a result of marketing and in-game promotions. For advanced casual games, we're now operating six titles on our platform. The combined PCU and ACU were 7.5 million and 2.1 million, respectively, compared to 5.6 million and 2 million last quarter. Both QQ Speed and QQ Dancer reached a record high PCU as a result of new play modes and in-game promotions. Monetization was roughly flat quarter- on- quarter.
As part of our new game launch on July 21st, our League of Legends was launched for unlimited closed beta testing. For client-based MMOG, we're now operating nine titles on our platform. The combined PCU and ACU were 4 million and 1.3 million, respectively, compared to 2.9 million and 1.2 million last quarter. Dungeon and Fighter broke record high PCU at 2.6 million following the release of its largest to-date expansion pack in mid-June, with new content, high experience levels, as well as enhanced gaming experience. For this game, we'll continue to put a lot of focus on fighting bots. Now, an update on our pipeline titles. QQ Xian Xia Zhuan , a self-developed 3D MMOG based on ancient Chinese fantasy, was open beta launched in mid-July.
C9 was on track for open beta in the second half, while Legend of Yul ong, another self-developed MMOG, was delayed to the first half of 2012. As for web games, Qi Xiong Zheng Ba reached 800,000 in PCU in May due to in-game promotional activities. Roku Kingdom, which is positioned as a healthy and educational gaming product for children, maintained the number one position in this category with a PCU of over 500,000. Now, in terms of our wireless business, the segment revenue for the quarter was RMB 794 million, an increase of 2% quarter- on- quarter, or 18% year- on- year. The quarter-on-quarter growth was mainly due to the growth of 2.5G-based global SNS and mobile games, while offset by certain unfavorable regulatory policies. Now, on the revenue breakdown side, SMS revenue was RMB 532 million, flat quarter-on-quarter, on an increase of 7% year-on-year.
2.5G-related revenue was RMB 253 million, an increase of 6% quarter-on-quarter, or 53% year-on-year. Mobile (Voice) VAS revenue decreased to RMB 9 million. In April, we launched a new mobile games open platform offering over 300 free-to-play casual games to mobile internet users in China. Currently, most of these games are for downloads. Looking forward, our wireless business will continue to be overshadowed by the double confirmation plus reminder, as well as cancellation before verification rules. We remain cautious on the near-term revenue trend, as we believe the negative impact of such rules will persist for the next few quarters, as well as other regulatory changes can occur in the meantime. However, we are quite focused on developing the mobile internet business. Although right now, the mobile internet products actually do not generate a lot of revenue, we believe that they are actually very popular with users and will generate user demand.
We believe that investing in this area would actually allow us to capture a lot of user demand. Over time, some business model can actually evolve. Now, finally, an update on our advertising business. Segment revenue was RMB 512 million, an increase of 82% quarter-on-quarter, or 29% year-on-year. The quarter-on-quarter growth was fostered by favorable seasonality in the second quarter. During the quarter, our top five advertiser categories were online services, food and beverage, autos, apparels, and online games. In terms of revenue breakdown, IM-based advertising was RMB 235 million, an increase of 83% quarter-on-quarter, or an increase of 46% year-on-year. Portal advertising was RMB 239 million, an increase of 82% quarter-on-quarter, or an increase of 7% year-on-year. Search-based advertising was RMB 38 million, an increase of 78% quarter-on-quarter, or an increase of 194% year-on-year.
On display advertising, revenue grew 23% year-on-year off the high base achieved during the World Cup and World Expo period last year. We're now focused on building traffic on our video platform to position ourselves for the increasing demand from advertisers on video advertising. Following the launch of our web-based video service, the combined daily unit visitor on our client and web-based video platform reached 21 million in June. For search-based advertising, revenue increased 194% year- on- year off a low base last year. While it's encouraging to note that our search ad revenue has climbed back to the level before we launched our self-developed engine in September 2009, we're now more focused on improving our search engine and advertising technology for the long term rather than revenue generation at this point in time.
Now, with this, I will conclude the business review and outlook section and pass to John for financials.
