Happy Thursday!

📝 Focus

• Tencent's Eggy Battle Royale

📊 In the Markets

• Burry & Buffett Bears?

• Yields up, Dollar up, EM down?

📖 MoneyFitt Explains

🎓 VIEs: You only think you own them

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📝 Focus

Tencent's Eggy Battle Royale

China's largest listed company and owner of the ubiquitous Weixin / WeChat super-app, internet conglomerate Tencent reported second-quarter net profits up by 41% year-on-year to Rmb26bn (IFRS basis), the fastest growth since late 2021, on revenue 11% higher to reach Rmb149bn. But the numbers fell short of HK/Shanghai's Finest, which had been expecting Rmb33.4bn and Rmb152bn respectively. Tencent's cost-cutting efforts and focus on "high-quality revenue streams with better margins" like advertising (up 34%) drove the rise in net profit, but...

..... ▷ But revenues fell short due to sluggish domestic gaming sales with a weak domestic pipeline compared to the success of smaller, more freewheeling rival NetEase’s sleeper hit "Eggy Party," its first smash hit in casual titles. NetEase was always associated with “hardcore games” like Fantasy Westward Journey and Tianxia but is now aiming (with cute, squishy eggs) at a broader audience, traditionally dominated by Tencent. International gaming was much stronger, clocking in 19% growth thanks to its shooter game Valorant, though without the slide in the Rmb that would have been 12%. Social networking was only up 2%, with subscription services offset by lower live streaming.

..... ▷ While a broad-based internet conglomerate, gaming and social networking are by far the two most important businesses for Tencent and fall under the vaguely-named Value Added Services (VAS) segment in its reporting. In the 2022 annual report, VAS contributed 52% of group revenues and 61% of gross profits, but there's no split given between them. The VAS segment includes a variety of businesses, such as online music, video streaming and e-books. The company has a user base of over 1 billion active gamers, and its social media platforms, Weixin/WeChat and QQ, have 1.9bn monthly active users. Tencent makes money from social networking through advertising and in-app purchases. Mini Games under Weixin's Mini Programs is the leading casual games platform in China and is a high-margin business.

..... ▷ In the gaming space, Tencent is a global leader and is investing in new technologies, such as cloud gaming and virtual reality, which are expected to drive growth in the gaming industry in the future. It is both a publisher of titles developed elsewhere as well as a developer of its own titles. But it's also been spending billions in global gaming company acquisitions for over a decade, taking both majority and minority stakes in search of the next smash hit. Its gaming acquisitions have allowed it to expand its portfolio of popular games and to gain a foothold in new markets as well as gain access to new technologies and talent, but the industry (often compared to movies) is notoriously hit and miss.

..... ▷ But like basically all other Chinese companies listed outside the borders of the Mainland, Tencent is, however, a Variable Interest Entity (VIE)🎓 which means that "ownership" of the company that you think you own through the shares you own has its own particular quirks.

Gaming Geek Corner:

Tencent has majority stakes in Riot Games (2011): League of Legends, Valorant, Legends of Runeterra, Teamfight Tactics; Supercell (2016): Clash of Clans, Clash Royale, Brawl Stars; Grinding Gear Games (2018): Path of Exile; and Techland (2023): Dying Light. It has minority stakes in Epic Games (40%): Fortnite, Unreal Tournament; Ubisoft (5%): Just Dance, Rainbow Six Siege, Assassin's Creed; and Activision Blizzard (5%): Call of Duty, World of Warcraft, Overwatch. Its own games include Honor of Kings: A mobile MOBA game (one of the most popular games of all time by revenue); PUBG Mobile: A mobile battle royale game; and Peacekeeper Elite: The Chinese version of PUBG Mobile.

📊 In the Markets

Burry & Buffett Bears? Wall Street closed lower after Federal Reserve minutes revealed divisions among officials regarding further interest rate hikes. The release came at 2 pm, and at first, the markets were happy with how policymakers were split between tightening further to stamp out inflation ("hawks") and holding off to see the effects of past hikes on the economy ("doves") and recovered the morning's losses. Then the vaunted experts on Wall Street added them up and found there were more hawks so sold off the markets. It was basically that, leading the S&P 500 to its deepest two-day drop since April.

That and still vague China worries and furtive chatter about famed hedge fund manager Michael Burry's bearish options positions (notional $1.5bn in put options, which allows him to buy back at a lower price) and Warren Buffett selling down equities. (Both were as of the end of June or during the 2nd quarter, the notional options exposure refers to the total value of the underlying asset, not the actual amount Burry has on the line, and the scale of Buffett's selling was small for his portfolio size. Not that they're not worth noting, though.) Adding to the economic growth and interest rate worries, US single-family housing starts surged 9.5% in July as high interest rates kept potential sellers from moving (and having to refinance the next place at higher rates) and left new buyers with no choice but to go for new homes (supporting Buffett's relatively small 2Q bet on homebuilders, though contrary to falling homebuilder confidence.) "Big Box" retailer Target rose 3% after beating Street profit, margin and inventory estimates, even though revenues fell for the first time in 6 years. All eyes on WalMart, which reports on Thursday. Worries about China's growth finally fed through to the energy markets, where oil slipped lower and looks like it will break its 7-week winning streak, though it's still up 10% since the end of June.

..... ▷ Yields on longer-term US Treasuries continued to rise as bonds got sold down (they move in opposite directions) and reached their highest levels since October (then the highest since 2007), and sent the US Dollar higher. The move over the last month was largely against the consensus Wall Street view, thanks to the expected peaking of interest rates. Higher interest rates and a stronger currency often go hand-in-hand, but when it's the USD we're talking about, it can be a red flag for emerging markets. Not that the EM space needs more to worry about, given what's happening in Argentina, Russia and, especially, China, where on Wednesday, the People's Bank of China (PBOC) injected the most short-term cash into the banking system since February to keep the economic wheels turning.