Earnings Call: Q3 2016

Nov 16, 2016

Thank you for standing by, and welcome to the Tencent Holdings Limited 20 16 Third Quarter Results 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. I must advise you that this conference is being recorded today. I would like to turn the conference over to your host today, Ms. Katherine Chen from Tencent. Please go ahead, Ms. Chen. Thank you, operator. Good evening. Welcome to our results conference call for the Q4 of 2016. I am Katherine Chen from the IR team of Constant. 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 and may not be realized in future for various reasons. Information about general market condition is also coming from a variety of sources outside of Genent. This presentation also contains some unaudited non GAAP financial measures 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 non GAAP measures, please refer to our disclosure documents on www.tencent.com/ir. Now let me introduce the management team on the call tonight. We have our Chairman and CEO, Pangmin Ma President, Martin Lau Chief Strategy Officer, James Mature Chief Financial Officer, John Lo. Pony will kick off with a short overview. Martin will discuss strategic highlights. James will speak to business review and John will go through the financials before we take your questions. I'll now turn the call over to Pony. Thank you. Thank you, Katherine. Good evening. Thank you for joining us. During the Q3 of 2016, we delivered strong financial performance for our core businesses. In particular our smartphone games and social performance advertising businesses reported above revenue growth rate and continue to generate healthy margins. 4 key infrastructure platforms supporting our ecosystem specifically payment and cloud services, we saw significant progress in adoption and usage. We will continue to make investments in these strategic areas. Let me give you the head line numbers and defer the discussion to the financial section. Total revenue was RMB 40,000,000,000 up 52% year on year and 13% quarter on quarter. Non GAAP operating profit was RMB15 1,000,000,000 up 43% year on year and 2% quarter on quarter. Non GAAP net profit to shareholders was RMB11.7 billion up 42% year on year and 4% quarter on quarter. Moving to our online platforms, total MAU for QQ increased 2% year on year to 877,000,000 with 647,000,000 of monthly active users logged in via smart devices. Combined MAU of Weixin and WeChat increased 30% year on year to 846,000,000. For Qzone smart devices MAU increased 1% year on year to 584,000,000. In games we launched several successful smartphone games including role playing games which help us expand user bases. Our PC client games sustained leadership in several genres, retaining many loyal gamers through a range of immersive in game and less intense game related activities. In media, we saw healthy growth in users and traffic for our news and video platforms. Digital content subscriptions for music and video services increased. In the Q3, we merged our online music business with China Music Corporation. We believe the combined company can help shift China Digital Music Ecosystem to more sustainable business models. In Mobile Utilities, our Mobile Security Service continued its momentum. Our mobile browser partnered with China Reading Corporation to promote authorized content distribution. We continue to improve search, discover and download experiences in our app store in Yongbao via deep linking. I'll now invite Martin to discuss strategic highlights. Thank you, Tony and good morning, good evening to everybody. Tencent not only conduct our businesses but also invest heavily into developing technologies that may not generate revenue directly, but are important for our ecosystems. 1 of these technologies is our security technology. In the course of the past few years, we have made significant advancement in our online security technology, which has enabled us to become a leader in the market. In mobile security, Quest Mobile ranked us number 1 in MAUs since 18 months ago with a widening lead. In PC Security our market share exceeded 30% according to iResearch. These achievements were supported by our core security technologies. For example, we scored excellent results at the Global Hacking and Vulnerability Discovery Contest this year, winning the number one title in point to own. Several months ago engineers in our Keane's QD Lab in their efforts to enhance QD for Internet enabled cars had discovered vulnerabilities that conceded direct manipulation of Tesla's control system and that was a very significant event in the entire industry. Following international standards practices we shared our findings with Tesla who implemented the pageantry immediately. We continued to be a leader in fundamental security technologies such as scanning viruses, releasing memory as well as boosting speed of handsets. We're also the leader in anti fraud technology for smartphones. We own the most adopted detection system for phony base stations. We also own the largest database of fraud phone numbers and industry leading prediction technologies based on big data analytical capabilities. As an evidence of our leading position we became Apple's official partner in anti spam services supporting iOS users to identify, report and block nuisance calls in China. With best in class security capabilities we are providing a superior infrastructural service with the ecosystem of our own applications as well as our partner services. For Tencent apps we protect user ID, passwords, personal information and virtual property. Our security app Mobile Manager will automatically ensure a virus free terminal environment by scanning the mobile phone, WiFi access as well as in app links. Our cloud based security capability help to detect fraudulent web pages and phone calls. For Online Finance, the security technology is in particular important because it allowed us to provide users a safe environment for payment and financial transactions. Based on data analytics, we can identify and control dubious transactions before they are conducted. By ensuring security, we can speed up the adoption of online financial transactions and make users comfortable with conducting high value financial transactions on their smartphones. For our partners, we integrate our security capabilities into our cloud services to protect enterprise IT systems, defend against DDOS attacks and safeguard their