[00:03:03] Clay Finck: While they’ve seen their growth slow over the past couple of years, their price to free cash flow is 15%, which is around the lowest it’s ever been, and half its historical average. But these valuation levels don’t totally go unnoticed by investors, as many are wary of the CCP’s involvement in their business affairs.

[00:03:21] Clay Finck: So during this episode, I wanted to uncover the story of Tencent and why it’s largely flown under most investors radar. To help me do so, I’ll be covering a book called Influence Empire by Lulu Chen. Chen performed a number of insider interviews going into intense detail to accurately highlight the Tencent story.

[00:03:39] Clay Finck: Tencent has largely flown under the radar by design. The billionaire founder, Ma Huateng, who goes by the English name Pony, intentionally shies away from media attention while historically, his arch nemesis, Alibaba founder, Jack Ma, is known for his high profile personality. For simplicity’s sake, I’ll refer to this Tencent founder as Pony or Pony Ma during this episode, as Chen does in the book.

[00:04:03] Clay Finck: The book also serves as a way for me to learn more about China and how the people there operate and think about business. I was recently chatting with a fund manager who had just visited China and he explained to me that the country is likely much different and more capitalistic than most Americans would believe it to be.

[00:04:19] Clay Finck: So I’d like to approach the subject with an open mind and a curiosity to learn more. And if you don’t think it’s possible to achieve good returns in China, I would encourage you to also check out episode number 661 with Richard Lawrence, who’s compounded capital at 14. 3 percent over 30 years investing in Asia.

[00:04:37] Clay Finck: And over the past 10 years, he’s been heavily allocated to Chinese stocks. The book highlights that China, in a sense, operates in a parallel universe, as one out of three web users aren’t able to view sites like Facebook, Twitter, or X, Snapchat, Instagram, The New York Times, and YouTube. China essentially has their own version of the tech names we know of here in the Western world.

[00:05:00] Clay Finck: Even when a Chinese person travels outside of the country, if they’re using a Chinese SIM card, they can’t use a site like Google. Chen refers to WeChat as the Swiss army knife of a super app that combines many functions all into one app. Two thirds of Chinese people use a Tencent app for all sorts of services, from texting to shopping, watching videos, playing games, and ordering food and a taxi, making it also the ideal tool for mass surveillance.

[00:05:28] Clay Finck: The way Chen puts it, the Communist Party finds the idea of Tencent both appealing and daunting. Pony Ma transformed from a carp leaping over the Dragon’s Gate. Initially he needed to avoid the CCP’s immense powers they held over him, and over time he inevitably became shackled to become part of the system that he wanted to change himself.

[00:05:49] Clay Finck: Pony Ma was born in 1971 on China’s southern island of Hainan, and when he was 13 his family would relocate to Shenzhen, which today is China’s fourth largest city. In middle school, Pony Ma would meet three of his co founders, and all four of them were really sharp students and had an obsession with STEM classes.

[00:06:08] Clay Finck: When Pony Ma was at university, thousands of students took over the streets of Beijing occupying the capital’s iconic Tiananmen Square, demanding democracy and the freedom to write their own destinies. Many of our listeners might know that Li Lu participated in this protest before escaping the country.

[00:06:26] Clay Finck: Not only is Li Lu an amazing investor, but he also has quite an amazing story, which I touched on back on episode 636. Due to Li Lu’s involvement in the protests, he was put on the CCP’s 21 most wanted student leaders, so just the fact that he was able to escape the country and do what he’s done here in the U. S. is quite remarkable. This protest led to the government rolling out tanks to put a stop to the movement. Pony Ma would major in computer science and rapidly earned a reputation as a computer maven. For his undergrad thesis, he created a software program to predict share price movements, and at the age of 22, he managed to sell the program to the company he was interning at for 50, 000 won, which was about three years salary for a fresh graduate.

[00:07:10] Clay Finck: Pony Ma would work for a page maker company in his first job out of school. A page maker can really be thought of as an early version of a smartphone that would beep or vibrate, letting someone know that they wanted to call you. In the five years he worked there, his salary increased by eightfold, and he became dissatisfied with being one of the many middle managers at the firm.

[00:07:31] Clay Finck: During the nineties, he became infatuated with the internet and its potential. He set up 4 phones and 8 computers in his home, costing him essentially all of the money he had made from selling that stock market program, which highlighted his tendency to go all in on the things he was most passionate about.

[00:07:49] Clay Finck: In 1998, Pony Ma reconnected with his old friend Tony Zhang, expressing interest in starting a company. The rough idea was to combine the product of a pager And that of the nascent internet. These two and three others would go on to start Tencent with seed capital of 500, 000 yuan. A lot was happening in the startup world in 1999.

[00:08:11] Clay Finck: Jack Ma started Alibaba, Steve Jobs introduced the iMac, Microsoft bundled its software in its Windows operating system, and Yahoo’s Jerry Yang made it onto the cover of Time magazine just before declining an offer to buy Google search technology for 1 million. The early days of Tencent were not easy, and they were just really scraping by.

[00:08:33] Clay Finck: Two of the founders still worked a full time job to help them pay the bills. Pony would then stumble on a service that would save the company, ICQ, which was an online chat system created by five Israelis in 1996. ICQ became the first widely adopted instant messaging platform. And a Chinese telecom company was making bids for someone to develop a similar product in China.

[00:08:58] Clay Finck: Thus began the story of Tencent’s controversial origins, being a copycat. Just as many of China’s largest internet companies started out by imitating their western counterparts, Sohu from Yahoo, Baidu from Google, Weibo from Twitter, Alibaba from eBay, and Tencent’s first hit came from ICQ. In 1998, less than 1 percent of the population had a computer in China.

[00:09:22] Clay Finck: And most people who did use a computer, did not own one. Tencent was successful in developing a chat software, and they understood their users. Leading them to early success. While rivals took a half hour to get the software downloaded, Tencent’s would take just 5 minutes. And their software included features like the ability to send messages to friends offline, and strangers who were online.

[00:09:45] Clay Finck: And for whatever reason, they ended up naming the software OICQ. AOL would end up buying ICQ, the original instant messaging platform, and they would sue Tencent for violating intellectual property rights. Tencent would lose the case and have to shut down OICQ’s website, and they ended up renaming the chat service to QQ.

