Tencent Holdings (OTC: TCEHY) released its first-quarter earnings report on May 18. The Chinese tech giant generated 135.5 billion yuan ($21.3 billion) in revenue, which was nearly flat from a year ago and missed analysts’ estimates of 5.5 billion yuan. This represented the company’s slowest year-over-year growth rate since its IPO in 2004.

Tencent’s net profit fell 51% to 23.4 billion yuan ($3.7 billion), which also beat analysts’ expectations of 5.1 billion yuan. On an adjusted basis, which excludes its investments and other one-time items, Tencent’s net profit fell another 23% to 26.3 billion yuan ($4.1 billion).

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Those numbers were ugly, but they weren’t surprising in light of China’s economic slowdown, the government’s crackdown on its major tech companies, and recent COVID-19 shutdowns. Can Tencent recover from this crisis and become a profitable investment again?

His VAS business is at a standstill

Tencent’s revenue from its value-added services (VAS) — which includes its domestic video games, international video games, and non-advertising social media and streaming services — rose just 0.4% from year-on-year to reach 72.7 billion yuan ($10.9 billion) in the first quarter.

Within that total, its domestic gaming revenue fell 1% to 33.0 billion yuan as the “direct and indirect effects” of the Chinese government’s stricter gaming time restrictions on minors reduced its number of games. active and paying users. Its international gaming revenue increased 4% to 10.6 billion yuan, driven by growth in Valorant and clash of clansbut this growth was partially offset by the slower growth of its hit Battle Royale game PUBG-Mobile in a post-lockdown world.

Its social media revenue rose 1% to $29.1 billion, with growth in its video-related subscription and live streaming services barely offsetting lower revenue from its music streaming services and games.

Tencent’s VAS business continues to tread water at the moment, but it cannot move forward unless its home gaming business generates significant growth again. That could be difficult, especially as Chinese regulators keep a close eye on new video game approvals and underage gaming habits.

Its advertising business is in trouble

Tencent’s ad business has boomed during the pandemic as online education, gaming, e-commerce and internet service companies increased spending to attract more consumers to the home.

But over the past year, Chinese regulators have cracked down on these thriving sectors with new restrictions on their content, promotional strategies and use of consumer data. Slower growth in the Chinese economy, which has been exacerbated by supply chain disruptions and new COVID-19-related lockdowns, has also generated additional headwinds.

As a result, Tencent’s ad revenue fell 18% year-over-year to $18.0 billion ($2.7 billion) in the first quarter. Its “social and other” advertising revenue, which includes its ads on WeChat, fell 15% to 15.7 billion yuan. Its media ad revenue, which includes ads on Tencent Video and its other media services, fell 30% to 2.3 billion yuan, even after selling more ads during the Beijing Winter Olympics.

Its fintech and business services are cooling

Tencent’s financial technology and business services revenue, which comes mainly from its WeChat Pay and Tencent Cloud ecosystems, rose 10% to 42.8 billion yuan ($6.4 billion). Unfortunately, this still marked the segment’s slowest growth rate since its inception in the first quarter of 2019.

The company attributed the slowdown to the resurgence of COVID-19 cases, which reduced its commercial payment volumes in the quarter, as well as its decision to pursue fewer “onerous contracts” with Tencent Cloud.

WeChat Pay could recover quickly after the new shutdowns end, as it already holds a new duopoly in digital payments with Ant Group’s Alipay (Ant Group is a close subsidiary of Alibaba Holding Group (NYSE: BABA)). However, WeChat and Alipay may still face unpredictable regulatory headwinds in the future as China passes new laws for its major fintech companies.

Meanwhile, its statement on Tencent Cloud suggests it may give up pursuing its two biggest rivals – Alibaba Cloud and Huawei Cloud – in the cloud infrastructure race in China with unprofitable deals.

Darker days could still be ahead

In the past, there were three main reasons to own Tencent: its booming gaming business, the rapid expansion of WeChat’s advertising ecosystem, and its long-term growth opportunities in the fintech and cloud markets. .

Unfortunately, these three catalysts have since faded away. Analysts expect Tencent’s revenue to rise just 5% this year, with its net profit plunging 49%. It also faces unpredictable regulations in China and delisting threats in the United States.

Simply put, we still can’t consider Tencent a bargain at 25 times future earnings. Alibaba, which arguably has a clearer path to a long-term recovery than Tencent, is trading at just 10 times forward earnings. So for now, investors should avoid Tencent (and most other Chinese tech stocks) and stick to more promising games to navigate this tough market.

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Leo Sun has no position in the stocks mentioned. The Motley Fool fills positions and recommends Tencent Holdings. The Motley Fool has a disclosure policy.

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