products and services. For developers, we helped them to screen applications for security vulnerabilities before release. All in all our security capabilities has allowed us to develop a healthy ecosystem for our businesses. So with that I'll pass to James to talk about our business review. Thank you, Marty. In the Q3 of 2016, our total revenue grew 52% year on year. Value added services represented 69 percent of our revenue, within which online games contributed 45% and social networks 24%. Online advertising was 19% of total revenue. The other segment, which includes payment related and cloud services accounted for 12% of total revenue. Looking at value added services, segment revenue was RMB28 1,000,000,000 in the 3rd quarter, up 36% year on year and up 9% quarter on quarter. Social network revenue was RMB9.8 billion, up 58% year on year and up 15% year on quarter. Strong performance of game related item sales and digital content sales drove the year on year and quarter on quarter revenue growth. In the 3rd quarter, the consolidation of China Music Corporation contributed over RMB800 1,000,000 to sequential revenue growth, of which over RMB700 1,000,000 was booked under the social network category. Our online game revenue was RMB18.2 billion, up 27% year on year and up 6% quarter on quarter. New smartphone games and strong performance of key PC titles contributed to the year on year revenue growth. Sequentially, PC games benefited from positive seasonality. Some of our big smartphone games such as Honor of Kings and JX Mobile delivered strong operating performances as well. Turning to social networks. For QQ, we added creative and fun features to enliven chat and community experiences. Specifically, we launched Centimeters Show, a mobile QQ product that provides users with animated personal avatars. With these avatars, users can interact with their friends inside the chat box or connect items from friends to unlock new features. We conducted an augmented reality torch relay campaign for the Rio Olympic Games and over 100,000,000 mobile QQ users participated in the 22 day event. For Weixin, we're beta testing a new function called mini programs. Users will enjoy a native app like experience conveniently without needing to leave the Weixin interface. Consequently, they can reduce their phone CPU usage and phone memory storage requirements. For WeiShin Pay, we significantly increased merchant adoption. On August 8, we launched our annual cash free day in many Tier 1 and Tier 2 cities. The total number of stores participating in this promotional campaign increased by over 7 times year on year to almost 700,000. In September, we added Weixin Checkout, a feature that helps merchants simplify payment integration and reduce registration process time. By scanning a unique QR code assigned to each store, consumers can check out and pay quickly, while store managers can manage billing activities efficiently. Looking at PC client games, revenue grew 10% year on year and 9% quarter on quarter. Daily active user accounts were down 9% year on year and stable quarter on quarter, while average concurrent user accounts for advanced casual games were down 18% year on year, and average concurrent user accounts for Massively Multiplayer online games were down 11% year on year. To put some color around these trends, increasingly fast broadband speeds are enabling more PC gamers to enjoy real time player versus player games, such as League of Legends and FIFA Online in which they alternate high engagement competitive sessions with low intensity practice review and game related chat sessions. Consistent with this migration in behavior, we're shifting our engagement focus away from maximizing user time spent in game and to more broadening overall user engagement via game related activities such as e sports and tournaments, video streams of popular gamers and game specific interest drives within QQ and Weixin. This shift in focus results in users spending less time passively sitting inside the game client, which naturally translates into fewer average concurrent users since the average concurrent user metric measures total active users multiplied by average time spent in the game client per user. However, the shift is not necessarily reducing user engagement with our games or willingness to spend money on game items and our PC game revenue increased despite the declining average concurrent users. Ultimately, we believe this broader engagement model should result in healthier, more sustainable gaming relationships with our key products. Our smartphone games revenue reached RMB9.9 billion, up 87% year on year and up 3% quarter on quarter. We were the number 1 ranked publisher in the iOS App Store top grossing chart globally and also number 1 publisher in Android App Stores inside China. In the Q3, we published 2 new casual games and 3 new mid call games. Our player versus player competitive games and role playing games continue to drive key Honor of Kings recently surpassed 40,000,000 daily active users, which we believe is a usage record for midcall games in China. Our recently launched role playing games such as JX Mobile, Yudong Mobile and Azir Mobile contributed materially to sequential revenue trends and were cultivating in esports culture for mobile games through high profile for titles such as Crossfire, Mobile and Honor of Kings. Moving on to online advertising, segment revenue was RMB7.4 billion, up 51% year on year and up 14% quarter on quarter. Brand advertising revenue was RMB3.1 billion, up 21% year on year and up 9% quarter on quarter. Revenue grew year on year and quarter on quarter due to mobile news feed ads and the Rio Olympics. About 700,000,000 unique visitors followed the Olympic Games in our news and video platforms, cementing our position as the online leader in terms of sports related traffic and revenue. Our top 5 brand advertiser categories were food and beverage, automobile, online services, personal care and consumer electronics. Performance advertising revenue was RMB4.3 billion, up 83% year on year and up 18% quarter on quarter. Weixin advertising, including moments and official accounts inventories, was the biggest contributor to the year on year and quarter on quarter growth. In September, we launched neighborhood ads that enabled local merchants to promote their services and products to the most relevant users within 4,000 business hubs in major cities. The number of Weixin