[00:10:06] Clay Finck: One year in, Tencent wasn’t making any revenue, so the co founders were also working various jobs to keep the lights on still. This would lead to a last ditch effort to make an appeal for IDG Capital to invest in Tencent. IDG was one of the earliest VC firms to step foot in China. IDG would join PCCW, who was backed by Asia’s richest man at the time, to invest 2. 2 million for 40 percent of Tencent in April of 2000. This capital wouldn’t really last long, though, for Tencent. They would quickly need more. As we know, 2000 is the year that the tech bubble burst in the US, and this of course spilled over into other parts of the world, including China, causing trouble there as well.

[00:10:49] Clay Finck: Despite having nearly 100 million users, Tencent still was not able to figure out a viable business model. As tech stocks were plummeting, who would want to finance an operation that didn’t make any revenue and only had eyeballs and clicks to point to? In their bleakest moments facing rejection after rejection, they received a visit from David Wallerstein.

[00:11:12] Clay Finck: David represented the largest telecom company in South Africa, MIH, otherwise known as Naspers. David kept an eye out for potential investments, and he noticed almost all of the internet cafes with computers lined up in them had OICQ downloaded on them. This piqued his interest, so he would invest 32 million to become the company’s largest external shareholder in 2001.

[00:11:35] Clay Finck: IDG would end up selling their stake down to 7. 2%, and PCCW sold all of their stake. To this day, Naspers remains Tencent’s largest shareholder 24 years later, and the value of the shares as of the time of recording is 100 billion, as they hold nearly 25 percent of the shares outstanding. That is a 3100x return over that time period, which is honestly just mind blowing.

[00:12:03] Clay Finck: As a part of the investment, Wallerstein decided to move to the US to scout for opportunities that could benefit Tencent, and every other week he would go back to Shenzhen to catch up with the founders. The model really worked for them. So Wallerstein would end up joining Tencent in 2001 when the company would only have 45 people at the time.

[00:12:22] Clay Finck: Tencent’s revenue stream would come from text messages. They were quite expensive in the US and they were actually much cheaper in China. The number of texts sent in one day in China in 2001 was about the same number of texts that was sent in the US for the entire year. They partnered with a telecom firm and users would pay 60 cents per month to get alerts on their mobile phones for messages received on their QQ desktops.

[00:12:50] Clay Finck: So the monetization came through the mobile phone users, which were only a subset of the desktop users. Their early efforts to monetize on desktop proved unsuccessful, while QQ was becoming a popular social media network where most users really refused to pay for anything. While Pony Ma was trying to figure out a way to get his users to pay.

[00:13:12] Clay Finck: He was upsetting his user base and a flood of new competition came in to the market offering a free alternative, leading them to pivot back to a free model. Then they launched avatars, allowing users to pay for unique features online to differentiate themselves or display their online status of having a unique avatar.

[00:13:33] Clay Finck: This model was cloned from a South Korean company called sayclub.com. Pony Ma continued to brainstorm ways to keep users on the platform. The massive success of Yahoo! encouraged him to launch a news portal, which was already a very competitive pawn to fish in. Tencent would manage to purchase the qq.com domain and launch their own news portal, pulling in content from various media outlets. Tencent’s strategy of building an interactive web experience is what differentiated them from their competitors. A user might be on the instant messaging platform and get an alert of the newest breaking news, keeping their users informed with what’s happening day to day.

[00:14:12] Clay Finck: Tencent’s management team would have bi weekly meetings that would start at 10am, and they would often go well beyond 2am with Pony leading and moderating the discussions. Chen described how some of Tencent’s most important decisions were made past midnight. Ideas were constantly being run by the group, they would debate and discuss, and the proposals that received a majority vote would end up passing through to implementation.

[00:14:38] Clay Finck: Then Pony Ma got connected with Martin Lau from Goldman Sachs who became his right hand man and helped him take Tencent public. Pony decided to list the company on the Hong Kong Stock Exchange, which was a rare occurrence for a tech company at the time. Most companies would list on the Nasdaq or the New York Stock Exchange.

[00:14:56] Clay Finck: Tencent would go public in June of 2004, raising 1. 4 billion Hong Kong dollars, which was equivalent to 180 million dollars. And they ended up hiring Martin Lau and bringing him on board. He would bring on standard U. S. corporate practices such as setting revenue goals and developing a five year plan to enter new businesses like social networking and digital media.

[00:15:18] Clay Finck: After going public, Tencent’s core business in the mobile text messaging space continued to see a lot of pressure from regulators. The telecom companies wanting a larger cut and facing pressure from their competition, fiercely trying to steal market share. And then they ran into their toughest competitor yet, which was Microsoft backed MSN.

[00:15:37] Clay Finck: Now MSN was an instant messaging tool that I used probably when I was 11 or 12 years old to connect with friends outside of school. This would have been around 2006 it’s pretty funny because it was one of my first personal experiences with online social networking. And I thought it was just the coolest thing ever getting to chat with friends online on your computer at home.

[00:15:59] Clay Finck: So that’s just a fun little antidote to get to read about MSN here. MSN had a significant user base in China in 2004, even without the local presence that Tencent had. MSN also had a more elegant and streamlined interface, which appealed to the urban population of office workers and students. While QQ was more grassroots and not as elegant, which appealed to a different demographic.

[00:16:22] Clay Finck: There was a joke around the industry that QQ did all of the hard work of educating users and cultivating the habits. And then a well funded MSN, they swoop in, enter the market with a better product. Of the 20 million instant messaging users, MSN was estimated to have a slight lead over Tencent in terms of users.

[00:16:41] Clay Finck: But now that Tencent had gone public. They also had a fresh infusion of capital and they weren’t going to go down without a fight. So they made investments into the product to try and attract that white collar user, and by June of 2005, QQ had 440 million users. At the end of the day, Tencent was able to move quicker within the Chinese market.

[00:17:02] Clay Finck: Which enabled them to get ahead of MSN. Another challenge for MSN was that they kept all of their data on servers in the US because China did not allow a foreign company to have their own data centers in China. And this led to a slower service overall for users. So Tencent ended up toppling MSN for instant messaging, and this wasn’t ever a big deal to Microsoft, of course, because instant messaging in China was never one of their top priorities.

[00:17:28] Clay Finck: They were too busy wrestling with Google over in the United States. At this point, Tencent really had transitioned from having a startup culture to becoming more of a legitimate organization with legs to become a big tech company. They ramped up the size of their organization and empowered their people with the freedom to pursue new projects that could attract tens of millions of new users.

