Tencent Music Entertainment: China's Largest Online Music Entertainment Platform Operator

Summary

• Tencent Music Entertainment has an edge over its competitors because Tencent Holdings Limited is its parent, and the company has strategic interests in other key industry players.
• Long-form audio and the extension of the paywall are Tencent Music Entertainment's key growth drivers in the medium to long term.
• Tencent Music Entertainment trades at consensus forward FY 2021 P/E and Enterprise Value-to-Revenue multiples of 45.9 times and 7.4 times, respectively.
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Elevator Pitch

I assign a Neutral rating to Tencent Music Entertainment (NYSE:TME).

Tencent Music Entertainment has an edge over its competitors because Chinese internet giant Tencent Holdings Limited (OTCPK:TCEHY) (OTCPK:TCTZF) [700:HK] is its parent, and the company has strategic interests in other key industry players. Looking ahead, long-form audio and the extension of the paywall are Tencent Music Entertainment's key growth drivers in the medium to long term.

Tencent Music Entertainment trades at consensus forward FY 2021 P/E and Enterprise Value-to-Revenue multiples of 45.9 times and 7.4 times, respectively. The company's share price has more than doubled in the past year, as Tencent Music Entertainment is perceived as one of the technology companies that benefited from more people working and staying at home due to the coronavirus pandemic.

With the decline in global daily confirmed cases of COVID-19 and the market rotating to "reopening plays," a correction in Tencent Music Entertainment's share price in the near-term is likely considering the stock's rich valuations, notwithstanding the company's long-term growth prospects. As such, I see a Neutral rating for Tencent Music Entertainment as justified.

Company Description

Listed on the New York Stock Exchange in December 2018, Tencent Music Entertainment refers to itself as "the leading online music entertainment platform in China, operating the country's highly popular and innovative music apps: QQ Music, Kugou Music, Kuwo Music and WeSing" in the company's press releases. The company also highlights that it's "the largest online music entertainment platform in China" based on monthly active users in its IPO prospectus.

The company generated 32% and 68% of its 9M 2020 revenue from online music services and social entertainment services and others, respectively. In the company's IPO prospectus, Tencent Music Entertainment noted that "paid subscriptions and digital music sales" account for the bulk of its online music services revenue, while "virtual gift sales and premium memberships" contributed the majority of its social entertainment services revenue. Specifically, subscriptions and non-subscriptions accounted for 60% and 40% of Tencent Music Entertainment's online music services, respectively in the first nine months of FY 2020.

Tencent Music Entertainment's Key Products

Source: Tencent Music Entertainment's December 2020 Investor Presentation Slides

Tencent Music Entertainment's Key Statistics As Of End-3Q 2020

Source: Tencent Music Entertainment's December 2020 Investor Presentation Slides

Support From Parent Is The Company's Key Competitive Edge

Chinese internet giant, Tencent Holdings Limited, is Tencent Music Entertainment's parent and largest shareholder, with a 55.6% equity interest in the company.

Tencent Music Entertainment highlighted in the company's IPO prospectus that "we benefit from unique access to Tencent’s massive user base, representing China’s largest online social community." The examples cited in the prospectus include that "the music module embedded in the QQ mobile app (by Tencent Holdings) allows QQ users to seamlessly access (Tencent Music Entertainment's) QQ Music" and "(Tencent Music Entertainment's) WeSing users can enjoy the recorded performances of their Weixin/WeChat and QQ friends (social media platforms owned and operated by Tencent Holdings) and interact with them on our platform."

There are more recent examples of how Tencent Holdings has provided significant support to Tencent Music Entertainment.

In January 2021, the new version of Tencent Holdings' social messaging app, WeChat 8.0, was launched, and WeChat users were now able to create and share short-form music videos using songs available on Tencent Music Entertainment's QQ Music. In the same month, Tencent Music Entertainment disclosed that "it entered into a definitive agreement to acquire 100% equity interest of Shenzhen Lanren Online Technology Co, Ltd ("Lazy Audio", "Lanren tingshu"), a well-established audio platform in China."

According to Tencent Music Entertainment's press release, Lazy Audio "is a comprehensive audio platform providing entertainment in the forms of audiobooks, Chinese comedy, podcasts and other radio shows to customers," and Tencent Music Entertainment is doing this acquisition "to significantly deepen our presence in the fast growing long-form audio industry in China." Notably, China Literature Limited (OTCPK:CHLLF) (OTC:CHLLY) [772 HK], a subsidiary of Tencent Holdings, was the major shareholder of Lazy Audio.

Also, Tencent Music Entertainment noted at the company's 3Q 2020 results briefing on Nov. 10, 2020, that "we continued to add more trend-setting content, including more music-centric variety shows that are popular among the younger demographic, which successfully attracted younger users on our platform." Many of these "music-centric variety shows" are produced by Tencent Holdings such as popular ones like "Produce Camp 2020," "Sisters Who Make Waves," and "Youth With You 2," and Tencent Music Entertainment has the exclusive rights to certain songs broadcasted on these shows thanks to having Tencent Holdings as its parent.