Thanks, Martin. Hello, everyone. For the second quarter of 2011, our consolidated total revenue was about RMB 6.74 billion, an increase of 44% over the same period last year, or 6% quarter- on- quarter. Operating profit was RMB 2.78 billion, an increase of 17% year- on- year, or a decrease of 18% quarter- on- quarter. Net profit was RMB 2.34 billion, an increase of 21% year- on- year, or a decrease of 19% quarter- on- quarter. Profit attributable to shareholders was RMB 2.35 billion, an increase of 23% year- on- year, or a decrease of 18% quarter- on- quarter. Basic earnings per share for the quarter was RMB 1.289. Diluted earnings per share was RMB 1.26. Since last quarter, we have provided you a few non-GAAP figures for reference. To recap, our non-GAAP adjustments will exclude financial impact due to acquisitions and the impact of share-based compensation.
Further details can be obtained from the MD&A in our disclosure. After this adjustment, non-GAAP operating profit would be RMB 3.2 billion, an increase of 2% quarter- on- quarter, or 28% year- on- year. Non-GAAP operating margin decreased to 47% from 49% last quarter. Non-GAAP net profit would be RMB 2.69 billion, an increase of 4% quarter- on- quarter, or 31% year- on- year. Non-GAAP net margin decreased to 40% from 41% last quarter. Non-GAAP net profit attributable to shareholders would be RMB 2.69 billion, an increase of 4% quarter- on- quarter, or 31% year- on- year. Non-GAAP basic earnings per share would be RMB 1.474. Non-GAAP diluted earnings per share would be RMB 1.442. I will now go through the selected items for the second quarter of 2011. Share-based compensation expenses increased to RMB 109 million and represented 3% of total revenue.
We recorded net other gains of RMB 3 million in comparison to net other gains of RMB 339 million last quarter. The difference was due to the recognition of a one-time gain of RMB 459 million in relation to the Riot Games acquisition and a donation of RMB 100 million to Tencent Charity Fund last quarter. Income tax expense was RMB 405 million in comparison to RMB 522 million last quarter. This primarily reflected the full quarter impact of reversal of deferred tax liability arising from the Riot Games acquisition, the reversal of income tax expenses as a result of finalization of enterprise income tax assessment for 2010, as well as a decrease in deferred tax liabilities recognized in relation to withholding tax. Looking at the revenue breakdown, IVAS made up 80% of the total revenue in the second quarter.
MVAS accounted for 12% and online advertising 8% of total revenue. In dollar terms, IVAS revenue was RMB 5.39 billion, an increase of 3% quarter- on- quarter, or 50% year- on- year. MVAS revenue was RMB 794 million, an increase of 2% quarter- on- quarter, or 18% year- on- year. Online advertising revenue was RMB 512 million, an increase of 82% quarter- on- quarter, or an increase of 29% year- on- year. Total cost was RMB 2.33 billion for the second quarter, an increase of 6% quarter- on- quarter, or 57% year- on- year. As a percentage of revenues, total cost was stable at 35%. Going one level down to the segments, IVAS gross margin was stable at 67%. MVAS gross margin decreased 3 percentage points to 59% due to increased staff cost and equipment depreciation.
Gross margin for online advertising increased 9 percentage points to 67%, mainly due to revenue growth during favorable seasons. Moving on to operating expenses for the second quarter, selling and marketing expenses were RMB 369 million, an increase of 23% quarter- on- quarter. This primarily reflected increased advertising and promotional expenses relating to microblog and other products, as well as increasing staff cost. It represented 5% of quarterly revenue. G&A expenses were RMB 1.36 billion, an increase of 52% quarter- on- quarter, and represented 20% of quarterly revenue. The quarter- on- quarter increase was mainly due to the impact of right gains, which included amortization of intangible assets amounting to RMB 191 million and one-time transaction cost of RMB 54 million. Excluding the impact of right gains, G&A increased 24% quarter- on- quarter. R&D expenses were RMB 672 million, an increase of 31% quarter- on- quarter.
It represented 49% of G&A or 10% of quarterly revenue. As of quarter end, we had about 12,900 permanent staff and over 3,300 outsourcing staff. Let's look at the margin ratios for the second quarter. Gross margin was stable at 65.4%. Operating margin decreased 12.1 percentage points to 41.3%. Net margin decreased 10.7 percentage points to 34.8%. On a non-GAAP basis, operating margin decreased 1.7 percentage points to 47.5%. Net margin decreased 1 percentage point to 40%. Now, I will provide a few key financial figures for your reference. CapEx was RMB 943 million for the quarter, an increase of 31% quarter- on- quarter. By breakdown, operating CapEx was RMB 823 million in comparison to RMB 642 million last quarter. Non-operating CapEx was RMB 120 million in comparison to RMB 79 million last quarter. We repurchased 211,000 shares for about HKD 40 million during the quarter.