[00:17:50] Clay Finck: This fostered the notion that people in the company had to create a product to prove their worth and move up the ranks. By 2009, shares of Tencent had increased by 40x and it was still really just getting started with its growth. But still, I think there’s something about the Chinese culture where the competition there can just be ruthless.

[00:18:12] Clay Finck: With Tencent’s tremendous success, they got branded as a ruthless copycat. They were now the big dog in town, and Zhou Hongyi from Qihoo, which was a mobile browser with 100 million users, this guy attacked Tencent’s instant messaging service, claiming that they were monitoring users and accessing data they had no rights to.

[00:18:33] Clay Finck: This sent Tencent into a bit of a public crisis because it led to users leaving QQ and management ended up making the difficult decision of not allowing people to use QQ on that browser that Zhou was managing. One of the key initiatives that Tencent pursued in the early 2010s was an investment they made in 2013 in Sogo.

[00:18:57] Clay Finck: This was China’s third largest search engine. So they invested 448 million for 36 percent of the company. Pony Ma figured that he shouldn’t be trying to do everything himself. And if he wasn’t able to hire the world’s best entrepreneurs, the next best thing would be to simply invest alongside them.

[00:19:16] Clay Finck: Tencent would then start to become a very important investment for mutual funds and retail investors as well. So most figured that Tencent would know the tech industry as well as anyone, and they were as well positioned as anybody to continue to grow with the tech scene. Shortly after that investment, they announced that they would be selling their e commerce segment to JD.com. And they ended up investing 214 million in exchange for 15 percent of the company. E commerce certainly wasn’t Tencent’s core competency. They were really good at generating traffic. So they figured that the e commerce business was in better hands under JD.com, and then they simply invested alongside them.

[00:19:57] Clay Finck: The way Chin puts it here is that these two investments would become the roadmap for over 800 investments that were to come in the years that followed. So their other core competency was really capital allocation and identifying attractive opportunities to invest in talented entrepreneurs of those 800 plus investments.

[00:20:18] Clay Finck: Over 120 of them have become unicorns and 63 have gone public. This is how Tencent got involved and invested with companies like Spotify and Snapchat. And they also took a 5 percent stake in Tesla in 2014. In 2014, Tencent’s market capitalization exceeded 150 billion, making them China’s largest internet company.

[00:20:42] Clay Finck: According to Chen here, there were only three major technology giants in China at this time. You had Baidu, Alibaba, and Tencent. Chen also has a chapter here on the rivalry with Alibaba. Alibaba pulled off the world’s largest IPO in 2014 when they went public, and over the past decade, Tencent and Alibaba have really battled it out and continued to expand their big conglomerates.

[00:21:07] Clay Finck: Porter Erisman stated, If Steve Jobs created the operating system for the smartphone, Jack Ma and his team created the operating system for commerce and China in the future. During its peak days, Alibaba processes more than half a million transactions per second across its sites and delivers a billion packages in a day, end quote.

[00:21:30] Clay Finck: Jack Ma landed himself in hot water when in October of 2020, he infamously railed against the inefficiencies of China’s traditional finance industry. And it’s regulatory overseers during a prominent business forum in Shanghai. The next month, the country’s stock market watchdog pulled the plug on the 35 billion IPO of Alipay Parent Ant Group, which was the company created by Jack Ma.

[00:21:56] Clay Finck: In the months that followed, Jack Ma vanished from the public view as regulators pursued a relentless campaign against both Ant and Alibaba, launching an antitrust investigation against the latter e commerce giant that ended with a 2. 8 billion fine. Alipay was what allowed Jack Ma to really dominate the e commerce space in China.

[00:22:18] Clay Finck: And he was walking a fine line in facilitating transactions and starting Alipay in 2003 since private companies weren’t allowed to venture into finance and the payments, Jack Ma had told his team that if anyone had to go to jail, he would go himself. In the early 2010s, the world started to shift from PCs to mobile and Tencent foresaw the transition they would need to make in creating a mobile app and transitioning through that shift.

[00:22:45] Clay Finck: Mobile payments were especially a competitive arena as WeChat competed directly with Alipay. One leg up that WeChat had was that they started with the social features and expanded to payments, whereas Alipay started with payments and they tried to add on these social features, but it really didn’t work the same way.

[00:23:05] Clay Finck: Because users didn’t have that real life connection established with those in their network. Pony Ma was of course a big believer in the internet and its power in connecting people and transforming industries. Using a similar strategy to Facebook, Tencent wanted to get as many people as possible on their platforms and get them to stay for as long as possible.

[00:23:26] Clay Finck: This brings us to one of Tencent’s most important investments, Meituan. It was my surprise to read that in Beijing and Shanghai, it’s often cheaper to have food delivered than to go get the food yourself. So back in 2019, You could order a roast duck from a local diner for 2. 99 via the delivery app Meituan, which was about 80 percent less than what you pay at the register, which to me just makes absolutely no sense.

[00:23:56] Clay Finck: Across the country, millions of people order two or three meals a day, as well as groceries, office supplies, haircuts, and massages. The 100 billion delivery market is dominated by Alibaba and Meituan. More broadly, Alibaba has a good grip on the retail market for physical goods, while Meituan has a stranglehold on the services market.

[00:24:18] Clay Finck: Meituan has 9. 5 million delivery people serving nearly 700 million customers in more than 2, 800 cities. What’s interesting about the story of Meituan is that as a startup, they received an investment from Alibaba, but the founder did not appreciate how they were being treated by Alibaba. So he secretly met with Tencent to receive a second investment from them to make Tencent then a significant shareholder.

[00:24:43] Clay Finck: This was a big win for Tencent and a pretty big setback for Alibaba who wanted their hands in all of online commerce. After receiving word of the Tencent investment, Alibaba would sell their stake at a significant discount to the market value when they were doing some fundraising at the time. Now, typically to be a successful tech startup in China, you would need an investment from either one company or the other Alibaba or Tencent in order to get that traffic from the internet and get those resources necessary to grow and establish your business.

[00:25:14] Clay Finck: And if you didn’t partner with one of these two, then it’s likely that one of your competitors would partner with them and you just wouldn’t stand a chance. Meituan’s founder, Wang Xing, had big ambitions from a early age. So he was in university in the early 2000s, and he realized early on that social networks were going to be a really big deal.

