The Tencent Story (Part 2 of 3)
Hello investors, welcome to my Substack, where I study the best Investors and businesses from around the world. In this week’s article, we’ll go over The Tencent Story. This is a three part series since I wasn’t able to fit the rich history of Tencent in just one article. This second article will cover Tencent’s Growth Before the IPO. Before I start, I want to make a quick note, Poly Ma’s real name is Ma Huateng, but for the sake of ease, I’ll be using Pony Ma throughout these articles on Tencent. In the last article, Pony Ma and his four friends started a company called Tencent and started to get traction on their messaging app OICQ. We’ll pick up from there.
Tencent’s Growth Before the IPO
Tencent formed another company, this time in the British Virgin Islands, called Keyword Technology Ltd, on November 23, 1999. Tencent Holdings Ltd became the parent company of the Tencent group later.
Tencent changed its registration location to the Cayman Islands and changed its name to Tencent Holdings Ltd in 2004, just before its initial public offering. Because of the simple registration process, low maintenance costs, and low tax in the British Cayman Islands, registering an offshore parent company was not uncommon among Chinese Internet companies.
Tencent established a wholly owned subsidiary company, Tencent Technology (Shenzhen) Co. Ltd., in February 2000. The goal was to split the company's software development and value-added services (VAS) businesses into separate subsidiary companies so that it could incorporate foreign investments while still operating value-added telecommunications and Internet services.
In the year 2000, Tencent's IM business grew even more. OICQ had five million registered accounts by April 2000. Tencent created a cartoon-penguin icon to promote its brand, which quickly became the company's symbol.
AOL, on the other hand, accused OICQ of infringing on ICQ's intellectual property rights. Tencent renamed its instant messaging service QQ in December 2000. In retrospect, he may not have wanted to call in OICQ because it infringed on AOL's product. OICQ, on the other hand, exploded in popularity, with users quadrupling every three months. OICQ reached one million users after nine months. However, this was before AWS (or Tencent Cloud), and servers were prohibitively expensive. AOL also sued Tencnent to have OICQ's name changed. Pony Ma launched a dual-track process to either sell the company or raise money because they were running out of cash.
Tencent had set a target of $431,000, but the best offer it received was $86,327. The lack of demand proved to be a fortunate break. With no takers, Ma sold 40 percent of Tencent for $2.2 million to IDG Capital, a Chinese venture capital firm based in the United States, and Yingke, a fund led by Chinese billionaire Li Kashing's son. It wasn't, however, the end of the road. Tencent was forced to change the name of its flagship product after AOL won its lawsuit. It went with QQ. As the company surpassed 100 million users without a revenue model, server costs continued to rise. Tencent had reintroduced the new QQ to the market.
To keep up with the growth, they approached Chinese search companies Sohu and Yahoo! China. Neither of them were interested. Then, in 2001, Naspers, a South African company, walked in the door and offered a $60 million investment. IDG sold 12.8 percent of its 20 percent stake and Yingke sold its entire stake for an 11x gain, giving Naspers 32.8 percent of the company for $19.68 million, preventing Ma from losing majority ownership.
In the same year, Tencent began working with China Unicom and China Mobile's Guangdong Bureaus to launch their first Wireless Application Protocol, also known as WAP (and no, I'm not referring to Cardi B). They agreed to include mobile QQ as a pre-installed program in their newly issued SIM cards as part of their WAP services. Tencent began collaborating with China Mobile's local bureaus in Beijing, Sichuan, Jiangsu, Zhejiang, and Shanxi shortly after.
By 2004, Tencent was delivering its mobile and telecommunications VAS through subsidiaries and branches of China Mobile and China Unicom. Tencent's balance sheet benefited greatly from the widespread adoption of mobile Internet. Take for example what they said in their yearly report in December 31, 2003:
For the year ended December 31, 2003, our revenues and profit for the year were $88.88 million and $38.96 million, respectively, representing an annual growth rate of 179.4 percent and 129.0 percent from 2002, respectively. Subscription-based revenues accounted for over 75 percent of our total revenues in 2003. For the three months ended March 31, 2004, our revenues and profit for the period were $31.25million and $12.97million, respectively.
Tencent went public on the Hong Kong Stock Exchange on June 16, 2004, after nearly a year of preparation. In 2003, Tencent hired Goldman Sachs to serve as the "global coordinator, lead manager, and bookrunner of the offering." Tencent and Goldman Sachs collaborated as a result of "mutual respect and appreciation," according to Tencent. Goldman Sachs was, in fact, the leading underwriter for Chinese companies' overseas public offerings at the time. Tencent's IPO in Hong Kong was significant because it was the first Chinese Internet company to be listed on the Hong Kong Stock Exchange's Main Board.
Source: Tencent, Prospectus. Tencent’s Structure as of June 2004, Before IPO.
Internet value-added services (IVAS), mobile and telecommunications value-added services (MVAS), and online advertising were all mentioned in Tencent's reports. IVAS and MVAS were both built on a basic instant messaging platform that allowed users to "communicate via text messages, images, video, voice, and e-mail." These services spawned an online social networking, entertainment, and gaming community. Tencent integrated targeted advertising into a variety of platforms.
Parallel to the Internet VAS provided on desktops, MVAS were gradually expanded to games, entertainment, and community networking with the widespread adoption of smartphones and the completion of 3G and 4G networks throughout China. The mobile sector was further strengthened through mobile applications, particularly after Tencent launched Weixin and WeChat, a smartphone-based chatting service, in 2011.
This concludes the second part of the Tencent Story. If you’re interested in a further deep dive, I'll leave a link below links to my sources, namely - The Acquired podcast, Not Boring by Packy McCormick, and Tencent the book by Min Tang, and the book - Tencent - Survivor, Challenger And Leader from Wu Xiaobo.
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