Mark Zuckerberg’s AR platform, the Metaverse, has often been questioned since its creation has been announced to the public. But while the masses are unsure of the digital future, major companies have been pouring billions of dollars into the development of software and innovative technology to accompany it. In particular, Chinese tech giants are chasing over 8 trillion dollars in the Metaverse, which is a big signal to companies globally that this may be a good investment opportunity.
The Metaverse: what is it?
There is no agreed upon definition of what the Metaverse actually is. However, some key features are common to all attempted characterizations of the concept. These include it being persistent, available, synchronous and immersive. These features crucial to develop the possibilities to better connect the digital and physical worlds, through technologies like virtual and augmented reality, and, more generally, innovations built around the idea that people will one day be able to live, work and play in virtual worlds, using cryptocurrency to buy virtual goods and develop their virtual existence. Currently, the metaverse is still in its initial stage. A more mature stage is expected to start from 2031, during which the independent metaverses from various industries are expected to gradually share data and develop unified standards, accomplishing integration. This latter is indeed seen as a fundamental step necessary for the development of the technology. Unified data standards, payment systems and identity authentication are all critical steps in achieving such a goal. It is difficult to imagine a successful metaverse until common underlying infrastructure, smart contracts and payment systems will make the metaverse interoperable, allowing individuals to transport their avatars from one domain to another, taking their virtual identities and possessions with them. In this regard, some steps are already being made. For example, almost every big firm in Silicon Valley has joined the Metaverse Standards Forum (MSF), which commits them to open, interoperable technical standards, so that an avatar designed for use in one company’s virtual world should work without trouble in another’s (a notable exception is Apple, which has a long tradition of incompatibility with other firms’ products). The real opportunities are expected to come from enterprise and industrial metaverses, where technological innovation will give the scope to address pressing global challenges, from climate change and the energy transition to productivity and growth. Innovations, although in their infancy, are already starting to be implemented. The most notable examples come from the applications of “digital twins”: virtual reflections of physical objects, that allow users to replicate a system’s various processes and study them by running any number of useful simulations. These innovations are not going unnoticed. According to recent research from Accenture, even at its nascent stage of development, 71% of executives believe the metaverse will have a positive impact on their organization, and 42% believe it will be transformational. In March, Citi forecast that 5bn people might be using the metaverse by the end of this decade, transforming commerce, art, media, advertising and healthcare. Such figures justify the projections according to which the metaverse business will also be extremely lucrative. McKinsey recently released a report, Value Creation in the Metaverse, stating that in eight years the field could be valued at $5 trillion – around the same size as Japan’s economy.
The Metaverse in Asia
Virtual realities are expected to have particularly transformational effects on Asian economies. Many see the emergence of the metaverse as being driven by two fundamental gravities - one technological and the other demographic. These two gravities are particularly pronounced in Asia, making it an extremely receptive region for the innovations in the field, and granting it a potential role in shaping what the metaverse will end up being. Its demographic edge comes from the fact that over 60% of the world’s youth aged 15 to 24 live in Asia, along with 1.3 billion mobile gamers - the biggest mobile player base worldwide. Moreover, millions of them are already spending time and money on popular virtual platforms like Fortnite, Roblox and Decentraland, testifying a big interest in virtual worlds and environments. From the technological point of view, Asian economies have built up extreme sectorial expertise in related branches of industry and research. Economies that excel in the manufacture and export of electronics, such as Taiwan - which, according to a 2021 Boston Consulting Group report, holds more than 90% of the manufacturing capacity for the world’s most advanced semiconductors -, may be well-positioned to benefit from the increasing demand for hardware and other user-devices. Others, such as Japan and South Korea, thanks to their large technology or R&D sectors could benefit from the demand for platforms and the design of complementary hardware and software. Yet others, like Vietnam and Thailand, are innovating and experimenting with blockchain technologies, which will be crucial in guaranteeing the existence of a sort of private property in virtual world. Also, strong institutions may be playing a crucial role, with the positive investment environments and strong digital and patent laws of Hong Kong and Singapore fostering flows of resources towards innovative uses. Finally, natural and cultural endowments might enter the picture. China and Indonesia, for example, which are abundant in natural resources