Moments advertisers increased by over 100% quarter on quarter. In response to advertiser demand, we've been shifting some mobile news feed inventory from selling on a cost per time brand model to selling on a cost per click performance model. This has had the effect of reducing our brand advertising revenue and increasing our performance advertising during the period. And now I'll pass to John to talk through our financials. Thanks, James. Hello, everyone. For the Q3 of 2016, our total revenue was RMB 40,400,000,000, 52 percent year on year or 13% quarter on quarter. Gross profit was RMB 21 800,000,000 up 40% year on year or 7% quarter on quarter. Share of losses of associates and joint venture was RMB 619,000,000 an increase from RMB 292,000,000 in the 2nd quarter. On a non GAAP basis, share of losses of associates and JV reduced sequentially from RMB206 1,000,000,000 to RMB107 1,000,000. Income tax expense was RMB2.5 billion, up 57% year on year or down 11% quarter on quarter. Effective tax rate for the quarter was 18.6%. Net profit to shareholders was RMB10.6 billion, up 43% year on year or down 1% quarter on quarter. After adjustment to non GAAP, operating profit was RMB15 1,000,000,000 up 43% year on year or 2% quarter on quarter. Net profit attributable to shareholders was RMB11.7 billion, up 42% year on year or 4% quarter on quarter. Let's turn to segment gross margin. Gross margin for VAS was 65.2 percent up 1 percentage point year on year reflecting a revenue mix shift to in house gains. Sequentially it dipped 1.5 percentage points reflecting increased content amortization costs relating to our premium video subscription businesses and the consolidation of China Music Corporation. Gross margin for online advertising was 36.3%, down 12.6 percentage points year on year and 9 percentage points quarter on quarter. Increased investments in video content was the primary reason behind the margin contraction. Moving on to operating expenses, selling and marketing expense was RMB3.3 billion, up 60% year on year or 39% quarter on quarter. The year to year jump reflected our aggressive marketing efforts to promote mobile app preloads, to drive mobile payment adoption and to promote our cloud services. Sequentially, marketing expenses for games, mobile news and video services were the main drivers. Total G and A expense was RMB5.9 billion, up 34% year on year or 11% quarter on quarter, within which R and D expense was RMB3.2 billion, up 29% year on year or 15% quarter on quarter. The year to year and sequential increase reflected staff costs relating to our organic businesses. We had just over 38,000 permanent employees at quarter end. University recruitment, CMC Consolidation and one off recruitment of some iSource manpower who previously engaged in our customer support work contributed to the sequential increase in headcount. As a percentage of quarterly revenue selling and marketing expense was 8% and G and A was 15%. R and D represented about 8% of quarterly revenue, while share based compensation was approximately 3%. Looking at margin ratios for the Q3, gross margin was 54%, down 4.6 percentage points year on year and 3.3 percentage points quarter over quarter. The combined effect of online advertising gross margin decline and bigger contribution from other segment drove year to year margin decline. Sequentially, fall through from lower ad ads and online advertising gross margin as well as bigger contribution from other segments were the main reasons. Non GAAP operating margin was 37.2 percent, down 2.3 percentage points year on year or 4 percentage points quarter on quarter. Non GAAP net margin was 29.5%, down 2.3 percentage points year on year and 2.7 percentage points quarter on quarter. Finally, let me provide a few key financial numbers for your reference. Total CapEx was RMB3.7 billion up 121% year on year or 143% quarter on quarter. Operating CapEx was RMB 2,000,000,000, up 76% year on year and 97% quarter on quarter. We purchased more servers and network equipments to support business growth such as cloud based services. Non operating CapEx was RMB1.6 billion, up 2 28% year on year and 2 45% quarter on quarter. We added RMB 1,200,000,000 for land use rights. Free cash flow was RMB 14,100,000,000 up 113% year on year or 45% quarter on quarter reflecting strong cash flow generated from our operations especially online games during the positive season in the Q3. Our net cash position at quarter end was RMB8.4 billion down 61% year on year and 65% quarter on quarter. The decline was primarily relating to the acquisition of Supershow, which we were funding investment with a combination of cash and debts. In July, we made a cash prepayment of US3.7 billion dollars or approximately US24.7 billion dollars and subsequently we recouped approximately US1.2 billion dollars in October, which is approximately RMB8 1,000,000,000. Fair market value of our listed associates and AFS financial assets amounted to approximately RMB94 1,000,000,000 as at quarter end. Thank you. We shall now open the floor for questions. Our first question comes from the line of Eddie Leung from Merrill Lynch. Please ask your question. Good evening. Thank you for taking my questions. I have a question on some of your cost items. Just wondering if you could share more color on the trend of sales and marketing expenses as well as our headcounts going into the future. Particularly if you are investing more for certain opportunities, what are some of the key areas that you pay extra attention to? And then just a housekeeping question, would be great if you could update us on number 1, your mobile game pipeline and number 2, the ARPU of different types of games? Thank you. Yes. Thanks, Eddie. In terms of sales and marketing, I think we continue to invest pretty heavily in a number of our strategic products. Obviously, the first one is around games, right, because games is our largest business segment and the marketing of games actually, especially sort of new games can generate good ROI if the games are of good quality. The sales and marketing pattern is more around sort of the launch of new games, but in certain areas such as sort of new MMORPGs, right, there needs to be sort of new continued marketing to attract the core users. The other large area of sales and marketing really sort of goes into our payment business as well as our app mobile app installation because we now own a large number of high DAU apps. And