Last month, the Trump administration announced it would ban Tencent‘s (OTC: TCEHY) messaging app WeChat in the U.S. However, the effort to enforce that ban beginning last week was halted by a preliminary injunction in a California district court.
The judge ruled that the ban raised concerns about the First Amendment rights of WeChat’s users, the U.S. government’s limits on controlling businesses, and the harm it could do to Chinese users in America. The injunction will allow a new lawsuit against President Donald Trump, filed by the U.S. WeChat Users Alliance (which isn’t affiliated with Tencent), to proceed.
The Trump administration’s moves against WeChat wouldn’t have significantly affected Tencent, since only a small percentage of the app’s users are located in the U.S. However, the Trump administration is now increasing its scrutiny of Tencent’s gaming investments in the U.S. — which could matter a lot more than its WeChat users.
Image source: Riot Games.
A closer look at Tencent’s U.S. gaming business
Tencent’s top gaming investments in the United States include all of Riot Games, which produces the hit PC game League of Legends; 40% of Fortnite publisher Epic Games; 15% of Glu Mobile; and 5% of Activision Blizzard. It also recently opened a new studio in California to produce high-end “triple A” games for next-gen gaming consoles.
The Committee on Foreign Investment in the U.S. (CFIUS), which is led by the Treasury Department, recently sent letters to those companies. Bloomberg claims CFIUS wants to know how these companies handle Americans’ personal data, but it’s unclear if those questions will escalate into full-blown probes.
Image source: Epic Games.
Tencent generated just over 4% of its revenue from outside mainland China last year. That revenue also comes from investments in other countries beyond the U.S., including Clash of Clans maker Supercell, PUBG maker Krafton, Assassin’s Creed publisher Ubisoft, Bayonetta maker Platinum Games, and Conan publisher Funcom.
Based on those numbers, it initially seems like Tencent’s U.S. interests only account for a low single-digit percentage of its total revenue. However, that percentage wouldn’t account for the revenue generated by those American businesses in other overseas markets, including China.
Bloomberg Intelligence analysts Vey-Sern Ling and Tiffany Tam recently estimated that Tencent’s U.S. assets could actually be worth “at least” $22 billion, and account for 6%-7% of its total revenue and profits. Therefore, any regulatory actions against Tencent’s gaming business in the U.S. could bleed over to its other U.S. investments and impact the growth of those investments in other overseas markets.
Could a few cloud deals defuse the situation?
If CFIUS raises concerns about the data storage methods at Riot, Epic, and Tencent’s other partners, those companies might need to prove that their user data is stored on American servers, or agree to move their data to American cloud platforms.
For example, ByteDance‘s TikTok recently averted a ban in the U.S. by striking a deal with Oracle (NYSE: ORCL) and Walmart, in which it agreed to move the data of TikTok’s U.S. users to Oracle’s cloud platform. Whatever actions CFIUS takes against Riot (Tencent’s wholly owned subsidiary) will likely set the tone for those discussions.
Riot currently maintains all its League of Legends servers outside of China and Southeast Asia, while Tencent and Sea Limited‘s Garena control its servers in China and Southeast Asia, respectively. However, CFIUS could argue that Riot’s North American server, which is located in Chicago, is still under Tencent’s direct control — and force it to move its user data to an unaffiliated cloud partner like Oracle, Microsoft, or Amazon.
The key takeaways
For now, CFIUS’s inquiries probably won’t threaten Tencent’s online gaming business, which grew its revenue 40% year-over-year last quarter and accounted for a third of its top line. Nonetheless, investors should still keep up with this developing story, since it could still generate unpredictable headwinds in the future.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Leo Sun owns shares of Amazon and Tencent Holdings. The Motley Fool owns shares of and recommends Activision Blizzard, Amazon, Microsoft, Sea Limited, and Tencent Holdings and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, short January 2022 $1940 calls on Amazon, long January 2022 $1920 calls on Amazon, long January 2022 $75 calls on Activision Blizzard, and short January 2022 $75 puts on Activision Blizzard. The Motley Fool has a disclosure policy.
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