GUANGZHOU -- Tencent Holdings faces new scrutiny from Chinese authorities, hampering the company's efforts to consolidate its position as China's top gaming developer and giving rivals an opening to encroach on market share.
The latest state action came over the weekend when China's antitrust watchdog said it would block the merger of Tencent video game streaming sites Huya and DouYu, using unusually blunt language to explain the reasoning behind the move.
The planned merger would grant Tencent isolated management of upstream and downstream markets, the State Administration for Market Regulation said Saturday.
Chinese brokerage Tianfeng Securities noted regulators' recent crackdown on the tech industry in a report Monday, stating that "the model in which the industry was driven by capital will likely face new norms."
Tencent initially invested in DouYu during 2016, followed by Huya in 2018. In terms of voting rights, Tencent controls roughly 40% and 70% in the two companies, respectively.
Live game streaming is anticipated to be a major growth sector. Tencent had let DouYu and Huya compete against each other to hone their services.
Huya controls over 40% of China's game-streaming market while DouYu's share tops 30%, SAMR noted, signaling concern with an entity that would command a share exceeding 70%.
Tencent sought to keep the two rising stars from cannibalizing each other's users and improve the group's operating efficiency. But SAMR's enforcement action upended those merger plans.
Tencent responded with a statement Saturday saying it will abide by the decision. The company did not disclose how it will handle DouYu and Huya, but pulling funding from one of the two is an option to resolve intragroup friction.
The rejected merger gives rivals a chance to crack Tencent's stronghold. ByteDance, the developer of TikTok, hosts video game livestreams on the Chinese version of the video app, Douyin, among other platforms. In March, ByteDance agreed to invest in Shanghai gaming studio Moonton, Reuters reported.
Though ByteDance's approach extends instead from downstream toward upstream, the company's quest to establish a vertical fiefdom in the gaming industry resembles Tencent's strategy. The intense rivalry by the two sides in the social media sphere will expand into video games.
With Tencent hounded by regulators and competitors, concerns about the company are not limited to game streaming. SAMR noted Saturday that Tencent's market share in online games surpasses 40%. This suggests that the watchdog is mindful of the company's bread-and-butter game development segment as well.
Tencent's gaming business generated 156.1 billion yuan ($24.1 billion) in revenue last year, accounting for over 30% of overall sales and ranking as the leading segment. The company invested heavily in titles capable of in-game purchases, a high-margin business.
In recent months, Tencent bought stakes in CMGE Technology, an outfit that offers a China-exclusive mobile game based on the "Dragon Ball" franchise. The internet powerhouse also acquired an interest in Zhejiang Century Huatong Group, which itself purchased online game developer Shengyue Network, a onetime Tencent rival.
Tencent invested in 46 targets within the video game industry, mainly developers, during the first half of this year, Chinese analytics firm IT Juzi said. The count exceeds the 31 deals for all of 2020, putting Tencent on a record pace.
The headwinds against the gaming business cast a shadow over the group's strategy. In 2018, the release of all new games stalled for months as Chinese authorities screened titles for any potential "bad influence" over minors. Tencent's earnings growth slowed during this stretch.
But at the time, the restrictions affected the sector as a whole. Game development was disrupted at Tencent and rivals alike.
If regulatory actions are focused on Tencent this time, the crackdown could benefit ByteDance and NetEase, China's second-ranked game developer.
Tencent has drawn closer to Japan's gaming industry. In 2019, it teamed with Nintendo to sell the Japanese company's Switch console in China. Last year, Tencent funded Marvelous Entertainment, the developer of farm role-playing series "Story of Seasons."
Riot Games of the U.S. and Finland's Supercell received backing from Tencent as well.
Tencent's leading position in the Chinese market, as well as its deep pockets, make the company an attractive partner. If Tencent's standing is undermined during the tug of war with regulators, international gaming companies may start looking at other options.