as a result, we actually sort of continue to market these apps, especially sort of in working with handset manufacturers as well as app stores to get these apps distributed to the users. And the other one that I think John mentioned in his prepared remarks is on the cloud business, which we are really opening up a new market segment, which is around enterprises and that's why we are spending in the marketing expenses. Now in terms of headcounts and our human expenses. I think the overall approach is that we try to control the number of our people, but we continue to enhance the quality of our overall team as well as we continue to pay competitively in the market and reward our employees when the company is actually sort of achieving great results. So that's the overall philosophy. Yes. And also in terms of the headcount perhaps you might feel that the increase was so significant this quarter versus last quarter, but as I mentioned before this is a special quarter because we have the new fresh graduates, we have the consolidation of China Music as well as converting some of our outsourcing functions such as customer support to be handled by our own permanent staff. In relation to the ARPUs, for MMOG it's between 310 to 450, advanced casual games was between 85 to 370 and the smartphone games is between 145 to 155. Thank you. Next question please. Thank you. Our next question comes from the line of Dheusch Menck from Goldman Sachs. Please ask your question. Thank you. We observed that Supercell's games have risen back to the top of the charts, displacing games that were popular a quarter ago. From a Tencent perspective, when and how does Supercell impact the P and L? And also, is there going to be specific strategy you'll deploy for Supercell games as of when they get launched in China? And second is related to the tripling in the cloud number that you've reported this quarter. Could you give us a sense of what the numbers are looking like as well as what percentage of the dip in gross margins can be attributable to potentially the cloud business or the payment side? Thank you. In terms of Supercell games, well, thanks for your observation. I think, yes, we're very glad to see that the games of Supercell actually returned to the top of the chart. And I think it's actually consistent with our long term view of Supercell, which is sort of they create a very exciting games that actually can be played by people, large number of people for a long time. And I think sort of part of it is also sort of as we continue to exchange knowledge about sort of how to design the commercialization of the games and how to actually sort of attract more people to pay for the games, they have actually sort of achieved better monetization on the games. Now with respect to the accounting, right, Supercell is going to be accounted for through the dividend method. So for this year, I don't think sort of there's going to be any dividend distributors. So that's why it's not going to make meaningful contribution to our earnings for a while. Now with respect to the cloud business, I think if you look at the others category, right, you can see sort of the gross margin has improved quite significantly. It's around 18% now. But sort of we have also talked about the fact that we are investing very heavily in the marketing of the services for both payment and cloud. And there's also sort of a large team of people who are actually working on these products. So if you count in the overhead, if you count in the marketing expenses, I think sort of these expenses are very significant compared to the gross profit. So that continues our theme around these services, which is we view the payment business, the cloud business as infrastructural businesses, services for our overall ecosystem. It's beneficial for our own services. It's beneficial for our partners' services. So that's why we're willing to take a very long term view and to continue to invest in these businesses despite the fact that it may not be profitable for the time being. We felt that they are very beneficial for our ecosystem going forward and can enhance the value of our overall business portfolio. So that's sort of the kind of philosophy that we're attaching to these businesses for the time being. Thank you, Martin. Thank you. Our next question please. Thank you. Our next question comes from the line of Alan Hellywell from Deutsche Bank. Please ask your question. Great. Thank you very much. Sorry, just a follow-up question on payments. I was wondering if you could offer some more color on the GMV mix between non monetizing payments and B2C payments and how that mix is likely to shift over time. And if we reference some of the publicly listed pure play payments companies, which seem to have operating margins in the low 20s, I'll take on board Martin's comment that this is a strategic part of the company. But how do we think about profitability emerging if we have those mile markers already? And then would love a little more detail on the quarter on quarter decline in advertising margin. And I guess related to that, any color on how the video market is evolving, particularly as if it's different to original expectations? Thank you. Yes, in terms of payments, I think it would be we can't sort of give you the exact GMV, but I would say we look at it from both angles, right. We're looking at it from sort of the number of transactions. We do handle sort of 100 of millions of transactions a day and out of that, I would say a big proportion of it is actually sort of in the category of social payments, which include wrap packets, which also include the transfers among consumers. But at the same time, we're seeing also sort of a significant amount of transactions that are business oriented and these transactions include our own sort of transactions, for example, game transactions. It includes a lot of online merchants transactions that include Didi and JD and Meituan DMP as well as sort of new people who use our platform to top up their cell phone. And then there's an increasing number of transactions which are actually sort of conducted by offline merchants. So you have the KFCs and McDonald's and sort of the supermarkets and the convenience stores who are actually sort of now receiving payment through WeChat and QQ Wallet. And at the same time, we're also seeing even smaller merchants, right, they can actually use a QR code and get paid and sort of they can use