[00:25:35] Clay Finck: So he launched one similar to Facebook, but was soon forced to sell it because he ran out of cash. Then he launched a platform similar to Twitter, and it was halted within two years due to government censorship. The CCP ruled that they didn’t want information to be able to spread so fast without control of such platforms.

[00:25:53] Clay Finck: So Wang decided that he wanted to build a tech company that just totally avoided controversy as much as possible. So he set out to make a platform that makes getting food easier, but he’s not easily off the hook as the company sits on a tremendous amount of data and they have location based consumption patterns of 690 million active users, which is double the U S population.

[00:26:17] Clay Finck: In 2015, a key merger took place between Meituan and Dianping, Meituan providing group buying and food delivery services, and then the other company was a rating and review platform similar to Yelp. Meituan would then take a big lead over their major competitor that was ali.me, which would eventually get bought out by Alibaba at a 9. 5 billion valuation. Wang would take a page from Jeff Bezos playbook and having no rush in becoming profitable from an accounting standpoint, he was very happy to reinvest as much cash flows as possible to generate new growth, reach a bigger scale and provide more value to customers. The way Chen puts it here is that Tencent’s investment in Meituan in 2015 encapsulates the social media giant’s favorite approach over the years, backing the right horses, then taking a hands off approach, end quote.

[00:27:12] Clay Finck: This brings us to the discussion on WeChat. According to ChatGPT, WeChat is the sixth largest social media platform in the world, with 1. 6 billion users. The top five platforms include Facebook, TikTok. But as we’ll be getting into, WeChat is much more than a social media platform. Chen describes WeChat as a platform that weaves together the fabric of society today in China, from gaming and shopping to getting a ride and booking a doctor’s appointment.

[00:27:42] Clay Finck: It’s like having the functions of PayPal, Citibank, Facebook, Instagram, Spotify, Expedia, Yelp, Uber, TikTok, and Amazon all on one platform. If we could go back to 2010, the world was awaiting the release of Apple’s iPhone 4 and telecom operators around the world were preparing for the switch from 2G to 3G, which promised faster and mobile internet connections.

[00:28:07] Clay Finck: Tencent controlled a large swath of social media and messaging via its QQ desktop app. But Pony Ma feared that his empire could be disrupted overnight, so he decided to come up with a product that had the potential to disrupt themselves before somebody else did. On a very late night towards the end of 2010, a programmer named Alan Zhang messaged Pony asking for permission to develop a social network tailored for smartphones.

[00:28:34] Clay Finck: Pony, who usually doesn’t go to bed until 4am, agreed to that request. Then Zang created the first version of WeChat, and even Tencent could not have imagined how successful it would have become. Hiring Allen Zhang was probably one of the best decisions that Pony Ma would ever make. Zhang had a passion for building great products and rejected the ideas of working a cushy job with a corporation.

[00:28:59] Clay Finck: And this seems to be a common theme throughout the book. So despite Tencent today being this massive organization, they’re still able to bet on these extremely talented and passionate entrepreneurs and just let them work their magic. In his twenties, Zhang created an email service called Fox Mail in 1997, and he was most interested in just creating the best product possible rather than trying to commercialize it and build a tremendous fortune just for himself.

[00:29:27] Clay Finck: He quit his corporate job to go all in on that project, and he ended up selling it for 12 million yuan, which is about 160, 000. And almost immediately he just regretted selling his passion project he poured his heart and soul into. The email service went in, getting acquired by Tencent in 2005, and Tencent then brought Zhang on board so he could continue working on it.

[00:29:50] Clay Finck: So Zenga created WeChat, which by definition was a direct competitor to QQ. And this helps illustrate sort of Tencent’s culture of having this competition amongst their own team members who, you know, they’re working on different social media or social networking apps. Initially, WeChat was not a big success as it just garnered a million users in the first six months.

[00:30:13] Clay Finck: By Tencent’s standards, this was really a dud. Then they watched another startup burst onto the scene called, TalkBox. They made it easy for people to send voice notes to each other because typing in Chinese was more difficult on these small screens than it was in English, and text messages were also expensive to send.

[00:30:30] Clay Finck: WeChat quickly developed their own push to talk feature and imitated the key breakthroughs that TalkBox created to send voice messages quicker and cheaper than everyone else. Here are some of Chen’s reflections in building a successful startup. Herein lies an important lesson that startup founders would swear by, timing is everything.

[00:30:51] Clay Finck: Come up with an idea too late and you miss the wave, yet roll out something too early and people will deem your product useless. In a market where copyright infringement is rampant, product design and execution trumps original ideas. Some would argue that plagiarism throttles innovation and deters creators, yet others argue it forces companies to come up with the best products based on micro innovation, in any case, TalkBox never bothered to sue WeChat or Tencent, which would have been an extremely arduous endeavor with little prospect of success under China’s legal system back then.

[00:31:29] Clay Finck: So already by 2012, WeChat would reach 100 million users. And tripled that number one year later. It not only overtook TalkBox, but even Tencent’s very own QQ, whose team largely dismissed the transition to mobile. One of Pony Ma’s mantras was, you either wait for someone else to kill you, or you will kill yourself first.

[00:31:53] Clay Finck: WeChat went on to build their Moments feature, which you can think of as a social media feed like the Facebook feed that made them so successful. So, WeChat evolved from a tool to send messages to a social media platform that attracted writers, journalists, and government agencies to build a following online.

[00:32:11] Clay Finck: Once WeChat crossed from being a platform focused on private messages and ventured into posts that would be featured publicly, the government stepped in and prompted Tencent to censor the platform and suspend certain accounts, and the CCP would soon start tracking private conversations. So if the CCP deemed that users were working against their best interests, then users would potentially be permanently banned from having a WeChat account.

[00:32:37] Clay Finck: Due to the CCP’s involvement with the company, WeChat is now a government monitoring tool that’s used to surveil its users as artificial intelligence can almost instantly detect banned words, images, and voice messages. And on top of that, Have a great firewall that can prevent certain information from entering the country from an international user.

[00:32:59] Clay Finck: And this is part of the reason why WeChat has largely been a platform mainly for Chinese users despite their attempts to grow internationally. Since international expansion wasn’t going to be a big primary driver of growth, the alternative solution was to expand the app itself and add more functionality.

[00:33:17] Clay Finck: So in 2016, they started to go down the path of essentially having different apps within the WeChat app. And this is referred to as mini programs. WeChat has seen strong growth and payments especially. So Alipay once accounted for the vast majority of online payments in China, but by the third quarter of 2020, its market share had fallen to 54 percent with Tencent on the rise.