As of quarter end, our net cash position was RMB 15.6 billion. The total number of shares in issue was 1.839 billion. This is all about financials. Thank you.
Thank you, John. Operator, shall we take the first question, please?
We will now begin the question and answer session. If you wish to ask a question, please press * 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 Vic Wei of JPMorgan . Please ask your question.
Hi. Thanks for taking my question. My first question is on Qzone. I wonder how should we look at the revenue breakdown between the subscription versus the item-based and also whether or partly on related item-based revenue?
As it stands right now, the majority, actually the vast majority of the revenue is still from the subscription revenue. There's an increasing amount of item-based revenue from both Qzone and Pengyou. Within that item-based revenue, the vast majority is actually coming from Qzone. Just to give you some sense of growth in terms of the two different sources of revenue, in the second quarter, the subscription-based revenue actually has a very slight decline, whereas the item-based revenue actually grew pretty substantially. It actually grew more than 100%. We're not in a position to talk about the exact mix. I think this should give you some sense of how the breakdown looks like and what the trend looks like.
Maybe if I can follow up on that, are you seeing more of the paying Qzone subscriber being the item-based paying user, or any kind of correlation we can see on paying or non-paying Qzone members?
Yeah, I think at this point in time, the item-based revenue actually comes from all sorts of different users. They're obviously sort of the people who have paying on a subscription basis have actually more propensity to pay.
Okay, great. My second question is, update the plans on advertising on Pengyou and Qzone platform?
At this point in time, there is actually some advertising related to Qzone already, whereas there's not that much of advertising on Pengyou. That's mostly related to branded advertising as well as activity-based advertising with branded advertising clients. Going forward, there will be experimentation around putting in more of long-tail advertising within the Qzone platform. Right now, it's still being developed and being tested out.
Okay, great. Thank you very much, Martin.
Sure.
Thank you. Next question, please.
Your next question comes from the line of Richard T. of Morgan Stanley. Please ask your question.
Pony, Martin , John , and Catherine , thank you for taking my call. I have two questions. Let me start with the question regarding open platform. This may prove to be a new catalyst for your company. Can you give us some granularity in terms of the partner, the volume growth for your partner, as well as what are the most popular third-party applications on your platform? When should we expect material revenue contribution from those third-party apps?
Yeah, I think we're still at the very early stage of the open platform implementation. I think we have planned for this for quite some time. I think there's actually quite a bit of interest among our potential partners on this. We still are implementing this at full speed. At the same time, I think there's a lot of issues that we need to resolve with respect to security and scalability. If you look at the applications that are on our platforms, with respect to Qzone, we have more than 50 applications right now on Qzone. You can look at Pengyou as sort of the pipeline or the testing bed for Qzone. On that platform, there are more than 600 applications already on Pengyou, and that's up from more than 300 in the previous quarter.
Around applications, we would say most of the popular applications right now are somehow game-oriented, and those are also the applications that are monetizable. In addition to applications, we also have other initiatives on our open platform, including this infrastructure, which allows different websites to be connected to our social platform and feeding their content to our social platform through the like relationship. We have quite a large number of websites which have been connected. As a matter of fact, there's more than 300,000 websites that have been connected. We have also launched our QQ login infrastructure, which allows QQ users to essentially use the QQ number to log into various websites. We have also seen a pretty significant growth in terms of the number of websites adopting this login infrastructure.
Going forward, we are also taking our open platform to our QQ platform through Q+, as well as putting some of these applications on our microblog platform. I think the way we look at this open platform strategy is that we are still in the very early days in terms of our open platform implementation. There are a lot of things that we still have to do. I think the determination is to continue to push on various fronts, including the product offering, the platform offering, as well as the depth of relationship that we build with all these open platform partners.
Thank you, Martin. That's helpful. My second question is regarding your Weibo microblogging service. Obviously, you have enjoyed quite a robust growth of more than 50% of Weibo user volume. Can you elaborate a little more on the activity level, as well as the potential plan for monetization and for your Weibo product, especially facing the competition from Sina? Thank you.
I think we have actually been very focused on building our microblog platform. We felt that the microblog platform has made pretty significant progress along a number of different dimensions, of course, along the dimension of user base, and as you mentioned, also along the line of user activity. I think when people sign up to a microblog platform, it takes time for them to be absorbed into it and to start gaining a level of activity. I think because of a lot of the users that we actually brought into the platform over a short period of time, the level of activity needs to be increased over time. I think we're seeing that increase gradually. There's also an increase in terms of the amount of content, especially with respect to contribution from celebrities.
