Tencent Music’s Long-Term Growth is Underpinned by Continuing Increase in Subscribers

Business Strategy & Outlook:

With over 600 million monthly active users, or MAU, Tencent Music Entertainment, or TME, is the largest music streaming platform in China. The firm monetizes through live streaming, a high margin business generating over 60% of revenue and over 100% of operating profit, while subscription-based music streaming remains loss-making. A low subscriber-to-user ratio in the mid-teen percentages offers a long runway for paying user growth in music streaming. With platforms putting more content, such as popular songs, behind the paywall, more users would subscribe, and fuel top-line growth. Potential revenue growth also comes from advertising, where the firm’s investments into long-form audio are likely to open up more ad inventory. Even though social entertainment (mainly video live streaming) contributes most of the firm’s revenue, still there will be minimal growth ahead given competition from Douyin and Kuaishou.

With China’s antitrust laws putting an end to TME’s exclusive music copyright agreements, more competition is anticipated for users. Its peer Cloud Music is aiming to bridge the content gap by signing with previously inaccessible labels. Despite competitive headwinds, TME will remain the largest platform for music streaming, benefiting primarily from network effect and intangible assets that maintain user engagement and stickiness. The subscription prices are unlikely to go lower because: 1) competitors are making losses and have little incentive for price competition; and 2) Chinese streaming platforms offer almost the lowest prices worldwide, so more discounts will be less effective in attracting users. Some margin upside is expected for Tencent Music as growing subscription revenue brings more cost leverage. Unlike developed markets, the supply side of music in China is more fragmented, with just 30% of licensing from top five labels. As licensors sell their content on a mostly fixed cost basis, TME is well-positioned to see margin expansion as revenue grows.

Financial Strengths:

TME is financially sound. As of the end of 2021, the firm was sitting on a net cash position of CNY 22 billion, more than three times that of peer Cloud Music. Despite some near-term industry challenges, the firm is expected to generate positive free cash flows over the next years. Taking advantage of the low interest environment, the company issued a total of USD 800 million (CNY 5 billion) senior unsecured notes at below 2% interest in 2020. The debt/equity ratio is running at a manageable 30%, and debt/EBITDA is maintained below 1.5 times as at the end of 2021. The firm shall maintain this capital structure. Given positive free cash flow assumptions, the firm can easily fulfill its debt obligations while simultaneously funding future investment initiatives. The business has been generating positive free cash flows since 2016. In 2021, it generated a free cash flow of CNY 3.5 billion. This is significantly better than peer Cloud Music, who will be burning through cash for the next couple of years. TME is expected to remain cash flow positive over the next five years.

Bulls Say:

Compared with Spotify, TME has plenty of room for subscriber growth that should come about as it moves more music content behind the paywall.
TME piggybacks off Tencent’s billion-plus user network. This relationship allows for better retention of users while attracting new ones.
By investing in independent artists and long-form audio, TME could better manage content cost over the long term.

Company Description:

TME is the largest online music service provider in China. It was founded in 2016 with the business combination of QQ Music (founded in 2005), Kuwo Music (founded in 2005) and Kugou Music (founded in 2004) streaming platforms. Tencent is the largest shareholder of TME with over 50% shares and over 90% voting rights held. TME also provides social entertainment services, including music live audio/video broadcasts and online concert services through the three platforms mentioned above, and online karaoke through an independent platform WeSing.

(Source: Morningstar)

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