[00:33:41] Clay Finck: Momentum further accelerated on WeChat with the release of the QR scanning function. For example, one could sit down for dinner, scan a code on the table, and start ordering food directly from the restaurant’s own mini app on WeChat. After the meal, you would then pay on the same interface using your WeChat digital wallet.

[00:34:00] Clay Finck: The same applies to booking movie tickets, streaming music, hailing a taxi, or unlocking a bike parked on the side of the road. All of a sudden, it didn’t seem so necessary to use a separate app for every activity in your life. It also meant that Tencent had the ability to gain a tremendous amount of personal information, far more than what Facebook or Instagram could ever get.

[00:34:24] Clay Finck: Despite the concerns around privacy, many users experience how WeChat’s design and how your social life relies on the app continues to just pull people back in and benefit from the value that it offers. So it’s just a tool that’s so valuable to its users. Allen, the creator of WeChat, he sort of mocks Facebook due to their focus on serving so many ads to its users.

[00:34:48] Clay Finck: He put more of his focus on maintaining a clear and clean interface and put much less focus on ads and alerts. He has a set of rules that he closely adheres to when it comes to designing WeChat. So his rules for a good product here include the product needs to be creative and have innovation. It needs to be useful and beautiful.

[00:35:09] Clay Finck: It must be easy to use. It should be reserved, not flamboyant. It’s honest. It needs to be long lasting and withstand the test of time. It doesn’t leave out any details and it must have a minimalist design. Less is more. Despite the success of WeChat, it initially was not a huge revenue driver for Tencent.

[00:35:28] Clay Finck: In 2014, WeChat accounted for just 10 percent of their revenues, and more than half of Tencent’s money came from desktop games. In 2015, WeChat reluctantly gave in to pressures from Tencent to start monetizing their platform with ads. So today, the business generates 16 billion in revenue per year, with a relatively small portion of that coming from advertising.

[00:35:52] Clay Finck: Transitioning here to another major investment for Tencent, in 2013, Tencent tracked down the founder of a scrappy ride hailing company called Didi. Richard Pang did everything he could to get a meeting with the founder, Cheng Wei, and he told him that he knows that he doesn’t want their investment, but he absolutely has to invest with them.

[00:36:14] Clay Finck: Before ride hailing, commuting in a massive city like Beijing just could be a total nightmare, which led to the rise of illegal taxis that operated without a government license. But ride sharing apps changed everything, and Tencent believed that it was going to be big in the near future at that point.

[00:36:33] Clay Finck: That same year, in 2013, Google Ventures had invested 250 million into Uber, its largest investment ever, and hundreds of ride sharing apps were emerging in China. There are some fun stories in the book related to Cheng Wei and his journey when trying to find his way in the world He showed up uninvited to Alibaba’s office And he told the front desk that he was looking for a job and he ended up landing a job in sales making 225 per month So this sales experience would prove to be valuable to Wei because he would need to figure out how to convince taxi drivers to sign up for DiDi when there are hundreds of other apps for them to sign up for.

[00:37:11] Clay Finck: In 2012, Cheng Wei started DiDi Dash, also known as Hong Kong Taxi. In DD, they were really a scrappy company in getting off the ground. They had a small team that would go to the railway stations and speak to drivers and try and get them on the app. And by doing so, they actually brought on 10, 000 drivers from that approach.

[00:37:31] Clay Finck: Another tough part is only a certain number of drivers would have a smartphone at the time, so instead of just handing out phones, which would be quite expensive, They targeted the younger drivers with phones who wanted a new opportunity and then might spread the word to their friends. So Tencent had met with Cheng Wei and they offered to invest at a 60 million valuation, double what the company was looking to get to ensure that no one else would snatch up a stake.

[00:37:56] Clay Finck: Meanwhile, Alibaba invested in one of their rivals, which influenced Cheng to side with Tencent. And once Tencent really bet big on the adoption of mobile payments, this put rocket fuel behind the growth of Didi. WeChat placed Didi on its services landing page, channeling an enormous army of users to the ride hailing app.

[00:38:16] Clay Finck: And in return, Didi adopted WeChat’s then nascent payment system in an attempt to transform drivers habits of only accepting cash. And Didi also subsidized users, accelerating the growth flywheel and building out those consumer habits. Now with the way things were heading, the two ride sharing apps were losing a ton of money trying to gain market share, and it got to the point where one company would have to dial back the spend and inevitably let the other company pull ahead, or the two companies would merge and then they could finally turn into a profitable enterprise.

[00:38:51] Clay Finck: So in 2015, the two would end up merging, forming China’s biggest internet merger. And there was word that Uber was also setting their sights on rolling out in China, which the two companies wanted to be well prepared for as well. In 2015, Uber seemed to have a pretty big advantage. They had a better app.

[00:39:09] Clay Finck: It was powered by more stable technology. And they were valued at 42 billion, 10 times that of Didi’s valuation at the time, just prior to that merger. So Uber entered the Chinese market head on, and both Didi and Uber spent 1 billion Yuan, or 100 million on subsidies. So to try and impose an attack on Uber, Didi invested 100 million in Lyft, their primary American rival.

[00:39:37] Clay Finck: The unprofitability of Didi and Uber would really continue as Apple would make a 1 billion investment in May of 2016 that would go into Uber. One month later, Uber raised another 3. 5 billion from Saudi Arabia’s public investment fund. After this, Didi realized that Uber had a lot of legs to go unprofitable for a number of years ahead.

[00:40:03] Clay Finck: So they went to the bargaining table to try and work with Uber and figure out a path forward to profitability. Ultimately, Uber would agree to actually withdraw from China and sell that segment of their business to Didi in exchange for equity. Thus, Didi joined the select club of Chinese corporations that succeeded against better funded American rivals.

[00:40:25] Clay Finck: It seems like an incredible milestone to kick out such a behemoth, especially since Didi had invested in their major competitor in the US. In the end, Tencent stood as the ultimate beneficiary as it held a significant stake in China’s go to app for all things ride hailing, and it used Didi to boost market share for mobile payments on WeChat.

[00:40:46] Clay Finck: Next year, I want to talk about another one of Tencent’s major business segments, which is gaming. In 2021, the gaming industry was estimated to have generated 176 billion in revenue, almost five times that of the box office of the movie industry. An estimated 2. 9 billion people play games on some form of digital device, which is nearly one out of every three people in the world.