Strategic Interests In Industry Players

Another key competitive edge that Tencent Music Entertainment has is the company's strategic interests in other industry players.

As per the chart below, Tencent Music Entertainment has a 2.3% stake in Spotify Technology S.A. (SPOT), while Spotify has an 8.4% equity interest in Tencent Music Entertainment making it the company's second largest shareholder. On the company's website, Spotify stresses that it "is the world’s most popular audio streaming subscription service with 345m users, including 155m subscribers, across 170 markets." Notably, Tencent Music Entertainment emphasized in its IPO prospectus that both the company and Spotify have "a common objective to foster a vibrant music ecosystem that benefits users, artists and content owners."

A June 29, 2020, Variety article highlights why Tencent Music Entertainment's cross-shareholdings with Spotify is important. In the article, it's mentioned that "Chinese regulations mean that Western media companies cannot sell directly to Chinese consumers," and "reciprocal share ownership arrangements allows these Western companies to earn something from China’s closed-off, but fast-growing market."

Tencent Music Entertainment's Shareholding Structure And Strategic Investments As Of December 2020

Source: Tencent Music Entertainment's December 2020 Investor Presentation Slides

Tencent Music Entertainment also has strategic interests in other key industry players, such as the international music labels. On January 29, 2021, Tencent Music Entertainment announced that "a consortium (the "Consortium"), which is led by Tencent Holdings Limited and comprising the Company (through one of its wholly-owned subsidiaries) and other co-investors, has completed the acquisition of an additional 10% equity stake in Universal Music Group." This means that Tencent Music Entertainment's effective equity stake in Universal Music Group has increased from 1% to 2% as a result of this recent transaction. Tencent Music Entertainment also has a 0.8% equity interest in Warner Music Group as per the chart above.

Tencent Music Entertainment claims to have more than 40 million licensed tracks as of June 30, 2020, which is why the company is able to attract sufficient monthly active users to have four of the five leading music mobile applications in China. Tencent Music Entertainment's licensing agreements with leading music labels are only made possible, because of its strategic interests in these companies.

In the same Variety article highlighted above, it's noted that "TME remains the biggest fish in the Chinese pond, and the partner of choice" for music labels, even though "the regulators ordered all Chinese music streamers to share 99% of their content with each other through sub-licenses" since the middle of 2019.

Also, it's noteworthy that another Chinese internet giant Alibaba (BABA) has chosen to exit the Chinese online music entertainment market, with the closure of its Xiami music app in February 2021. This is a reflection of Tencent Music Entertainment's market dominance and competitive advantages in this space.

Long-Form Audio And Paywall Extension Are Key Growth Drivers

Moving forward, long-form audio and the extension of the paywall are Tencent Music Entertainment's key growth drivers.

At the company's 3Q 2020 earnings call on Nov. 10, 2020, Tencent Music Entertainment disclosed that with respect to long-form videos, "the total content that we have right now is actually over triple-digit year-over-year growth when compared to last year" and the monthly active user penetration rate expanded from less than 5% in 3Q 2019 to 11.7% in 3Q 2020. In an earlier section of this article, I highlighted that Tencent Music Entertainment had acquired a company called Lazy Audio as part of its strategies to expand its long-form audio business which was only started in 2019.

More importantly, Tencent Music Entertainment stressed at the recent 3Q 2020 results briefing that "with every additional time spend that we get on this type of long-form audio content, these are incremental and accretive to the overall strength of our platform" and "we are at an early stage of growing this business, the absolute level of time spent (by users on its platforms) is still a long way from where we want it to be."

Separately, Tencent Music Entertainment continues to extend its paywall. The company is estimated to have 20% of its content behind a paywall by the end of 2020, while only 10% of its content was behind a paywall in 2019. This has helped the company grow the number of its paying users by +30.4% YoY to 62.2 million as of September 30, 2020.

Tencent Music Entertainment has a very optimistic view of the upside from the extension of its paywall over time. The company noted at its 3Q 2020 earnings call that the "Chinese online music industry is still at an early stage of development and continues to be in a long-term secular trend that will provide a lot of monetization opportunities," and stressed that "we have been fairly aggressive in adding a lot of content (behind the paywall) in the first 3 quarters of this year (2020)."

Valuation And Risk Factors

Tencent Music Entertainment trades at 45.9 times consensus forward FY 2021 P/E (normalized net profit as determined by sell-side analysts) and 7.4 times consensus forward FY 2021 Enterprise Value-to-Revenue based on the company's share price of $26.51 as of March 5, 2021. As a comparison, the loss-making Spotify is valued by the market at a relatively lower 4.5 times forward FY 2021 Enterprise Value-to-Revenue.

All market consensus numbers used in this article are sourced from S&P Capital IQ.

The key risk factors for Tencent Music Entertainment are a deterioration in its relationships with key industry players like music labels, a failure to capitalize on the growth opportunities in long-form audio, and a slower-than-expected pace of growth in the number of paying users on its platforms.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.