How This Chinese Company Could Overtake Facebook

Despite having more than one billion users, Facebook could soon lose its dominant position in the social network space. According to WorldofCEOs founder Steve Tappin, Chinese investment holding company Tencent Holdings is close to become the owner of the largest social network in the world, thanks to its mobile text and voice messaging communication service WeChat, which has experienced explosive growth since its release in January 2011.

Tencent is the leading Internet force in China
Tencent Holdings owns two huge instant chat applications: QQ, designed for desktop, and WeChat, optimized for mobile. Together, these two applications handle more than one billion monthly active users, and just 65 million behind Facebook, which recently admitted that it is losing teen users. Furthermore, the amount of users Tencent handles every month is ten times the amount Chinese competitor and social network company, Renren, manages.

The amazing growth story of WeChat
WeChat was released in 2011, and has experienced massive growth in the past three quarters. Furthermore, the application has become popular not only among Chinese, but also overseas. To improve localization, Tencent Holdings released a collaborative translation platform, where fans help to translate the application into Arabic, Hebrew, Indonesian, Japanese, and several other languages. As a result, between May and September 2013, its overseas users doubled from 50 million to 100 million.

Source: Statista

Now, considering that WeChat's international presence is relatively small, and that China alone has 460 million mobile web users, the growth story of this app could be just starting.

Monetization and revenue diversification matter
Since user growth not always translates into revenue growth, it's worth analyzing Tencent Holdings' monetization strategy. As a holding company, it owns several tech business units, from auction site to a number of online multiplayer games. This allows Tencent Holdings to explore interesting cross-selling opportunities and synergies between its services. For example, the firm uses QQ to promote its games. The company also monetizes its applications directly via premium accounts, micro-transactions, and advertisement.

On the other hand, Facebook's revenue model is heavily dependent on advertising. According to the third quarter earnings call, revenues came in at $2.02 billion, up 60% from the year before. However, 90% of total revenues came from advertising. Since advertisement expenses change according to economic business cycles, Facebook's revenue could be more volatile than Tencent Holdings. Furthermore, according to Morningstar, several advertisers are unsure if they are spending money wisely on Facebook ads.

Tencent Holdings' revenue diversification and cross-selling ability is reflected in the company's fundamentals. Net profit rose 37% in the first quarter of 2013, and 19% in the second quarter. Advertising represents roughly one third of the company's total revenue. The good news is that, since the company is not monetizing WeChat yet, profitability should improve in the long run.

Notice that despite owning one of the biggest social networks in China with roughly 194 million active users, Renren is not profitable. Like Tencent Holdings, Renren has a rich portfolio of services, from online gaming to video sharing applications. However, the company is also investing heavily in mobile strategy and video acquisition to maintain its strong top line performance. This trade off reflects how challenging it is to run a profitable social network in the second largest economy, where there are several networks which exceed 100 million active users.

Despite its weak profitability, Renren deserves special attention due to its current valuation. The company's user base represents one fifth of Tencent Holdings' total user base. However, Renren's $1.27 billion market capitalization is well behind Tencent Holdings' $100 billion market value, a huge difference that suggests a potential upside for Renren. The company recently showed investors it can use the power of its social network to release new services like group-buying site, which giant Baidu valued at $271 million.

Final Foolish takeaway
Tencent Holdings will soon overtake Facebook, and become the largest social network. More important, the company's attractive growth prospects, diversified product portfolio, and previous experience monetizing QQ suggests that it won't have any problem in monetizing its latest application, WeChat. As a result, profitability and top-line performance should both improve.

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Adrian Campos has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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