[00:41:11] Clay Finck: Tencent is at the center of the global gaming industry, as they have studios that have created the biggest global titles including Fortnite, League of Legends, World of Warcraft, and Clash of Clans. They also generate around a third of their revenue from their gaming segment. Tencent launched their initiatives in gaming in 2004.

[00:41:30] Clay Finck: Users could simply log onto the platform using their QQ accounts on desktop, and users could see what games their friends were playing. In those early years, Tencent continued to be accused of copying what their competitors were doing, which led to Nexen suing Tencent in 2006 for copyright infringement and improper competition in Beijing.

[00:41:50] Clay Finck: Making it the first lawsuit that involved an international corporation suing a Chinese internet company. The case lasted six months, and the court ruled that Tencent had not violated copyright and not competed improperly. Tencent had a pretty large legal team that specialized in copyright and M& A, which helped them license the rights to their own games.

[00:42:11] Clay Finck: One investment in the gaming space that Tencent would make was in Riot Games. Riot wanted to create games in the multiplayer online battle arena space. So this is a MLBA. You can think of this as having a vast number of players working together or in teams on a map in the game. This led to them releasing League of Legends in 2008.

[00:42:35] Clay Finck: Part of the appeal in a game like this is the freemium model, so players could play for free, but to get the exclusive upgrades and perks, then you needed to pay for it. So the free version sort of sucks users in, and once they love the game, many are bound to pay in some form or fashion down the road if they have the means to do so.

[00:42:54] Clay Finck: Soon after the launch of that game, Tencent managers, they were avid players of the game, and this was part of their due diligence on the company itself before they ended up investing, so Tencent would end up purchasing. 94 percent of Riot Gaming for 400 million and Riot would end up being one of Tencent’s best bets in gaming as it generated a lot of cash and it opened up offices in more than 20 countries.

[00:43:17] Clay Finck: Another interesting aspect of the deal was that Riot would operate like a separate company, and Tencent employees would not have access to the source code for League of Legends. So Riot, in a sense, was owned by Tencent, but it had some protections from Tencent’s other business units. To prevent them from cannibalizing themselves to some extent, Facebook would take a similar approach when they acquired Instagram, they would own Instagram, but Facebook employees wouldn’t have access to a lot of what’s going on there in 2020 League of Legends would generate 1.

[00:43:48] Clay Finck: 75 billion in revenue. Making it one of the most lucrative games in the world. Tencent and Riot would, uh, rub shoulders over the years. So, Tencent being the distributor of the game in China, they would keep at least 70 percent of the revenue for the region, creating a source of frustration for managers at Riot, who felt that they were really being taken advantage of.

[00:44:10] Clay Finck: Another investment Tencent made was in Epic Games. In 2013, they paid $330 million for 40% of the company. Epic Games created the mega popular Fortnite Battle Royale, which gained a whopping 350 million players globally. The game captured the attention of so many entertainment seekers that Netflix and their 2019 investor letter said, we compete with and lose to Fortnite more than HBO for screen time, despite Fortnite being free to play.

[00:44:41] Clay Finck: It still generated 5. 1 billion dollars in revenue in 2020. To make money, players could pay for items in the game, some of which would give players a leg up over their competition. These items would go for anywhere from a few dollars to twenty dollars each, and it’s reported that 69 percent of players spent money on in game purchases on Fortnite.

[00:45:02] Clay Finck: Epic also developed a technology referred to as Unreal Engine, which was a 3D graphics technology behind the game that helped render images, adding 2D image. The Unreal Engine helped the company create a number of big hits, and they offered the technology to other gaming companies in exchange for a fee.

[00:45:23] Clay Finck: The technology would also end up getting adopted in other fields such as architecture, vehicle design, and film creation. Epic Games was one of those key investments for Tencent that helped make their gaming division a global powerhouse. Their founder, Tim Sweeney, reminded them very much of Elon Musk, and the business economics were attractive as the industry was shifting from box sales to the software as a service model.

[00:45:47] Clay Finck: Interestingly, part of what won over Sweeney in choosing to raise capital from Tencent It was that they promised freedom and independence. So Tencent was shifting to buying minority stakes and granting the company’s full autonomy instead of working on everything itself and competing with everybody else.

[00:46:06] Clay Finck: Similar to what I discussed with the movie industry and Buffett’s investment in Disney back in episode 682, the gaming industry was very much reliant on one hit wonders, making it difficult to build a sustainable and reliable business model. To help create more reliable recurring revenue, companies have shifted towards in app purchases, leading companies to buttheads with Apple, who on their devices takes as much as 30 percent of the revenue that games generate on the devices.

[00:46:35] Clay Finck: In 2020, users of Apple devices spent 72 billion on the App Store. And Apple kept 22 billion of that. Epic Games and Apple would go head to head as Epic tried to release their own payment system, and Apple and Google both removed Fortnite from their platforms, which took them to court where the U. S.

[00:46:55] Clay Finck: District Judge would mostly side with the U. S. counterparts. And in addition to needing to make the shift from desktop to mobile in the social media space, they also needed to make that transition in gaming as well, as the technology and internet speeds would inevitably improve and mobile phone adoption would continue to increase as well.

[00:47:14] Clay Finck: One big mobile game that Tencent got a hold of was Clash of Clans. That game was released in 2012 and in 2016, Tencent led the 8 billion takeover of Supercell. Supercell is an interesting business because they operated on the basis that they would work in these really small teams to ensure high efficiency and just zero bureaucracy.

[00:47:35] Clay Finck: This ties into the approach that Warren Buffett and Mark Leonard have taken of letting their business operate independently and try to keep bureaucracy from creeping in. Supercell felt that Clash of Clans would be a really big success, and then when they launched it, they wanted to make the game as accessible to the widest audience possible, and they wanted to make it as social as possible.

[00:47:55] Clay Finck: So by the third month of its release, it became the top grossing game in the U. S. After Tencent caught word that SoftBank was planning to offload their stake in Supercell, Martin Lau flew to their office to try and grab a stake for Tencent. Soon after, Tencent acquired a controlling interest in the Finnish studio.

[00:48:14] Clay Finck: And we haven’t even got to esports yet. The US has the largest esports market in the world, with China being in second. Tencent even has aspirations to use all of their various brands and games to leverage them into creating a Marvel like universe. Where they convert their intellectual property to books, movies, games, and vice versa.

