Tencent Tests a Cloud Gaming Platform in China

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Tencent (NASDAQOTH: TCEHY) recently began testing out a cloud gaming platform called Start in Shanghai and Guangdong. The platform is in an early developmental stage, but the world's top gaming publisher could soon join Alphabet's Google, Sony, and other contenders in the emerging cloud gaming market.

Not a major surprise

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This news isn't surprising, since Intel (NASDAQ: INTC) revealed that it was co-developing a cloud gaming service called "Tencent Instant Play" with the company in February. Intel claimed the platform would let players play games "anywhere, anytime, on nearly any device" across 5G networks.

Intel and Tencent revealed demos of Instant Play at Mobile World Congress in Barcelona in February, and the Game Developers Conference in San Francisco last month. It's unclear whether Start is a rebranded version of Instant Play or a completely separate project.

Reviewing Tencent's gaming woes

Tencent's massive portfolio of games includes PC hits like League of Legends and mobile hits like Honor of Kings, Clash of Clans, and PUBG Mobile. It also owns stakes in PUBG publisher Bluehole and Fortnite publisher Epic Games.

Online games produced 29% of Tencent's revenue last quarter. However, its gaming business was held back over the past year by Chinese regulators' nine-month freeze on new game approvals, which ended last December, as well as an ongoing decline in its PC gaming revenues due to gamers spending more time on mobile devices. Here's how its gaming business fared over the past four quarters:

Tencent's Year-Over-Year Revenue Change in Gaming

Segment

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Smartphone gaming

68%

19%

7%

12%

PC gaming

0%

(5%)

(15%)

(13%)

Total online gaming

26%

6%

(4%)

(1%)

Prior to China's moratorium on new game approvals, which started last March, Tencent planned to reinvigorate its PC gaming business by launching Fortnite, PUBG, and Capcom's Monster Hunter: World on its WeGame PC platform. Unfortunately, regulators in Beijing banned Monster Hunter shortly after its launch, and the PC versions of Fortnite and PUBG still haven't been approved there.

In the smartphone segment, Tencent squeezed through some previously approved games during the freeze, and Honor of Kings remained China's top title. These conditions kept the business treading water, but the company is still waiting for approval of microtransactions in PUBG Mobile, which would let it finally monetize the popular battle royale game.

Why Tencent needs cloud gaming

Tencent's gaming business still remains highly vulnerable to the whims of the Chinese government. Launching a subscription-based cloud gaming service could enable the unit to generate more predictable returns.

When players can stream their games from a server over the internet like a live interactive video, that also eliminates the need for powerful local hardware. So they can play high-end games on any device with a high-bandwidth connection.

Sony's PS Now service, which streams more than 750 PS4, PS3, and PS2 titles to PS4 consoles and PCs, is the most established cloud gaming platform on the market. Alphabet says its upcoming Stadia platform will stream higher-fidelity games than PS Now; other contenders -- like Microsoft's Project xCloud and NVIDIA's GeForce Now -- have similar ambitions.

As countries upgrade their wireless networks to the much-faster 5G standard, and the costs to consumers for using wireless data decline, streaming cloud-based games "anywhere" could become a reality. That's especially true in China, where regulators mandated that telecom companies reduce what they charge customers for data use, a move intended to increase the country's mobile internet penetration rate ahead of its 5G deployments.

That makes China, already the world's largest gaming market, an even more fertile one for cloud gaming. If Tencent bundles all of its PC and mobile games into a single subscription platform, it could offset the headwinds of fickle government approvals and soft demand for PC games. That would also widen its competitive moat, and complement its Tencent Video and Tencent Music subscription platforms. Tencent could even bundle those cloud services together, leveraging the popularity of the individual offerings to grow its market shares across them all.

But will Tencent launch Start anytime soon?

From one perspective, Start makes strategic sense for Tencent, but the creation and maintenance of a cloud gaming platform is a costly affair. Those hefty initial outlays could hinder the service from becoming profitable, and to the degree that it attracts players, it could cannibalize the company's currently profitable gaming businesses.

That's probably why it isn't rushing into the cloud gaming market yet. Start could represent the next step for Tencent's gaming business, but launching it too early could have disastrous consequences for its bottom line.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Tencent Holdings. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Microsoft, Nvidia, and Tencent Holdings. The Motley Fool has a disclosure policy.