Tencent – Helpful regulation.

Short-term pain for long-term gain.

• While the move by the Chinese regulator is hurting Tencent badly right now, greater regulation will, in the end, work in Tencent’s favour by keeping out smaller, more innovative and nimble competitors.
• Tencent suffered again on Friday 31^st August by falling another 4.5% bringing the year-to-date decline to 16.7%.
• The reason for the decline is the increasing regulation being imposed by the Chinese government on the Chinese games market.
• China is not only by far the most regulated games market in the world, but it is also the most opaque, meaning that sweeping regulatory changes can hit market participants with no warning.
• Games in China go through a two-step approvals process.
  • First, Ministry of Culture and Tourism which checks the game for content that is deemed to be sensitive.
  • Second, a second agency then issues a licence allowing the game to go for sale.
  • It was this second agency that ceased all approvals with no warning where restructuring is thought to have caused the stoppage.
• To complicate matters still further, now the Ministry of Education is weighing in with a series of guidelines for how much children should be allowed to engage with games as well as restrictions on the numbers of both online games and regular titles.
• This is leading to the formulation of a Byzantine regulatory environment where getting games approved will become almost as much of a skill as writing the games themselves.
• In this environment, it is the big companies that will end up winning.
• This is because only the big companies will be able to afford to have large compliance departments that can deal effectively with the regulator and ensure that products come to market.
• It is very bad news for small start-ups and innovators as it will now become almost impossible for them to get their games approved.
• This is likely to result in smaller companies either closing down or selling themselves to the big companies resulting in declining competition.
• While this trend is causing a correction in both Tencent and NetEase, as no one saw this coming, it will benefit them in the long run as competition in the Chinese gaming market declines.
• This is particularly the case for Tencent which has proven to be adept at navigating its way through regulatory problems over the last few years.
• Hence, this is likely to be a short-term correction and I am looking for the right moment to buy back into Tencent.