Once high-flying Chinese tech giants are now looking to scale back costs

Chinese tech giants Alibaba and Tencent often talk about all of their innovations and new products during earnings calls with investors.

But the second quarter was different. Executives at China’s two largest tech firms focused on something a little less flashy — keeping costs down.

It comes after Alibaba and Tencent posted a set of second-quarter results that confirmed these once free-wheeling and high-flying behemoths are not growing anymore.

China’s biggest e-commerce player Alibaba reported flat growth for the first time ever for its April to June quarter. On Wednesday, gaming and social media giant Tencent posted its first-ever quarterly year-on-year revenue decline.

Alibaba and Tencent have felt the effects of a Covid-induced economic slowdown in China that is hitting everything from consumer spending to advertising budgets. The tightening of domestic technology regulation in areas from antitrust to gaming over the last year and a half is also weighing on results.

As revenue remains under pressure, both giants have looked to be more disciplined in their approach to spending.

“During the second quarter, we actively exited non-core businesses, tightened our marketing spending, and trimmed operating expenses,” Tencent CEO Ma Huateng, told analysts during a call Wednesday. “This enabled us to sequentially increase our earnings despite difficult revenue conditions.”

Indeed, Tencent’s profit, when excluding certain non-cash items and impact of merger and acquisition transactions, rose 10% from the previous quarter.

Tencent President Martin Lau said the company exited non-core businesses such as online education, e-commerce, and game live streaming. The company also tightened marketing spend and cut down low areas of investment such as user acquisition. Tencent’s selling and marketing expenses fell 21% year-on-year in the second quarter.

The Shenzhen-headquartered company’s headcount was also down by 5,000 versus the first quarter.

James Mitchell, chief strategy officer at Tencent, said that with these initiatives plus investments in new areas, the company can “return the business to year-on-year earnings growth, even if the macro environment remains as it is today” and even if revenue growth remains flat.

Alibaba meanwhile flagged its cost cutting drive earlier this year and continues to push forward with it.

“In the coming quarters and the remainder of this fiscal year, we will continue to pursue the strategy of cost optimization and cost control,” Toby Xu, chief financial officer at Alibaba, said during the company’s earnings call this month.

Xu said the Chinese e-commerce giant has “narrowed losses” in some of its strategic businesses.

Alibaba and Tencent have had to play a delicate balancing act to convince investors that while costs are being cut, they’re still investing in the future.

“For them to go back to [the] earnings growth path, cost optimization only is not enough. They need to find new growth drivers,” Winston Ma, adjunct professor of law at New York University, told CNBC via email.

Alibaba has been focusing on boosting its cloud computing business, an area executives and investors believe is key to better profitability at the company in the future. Cloud was Alibaba’s fastest-growing area by revenue in the June quarter.

Meanwhile, Tencent talked up the potential for ads in its WeChat short-video feature to become a “substantial” revenue source in the future. Tencent runs WeChat, China’s largest messaging app with over one billion users.

Alibaba will continue to focus on areas with “long-term potential” such as cloud computing and overseas e-commerce, Chelsey Tam, senior equity analyst at Morningstar, told CNBC. “For the unprofitable businesses it will evaluate the cost and benefits.”

Ivan Su, senior equity analyst at Morningstar, said that Tencent has “done a really good job balancing long-term investments and near-term profitability.”

“If you look at the cost initiatives they announced, some of the reductions are permanent, such as cloud migration and shutdowns of unprofitable noncore businesses, while others (marketing budget pullback and hiring slowdown) are more temporary in nature. So there’re multiple levers they can pull to create such balance,” Su said.