Premium content costs have started to eat into margin growth for Chinese digital giant, Tencent, but continued momentum in advertising, as well as longer-term monetization through an emerging SVOD business, promise greater returns.

Tencent’s SVOD revenue grew 800% Y/Y in the Sept. 2015 quarter, inflated through comparisons with a low base. More significantly, video is helping boost the company’s overall business.

Online ad revenue doubled Y/Y to ~RMB 5 billion (US$817 million), with brand advertising up 67% Y/Y and accounting for 50% of total ad sales, driven by online video traffic (led by The Voice of China 4 program).

“The video platform is actually a very important part of our overall traffic ecosystem,” remarked Tencent president Martin Lau on a Nov. 11 earnings conference call.

“It generates a very engaging amount of time with our users. And when you look at our overall IP strategy, which gets us into the literature [ie online publishing and ebooks], it helps us to monetize the content there as well as across games,” Lau continued.

“A lot of these different platforms will work together, and the overall profitability of the entire ecosystem will be bigger than the individual platforms on an aggregate basis.”

Based on video views within Tencent's video app and inside its Weixin mobile platform (called WeChat outside China), Tencent continues to lead mobile video traffic.

As a result, the company’s mobile inventory more than doubled Y/Y, which also helped lift ad sales for online video.

SVOD content drivers

At the same time, Tencent has been investing in various premium franchises and output deals, spanning tie-ups with HBO, Paramount Pictures, NBA, Star Wars and the entire James Bond franchise, including the newly released Spectre.

The biggest drivers of its subscription video business are top-tier local and Hollywood dramas, movies and sports.

The company has also been busy setting up both Tencent Pictures and Penguin Pictures.

Tencent Pictures is focused on managing Tencent-sourced IPs, and exploiting these through different windows such as movies, TV series and games.

Penguin Pictures focuses on taking usually minority stakes in drama series that are being created, therefore participating in the distribution of IP that's often sourced from outside Tencent.

A long-term business

Tencent chief strategy officer James Mitchell said: "We were not the first mover in video, and so for us the video industry has always been extremely competitive, and it probably always will be somewhat competitive.”

Mitchell added: "That said, we think that we've done several things that improve our competitive position and that insulate us, to some extent, from some of the shorter-term disruptions in the market.

“For example, we've purchased a large volume of very high-quality content on long-term multiyear contracts, such as our NBA basketball rights, our HBO rights, our Paramount rights, our Star Wars rights and our James Bond rights."

Profitability is not a near-term target, Mitchell concluded.

"Right now, what we're seeing is that as we spend more money on content, we attract more users, which generates more revenue, enhances our platform quality, and so we continue to reinvest in content rather than focusing on near-term profitability."