like nickel, rare earth and lithium, are poised for the increase in manufacture of new user-devices. Vietnam, Philippines, Pakistan, India and Indonesia have large digitally ready workforces. All of the economies can also bank on their rich cultural capital to build creative content for the metaverse. Embracing the metaverse could unlock a trillion-dollar opportunity in Asia. Developing the technology stacks, human capital and regulatory frameworks required will benefit a wide range of industries and economic activities. The metaverse’s contribution to gross domestic product in Asia could be between $800 billion and $1.4 trillion per year by 2035, according to a Deloitte’s report. Morgan Stanley analysts predict that, by 2031, the metaverse would be worth about US$8 trillion in China alone. While abundant research points to the region’s huge economic potential, how ready it is for the metaverse ultimately depends on the unique strategies the underlying economies may take to accelerate the economic benefits of the metaverse. Many of them are standing up to the challenge and trying to embrace the coming opportunities. China has already set out trajectories for metaverse development and is building on its strengths to optimally do so. In August 2022, Beijing announced a two-year metaverse innovation and development plan, aimed at developing its infrastructure and promoting its usage. Shanghai also included the metaverse in its latest five- year development plan at the end of last year. Yet, the country still faces heavy regulatory challenges in developing the metaverse, exemplified by the fact that cryptocurrencies are banned within the country. Similarly, South Korea is also trying to make the most of its advantages and foster the industry, becoming one of the first national governments to directly invest in the metaverse, adding to investments that to date have been predominantly a private sector and big tech-focused initiative. The government is earmarking US$1.77.1m as part of its Digital New Deal, a program for investing in new technologies in the country’s economy. More generally, from Hong Kong - where the owner of Hong Kong’s benchmark Hang Seng stock index has recently launched new indices specifically for the metaverse, that include virtual reality (VR), gaming and other digital experiences that use advanced technology in virtual spaces, testifying that companies active in the field are growing quickly in popularity as investment themes among investors - to Thailand - that recently hosted its first Metaverse Job Fair - Asian countries appear full of opportunities, and investors worldwide are following the situation closely.
A look into the major Asian Metaverse players
Looking at Asia, some of the major companies active in the metaverse include ByteDance, Alibaba, Huawei, Baidu, Xiaomi, NetEase and Tencent amongst others. ByteDance, a company that fully owns TikTok and its Chinese counterpart, has been not only actively invested into the Metaverse since 2021, but it has also acquired other firms with virtual reality potential to ensure a strong role within the AR. Alibaba, a luxury brand shopping platform has recently invested 60 million dollars into AR glasses maker Nreal, as they claim it can provide a better experience for Metaverse users, providing a mixed experience between live shopping and AR for millennials. Huawei, a company known for producing a wide range of technological devices, has placed a great emphasis on connectivity and computing within the Metaverse. Together with Samsung and LG, Huawei has one of the most patent applications for the Metaverse in the whole world, showing that it recognizes the potential to grow and develop the AR experience. Baidu, an internet service provider and large technological company, has recently created the XiRang. Xiaomi is another interesting case within the Metaverse, as in January of 2022 the Chinese tech company has made public their creation of the ‘Gene Sequenced’ Virtual Blockchain Characters, a technology that will allows for all users to have unique characters within the Metaverse, without duplication — much like in real life. Lastly, NetEase is the second largest publisher of online games in China while Tencent is the first. While NetEase has invested into the social network IMVU, and games like Minecraft, Tencent has released LuoBuLeSi, the Chinese version of ROBLOX, and social media apps: Weixin and WeChat, with 1.26 billion users combined. However, it can be at least 6 more years before the Metaverse can fully deliver the full user experience as desired. Therefore, while many companies are currently investing into the Metaverse and hoping for high returns in the future, the exact timeline and integration into society is unknown, meaning it can take much longer than expected.
Tencent: the biggest Metaverse player in the APAC
Now, we will focus on the biggest Metaverse player in the APAC region: Tencent. In the following section, we will present and analyze Tencent’s performance in the third quarter of 2022, its overall profitability, and lastly its current valuation. Tencent is China's largest gaming and social media company. The company has been dubbed the "Meta of China," but it is much more than that. Tencent is the number one gaming company in China by users and revenue. But that's not all, Tencent has large investments in major technology companies such as Tesla (TSLA), NIO (NIO), JD.com (JD), Spotify (SPOT) and others with a fair value of about $75 billion. The company's experience and leadership in social media, gaming, and the cloud means that Tencent is the ideal stock to play in the "metaverse."
