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Hot Stock Commentary | Summary of Tencent's Q2 Financial Results

💡 Core Viewpoints

1. Solid financial performance: In Q2 2026, Tencent reported total revenue of RMB 204.885 billion, an 11% year-on-year increase, slightly beating market expectations. Among them,the domestic gaming business performed particularly well, with quarterly revenue reaching RMB 47.3 billion, a significant 17% year-on-year increase, driven by titles such as "Delta Force," "Valorant Mobile," and "Roco Kingdom: World." Advertising revenue reached RMB 43.6 billion, up 22% year-on-year, accelerating further from Q1. FinTech and Business Services generated RMB 60.3 billion, a 9% year-on-year increase. Non-IFRS profit stood at RMB 68.415 billion, up 9% year-on-year. International gaming revenue was RMB 18.6 billion, down 0.8% year-on-year, missing expectations.

2. Cash flow under temporary pressure: Dragged down by massive AI capital expenditures,the company's capital expenditure for the quarter reached RMB 52.8 billion, causing free cash flow to turn negative temporarily to -RMB 13.8 billion. This asset-heavy investment model has sparked market concerns about the prolonged payback period for AI investments and short-term profit pressure, leading to short-term pressure on the stock price. As AI investments continue to increase,the market is reassessing the valuation anchor, shifting from a cash flow basis to a cash reserve basis,which means that the market's positioning of Tencent needs to consider changes in the consolidated balance sheet.

3. Impact on the industry chain: Tencent's AI business has exceeded previous conservative expectations, with cloud business revenue growth rising to the 20%+ range, which is positive for the AI computing power supply chain. However, management has not fully demonstrated AI monetization rates to the market, so concerns remain regarding the realization of Capex ROI. ▎ Financial Performance

Total revenue was RMB 204.885 billion (+11%), slightly higher than market expectations. Non-IFRS profit was RMB 68.415 billion, a year-on-year increase of 9%.

In the first half of the year, Tencent achieved operating revenue of RMB 401.243 billion, a year-on-year increase of 10%; Non-IFRS profit was RMB 136.32 billion, a year-on-year increase of 10%.

Excluding the impact of revenue, costs, and expenses from new AI products (primarily Hunyuan Hy, Yuanbao, CodeBuddy, WorkBuddy, and the WeChat AI agent Xiaowei), Non-IFRS operating profit increased 19% year-over-year to RMB 86.1 billion. AI-related products remain unprofitable, dragging down the company's overall profit margin.

▎ Segment Performance

– Domestic Games: Revenue reached RMB 47.3 billion, up 17% year-over-year, significantly beating expectations. Growth was driven by Delta Force, Valorant Mobile, and Roco Kingdom: World.

– International Games: Revenue stood at RMB 18.6 billion, down 0.8% year-over-year, missing expectations; however, it rose 4% year-over-year on a constant currency basis.

– Advertising Business: Revenue totaled RMB 43.6 billion, up 22% year-over-year, accelerating further from Q1, reflecting progress in AI monetization.

– FinTech and Enterprise Services: Revenue amounted to RMB 60.3 billion, up 9% year-over-year. Cloud business revenue growth has accelerated to the 20%+ range, driven by AI computing demand and overseas expansion.

WorkBuddy's gross margin for paying users has approached the overall level of Tencent Cloud.

▎ Profit Margins and Costs

– The overall gross margin in Q2 was 58%, beating market consensus expectations.

– AI-related new products incurred an overall loss of approximately RMB 10.5 billion in Q2, higher than RMB 8.8 billion in Q1, reflecting continued increased investment in AI.

– Depreciation and expenses related to right-of-use assets rose from approximately RMB 7.7 billion in the same period last year to RMB 11.2 billion, a year-on-year increase of 46%.

– Technical infrastructure operating costs excluding depreciation increased from approximately RMB 7.5 billion to RMB 15.2 billion, a 100% growth, mainly driven by AI investments and increased utilization rates.