our face to face payments to effect transactions. So I would say there is a large number, still sort of predominant number of person to person social payments, but in terms of growth rates, the commercial transactions are actually growing faster in terms of growth rate. I think James will talk about our video and advertising business. So for the advertising gross margin, there are positive factors and negative factors in this quarter that the negative factors are more obvious. On the positive side, there's the growth in social performance advertising, which tends to be relatively high gross margin because it's on our own social properties. And there's the rapid growth more recently of news advertising, which is also relatively higher margin. On the negative side, there's specific kind of cost heavy events during the quarter for video, notably, that the Voice of China or Sing China competition and the Olympics. And then there's a more general trend of video content costs increasing extremely rapidly due to a relatively competitive environment. You asked whether the video environment is evolving as we would have thought or differently from what we would have thought. I think it's evolving pretty much as we would have thought, but perhaps even more swiftly in terms of the shift from being a primarily advertising funded model toward consumers being willing to pay for subscriptions. And our video team recently disclosed we have about 20,000,000 people now paying for subscriptions, up from 100,000,000 a couple of years ago. Now that shift overall, we think is positive in the long term, but it does it's not without its costs. And one of the costs is that as more and more users pay for the premium video service, in China, there's a history where once you pay for these premium video services, as well as having access to premium content such as Western movies or Chinese TV series, you also don't watch ads. And so the increased take up of premium video subscriptions has a negative impact on the industry's total advertising inventory load. So that's what's happening in the online video market in terms of competition margins and the shift from an ad funded to an ad plus subscription funded? Yes. Sorry, Jim. Go ahead. Yes. Sorry. I know that as I recall, I think there was a quintupling in the number of either P4P or WeChat based advertisers in the June quarter over March. Could you guys also update us on what kind of growth we've seen in the number of P4P advertisers quarter on quarter? I think we disclosed the total number of Weixin Moments advertisers more than doubled quarter on quarter, and that would have been driven primarily by what you referred to as the kind of the P4P advertisers? Got it. Thank you. Yes. I actually missed sort of answering your question about sort of payment margins. I think what you're seeing in the listed sort of payment companies is actually sort of operating in the U. S. I suppose and the environment is actually sort of very different. Payment is actually sort of quite local practices as well as the regulation driven business in the sense that sort of if you look at credit cards in the U. S, right, they get paid 300 basis points, thereabouts, but in China, right, credit cards get paid sort of a fraction of that. And I would say sort of in China, the situation for online payment is similar in the sense that it's actually a more competitive market. If we're dealing with sort of captive business, right, if for example, sort of you have a captive e commerce business and sort of then the kind of margin is different. But then sort of if the commercial transactions is actually sort of out there competing by having 2 large payment platforms, I think sort of the pricing is actually very competitive, marketing is actually competitive. So that's why I feel that we should be looking at sort of in the medium term of our payment business as more like an infrastructure business for the entire ecosystem rather than sort of a business that will generate profit. Understood. Thank you. Thank you, Allen. Next question please. Thank you. Our next question comes from the line of Alicia Yap from Citigroup. Please ask your question. Hi, good evening management. Thanks I have two questions. Number 1 is related to the overall mobile games industry for the Q3. So wanted to get a sense, was the revenues that you achieved meeting your internal expectation, was there any seasonal effect for the industry as a whole for the 3Q? Is there any lack of new games launch or was that other social activity that might have taken away some of the user time spent? And in related to that, for mobile games, if you could share with us some of your user analysis, for example, on average, how many games a single user usually play during the same period? And if you have data, for example, on percentage of gamers that who play 2 to 3 games, gamers that who play maybe only 1 game and maybe gamers that play more than 3 games? So I think in terms of the mobile game business performance versus our expectations in the industry, we disclosed our mobile game revenue grew over 80% year on year. So you can assume that we're fairly happy with 80 something percent year on year revenue growth. From a quarter on quarter perspective, the trends get bounced around by the timing of specific new games, the timing of monetization events within games and so forth. But we tend to look more at longer time periods and year on year comparisons rather than very short term comparisons, because otherwise we'd be kind of continually chasing our tails. In terms of the user analysis, one appealing trend about our mobile game position this year has been that we've seen quite a nice up I mean, We have well over 100,000,000 daily active users from mobile games, and that number has increased quite substantially year to date. So we think that that puts us in a very strong position in the industry. Our leadership in revenue is balanced by actually a wider leadership in terms of usage. I think that the sort of median would be that the users would be paying, playing sort of 2 games or so on a regular basis, so that there's obviously a very high degree of dispersion around that medium. I see. I see. Very helpful. My next question is related to payment. I think you mentioned on the press release that you attracted 700,000 merchants to participate on that promotion day in August. Just could you elaborate a bit of the backgrounds of these merchants, for