That includes celebrities who sign up on an individual basis, as well as institutional relationships that we have built throughout the quarter. As you can see, we actually sort of have built relationships with, for example, (TBB), with EEG, so that we actually sort of can provide a platform for their artists to put their content and various activities onto the microblog platform. We have also sort of built relationships with various media and organizations around China so that they can actually use our microblog platform as a platform for information dissemination, as well as for interactivity within the organization. I think the progress on increasing the user activity along different dimensions has been quite solid. In terms of monetization, I think there's really no plan for us to monetize our Weibo platform at this point in time.
I think right now the focus is really to build user experience, as well as to build user activity into this platform.
Yeah, that's helpful. Thank you, Martin.
Thank you. Next question, please.
Your next question comes from the line of Eddie Leung of Merrill Lynch. Please ask your question.
Good evening. Thank you for taking my questions. I have a couple of questions. The first one is about your social platform. Could you provide us more color on how your users allocate their time and activities on your various social platforms, including Pengyou, Qzone, and Weibo? Could you also share with us the ARPU range of your different types of games and the ranking of your community IVAS in terms of growth rate? Thank you.
Actually, that's a lot of questions to answer in different dimensions. Now, let me take the first one, and then John can take the last two. In terms of our social infrastructure, I think our social infrastructure covers three distinctive areas. The first one is actually communication, and that includes QQ, our instant messaging platform, and email, our QQ Mail platform. The second one is our social networking platform, which includes Qzone as well as Pengyou. The third one is social media. I think these different platforms actually serve different purposes, right? Communication, either it serves the simultaneous communication, as well as communication through email. On Qzone, on the social networking side, Qzone and Pengyou serve users in different needs. For example, Qzone serves, I think, the more broad-based need for staying connected, for sharing updates, pictures, and sharing different types of gaming experiences or music, the likes of that.
Whereas Pengyou actually caters to the white-collar people, as well as the university students who are at the stage of expanding their real-name-based social network. Also, if you look at Tencent Weibo, it's actually a social media in which it satisfies people's needs for information and for interactions around media topics. I think it's really a two-dimensional thing in the sense that there are different people who will be spending time on different platforms, and they are spending different time on different platforms also based on their different needs. What we try to do is actually to build enough integration into these different platforms so that for sharing of certain information and for especially interactivity, we can actually allow users to do it across our platforms more easily than individual platforms.
At the same time, we also try to build each one of these platforms to be its best-in-class for that particular application.
Yeah, in relation to the ARPU, MMOG would be RMB 90 - RMB 130 per quarter, whereas advanced casual game would be RMB 45 - RMB 80 per quarter. For the growth rate of community value-added services, the growth rate as well as the absolute growth amount in descending order would be Qzone, premium membership, and QQ Show.
Thank you, Martin and John. I appreciate it.
Okay, thank you, Eddie. Next question, please.
Your next question comes from the line of Catherine Leung of Goldman Sachs . Please ask your question.
Hi. Thank you for taking my questions. My first question is whether you can elaborate on the degree of impact we should expect to see from the transition to the open platform that you mentioned in the press release. Also, for a particular user, would you expect item-based revenues to be in-person or to the subscription revenue over time? At some point, will Pengyou cease to be an incubation center for apps for Qzone? My second question is whether we should expect resistant development cost growth to continue to accelerate for the remainder of the year. Is most of this cost increase related to the open platform or some other areas like e-commerce or your Weibo? Thank you.
Okay. On the revenue side, I think in terms of the revenue between sort of subscription and item-based, we felt that over time, right, they should cater to different groups of user demands. Hopefully, a lot of the item-based revenue would be incremental. I think in the early days, in the first couple of quarters, we did try to use various promotional as well as operational measures to, I would say, bootstrap the item-based revenue so that our platform can become an attractive platform for third-party developers. We install a fair amount of confidence and excitement among the partners and potential partners. Over time, what we want to see and hope to see is that the item-based revenue can actually help us to address the needs of an incremental number of paying users, as well as allow existing paying users to pay more under the gaming environment.
Now, in terms of cost, we are at a stage of the development of the industry in which there's an increased pace of innovation. You can see with the growth of social network, with the growth of e-commerce applications, with the growth of mobile internet, there are indeed a lot of new opportunities and new innovations. The goal of Tencent has always been to be able to stay at the forefront of innovation in various areas which are important to users. In some cases, we would be developing the technology and platform in-house. At the same time, we are also adopting an increasingly open approach such that we can actually create a platform for third parties to develop their applications. At the same time, we also invest in some of these companies if we feel that there's enough synergies between the two companies.
