China mobile gaming: Buy your way

When mobile messaging app WeChat launched its first batch of games earlier this month, the Candy Crush Saga-like Tiantian Ai Xiaochu was downloaded more than 4 million times in the first 24 hours. Instead of charging users to download and play, WeChat owner Tencent is betting that the social network's 236 million active users will complete in-game micro transactions such as buying extra lives.

This free-to-play model is an extension of Tencent's online games business, which sets it apart from its major rivals. The company's online games revenue reached RMB7.59 billion ($1.2 billion) in the second quarter of this year, up 1.6% on the previous three months, thanks to growth in massively multiplayer online games (MMOG) such as League of Legends and Dungeon and Fighter on its QQ Games portal.

"There is steady cash flow in MMOG, in China and outside, but the growth rate is not remarkable," says Will Tao, analysis director at iResearch Consulting Group.

Mobile revolution

Since hitting 3% in 2010, the segment's growth rate has gradually declined and is expected to be around 1.2% by 2016, according to iResearch. At the same time, more Chinese are playing games on smart phones. Mobile online games revenue jumped 119% year-on-year in the first half of 2013, surpassing $400 million.

So the recent integration of games and a mobile payment service into WeChat could potentially be a revenue generator. Multi-platform texting app KakaoTalk released Kakao Game last year and its monthly revenue rose nine-fold to $35.3 million in three months.

WeChat games are currently only available in China, but could roll-out to the service's over 100 million registered users in Southeast Asia, India and Latin America. Tencent plans to spend up to $200 million this year to advertise WeChat in emerging markets. The company is also building a mobile games open platform - featuring in house titles as well as those sourced from third-party developers - for WeChat and instant messenger service QQ.

"Part of Tencent's strategy is to invest in good content developers and publishers worldwide so they're very interested to see what other content is out there, how it's made, just to have access to good, talented developers. That's a key focus for them," says Hans Tung, Beijing managing partner at Qiming Venture Partners.

Tencent is not alone in using M&A to build its presence in the mobile space. Baidu recently agreed to pay $1.85 billion for NetDragon Websoft's 91 Wireless, a Chinese mobile app store and game operator. With Google's Android mobile operating software the most popular in China yet its Google Play application store often inaccessible, a host of third-party store providers compete for users. It is a fragmented market and content is often infested by viruses and malware.

In 91 Wireless, Baidu will have one of the largest third-party app distribution platforms in China and a viable competitor for rival Qihoo 360's app store.

IDG Capital Partners, DT Capital Partners, iD TechVentures and Temasek Holdings-owned Vertex Venture were investors in 91 Wireless, and the mobile segment has seen an increase in investment and M&A activity over the last year. Mobile game developer China Mobile Games & Entertainment Group acquired eight game development teams last year and has raised $25 million in funding for further business development.

"The reason we are not as afraid of the creative risk in the investment is because we know mobile gaming is the best way to monetize traffic. If you have one hit game the chance of being bought by someone is actually pretty high, whether it's a listed Chinese media company or an online game developer overseas. People will want to buy you for the asset you have already. You don't have to IPO," explains Tung.

Gaming is different from other internet business because net margins are usually around 20-40% with a hit title. But valuations have risen in step with revenues. Developers with top-three ranked mobile games are now asking for pre-money valuations of $100-200 million, Tung adds, although price-to-earnings ratios are still in the single digits so investors are still interested.
However, Lisa Cosmas Hanson, managing partner at research firm Niko

Partners says that while web and mobile games have higher average revenue per user (ARPU) and lower development costs, life cycles are shorter and competition is greater. She says that a company can get far more mileage out of an MMOG.

Increasingly acquisitive

The emphasis on expansion also applies to the more established online gaming business, which is looking for growth in international markets.
Online game operator Perfect World makes 25% of its revenue from outside of China. A portion of this is from licensing deals with game operators, especially in fragmented markets like Southeast Asia, where they must deal with different languages and payment systems.

"The first thing a Chinese company entering Southeast Asia will realize is that coming from a large market is actually a bit of a challenge - a negative return since they have to focus on five different smaller markets. They would rather concentrate on high-paying markets such as Europe, US or Japan," says Ku Kay Mok, a partner at Gobi Partners.

Indeed, Tencent has targeted acquisitions in the US. In 2011, it bought a majority stake in online games developer Riot Games - maker of League of Legends, one of the most-played games in the world - for nearly $400 million. It followed this with an investment in game and technology developer Epic Games, taking a 40% stake for $330 million. Epic's Unreal graphics engine is licensed out to other game studios.

Last month Tencent bought nearly 25% of Activision Blizzard, having gone into partnership with the games publisher last year to produce Call of Duty for the Chinese market, which involved modifying the existing game for a free-to-play, microtransaction-based business model.

With China's emergence as the world's biggest consumer market for online games in the world, domestic operators will continue to eye cross-border expansion to access new growth potential. Shareholders in these now-listed companies will demand it.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Media
• Technology
• Greater China
• Venture
• Gobi Partners
• Tencent
• Baidu
• TMT
• China
• Venture