example, the industry vertical, the size of their business and also maybe average numbers of payment transaction that they received during that day of their promotions? And in related to that, I also noticed you have gradually introducing various payment scenarios for the Hong Kong WeChat payment feature. So I wonder if management could share your strategies and thoughts about expanding your payment service into the overseas market? Thank you. Yes, in terms of the cash less pay, I think this is a way for us to raise the awareness among the merchants on getting their customers to use Weixin payment and QQ Wallet. And the 700,000 merchants are actually sort of pretty widely distributed sort of across different industries. That include as I said convenience stores and sort of food and beverage outlets and supermarkets to name a few of those. And I would say the result is actually quite good, despite the fact that we did spend quite a bit of money in terms of subsidizing some of these payments. But what we actually usually look at is how many of the converted users actually sort of continue to use the mobile payment services afterwards, right. And we found that sort of there's a pretty high rate of users once adopting this payment solution then sort of continue to use it on an ongoing basis. So we are very pleased with that result. Now in relate to the Hong Kong expansion, I would say it's obviously important long term strategy for us to serve different markets. I think the first group of users that we definitely want to serve is actually the people who are traveling, China people who are traveling outside of China, right. When they're traveling overseas, we actually want to allow them to be able to pay with Weixin Payment and QQ Wallet. And then we would look at expansion into selected local markets I think on a much more cautious basis. The Hong Kong is a market which serve both purposes. One is there are a lot of mainland Chinese who are traveling to Hong Kong on a continuous basis and a lot of Hong Kong merchants actually sort of would welcome the adoption of the coverage of Weixin Payment. And at the same time we have a pretty large user base in Hong Kong for WeChat and as a result we would like to be able to serve with our payment services. Now having said that, I think sort of the regulatory environment as I said sort of for each one of the markets is very different and sort of the practices of financial institutions are actually quite different. So right now for example in Hong Kong there are only limited number of banks who can actually allow us to have the kind of experience in China where you can just buy a banking card to the WeChat and QQ account. And if you actually have to use credit card for the payment, right, then a lot of the social payment actually sort of is very difficult because the transaction cost is actually high. And also sort of the credit card companies do not like to move cash. So I think Hong Kong will continue to cover our services, but the kind of dynamics is actually quite different from China. Okay, great. Thank you. Thank you, Alicia, for your questions. Next question, operator, please. Sure. Our next question comes from the line of Wendy Huang from Macquarie. Please ask your question. Thank you. So currently, you are lumping the payment and cloud revenue together into others. So can you give us some color which part contributed to the bigger portion of the other revenue? And also the gross margin 18% you reported for this segment, is this margin expansion more driven by payment or more driven by the cloud? Related to that, I also noticed that there is accounting change on your restricted cash, which I believe is related to the RMB 125,000,000,000 on your WeChat payment platform. And you mentioned in your press release, this is because some of the operating environment change in the PRC. So can you maybe share what kind of operating environment change in payment or Internet finance space trigger you to make this change? Yes, that's my first question on the payment and cloud. Thank you. Let me answer the question regarding the restricted cash first. I think that's been from time to time there has been guidance being accumulated by relevant authorities in relation to cash on behalf of your customers. And I think during the Q3, there has been some guidance that talks about that. So as a result, we make some changes to the customer agreement in terms of the payment business and as a result the related asset which is the restricted cash as well as the liabilities have been made off balance sheet. Anyway it hasn't got any impact on the net asset as a whole because anyway we have the corresponding liabilities in there beforehand. I think for this we have made clear that the restricted cash does not belong to us. Yes. So in terms of others, right, payment is the bigger portion and in terms of the pickup in gross margins, payment is also the higher contributor. And part of it is sort of our charge on people withdrawing cash, right, start to really come into full force. And the other one is that as you see sort of when we launch a lot of promotions in terms of cash free dates, it actually in use a lot of transactions on the offline merchants and sort of for those we actually generate revenue as well as some gross profit. But of course, a company that is actually an increased amount of marketing expenses. Thank you. My second is one thing that comes from Maybe we should leave this to other ladies. Wendy, we'll put you back on the queue for the second round of questions, okay? Sure. Thank you. Thank you. Yes. Next question operator, please. Sure. Our next question comes from the line of John Choi from Daiwa. Please ask the question. Evening and thanks for taking my question. My question is on your new initiative on the mini program. Could you guys share with us the latest progress on the beta testing, including the developers' feedback, when you expect to launch and how you plan to monetize it? Is this going to be is it fair to say this is the major purpose is to increase the user engagement within the recent users? And secondly, a follow on your content side. Content investment, what is the path for next year on the investment side and how will this further impact your margins on the advertising side? Thank you. Yes, our mini programs we're still in the beta testing, there are several 100 developers who are now developing mini programs and we are doing the