In reaction to the increased pace of innovation, as well as the increasing opportunities within the internet industry, we would be actually investing more in terms of research development. We will also invest more in our relationship with the various partners within the industry value chain. That would involve creating revenue opportunities for these partners, sharing more revenue with them, as well as investing in them through different occasions. All these will be happening going forward.
Thank you. Just out of curiosity, will Pengyou stop being the incubation center for the apps for Qzone at some point?
I think right now, the infrastructure actually was set up pretty smoothly, such that there is sort of an incubation center and testbed for applications. I think we'll keep it for the foreseeable future. When Pengyou grows to a certain size, which are sort of very big, we may sort of rethink that strategy. We may sort of create a separate mechanism for testbeds. Right now, we will see that continuing for the next two quarters.
Okay, thank you.
Your next question comes from the line of (Warren Young of Credit Suisse. Please ask your question.
Hi. Thank you for taking up my questions. I have two questions. One is on the online video. As we've seen, Tencent is getting to be quite aggressively into the online video space and forming kind of a content partnership for procuring video content. How do we see the kind of potential revenue contribution, as well as the cost potential incurred of the cost of both on the bandwidth and the current cost in the next couple of quarters? Second question with regard to the investment of Tencent in so many of these internet e-commerce companies, as we've seen the intangible assets dropping RMB 400 million and investment in associates jumping at RMB 1 billion on a quarter-on-quarter basis. Also, there are a lot of news sources saying Tencent is getting into a lot of e-commerce companies.
How do we see some of these investments to be potentially contributing to Tencent positively? Also, will Tencent keep repeating some sort of investment phases in the next couple of quarters' time? Thank you.
Yes. In terms of video, I think I would say a number of points, right? Number one is we do see the potential in video in the sense of both user demand as well as advertising dollars. That's why we are actually very focused on building that platform. Number two is I think we have a solid base established through our many years of operating our QQ Live platform. We have accumulated a good technology platform, a solid user base, as well as good expertise in managing content. Having said that, we have underinvested historically in this business, both in terms of bandwidth as well as in terms of content acquisition. That's why in the past two quarters, I think we have been very focused on building our web-based platform, which allows us to sign up users more easily.
Also, we have been acquiring content so that we can provide, I would say, sort of industry-leading content to the users. In the foreseeable future, I think we'll continue to be quite focused on building the platforms and building the user base first. The advertising dollars, we believe, will come once we have been able to build the platform and accumulate a large user base. We're not too worried about that. I think in the next two quarters, the focus will continue to be building the user base. In terms of cost, I think we will be spending, I would say, sort of at industry level, at least sort of in par with the industry peers in order to stay competitive. Obviously, we have certain advantages in terms of our platform and being able to attract users.
If you look at sort of the costs incurred in relation to that, I think we are willing to spend at the level where other industry peers are spending. In terms of the investment in e-commerce companies, I think we do look at e-commerce as an important application for users. Increasingly, more and more purchasing activities are actually sort of happening online. That's a trend that we have seen based on our pretty long investment in our payment platform, as well as on our marketplace platform, BeiBei. We've seen pretty significant and consistent growth in the transaction volume in both platforms. That's why at this point in time, starting from, I think, late last year, we have been starting to be much more involved in investing in the e-commerce industry.
We felt that if we actually can invest in the best-of-breed e-commerce companies, these companies can actually form partnerships with us. At the platform level, we can provide a platform of users, and we can provide a lot of infrastructural services to them, including customer acquisition, loyalty programs, payment platforms, and so on and so forth. We can actually help some of them to grow and capture the opportunities in the e-commerce business. We look at e-commerce as a very, very large market. We definitely want to have multiple points of getting into play in this market. That is why we are building our own platforms, be it the payment platform, be it the BeiBei platform, and our Taipei loyalty program platform. At the same time, we are also investing in vertical areas so that we can have multiple touchpoints on the e-commerce market.
Hi. Thank you. Just one quick follow-up on the online video. Can you just share with us the current percentage of revenue from the advertising side coming from the online video space? Thank you.