Tencent: Analysis of the different business segments
Tencent reported mixed financial results for the third quarter of 2022. Total revenues were $19.7 billion (RMB 140.1 billion), down 2 percent year-on-year but up 5 percent quarter-on- quarter. Most of Tencent's revenue (52%) came from value-added services. [VAS] includes social networks (21% of revenue), domestic sports (22% of revenue) and international sports (9% of revenue). Online advertising contributes 15 percent of revenue, and its fintech and business services segment contributes 32 percent of revenue. The value-added services segment recorded revenues of $10.1 billion (RMB 72.7 billion), down 3 percent year-on-year. This was mainly due to a 2% decline in social networking revenue to $4.2 billion. Positive for social networking was the growth of Tencent's "mini programs," a platform launched in 2017 that allowed developers to create mini versions of applications built directly on the WeChat ecosystem. By the third quarter of 2022, Mini programs will surpass 600 million daily active users, a rapid 30 percent year-on-year growth, with daily Mini programs growing 50 percent year-on-year. WeChat's Mini Programs platform has begun to gain popularity with physical retail brands and grocery stores that want to bridge the gap between offline and online. "Health Code" mini-programs have also proved extremely popular since the pandemic as they help verify a user's health and ability to travel. Tencent continues to build its metaverse by offering virtual spaces with brands such as Gucci and KFC as part of its QQ app. Tencent's gaming business is huge as the company owns major game studios such as Riot Games, while having investments in studios such as Epic Games and the popular social game Roblox (RBLX). Its owned brands include the popular League of Legends, Honor of Kings, Crossfire and many others. Despite strong gaming activity, revenues from domestic games declined 7 percent year-on-year to $4.4 billion (RMB 31.2 billion). This decline in revenue was driven by a Chinese government regulation to prevent children under the age of 18 from playing during the week. This rule may seem overly controlling to those of us in the West, but the goal of the Chinese government is to raise smart, focused children. There have also been calls from parents to help prevent gambling addiction, which is prevalent in China and Asia. In any case, it is bad news for Tencent, as gaming time for users under the age of 18 has decreased by 92 percent year-on-year. The good news is that adult gamers (daily active users) grew by a double-digit percentage year-on-year. It was inspired by existing game titles such as Honor of Kings, Peacekeeper Elite, and Crossfire, as well as newer game titles such as Wild Rift and Arena Breakout. International games grew 3 percent year-on-year to $1.6 billion, which is not bad considering that the games industry is going through a cyclical decline after the 2020 boom. This is a common trend I have noticed in analyzing companies such as Microsoft (MSFT) with its Xbox sales and even Nvidia (NVDA) with its PC gaming graphics cards. Tencent's music subscription revenue grew year-on-year in line with the increase in paying users. Its video subscription revenue declined slightly year-on-year due to delays in content programming. This was slightly offset by higher member prices that led to an increase in average revenue per user. Total video subscriptions reached 120 million, with total music subscriptions at 85 million. To put the scale of music subscriptions in perspective, Spotify, the world's largest music streaming provider (excluding China), had 138 million paying subscribers. Tencent is also an investor in Spotify, so it will benefit from the growth of international music streaming. Tencent's fintech business, which includes WeChat Pay, lending and wealth management services, has continued to grow. The volume of commercial payments grew at double-digit rates year on year with growth in food, catering and transportation. China has a growing middle-class population that is becoming increasingly "cash-rich," so Tencent is in a prime position to capture more of this economic activity with its fintech business. Tencent’s video conferencing platform "Tencent Meeting" has surpassed 100 million MAUs. To put things in perspective, Zoom (ZM) has about 300 million monthly active users outside China, although most of these are free level users. Tencent Cloud continues to build its infrastructure in 26 regions and 70 availability zones. The segment is also the No. 1 communications PaaS (platform as a service) by revenue in China, according to a Gartner report cited in Tencent's annual report. The cloud industry in China is expected to triple by 2025, driven by the digital transformation of China's traditional manufacturing industry.
Tencent: Profitability and spending
Tencent reported gross profit of $8.6 billion (RMB 62 billion), which decreased 1 percent year- on-year but increased 7 percent sequentially. Operating income was $7.2 billion (RMB 51.6 billion), down 3% year-on-year but up more than 70% sequentially. The increase was driven by a 32 percent reduction in marketing expenses as the company reduced its spending in this area to adjust to economic conditions. The company also improved professional services margins and optimized bandwidth and server utilization to reduce video account operating costs. Management has "optimized" its workforce by downsizing it, following the likes of several technology companies such as Meta Platforms (META) and Twitter (TWTR). Diluted earnings per share were $0.56 (RMB 4.1), a substantial increase of 0.7 percent year-on-year or 114 percent in the quarter. Free cash flow in the 12 months to September 2022 was $13.8 billion (RMB 98.9 billion), down 8.6% year-on-year. Adjusted EBITDA margin was also reduced from 35% in 2021 to 33% in 2022.Tencent has a strong balance sheet with $44.5 billion in gross cash and holdings in listed companies such as Tesla, JD.com and Spotify with a staggering fair value of $75 billion. In addition to holding stakes in unlisted companies worth $48 billion. The company has a whopping $51.6 billion in debt, but "only" $1.9 billion of this is current debt due within the next 2 years.
In conclusion, the Metaverse’s features make it particular appealing for the Asian economies, whose major players will benefit from the main demographic and technological trends characterizing this geography. On the other hand, high regulatory risks and an unpredictable timeline lie in the future of the Metaverse. Will it succeed to be the “next big thing” or will it be destroyed by the adverse factors?
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