Why Tencent Likes The Music Streaming Business

Summary

• Spotify’s NYSE IPO filing valued its Chinese partner Tencent Music Entertainment at over $12 billion. Tencent Music Entertainment’s valuation last December was only $10 billion.
• The December 2017 equity exchange between them led to Spotify owning 9% of Tencent Music Entertainment. In exchange, Tencent received 7.5% stake in Spotify.
• Spotify’s direct listing at NYSE might give it a valuation of over $23 billion.
• TME and Spotify's growth can eventually lead to cheaper music licensing fees for streaming.
• The music streaming business helps reduce Tencent's reliance on video games revenue.

Tencent’s (OTCPK:TCEHY) share swap with Spotify last December proved to be rewarding for the Chinese company. Spotify’s IPO filing valued its recently-acquired 9% stake in Tencent Music Entertainment (TME) at 910 million pounds ($1.25 billion). This consequently gave Tencent Music Entertainment a valuation of over $12 billion.

(Source: Tencent/Spotify)

Two months ago, TME’s valuation was only $10 billion. Aside from the $2 billion increase in TME’s valuation, Tencent’s recently acquired 7.5% stake in Spotify is going to be worth more than $1.7 billion. Spotify’s direct listing at NYSE is projected to result in a $23 billion valuation. This optimism can be attributed partly to the robust 53% Year-over-Year growth in U.S. music streaming revenue. From $2.2 billion in 2016, music streaming in the U.S. generated $3.4 billion in revenue last year. As of October 2017, Spotify had 18.2 million paid subscribers in the U.S.

Furthermore, Spotify’s IPO performance could be a good barometer on TME’s forthcoming IPO. TME could be worth much more than $12 billion. Spotify only has 71 million paying customers. TME already touts 700 million monthly active users with 120 million subscribers who buy or pay for streaming music. TME is so dominant in China’s music streaming that Apple (AAPL) Music only has 3.5 million subscribers in China.

Tencent owns QQ Music, Kuwo, and KuGuo.

(Source: TechNode)

Listing TME publicly could raise $1 billion for Tencent. This money can finance more exclusive music deals for China’s music streaming market. Tencent needs to license more songs to match Spotify’s library. TME currently serves only 17 million songs to its 700 million monthly active users. Spotify offers 35 million songs to its global customers.

After Dominating China, India Is Next

Tencent led a $115 million investment in Gaana. Gaana is a commercial music streaming service provider in India. As of August last year, Gaana was the no.2 local (30% market share) music streaming app in that country. Given the opportunity, Tencent will most likely take a controlling stake in Gaana. Like China, India’s huge population also makes it ideal for cheap/affordable paid music streaming.

India’s recorded music industry will be worth $300 million by next year. Majority of that will eventually shift to music streaming. India is now the second-biggest market for smartphones. If the Chinese people can afford to pay for QQ Music’s monthly subscription plans of $1.22/$1.83/$2.1, I’m sure a large number of India’s citizens can also afford them.

Final Thoughts

Tencent likes the music streaming business because it helps reduce its dependence on video games revenue. Music streaming helped Spotify earn $5 billion in revenue last year. Yes, Spotify is still losing money, but its gross margin is improving. As streaming music service providers become larger, they can gain more leverage when negotiating for music licensing fees.

Record companies and musicians know that paid streaming is the best way to monetize. My takeaway is that streaming is the savior of the music industry. The advent of smartphones rendered CDs near obsolete. The music industry has a lot to be grateful for. Since its inception, Spotify has paid $10 billion in music licensing. Apple, Google (GOOG), Amazon (AMZN), and Tencent must have also spent billions of dollars more on streaming music licensing/royalties. Ad-supported and subscription streaming also reduced music piracy.

More often than not, people capitulate to their savior’s wishes. TME and Spotify could become decent profit makers once musicians and record companies provide cheaper licensing fees.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long TCEHY, GOOG, AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.