Editor’s Note: From time to time the Katusa Research Special Situations team looks deep into different sectors. Over the next three days, we’ll introduce you to a monster profit generating machine.
You’ve probably never heard of the seventh-largest company in the world.
The top six – Apple, Google, Microsoft, Amazon, Berkshire Hathaway and Facebook – are household names. But the current seventh-largest company didn’t even rank in the top 10 in 2017.
But it owns a social media network actively used by 15% of the world’s population.
It owns the leading online video streaming platform in China.
It owns the largest online library in China.
It owns the top three music streaming services in China.
It owns the Chinese equivalent of Google Ads.
The list goes on. But the fifth-largest company in the world – Tencent – is a video game company.
It started in 2007, when the Stanford-educated president of Tencent, Martin Lau, decided to get serious about video games. Tencent’s revenue was a trivial USD$500 million, and Martin wanted to change that.
So he came up with a strategy. He scoured the continent for the best games he could find, then adapted them for the Chinese market.
When the games were broadcast through Tencent’s instant messaging service, “QQ,” they were instant hits. Martin realized the insanely profitable future of Tencent.
Over the last decade, Tencent has invested heavily in video games, both in internal production and external investment. It now holds a large stake in most of the largest gaming companies in the world. This includes Activision-Blizzard, Grinding Gear, Ubisoft, Miniclip, Riot, Supercell, Glu, and Epic Games (maker of Fortnite).
Despite setbacks, Tencent remains among the fastest-growing video game companies in the world. It earns more revenue from video games than Activision-Blizzard, Electronic Arts and Apple… combined.
And the company’s full-year revenue for 2018 is expected to be USD$38 billion.
A Recipe for 7,500% Growth in One Decade
To get from half a billion to $38 billion in under ten years, Tencent developed a formula that helps them create new “Fortnites” on a commercial scale.
When Tencent started getting into games, piracy had destroyed game sales in China.
But the sales of virtual goods such as skins and weapons were strong… and climbing.
So Tencent settled on a strategy of distributing games for free, and earning a profit on in-game purchases (sound familiar?).
Steve Gray is an ex-Electronic Arts employee who began running Tencent’s game production division in 2009. He says that the company deliberately chose not to create many of its own games.
Instead, Tencent has decided to find the best-in-class games that have already been developed. And then the company adapts them to the Chinese market.
Once linked to the massive, billion-person WeChat user base, Tencent receives instant feedback on what is working and what is not. Then, it can make incremental changes to the type of gameplay and features players want until it hits the jackpot. This allows it to “moneyball” video games.
But the real key to Tencent’s success lies in its technology.
It developed the capability to support tens of millions of concurrent gamers. Companies that launch a video game on Tencent have to be able to support that many gamers at once.
This has granted Tencent the Midas touch: Any game they develop or have developed for them is nearly guaranteed phenomenal success.
Take mobile games, for instance. In 2017, Tencent decided to dabble. So they developed a Multiplayer Online Battle Arena (MOBA) game in-house called Honour of Kings. Within months, it had become the most popular smartphone game in China by number of daily active users.
A High Chance for a Homerun for Every At-Bat
Other video game companies have a problem.
They work in near-obscurity for years. They’re suddenly thrust into the limelight with a billion-dollar hit, then slowly fade into the shadows.
For example, you’d probably never heard of Epic Games before Fortnite, and it remains to be seen if they can strike gold again!
But because of its process of fine-tuning games to players, Tencent isn’t a one-hit wonder. They can hit a homerun nearly every single time.
Imagine making a movie with Netflix.
They have data – down to the second – on what viewers love to watch and re-watch. That makes it easy to make a movie people will love.
Tencent has a decade of video game analysis for hundreds of millions of players. They know what people will love… and more importantly, what people are going to love.
So when the company picks out a new game, you know that’s where video game players are going next.
And Tencent has cemented a five-year distribution partnership with the company we’re going to release a report on tomorrow.
Using their data analysis, they can choose any game they want. And they’ve chosen one that combines an RPG with a shooter, a concept that is completely unique in the Chinese market.
Tencent knows that it fills a long-term, unexploited niche in the market, and they have given it their stamp of approval.
And the Tencent stamp… means a company can be set up to make billions.
The Great Video Game Wall of China
But for any video game company that wants to release a video game in China, there’s a catch.
Every video game released in the country has to go through an arduous approval process with the Chinese government. Less than 20% of games are ever approved. And the Chinese government shut down the approval process for most of 2018.
That means games like Fortnite, which have yet to be approved for sale in China, have not made any money off the huge Chinese gaming market yet.
And there’s another blockade in the battle to get into China…
Western-based video game developers must have a Chinese partner to be able to publish their games in the country.
But the company we’re profiling today has already received approval to sell their flagship game in China.
That game could be set to hit prime time in 2019 and beyond with Tencent’s massive push behind it – in the biggest and best video game market in the world.
Remember that vision that Tim Sweeney of Epic Games had of people paying for in-game items instead of purchasing the game wholesale? He took that single idea to the U.S. population and made a mint in under a year.
A major hit means the potential of blockbuster returns for early investors
One main hurdle for investors is that most video game companies are private.
When they hit a big score and the title goes mainstream, they are profit turning machines. Games like League of Legends and CrossFire can rake in over $100 million per month.
But since most video game companies are private, investors can’t participate.
But you’re in luck. The Katusa Research Special Situations team knows the names of several opportunities to play the sector.
Video games are to Millennials and Generation Z what television and radio were to Baby Boomers.
It’s what the Internet boom was to Generation X.
Don’t let a mega trend slip by again.
The Katusa Research Special Situations Team