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Business Trends

China's censorship casts shadow over internet businesses

Domestic companies adapt to scrutiny, but crackdown adds trouble to Google's entry

A child in China plays the game "Honor of Kings" by Tencent. The government is tightening control over the internet, a development that has the industry worried.   © Reuters

Beijing's increasing intervention in the internet sector has raised pressure on Chinese businesses ranging from game producers to live-streaming sites, a chilling effect that also may hamper attempts by Facebook and Google to enter the world's largest internet market.

Hong Kong-listed Tencent Holdings reported its first decline in quarterly profit in nearly 13 years on Wednesday, as state regulators failed to grant approval for in-game purchases involving the company's new hit video game, "PlayerUnknown's Battlegrounds Mobile." Online games contribute roughly 40% of Tencent's revenue.

Shares of Tencent slumped accordingly as investors worried about its future growth, wiping out 93.24 billion Hong Kong dollars ($11.9 billion) in market value during Thursday morning's trading.

Tencent has suffered two major blows this week. On Monday, Chinese officials forced the Shenzhen-based company to remove "Monster Hunter: World" -- a popular role-playing computer game it licensed from Japan's Capcom -- from its platform. Tencent said it was told the game "did not comply with regulations."

Though no Chinese company has disclosed financial losses associated with the tighter government control, the damage has not gone unnoticed.

Reasons behind Beijing's crackdown remain unclear, but market observers say the game shutdown won't be a one-off event.

"Chinese leaders have stated their desire to tighten up control over the [web] content," said Xue Yu, an analyst with global consultancy firm IDC, citing a statement published last year by the State Council, China's cabinet. "This is going to be a long-term trend."

Though he called the restriction "necessary" given that China's cyberspace has been flooded by rumors, "the tougher scrutiny will do more harm than good for the country's internet businesses," Xue said. "It will kill business innovations. It will also hamper the financial performance of Chinese companies, as they now have to wait for a longer time before their products can hit the market."

Mobile games offer one example. China's State Administration of Radio and Television, which monitors entertainment content in the country, suspended its issuing of licenses in late March. Previously, producers of a game usually spent three months undergoing assessment by regulators, Xue said.

While censorship is no stranger to Chinese companies, almost every analyst in Tencent's earnings call Wednesday raised questions over regulatory risks. Tencent, the world's biggest games producer, declined to speculate on whether Chinese leaders have tightened their grip over the game industry. The company instead attributed the delays in new licenses to a longer-than-expected overhaul of the entertainment watchdog.

"We do believe it's not a matter of whether this game ["PlayerUnknown's Battlegrounds Mobile"] will be approved for monetization. It is a matter of when exactly we can actually do that," President Martin Lau told analysts. But Lau also flagged online gaming as "one key area of weakness" for the company's future revenue growth, citing a lack of "visibility on the license resumption time" as the biggest concern.

Lau's comments, together with the company's disappointing second-quarter results, sent Hong Kong stocks lower. The MSCI Emerging Markets Index, which counts Tencent among its top 10 holdings by weight, dropped 1.8% on Thursday while Hong Kong's benchmark Hang Seng Index slipped 0.6%.

Tencent isn't the only one that analysts worry about. When Chinese search engine giant Baidu hosted its earnings call this month, similar queries popped up three times during a 30-minute Q&A session.

"We haven't seen any negative impact over the past couple of quarters because our standards have always been higher [than the government's]," said Robin Li, the chief executive. Li was addressing one analyst's concerns over Baidu's ability to cash in on its news business and online ads as Beijing keeps a closer eye on what should stay on the web.

"We are able to maintain a high standard and close dialogue with the regulator," Li assured analysts. According to Baidu, its artificial-intelligence-powered monitoring system can now delete online ads containing sex, violence and any other unwanted content at a rate of up to 4,500 ads per minute.

Other Chinese internet companies also have scrambled to reduce regulatory risks. According to a statement on the website of the State Administration of Radio and Television, some live-streaming platforms have deployed facial recognition solutions to identify users. The government watchdog did not specify which companies.

People play online games in an internet cafe in downtown Shanghai. People play online games in an internet cafe in downtown Shanghai.   © Reuters

Technology aside, more people also have been hired to help companies remove unwanted content before the government does so. Beijing-based news aggregator Toutiao, a unicorn backed by Sequoia Capital, has said it will expand its self-censorship team to 10,000 people, up from 6,000 in April.

The regulatory issues add incentive for Chinese internet businesses to search for a safer, alternative revenue stream in other countries, said Tom Wijman, consultant of market intelligence company Newzoo.

"Expanding internationally diversifies this risk factor, which is what shareholders of these businesses will be looking for, particularly after the events of the past months," Wijman said. "Gaming businesses, such as Tencent, will likely look to launch self-developed games globally, as it has been doing with 'Arena of Valor' and 'PUBG Mobile.'"

Wijman said other internet business, such as social media giant Weibo, "are currently quite local but might look to expand to markets similar to China's, or might attempt to capture emerging mobile markets such as Indonesia and India."

Beijing's regulatory crackdown traces back at least a year. In July 2017, Tencent lost $17.5 billion in market value after state-backed newspaper People's Daily criticized the company's mobile game "Honor of Kings" as too addictive.

This year, a request by state regulators to clean up the internet led iQiyi, China's answer to Netflix, to remove 1,022 movies -- about one-third of the total -- from its website in April. One such movie was "Fight in Causeway Bay 3," an action film that compiled the seventh-highest gross on iQiyi's platform last year with distribution revenue of 11.3 million yuan ($1.6 million).

That same month, Chinese officials also banned "Neihan Duanzi," an online jokes app developed by Toutiao. According to market research firm QuestMobile, until the regulators stepped in, the app had more than 38 million monthly users -- equivalent to the population of Poland.

While Chinese companies have adjusted their strategies to fit the government's requirements, their international rivals face a dim outlook.

"Regulatory compliance would remain a big barrier for Western internet companies like Google," Xue said. "Once the search engine enters the Chinese market, it will have to play by Chinese rules. Whether Google can accept Beijing's requirements is a big question mark."

Google -- currently blocked in China -- has already been under fire. In a letter circulated on the internet, hundreds of Google employees questioned the company's decision to abide by Beijing's request and build a censored search engine, saying these actions "raise urgent moral and ethical issues." Beijing's tougher scrutiny could worsen the problem, analysts say.

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