[00:48:35] Clay Finck: And finally, we have the music streaming business as well. Tencent has created a music streaming service similar to Spotify, which lies in a division that was spun off and listed separately in Hong Kong under Tencent Music Entertainment. Today, this business generates around 3. 8 billion in revenue, and they’ve struggled in the past few years in terms of growth like many Chinese businesses have.

[00:48:57] Clay Finck: Tencent does not have to battle with Spotify in China, but they do face some competition from NetEase and Baidu Music. Oddly enough, Tencent and Spotify would actually collaborate on an investment though. In December of 2017, a share swap took place in which both companies would take a minority stake in each other.

[00:49:15] Clay Finck: Spotify would hold 8. 9 percent of the Chinese music streaming service, while Tencent would hold 9 percent of the Swedish firm. This opened the door for further collaboration, including sharing music content in respective markets. This brings us to Chapter 11, titled The State vs. Goliath. Around April of 2018, Tencent caught word of a policy change that would suspend approval of new gaming licenses.

[00:49:41] Clay Finck: This meant that Tencent wouldn’t be able to generate money from its most popular games in the market. From the government’s perspective, they were concerned about the prevalence of violence in games and how it was fostering addiction among the nation’s youth. Officials even criticized Tencent for the growing incidence of myopia among children.

[00:50:00] Clay Finck: When times are good, it’s easy to invest in something like Tencent to get broad exposure to the Chinese economy. And invest in the big player that can hopefully navigate the challenging and sudden policy changes. This event proved that the policy risks work significant investing in Tencent. In April of 2018, shares of the company traded around 380 Hong Kong dollars after a magnificent run since the IPO in 2004.

[00:50:26] Clay Finck: And as of the time of recording here in January 2025, shares still trade around 380 Hong Kong dollars. So over a, say, six year time period, the shares have really gone nowhere. In June of 2018, Tencent’s profits would fall for the first time in over a decade, partially due to their inability to profit from their most popular games.

[00:50:49] Clay Finck: Tencent was now forced to start limiting the amount of time that children could spend on their games, and verify the ages and the identities of each player. Next, Tencent began to scrub their games of violence, swapping green liquid for blood, promoting peace, and inserting banners that proclaimed nationalistic slogans.

[00:51:08] Clay Finck: After such changes, a flood of negative reviews came in from the gaming community. Veteran gamers felt like the excitement of the game had been taken away from them. These changes helped relieve Chinese government’s concerns and allow Tencent to monetize their games as well. And the rise of China’s tech industry also caught the attention of U.

[00:51:28] Clay Finck: S. politicians. U. S. Senator Marco Rubio questioned MSCI Inc. on why they added hundreds of Chinese stocks to its benchmark Emerging Markets Index, which led to billions of passive investment dollars being invested in these companies. Rubio stated, We can no longer allow China’s authoritarian government to reap the rewards of American and international capital markets.

[00:51:52] Clay Finck: Firms like MSCI have an obligation to make sure investors know whether their investment dollars are unwittingly aiding Chinese state owned and state directed companies linked to Chinese efforts to steal American innovation, undermine fair competition, increase threats to U. S. national security, and economic security, etc.

[00:52:13] Clay Finck: End quote. MSCI simply countered by stating that no U. S. law or regulation prohibits them from adding Chinese companies to their indexes. In some ways, China had the U. S. to thank for its unprecedented digital evolution as a large chunk of the capital behind its tech giant’s success can in fact be traced back to funds that manage money for Texas teachers, San Francisco firefighters, Minnesota policemen, and Louisiana judges.

[00:52:40] Clay Finck: Pension funds and endowments pour money into venture capital and private equity, and their funds search all over the world to find the best investment opportunities. The way Chen puts it is that in China, they struck gold. Amidst all of the tension between the U. S. and China, Tencent tried to keep a low profile, and Pony Ma all but vanished from public events.

[00:53:02] Clay Finck: But given the size of their business and the number of markets they had a foothold in, it made them an easy target. For example, after Tencent signed a 1. 5 billion deal with the NBA to stream games online in China, an NBA executive expressed his support for Hong Kong pro democracy protesters, which prompted Tencent to suspend game broadcasts.

[00:53:24] Clay Finck: Over time, tensions only increased, as in May of 2020, the U. S. Senate overwhelmingly approved legislation that could lead to Chinese companies getting barred from listing on U. S. stock exchanges. It required companies to certify that they are not under the control of a foreign government. Another major issue was China’s refusal to let inspectors from the Public Company Accounting Oversight Board review audits of mainland companies like Alibaba and Baidu that trade on American markets.

[00:53:54] Clay Finck: In September of 2020, President Trump announced that WeChat would essentially be shut down in the US. Because it was deemed a national security threat, but the plan was vetoed by a magistrate judge that argued that this would violate the free speech rights of Americans who rely on the app. Around this time, Jack Ma saw the perfect opportunity to demonstrate his value to China.

[00:54:17] Clay Finck: Ma’s crown jewel, Ant Group, was expected to go public, and the fintech giant was expected to be the biggest IPO in the world at around 35 billion. Ma was very public that now was the most critical time in the development of finance and spoke out against anachronistic government regulation. The Chinese government did not respond so kindly, as shortly after, they suspended the world’s largest IPO just days before listing, and delivered the message that Ant’s days of relaxed government oversight and minimal capital requirements were over.

[00:54:51] Clay Finck: The Antitrust Authority then issued 22 pages of proposed anti monopoly rules, which many read as a veiled warning to Jack Ma and fellow entrepreneurs to tone down their swagger. Investors watched in awe as China torpedoed the ambitions of its national champion. And the bigger question was whether the crackdown on Ant was an isolated incident, or whether it signaled more trouble to come for the wider industry.

[00:55:19] Clay Finck: Ant was at the forefront of scrutiny from regulators due to being the leader in fintech, but Tencent and other smaller competitors would also need to overhaul their business to appease regulators. China’s new generation of fintech companies made financial services more convenient and more accessible to hundreds of millions of users, but at the same time, they also destabilized the country’s financial infrastructure.

[00:55:43] Clay Finck: And took business from the state owned banks. In April 2021, regulators also levied a 2. 8 billion fine against Alibaba, accusing them of monopolistic conduct. These moves by the CCP sent chills down the spine of Chinese tech billionaires, which began fading into the background as some stepped down from their role of CEO or chairman, and many began donating significant amounts to charity.