I think right now it's just very, very small amounts. That's why I said at this present time, what we are focused on is really building the platform rather than harvesting on the advertising revenue dollars. There needs to be actually a lot of time spent on building up the advertising platform. On a relative basis, we felt the resources would be much better spent on building up the traffic platform and the video and content management platform. That's why that's the focus right now. The revenue in the existing quarter from video advertising is actually quite minimal.
Okay, thank you very much.
Your next question comes from the line of Alex Yao of Deutsche Bank. Please ask your question.
Hi. Good evening, everyone. Thank you very much for taking my question. I have two questions. One is regarding the online video. How would you like to differentiate the Tencent Video offering in China's online video market in the long run? Also, can you talk about your content purchase strategy in the next several quarters? A second question is, can you talk about your general M&A strategy? It seems that the company has been making increasingly more investment in the content generation and the e-commerce area. Can you talk about the rationale behind this activity? Thank you very much.
Yeah, I think in terms of the video platform, I think the key advantage that Tencent has got is really one is our access or our availability of users, our access to the users. I think this is actually quite well demonstrated in the fact that if we have the same content being played on multiple platforms, usually we have one of the industry-leading number of viewerships. Even at this present time, even in the past, we have been quite cautious in terms of spending on our bandwidth because we actually are a very convenient access point for users. I think the second one is integration of the video content with our sharing infrastructure and with our social infrastructure.
We felt that when we can provide the way through which users can share a lot of their preferences and their video with their friends, it actually induces additional demand and helps users to get a better experience. I think those are the areas through which I think we can have some kind of advantage for the users. Now, in terms of our content acquisition strategy, I think in the past, we have been very cautious in terms of content acquisition. I think in the future, we'll be more generous in terms of content acquisition. We definitely want to be one of the leaders in terms of the comprehensiveness of the content presented to users.
I think in some cases, because we can cross-leverage a particular content across our different platforms, including video, including, in some cases, music, in some cases, our microblog platform, in some cases, our gaming platform, we can provide some differentiated cooperation model with content owners. Over time, for some cases, it can provide us with some kind of advantage. Now, in terms of our investment strategy, I think in my answer to Wendy's question, we did touch upon e-commerce already. We believe it's a very large market. There is market potential for various kinds of business models. We also have a pretty strong platform of infrastructure that's relevant to different business models. That's why we felt that we can build our own platforms. At the same time, we can also use our infrastructure to help various vertical companies to gain advantage.
That's why we try to identify those areas where there is a best-of-breed company. There's a pretty good fitting with our culture. There are synergies between our infrastructure and platform with their vertical capability. On the content side, as I talked about, there's an increasing number of platforms that have some kind of synergies with video or music content. For example, a particular piece of video or music content can be used across our video, music, gaming, and microblog platform, as well as portal platform. That is why we felt that establishing a longer-term relationship with content owners can also help us to build a long-term relationship. We can actually work on a more long-term basis to develop some new models for helping them to create better content or distribute their content better and establish a win-win relationship between us and them.
In addition to business cooperation, we also, in some cases, invest in these companies so that we can foster this kind of longer-term relationship for experimentation of new models. Having said that, we continue to exercise discipline in our investment and acquisition approach. We do look at the fitting of our culture, the existence of synergies, as well as we look at valuation actually quite intently. When valuation becomes too high, we also exercise more caution in terms of our investment and acquisition.
Got it. Just one very quick question. What would be the amortization of intangible assets in the next several quarters?
As the amortization, the methods you know, amortization charges incurred will linger for another two and a half quarters.
Got it. Thank you.
Next question, please.
The next question comes from the line of Gary Ng of UBS . Please ask your question.
Thank you very much for taking my question. My first question is related to League of Legends and Riot Games. Firstly, on the ARPU level in the U.S. to China, I'm just curious, for example, Riot disclosed that recently League of Legends got 500,000 TCU in U.S. and Europe combined. On a like-for-like basis, how does that compare to a 500,000 TCU game within your portfolio? In relation to that, when should we expect Riot Games to be breaking even? I have a follow-up after that.
Okay. In terms of the monetization of LoL , I think there is obviously sort of if you look at the Western market, right, typically what happens is the ability to pay is actually higher in those markets. However, at the same time, what happens with League of Legends is that I think the philosophy of Riot Games has always been more providing a platform such that people can have a fantastic and outstanding gaming experience rather than really exploiting people on the monetization side. I think the gaming team development philosophy has been monetizing at a relatively modest level. I think that's sort of how we look at the current monetization of LoL in the Western world right now.