testing. I think in the next version of Weixin, it will support the Mini program. Now in terms of the feedback, I think we have to see, right, but sort of from a technical perspective, I think the goal for us is actually for Meaningful Grams to provide to some extent an upgrade experience from our official accounts. Official accounts, if you look at it, it's actually sort of media and content type of platform, whereas sort of mini programs actually provide much more flexibility for the developers to develop their services right into the WeChat, the Weixin platform. And it would help the service to actually run like an native app with much faster speed and it would actually sort of allow a lot of services which we believe sort of hard to induce people to download an app, these are sort of a lot of times infrequently used services. But if you have the mini program, the users when they want to use the program, when they need to use the service, they can actually access the service very quickly. Some of these maybe sort of merchants offline, they can actually promote these mini programs and some of the developers maybe sort of online operators, but their services are infrequently used, but if users want to search for their services and then use it immediately, they can actually do that. So that was the goal of Mini Program and we'll have to see how many developers would develop the programs and how would these be received by the users. But what we want to do is actually sort of provide a platform so that more creativity can be put into the Weixin platform. In terms of video content costs, I think it will come as no surprise to you or anyone else that the industry is experiencing very rapid content cost inflation, particularly for certain categories of content such as high profile TV drama series from both China and Korea. And we have accordingly been expecting modeling for a very sharp increase in our video content costs as we move from 2016 to 2017. And some of that would already be locked in because of the need to pay for content ahead of screening. The increase in content costs naturally flows through into downward pressure on our video and our online advertising margin structure. The extent of that downward pressure naturally depends on how much we offset via video advertising growth and video subscription revenue growth. Thank you. Next question please. Thank you. Our next question comes from the line of Alex Yao from JPMorgan. Please ask your question. Hi. Good evening, everyone. Thank you for taking the I have two questions. One is on gaming side. Can you guys discuss where and how will you deploy augmented reality AR technology to your gaming content? And how should we think about the impact from introduction of AR on gaming engagement and monetization? And secondly is on the performance ads. Can you comment on the ads load of Moments and the Qzone? We understand that you guys are prioritizing on the harder part of as infrastructure such as technology distribution, etcetera. What will make you comfortable to release more inventory and when would that be? Thank you. In terms of AR, I think it's actually very early technology, right? So the industry is actually testing that out both VR and AR. I think we are quite some time away from sort of these technology being used in sort of big user games. I think sort of with AR and VR, in particular VR, right, we felt sort of this is more like a deep immersive type of gaming experience. So it would appeal to people who are now the console or PC game players who want to have sort of a much more immersive experience. Now, sort of then we need to have the developers who can develop these games. So, I think it's unlikely in the near future that we will see large DAU games coming in the form of either AR or VR. Now sort of Pokemon GO, you may say, oh, it's an AR game, but we don't think sort of it's core to the user experience. It's more like an LBS type game. So I think that would be some time to go. Performance ads, maybe James, you want to talk about that? Yes. So as you're aware, we have, I think, a very moderate ad inventory load on Qzone and an even more moderate one ad per day ad inventory load on Weixin moments. I think our focus is less on increasing that ad load and more on providing better tools, providing better performance measurements and so on, so that we can utilize the existing ad inventory more efficiently. And if you look at the growth in our performance advertising revenue year to date, a great deal of it has been driven by us utilizing the existing Weixin Moments ad inventory increasing efficiently, particularly by allowing smaller advertisers, more local advertisers to buy more targeted slices of consumer attention in 3rd and 4th tier cities. So we have plenty of room to increase ad inventory at the right time. If you compare the ad inventory on our properties with those of our peers globally or even if you compare the ad inventory on our social properties with the ad load on news apps in China, that there's a very substantial gulf. But that's something we can sort of hold in reserve for the future. And for the present, we're really focused on the tools, the performance measurements and on increasing the raw number of advertisers who are participating in the performance bidding. Thank you. Operator, in the interest of time, we'll take the last three questions, please. Sure. Our next question comes from the line of Choo Hsing from HSBC. Please ask your question. Great. Thank you very much. I wanted to ask you a little bit about some brand advertising. What do you think the current demand outlook might be for brand advertising for next year? And also, I wanted to know if you can add a little bit more color regarding the shift in the news feed revenue from CPT to pay for performance in terms of maybe the magnitude of that shift? Thanks so much. So on your second question about the magnitude of the shift, we're quite conscious about what we called out in the commentary. So you can assume that it was of sufficient magnitude that we felt it ought to be called out. I think it reflects some interesting trends. 