[00:56:09] Clay Finck: WANs Wang Zing donated $2.7 billion worth of stock to a personal charity promoting scientific research in education. In pen duo duo’s, Colin Hu Huang gave $1.8 billion to an educational fund, the 10 cent backed ride hailing company. DD would go public in the US market in June of 2021 at a $68 billion valuation.

[00:56:32] Clay Finck: On the surface, it looked like a huge success, and one of Didi’s co-founders was now a billionaire. But two days after Didi’s debut, Chinese regulators banned the ride hailing service from the App Store. In preparing to go public, the Chinese government expressed concerns about the disclosures that Didi would provide to investors and the security of the data they held.

[00:56:53] Clay Finck: They didn’t disprove of a U. S. listing, so they went ahead with the IPO. The company told the investment bankers that they wanted to keep a low profile and all the company would do would announce the listing on their internal forum. On July 1st, shares were up 16 percent and management felt vindicated in their decision.

[00:57:13] Clay Finck: And then that evening, the cyber security watchdog posted a notice on its website. The agency is launching an investigation into D. D. to safeguard national security and protect the public interest. D. D. ‘s share price then tanked, falling by nearly 50 percent in one month, just five months after going public.

[00:57:32] Clay Finck: Didi announced that they would start preparing to withdraw from US exchanges. So this example of Didi would crystallize investors worst fears about the nature of working alongside the Chinese government. In the summer of 2021, many investment professionals believed that China’s clampdown on their largest tech businesses was nearing an end.

[00:57:53] Clay Finck: Soon after, the Chinese government went after the online education sector, which at the time was expected to generate 76 billion in revenue in 2024 and had backing from Sequoia, Alibaba, and Tencent. Suddenly, companies in this space were ordered to go to non profits, and that companies that teach school subjects can no longer accept overseas investment.

[00:58:16] Clay Finck: Tencent also received further scrutiny from regulators. Chinese citizens age 18 and under were banned from gaming more than 3 hours a week, which hurt shares of Tencent. In 2021, shares of Tencent were down 19 percent while the NASDAQ rose by 21%. Various initiatives and relationships with specific people within the government caused suspicion towards Tencent even though they were largely compliant and cooperative with regulators.

[00:58:43] Clay Finck: Tencent had to revamp various departments across the company, and in November of 2021, regulators ordered the company to stop rolling out new apps or updates, declaring that its products violated data protection rules. Tencent then embarked on a number of divestments and asset sales, as they sold 16 billion worth of stock in JD.

[00:59:04] Clay Finck: com. And reduced its stake in Southeast Asia’s largest gaming company, C Limited. Tencent is now fully embracing what company executives have acknowledged as a paradigm shift in the industry. Dawn are the years of reckless expansion, aggressive marketing, and zero sum competition, which partly defined the golden era of Chinese tech.

[00:59:25] Clay Finck: That chapter of the story has now come to an end. Chin shares here that the lesson for Pony Ma is that he and his company have no bargaining power with the Chinese government. As authorities move to rein in these tech giants, Tencent is expected to hand over key data and, at its extreme, ownership to the government, so the party can maintain an even firmer grasp on the nation.

[00:59:47] Clay Finck: These types of moves make investors question if the government is going after the concept of capitalism itself. These types of actions by the government have led me personally to simply avoid investing in any Chinese company. Investing is already hard enough, so I ask myself, why would I make it even more difficult by investing in a communist country?

[01:00:09] Clay Finck: Perhaps some investors can do quite well investing in China, I prefer to play a different game myself that suits me better personally, that I also understand better. Shifting gears and getting to the end of the book here, Chen also touches on Tencent’s cloud business, which powers about everything that Tencent does.

[01:00:27] Clay Finck: Initially, they built out the cloud segment to support the growth of WeChat and they then decided to offer the same services to other businesses. I don’t believe Tencent discloses their cloud revenue and their financials. They do rank third in China in cloud revenue, I believe with Alibaba being first with about double the market share.

[01:00:45] Clay Finck: And Tencent is really always on the lookout for emerging trends. So they’re always looking for that asymmetric payout and different industries, whether it be driverless cars, AI. One thing that’s interesting about Tencent stock today is that they’ve significantly ramped up their share buyback program.

[01:01:03] Clay Finck: When I look at the chart for the Hong Kong listing, it peaked at around 700 Hong Kong dollars in early 2021. 380 Hong Kong dollars per share. In the trailing 12 months, the company generated 35 billion U. S. dollars in operating cash flow and they’ve repurchased 13 billion dollars worth of shares. That’s nearly triple the amount they repurchased back in 2022, which was another example of when they ramped up their buybacks.

[01:01:29] Clay Finck: In the most recent quarter, the company had 8 percent growth in revenue and 19 percent growth in operating profit, which seems quite good given the current macro environment in China. None of the major business segments really stood out to me in terms of the growth, but they are seeing some strong margin expansion, especially in their fintech and business services segment.

[01:01:49] Clay Finck: And there’s also the argument that players like Alibaba and Tencent are going to be leaders in the AI race because of all the data they’re able to collect from these massive platforms. The CCP has also made AI a national priority, investing billions of dollars into research and development. Another challenge that China faces is getting access to advanced chips, since U. S. sanctions have restricted the supply of high end semiconductors, which includes the advanced chips from NVIDIA and AMD, which are essential for running complex AI models and advanced chip manufacturing. As a result, China is investing heavily into domestic chip design and manufacturing in order to reduce reliance on foreigners, but I think that Tencent is going to be a big player globally with regards to AI, and it’s a segment worth monitoring for investors.

[01:02:38] Clay Finck: With all that said, there’s so much to think about here for investors in China. You have China being a major player in competing with the U. S. globally, you have the political risk and geopolitical concerns, but many Chinese companies also trade at a discount on a relative basis to their U. S. peers, meaning that much of this is potentially already priced into the shares of these Chinese companies.

[01:03:00] Clay Finck: It’s going to be fun to watch how this plays out in the later 2020s, and it’s up to each investor to determine whether they’re comfortable with the political risk and if they can get a good sense of the business before investing in China because of just cultural differences. Really? I feel like it can take quite a bit of time to really get to know a business there and understand those cultural differences as well.

[01:03:21] Clay Finck: All right, that’s all I had for today’s episode. Thank you so much for tuning in, and I hope to see you again next week.

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