▎ Cash Flow

Net cash from operating activities in Q2 was RMB 52.7 billion, down from RMB 74.4 billion in the same period last year, a year-on-year decrease of RMB 21.7 billion, primarily including significant AI-related prepayments.

Regarding free cash flow:

– Book free cash flow:-RMB 13.8 billion(Net cash from operating activities: RMB 52.7 billion, less capital expenditure payments of RMB 59.3 billion, media content payments of RMB 5.0 billion, and lease liability payments of RMB 2.2 billion)

– Free cash flow excluding prepayments for computing power:+RMB 37.6 billion

– Scale of prepayments for computing power in Q2:RMB 51.4 billion

▎Capital Expenditure

Capital expenditure amounted to RMB 52.8 billion, accounting for 26% of total revenue; a year-over-year increase of 176% and a quarter-over-quarter increase of 65%.

– Management noted that capital expenditure directed toward AI-native businesses is primarily concentrated as one-time investments in this year and next.

– Adequate reserves for inference computing power are indeed necessary. Any future increases in capital expenditure will be fully aligned with the revenue levels generated by the business.

- Management mentioned that capital expenditures should consider not only operating cash flow but also the consolidated balance sheet.

- The capital allocation strategy will be dynamically adjusted to flexibly respond to market conditions. If the company determines that more cash is needed for capital expenditures, it will correspondingly reduce the scale of stock buybacks to maintain an overall dynamic balance.

▎AI Strategy

From the company's perspective, management outlined a "downside protection mechanism": Computing infrastructure can be leased out externally via Tencent Cloud in the future to absorb idle computing power and hedge against high capital investments. However, at present, the vast majority of new computing capacity will be dedicated to self-developed large language models and AI applications to secure a leading position in the domestic market.

– Strategic upfront investment to secure a ticket to the AI era's infrastructure; Strong cash flow from core businesses can support these investments; the risk lies in whether these investments can be efficiently converted into revenue from cloud and AI products.

– WeChat: The current strategy is to fully adapt WeChat to the AI era, currently in a phase of moving forward while observing.

– WorkBuddy: The gross margin for paying users and the Model-as-a-Service (MaaS) business has currently reached parity with Tencent Cloud's overall gross margin. The lower consolidated gross margin is due to subsidies allocated to free users to capture market share and drive user growth; however, the gross margin performance for the paying customer segment alone is quite robust.

– The market is closely watching the performance and capabilities of Hy4 following its launch.

▎Valuation

Tencent's valuation anchor is shifting from cash flow to a cash-based anchor, which is one of the reasons for market concern.

- The company's core business remains stable, with profit margins continuing to rise.

- The AI business (Workbuddy, Xiao Wei, and Hy4) has made some progress compared to the previous quarter, but it has not yet fully demonstrated its monetization potential to the market.

- Key market focus going forward: The launch timeline of Hy4, the commercial implementation and paid conversion speed of the Workbuddy office agent, and user feedback and iterations from the phased rollout (gray-scale testing) of the WeChat AI assistant "Xiao Wei".

- Free cash flow turned negative in Q2, although profit margins remain supported. In the future, as capital expenditures gradually convert into depreciation costs, Tencent's profit margins will face pressure if AI monetization falls short of expectations, with EPS potentially turning negative next year.

– Tencent's current strategy continues to prioritize AI development, and the monetization rate of AI will become a core catalyst for its stock price.

– Regarding the stock price: The market expects AI capital expenditure to crowd out future stock buyback volumes, while the pace of AI business monetization remains unclear, putting short-term pressure on the stock price.

▎ Risk Warning

– Risk that ROI on AI capital expenditure fails to materialize

– Risk that AI monetization rates fall short of expectations

– Risk of margin pressure after capital expenditure is converted into depreciation

– Risk of reduced stock buyback volume

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