In terms of the business itself, with respect to Riot Games, I think one clarification that we want to make is that the revenue that you see with respect to League of Legends or Riot Games right now is actually there's some anomaly in it because when we actually make the acquisition, we actually restart the process of accruing revenue. All the revenue generated by Riot Games is actually on an accrual basis. Because you restart the clock at the time when we make the acquisition, for the first few months, the amount of revenue that you book is actually much less than the amount of consumption that's by the users. The revenue is small because of this reason. If you look at the consumption, this company is already breaking, it's already profitable,
actually.
Oh, wow. That's very impressive. Just one follow-up on League of Legends before my next question. Does the PCU in the U.S. and Europe already get included in your Q2 combined PCU, or is it under MMOG or ACG?
No, it's not.
Okay. Great.
What we talk about is actually like for like and also, you know, the China PCUs. It does not include Western world PCUs generated by Riot Games.
I see. My second question is relating to Qzone and Pengyou, the relationship between the two. I guess just from a user perspective, is there really demand for having two completely separate platforms? I can appreciate the fact that the design and the positioning of the two platforms are quite different. In terms of the user interaction and the demand from the user, I guess the question is, in two, three years' time, do you think there's still a need for two separate platforms addressing similar interactions, or am I completely misunderstood in terms of the two different platforms, product maker?
I think they're not completely separate, right? I think what they provide for our features and functionalities is for different user needs. That user needs can exist for different users, but they can also exist for the same users. What we want to do is actually to say there are two platforms in which we can actually address different user needs. In particular, for our Pengyou platform, it is actually the needs of the people who want to use the real name to expand their social graph, especially at the stage of their life when they enter college and when they enter into the workspace. These needs can be for the same person as well. As a matter of fact, when we look at college students, for example, I think a lot of the college students actually are using both of the platforms.
What we try to do is actually we provide a user interface such that they can actually move across these two platforms very easily. If they share, they can decide to share to both networks, or they can decide to share with only one group of their social graph. I think in a way, it's providing for different scenarios of usage, but at the same time, for the people who want to use these platforms both, we actually provide them with a fair amount of integration so that it's very convenient for them.
I see. Thank you very much. Sounds like Google + to me. Thanks very much, Martin.
Yeah. Thanks.
Your next question comes from the line of Wendy Wang of RBS . Please ask your question.
Thanks for taking my questions. My first question is also regarding the game. Can you elaborate on your relationship with Zynga, and also whether you will launch more games developed by Zynga, and what kind of economic terms you're having in this relationship? You just licensed Blade & Soul from NCSoft. Should we expect this game to be launched in the China market in 2012 or maybe even beyond that? Thank you.
Yeah. With respect to Zynga, I think we have a very cordial relationship. We have just launched CityVille on our Pengyou platform, and I think the response has been encouraging on the platform. We obviously want to build a long-term relationship with Zynga. I think the focus for now is actually to make sure that CityVille actually becomes a successful product on our platform. From that, we can actually foster a longer-term relationship, and we can bring more of their games to China and onto our platform. In terms of Blade & Soul, we are very excited to get the game title. It's an exciting title from NCSoft. I think the trait of NCSoft is actually to develop a very high-quality title.
I think we really can't say when this product will be launched in China because a lot of it actually depends on when NCSoft decides that this is a good enough quality to launch. As a partner, we actually respect that attention to quality. That's actually one of the reasons why we see eye to eye in terms of the philosophy in approaching this. From a Blade & Soul perspective, we would much rather wait for it to become polished enough so that NCSoft tells us, "This is a great quality game," and they want us to launch rather than saying, "We are committed to a particular time frame.
Okay. Thank you. Next question, please.
Your next question comes from the line of Jin Lee of CICC. Please ask your question.
Good evening. I have two questions. My first question is regarding mobile internet. After using various kinds of Tencent mobile applications on smartphones, it seems that it becomes more user-friendly as I can use Tencent's different services within one application, such as on Qzone, instead of logging onto different applications. However, I also understand that Apple seems to like the in-app model. My question is, did we meet any review problems when we submit those applications with integrated services in iOS? Any comments on future strategies on mobile internet are highly appreciated.
Yeah. If I understand your question correctly, you're saying whether we ran into any approval problems with Apple, right, when we have integrated services. I think we obviously work very closely with Apple in making sure that our application can be approved to be put onto the App Store. Sometimes we do actually need to make changes according to the requirements of Apple. We felt that since we need to actually get onto the platform, we do take a constructive approach and make the changes that Apple requires us to do. So far, I think the process has been relatively smooth. In terms of mobile internet, as you rightly pointed out, we are actually putting out quite a lot of applications onto the mobile platform, particularly for a smartphone platform. I think our strategy will continue to be sort of twofold.