1 is that traditionally brand advertisers are increasingly adopting a performance mindset. A second is that the growth of news aggregator services like perhaps Headline say or Jinro Toiao that monetize more aggressively than we might have done in the past has illustrated that there is very great performance advertiser demand to put their ads into a sort of a news driven news feed environment. I think that's partly because of the nature of smartphone screen versus PC screen, that on the smartphone screen, you're kind of trained to continually scroll, click, scroll click, scroll click. And so that lends itself very well to performance advertising that's paid on a cost per click basis in a way that it didn't necessarily lend itself for a Yahoo! Homepage on the PC. So there's been a fairly substantial shift driven really by advertiser demand as opposed to our supply decisions away from brand and toward performance advertising within particularly our news app and also some of our other services. So that's part of the reason why you've seen the divergence in growth rates between very fast performance advertising revenue growth on the one hand and decelerating brand advertising revenue growth on the other. In terms of the brand advertising outlook for next year, historically, we don't have a great deal of visibility until we enter the annual commitment process in December, January. But overall, it's clearly a relatively weak economic environment and there are specific pockets of additional weakness, whether due to government regulatory policies such as real estate. I think for Tencent, we believe that the pattern of performance advertising growing faster than brand advertising will certainly continue in 2017, while brand advertising will have to grapple with these macro headwinds as well as specific factors such as advertising inventory moving from brand to performance and the trend I mentioned in video of consumers paying for subscriptions and then enable them to skip the brand advertising. Thank you. Thank you. Next question. Thank you. Our next question comes from the line of Evan Zhou from Credit Suisse. Please ask your question. Hi, good evening. Thank you for taking my questions. My question is regarding our core products, user engagement. I noticed that there's a slight decline quarter over quarter on QQ product and especially on the smart device MAU also came down even a bit larger than the overall MAU for Q2. And also Qzone, Q on Q MAU went down as well. So I was wondering, is there any kind of seasonality impact or any specific product feature changes that's making this a move? Or what do you see as kind of overall outlook for our relative speaking more legacy product lines such as QQ and Q3? Thank you. Yes, I think on the social products, we look at it from 2 different angles. The first one is actually sort of overall user base and engagement across our platforms because sort of there are a sort of pretty significant number of people who are actually using both QQ and WeChat. And I think for us as a company, we tend to look at sort of whether we are increasing the total number of users using both QQ and WeChat and whether sort of the users are using our platform on a more frequent basis. I think the answer to both of the two questions is actually yes. Now the second perspective that we looked at is actually sort of are we covering the different segments of people with some kind of dedicated and specialized products. And I think if you look at the user base where people use either QQ or WeChat, right, I would say QQ now is actually increasingly popular among the young cohorts, the young users. And obviously QQ continues to be sort of very strong with users who are using sort of new office workers when they are in office, when they are sitting right next to a computer or they need to send very large files and communicate with other users, other workers, co workers and sort of QQ is the preferred product. So with these two group of users, I think sort of engagement is still very high, particularly with respect to the young users. It's actually increasing the adopted by the users at younger age. So I think overall we are actually pretty happy to see the overall portfolio is actually engaging with more users with higher frequency of engagement and at the same time each product is actually sort of pretty successful in covering the differentiated user base as well. Got it. Thanks, Martin. Thank you, operator. We shall take the last question, please. Thank you. Our last question comes from the line of Natalie Wu from CICC. Please ask your question. Hi, thank you for taking my question. Just a quick question, what's the split of branded format in terms of mobile news revenue? And what's the current revenue split among Tencent News app and Tian Tian Kuai Bao? Thank you. Well right now the revenue on the news side is actually predominantly Tencent News. Tianjin Kuibao is actually relatively new product. We actually sort of new one that focus on improving the user experience. So that's why as you look into the app, right, the ad load is actually relatively small. I think there is a potential to have sort of meaningful ad load on TianDian Huibao going forward. But sort of for the time being, I think we're more focused on the user experience. Naki, sorry, I didn't touch the first part of your question. Yes. I think that for your mobile news app revenue, you just split that into like brand advertising and performance based advertising, right? So I just want to get some color about the split to every like $100 you get from your like mobile news app, how many will you or how much will you be recognized into the brand of Haifeng and how much Roughly, yes, I mean, it's been changing very quickly. As of Q3, it was roughly 2 thirds brand, 1 third performance, but the mix has been if you go back a year and a half ago, it would have been 90% brand, 95% brand. So it's in flux. But for the reasons I mentioned that the overall industry is changing in the advent of new news aggregator services that have driven performance advertising very aggressively, monetized at very high rates and sort of unlock the door to performance advertisers being willing to advertise much more in a news driven newsfeed environment. Understand. Thank you. Okay. Thank you very much for your questions and thank you, operator. We're closing the call now. If you wish to check our press release and other financial information, please visit our company website at www.tencent.com/r. A replay of this webcast will also be available soon. Thank you and see you next quarter. That does conclude our conference for today. Thank you for participating in Tencent Holdings Limited 20 16 3rd quarter results announcement conference call. You may all disconnect now.