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Tencent opts for strategy that fits with 'Made in China 2025'

After clashes over youth gaming, tech giant plays up industrial offering

Young boys play Tencent's game "Honour of Kings" which has been criticized for being addictive.    © Reuters

TOKYO/HONG KONG -- China's Tencent Holdings may be feeling a bit bruised after a year in which it has faced harsh criticism from Beijing over the effects of online games on children. Shares in the Chinese social media and gaming company have tumbled by a third since January and in August the group announced its first quarterly profit dip in 13 years.

So news that it plans a restructuring that will align it more closely with Beijing's "Made in China 2025" initiative is either happy coincidence or a canny move to gain favor by promoting the country's ambitions to join the ranks of U.S., Germany and Japan as a major industrial power.

Beijing has made transforming the country into a high-tech powerhouse a top priority. Under the initiative, China seeks to dominate in industries such as robotics, information technology, aviation and new energy vehicles.

In the tech sector, the internet of things and fifth-generation, or 5G, wireless networks are key battlegrounds. And this is precisely where Tencent intends to focus more of its energies under the restructuring announced over the weekend.

"Tencent's mission is to become a digital assistant of all industries," said Liu Zhiping, company president, in announcing the company's first restructuring in six years. Tencent said it intended to "promote the upgrade from consumer internet to industrial internet," which will see consumer-content businesses consolidated and the creation of a new group for cloud and smart industries.

Some analysts see the government's hand behind Tencent's latest shift. As the trade war with the U.S. takes its toll on Chinese manufacturers, Beijing wants to use private enterprises, such as Tencent and Alibaba Group Holding, to achieve technological independence from the West, said Kokichiro Mio, a China analyst at NLI Research Institute in Tokyo.

The country's desire for independence in the tech sector intensified after Chinese smartphone maker ZTE was nearly destroyed when Washington earlier this year blocked shipments of key components for its smartphones and other cellular equipment. The U.S. claimed that the company had sold products to North Korea and Iran in violation of international sanctions. ZTE was able to resume business after reaching a deal with Washington in June. Last month, however, the U.S. slapped tariffs on $200 billion worth of Chinese goods.

"China's manufacturing industry is competitive only as long as it has a supply of key components from the West," Mio said. "China thinks it will never be able to compete head-to-head with the West unless it can independently develop innovative products."

"The Chinese government is trying to control private enterprise, not destroy it," said Yasuhiro Chihara, China analyst at Naito Securities in Osaka.

As part of its restructuring, Tencent will set up a technical committee to push for research and development in such fields as artificial intelligence and 5G technologies.

The decision follows Beijing's crackdown on the distribution of video games -- Tencent's biggest revenue stream.

Prompted by growing public criticism of the industry for failing to tackle mental health issues such as online addiction, Beijing has moved to curb the amount of time Chinese school children spend with their gadgets. Government ministries said they plan to limit the number of online games and new releases, and may impose age restrictions.

Tencent has responded by announcing earlier this month that it would use police data to identify minors and limit the time they spend playing its online blockbuster, "Honour of Kings." But with a freeze on approvals for new games, Tencent's earnings took a hit, reporting its first fall in quarterly profit in more than a decade.

The group is also feeling the heat in its other businesses. Regulation is weighing on its popular digital wallet. Tencent once enjoyed interest income from millions of Chinese who parked spare money in the service. But Tencent will soon lose that revenue: In January 2017, the People's Bank of China required third-party payment groups -- including Tencent's WeChat Pay -- to hold 20% of customer deposits in interest-free custodial accounts at a commercial bank. That ratio was increased to 50% in April and is expected to hit 100% by 2019.

The company claimed in its second-quarter earnings report that it is still "midway through this transition" and "our payment service revenues, and to a greater extent, gross margins continue to be adversely affected" by the new regulation.

Meanwhile, its other revenue generators have also been threatened by newcomers. As Beijing-based news aggregator startup Toutiao lured away users -- as well as advertisers -- Tencent's online advertising revenue grew only 39% year-on-year in the second quarter, compared with 55% growth in the previous quarter.

In April, the company also reportedly poured 3 billion yuan ($436.72 million) into boosting its video sharing service in an attempt to prevent more WeChat users from turning to rival Douyin. With China's population growth slowing down, analysts say the fight for existing customers will only heat up.

All have contributed to Tencent's quarterly profit decline in August. On Friday, Tencent shares in Hong Kong closed at 323.20 Hong Kong dollars, compared with HK$476.6 in January.

Tencent's recent troubles illustrate the difficulty of surviving in the Chinese market without the approval of authorities, even for such an influential company. The company though told state-owned China News Service on Sunday that "the restructuring definitely will not result in any job cuts."

Chinese technology companies have flourished in part by toeing the government line. Alibaba and its Ant Financial mobile payment affiliate, for instance, provide financing to people in rural areas and help them sell products to urban dwellers, a service that is believed to please a government keen to address underdevelopment in rural areas.

Moves by internet companies to accommodate Beijing's requests, such as restricting access to sensitive content and providing information about users, are common in exchange for the authorities' blessings and sometimes even subsidies, Mio said.

Whatever the motivation, Tencent's latest moves may well help to smooth its relationship with the authorities. And investors must be hoping that a better relationship will also help to stop the slide in Tencent shares.

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