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Tencent rejection adds woes to China's slowing game industry

Squeezed at home, mainland developers look to US, Japan and Europe for demand

China's video game industry is experiencing its slowest growth in a decade, as regulators weigh in on a market that observers think has reached its peak.

Analysts and investors will be watching Wednesday as Chinese social media leader Tencent Holdings announces its second-quarter earnings after a major blow. The company was forced on Monday to pull "Monster Hunter: World" -- a popular action role-playing game developed by Japanese studio Capcom -- from its WeGame platform, merely five days after the game's launch.

Part of the monster-slaying game's contents failed to meet regulatory requirements, Tencent said, and regulators canceled the game's operating license in China due to a "large number of complaints," without further elaboration.

 An analyst speculated that the regulator's decision may have more to do with Tencent's handling of the licensing process than the game's content.

Shares in Tencent, the world's biggest video game company by revenue, closed down 3.43% on Tuesday in Hong Kong.

Beijing's move deals the latest blow to a video game industry already facing a slowdown in the domestic market.

China has the world's biggest game industry by revenue and users, with an army of 600 million players -- roughly twice the U.S. population.

China's gaming market grew only 5% on the year in the first half of 2018 to reach 105 billion yuan ($15.2 billion), the first single-digit growth since 2009, according to a report this month by Beijing-based research company CNG and China's official gaming association, GPC.

Some observers attribute the slowdown to the rise of video apps such as Douyin and Kuaishou, which compete for the Chinese audience's attention and time, while others cite a shifting regulatory environment.

The State Administration of Radio and Television, which monitors entertainment content, has licensed no new games since late March.

Though an ongoing restructuring of the government watchdog has been the major cause of the bottleneck, "Chinese regulators have also tightened their grip over the production of games in recent months," said Cui Chenyu, an analyst at the Shanghai office of global consultancy IHS Markit.

Yet this cloudy picture for Chinese gaming companies has a silver lining, as international players increasingly favor made-in-China video games. NetEase, one of the country's top game producers, reported a strong financial performance in the second quarter, thanks partly to rising popularity abroad.

"Although income from overseas markets has yet to take a lion's share in Chinese companies' revenue, we have seen its contribution growing day by day," said Kern Zhang, an analyst with App Annie, a market research company specializing in online games. "For Chinese games companies, overseas markets have been and will be the primary growth engine in revenue."

The unclear domestic market makes foreign expansion essential for Chinese game companies, analysts say. "The Chinese gaming market is really not at its best at this moment, due to the suspension of license issuing, making companies here craving for overseas success," Cui said.

Eyes now are on Tencent as the Hong Kong-listed company releases earnings on Wednesday.

"PUBG Mobile," a multiplayer online survival game introduced by Tencent in May, averaged revenue of roughly $1.5 million to $2 million monthly from overseas players during the second quarter, according to IHS Markit. "Arena of Valor" -- another Tencent hit -- also secured a spot in a top 10 list of Chinese games compiled by App Annie based on overseas revenue in the first half of 2018, though App Annie declined to disclose exact sales figures for each game. That list also included "Knives Out," a battle royale mobile game developed by NetEase.

NetEase, Tencent's chief competitor in video games, told analysts in a conference call last week that "Knives Out" was the top-grossing game in Apple's App Store in Japan for most of June. Japan, alongside the U.S. and Europe, represents the most desired market for the Nasdaq-listed Chinese company.

"The advanced quality of these games coupled with our decadelong experience in marketing and operations have let us see early signs of success in the global market," said CEO William Ding.

This, together with in-game revenue from domestic players, helped NetEase grab 10.1 billion yuan from online games during the second quarter, marking the strongest growth rate for the segment since the first quarter of 2017, Ding said.

Overall sales of Chinese games for smartphone users in overseas markets jumped 40% year over year to reach $2.6 billion in the first half of 2018, according to App Annie. Meanwhile, 243 games achieved revenue of at least $1 million abroad, up from 192 games in the same period last year.

While Chinese games flourish both in emerging economies and advanced markets, statistics from App Annie show that American gamers played a key role in boosting sales. In the first half of 2018, players in the U.S. downloaded more Chinese games than anyone else in the world, and they also ranked as the biggest spender during that period.

Chinese companies have thrived overseas thanks to the improved quality of their games as well as their experience operating in highly competitive markets like China, analysts say. Cash also has paved the way for Chinese game developers to conquer the world.

NetEase has poured at least $150 million into two Western game developers so far this year, a move Ding called a "strategic investment" to gain know-how and market access. Tencent has taken similar steps. In February, Seoul-based chat app Kakao's gaming business landed $130 million from a group of investors led by Tencent. 

In the first quarter of 2018, Tencent's revenue from online games reached 28.8 billion yuan, or 39% of the Shenzhen-based company's total.


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