One is to migrate and customize our existing PC-based internet services onto the wireless platform and developing these applications so that there's a seamless user experience when users are using our services on PC or on the headset. The other one is actually also to look for the additional opportunities such that we can actually develop specific mobile applications, applications like mobile games, which exclusively run on the mobile platform and cater to the specific needs of local users. We are also quite excited about this kind of opportunity, and we're investing quite a bit of resources to launch mobile applications.
Okay. Thank you. Operator, in the interest of time, please leave the last two questions.
Sure. Your next question comes from the line of Ming Zhao of SIG. Please ask your question.
Thank you. I have a question on the cost and expense, which relates to the margin. The first question is, in the G&A expense in the second quarter, what would be the amount that won't be recurring in the third quarter, sort of non-GAAP item there? Secondly, more general, if we look at the second quarter cost and expense as a percentage of revenue, except the G&A, there's not much changed. You are guiding for higher expense because of the investments and spending in the future. How should we look at those expense and cost line as a percentage of revenue going forward or the margin trend? Thank you.
I think in terms of the G&A expenses, I've mentioned before that there's one big item, amortization, which will linger for another two and a half quarters. Besides that, in the presentation before, I also mentioned that there's one-off transaction costs in relation to acquisition amounting to RMB 54 million. Other than that, all the other expenses in the G&A would be pretty much recurring in nature. For the expenses as a percent of your revenue, I must say that we're a company who will invest if we have to invest, rather than managing the expenses through looking at the percentage of revenue. We have been actively investing in a number of areas, including promotion and advertising, in particular in the microblog services.
On top of that, if you're talking about other types of costs or cost items, we have been actively investing in video content and other types of content as well as broadening our broadband capacity, as well as adding on extra service to augment the business growth as part of our open platform strategy.
In a nutshell, I think the nature of our business is that you have to build the services, build the traffic first before revenue can be generated. There is typically sort of a mismatch in terms of that. As the philosophy and as history proves, we have been quite focused on building the traffic and investing in the platforms. When we can actually attract enough users, then at some point of time in the future, certain business models will evolve and it will generate revenue and generate returns. I think in some businesses, we are at the phase of investment for the traffic right now. It will be only after time that certain business models can actually be achieved. At that time, I think the return will be reached. You have to have the investment first before the business model can be developed.
Thank you.
Let's take the last question, please.
The last question comes from the line of Harry A. of BNP . Please ask your question.
Good evening. Thank you very much for taking my question. My question is regarding the mobile open platform that Tencent cooperated with the Japanese developer GUI. I just wonder how much will Tencent share the revenue with the third-party game developer and the GREE. The market says Tencent probably will charge 20% and GREE maybe 5% and some part of like 10% -50 % to the online payment system. Could the management, please, elaborate that? Thank you.
At this point in time, we are not in a position to comment specifically on the commercial terms. As a philosophy, we would share revenue with our partners and with our content partners in such a way that it really compensates fairly the contributions of the different parties. At the same time, it provides an incentive for all parties to collaborate to keep building the platform. I think the exact amount will have to be through a process of discovery.
Okay. Thank you. One follow-up question on the online payment system. Can I know how much the commission rate will be, maybe in a range of 1% or even below 1%?
They're definitely not even close to 1%. I think you know at this point in time, the focus of our payment platform is really to build user base on one end and to build payment relationships on the other end. As a result, we can actually have a network effect that generates an increasing amount of gross payment volume in our platform. I think you know having a competitive pricing policy is actually core to sort of building these different building blocks of the payment network. I think you know in the past, we have been pretty successful in building these building blocks. We have seen a consistent growth in our number of users, in our number of merchant relationships, and in the payment amounts, right? I think we're still in the early days of building this virtual cycle. We're not going to actually focus on charging our customers.
Okay, thank you very much for all of your questions.
Thank you.
Yeah. Thanks very much for all of your questions. We're going to round up the conference call now. If you wish to check out press release and other financial information, please visit our IR website under www.tencent.com/ir. We'll also post a replay of this webcast on the site shortly. Thank you very much. See you next quarter.
That does conclude our conference for today. Thank you for participating. Tencent Holdings Limited, 2011 Second Quarter and Interim Results under.