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Should Investors Worry About Tencent’s Stake in Activision Blizzard?

Activision Blizzard (NASDAQ: ATVI) recently joined the growing list of companies caught in the crossfire between China and Hong Kong. It all started when Chung "Blitzchung" Ng Wai, a professional gamer from Hong Kong, won Blizzard's Hearthstone Grandmasters tournament in Taipei.

During a live post-game interview, Chung donned a mask (in response to Hong Kong's new anti-mask law) and shouted "liberate Hong Kong, the revolution of our times" in Mandarin. Shortly afterward, Blizzard withdrew Chung's $10,000 prize, banned him from Hearthstone tournaments for a year, and fired the two Taiwanese casters who hosted Chung's interview.

Blizzard claimed that Chung violated the tournament's rules, which forbid players from making offensive statements or damaging Blizzard's brand. The decision sparked a fierce backlash from gamers, as calls to boycott Blizzard's products trended on social media and popular Hearthstone caster Brian Kibler announced that he would no longer participate in future Blizzard events.

Image source: Getty Images.

Many gamers also accused Chinese tech giant Tencent (OTC: TCEHY), which owns a 5% stake in Activision Blizzard, of forcing the decision. Blizzard eventually backed down, agreed to return the prize money to Chung, and reduced his suspension. In a statement, Blizzard president J. Allen Brack admitted that the company "reacted too quickly" to Chung's remarks.

Nonetheless, the Blitzchung controversy highlights just how much Chinese money matters to Activision Blizzard. Should investors be concerned about Tencent's influence over Activision's future decisions?

Meet the world's biggest video game publisher

Tencent is the world's largest video game publisher by annual revenue. Its first-party portfolio includes popular games like Honor of Kings (also known as Arena of Valor) and Game for Peace.

It also owns League of Legends maker Riot Games, majority stakes in Clash of Clans maker Supercell and Path of Exile maker Grinding Gear Games, 40% of Fortnite maker Epic Games, 36% of Warhammer maker Fatshark, a 29% stake in Conan Exiles developer Funcom, an 11.5% of PUBG maker Bluehole, a 9% stake in Elite Dangerous maker Frontier Developments, and 5% stakes in Activision and Ubisoft.

In short, Tencent resembles the British Empire of the video game industry. But unlike the British Empire, Tencent doesn't plant its flag on all its conquests, so many gamers and investors remain blissfully oblivious to the company's influence. However, Tencent's sphere of influence is now becoming increasingly visible as its partners awkwardly tiptoe around powder keg issues like the Hong Kong protests.

But did Tencent force Blizzard to do anything?

Many gamers blamed Tencent for forcing Blizzard's hand, but the speed of Blizzard's decision indicates that it could also have been the company's own snap decision. This makes sense, for two reasons.

First, China is still the largest gaming market in the world. Niko Partners estimates that the total number of gamers in China will rise from 604 million in 2017 to 768 million in 2022 and that the vast majority will be mobile gamers. That's a market Activision can't afford to lose. Activision doesn't disclose how much revenue it generates in China, but it represents a large percentage of its Asia Pacific business, which generated 12% of its sales in the first half of 2019.

Image source: Activision Blizzard.

Second, Activision is still awaiting the government approval of Call of Duty Mobile (which was developed by Tencent) in China. The game has been a global hit with over 100 million downloads within the first week, but it still needs access to China to reach its full potential. It's likely that Activision wanted to prevent the Hearthstone incident from endangering that plan.

During last quarter's conference call, Activision Blizzard chief operating officer Coddy Johnson stated that the company would leverage Tencent's "massive network, broad distribution channels, and local marketing expertise" to ensure Call of Duty Mobile's successful launch. Activision's "mobile and ancillary" revenue, which mainly comes from mobile games, accounted for nearly a third of its top line in the first half of 2019.

Tough choices down the road

Activision Blizzard's Hearthstone debacle is another headache for Tencent, which is still reeling from a backlash against its NBA broadcasts and new questions about its data-sharing arrangement with Apple.

Activision isn't the only company that's struggling to straddle the Chinese and foreign markets. Over time, many American companies might need to make tough choices between supporting free speech or generating revenue from Chinese consumers. Activision seems to be leaning toward the latter -- and investors should consider what that means for the future of the company and the video gaming market.

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Leo Sun owns shares of Apple and Tencent Holdings. The Motley Fool owns shares of and recommends Activision Blizzard, Apple, and Tencent Holdings. The Motley Fool has the following options: short January 2020 $155 calls on Apple, long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and long January 2020 $150 calls on Apple. The Motley Fool has a disclosure policy.


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