Business modell
Tencent Music Entertainment Group (TME) is the largest online music entertainment platform in China, operating four of the top five mobile music apps based on the number of mobile users in 2020, and operates online music entertainment platforms offering online music, online karaoke and music-related live streaming products, and long-form audio in the People’s Republic of China.
Quelle: Tencent Music IR, Financial Results (Investor Presentation)
Online Music
The associated apps (QQ Music, Kugou Music and Kuwo Music) allow users to discover and listen to music in a personalized way. They offer a wide range of music discovery features, including music search and recommendations, music ranking charts, playlists, official music accounts, and digital releases. They also offer comprehensive music-related video content such as music videos, live performances, and short videos.
Quelle: https://www.techinasia.com/comparison-tencents-dominant-music-apps
Online karaoke
WeSing allows users to have fun by singing together and sharing music with friends.
WeSing was also the largest online karaoke community in China in 2020, based on the number of mobile users.
Quelle: https://www.boomradar.com/download-wesing-for-pc-windows-7-8-10-mac/
Live Streaming
Kugou Music, Kuwo Music, WeSing and QQ Music, Kugou Live and Kuwo Live provide an interactive online stage for artists and users to showcase their talent and connect with those interested in their performance.
The aforementioned apps for live streaming offer are also the most popular in that segment.
Quelle: S1 Filling
Long-form Audio
Long-form audio refers to other services that can be perceived auditorily, such as audio books.
Kuwo Changting is the name of the Company’s proprietary audio platform, which offers users various audio content, including audiobooks, cross-talks, and other entertainment services. In March 2021, it also completed the acquisition of Lanren Changting to further expand its audio content offerings. Lanren Changting has an extensive catalog and recording capabilities to produce more audiobooks and provide users with a better audio experience.
Quelle: https://www.liqucn.com/rj/25472.shtml
Other Music Services
- Sells music-related goods (including Kugou headphones, smart speakers).
- Services that help smart device and car manufacturers develop and run their own music services on their devices and vehicles
- Online ticket sales services for music events
Quelle: https://ir.tencentmusic.com/financial-Results
Revenue sources
TME has diversified its revenue sources across four different segments.
Music subscriptions
TME currently offers users subscription packages for its QQ Music, Kugou Music, and Kuwo Music products.
Basic subscription packages cost 8 RMB per month for a fixed number of downloads per month.
Users can also subscribe to premium memberships priced from 15 to 18 RMB per month to access a range of additional features and privileges, including additional personalized app themes, more audio settings that enhance the listening experience, video downloads, unlimited playlist storage, and faster streaming and download speeds.
Advertising
TME offers various advertising services in the form of full-screen ads that appear automatically when a user opens the mobile applications, as well as industry-standard banner ads in various sizes.
Content sublicensing
Due to the many exclusive licenses held by Tencent Music, the Company is able to sublicense certain licensed content to other online music platforms. The licensing and distribution agreements are mostly set at a fixed price for one year. However, the agreements are renewable if both parties agree.
Quelle: https://ir.tencentmusic.com/download/2Q21+TME+Investor+Presentation.pdf
Social entertainment services
TME derives its revenues from online karaoke and live streaming services primarily from the sale of virtual gifts, including consumable, time-based and durable virtual items.
Consumable virtual items are primarily used as gifts sent to online karaoke singers and live streaming performers by the audience during their performance to show their support and appreciation for the performance. During live streams, special visual items, such as diamond rings or cars, are displayed on the screen when these gifts are sent to the singers or performers.
In addition to selling virtual gifts, TME also generates revenue from online karaoke and live streaming services through the sale of premium memberships. For online karaoke, they include higher resolution soundtrack and access to video clips with vocal exercises. For live streaming, these privileges include enhanced status and visibility when users interact with live streaming performers and other users. In addition, select live streaming artists can produce and sell their own digital albums through the TME platform if they share a portion of their revenue with TME. Revenue generated on the platform is shared with karaoke singers and live streaming artists or their agents, generally based on a percentage of revenue from the sale of virtual gifts attributable to their performance.
In addition, similar to advertising on their online music apps, they offer various advertising services on their online karaoke platform.
The sale of music-related merchandise, including Kugou headphones, smart speakers, WeSing karaoke microphones, and hi-fi systems, is also included in this segment.
Growth opportunities
Market leadership
When it comes to music industry leadership, Tencent dominates the Chinese online music entertainment apps in terms of monthly active users. A look at the chart shows that Tencent Music takes the first three places with its apps.
Tencent Music Entertainment has more than 60 million music titles on its platform and has hundreds of national and international music labels as partners, which distinguishes the company from its competitors. The company’s strategic interests in other players in the industry ensure that they have exclusive licenses for many music titles.
Quelle: https://kr-asia.com/key-stat-tencent-acquires-10-stake-in-newly-listed-warner-music-group
The figure above shows that Tencent owns 9.1% of Spotify, 10% of Universal Music Group, and 10.4% of Warner Music Group. As of June 30, 2020, Tencent Music Entertainment claims to have over 40 million licensed tracks, enabling the company to attract and retain monthly active users for its mobile music applications. For Tencent Music Entertainment’s licensing agreements with major music labels, the strategic holdings are very important.
Moreover, the exit of Xiami Music Apps, which was backed by Alibaba in February, is further evidence of Tencent Music Entertainment’s market dominance in the music industry. It shows how hard they are making it for competitors to keep up in this space.
Low Paying-Ratio
Comparing the paying ratios (share of paying customers) of Spotify and Tencent Music Entertainment, Tencent Music Entertainment has a very low ratio, as only 10.6% of its total monthly active users are premium subscribers. Spotify, on the other hand, has a paying ratio of 45.2% (as of Q2 2021). This suggests that there is still room for Tencent Music to monetize its users and convert them from free to premium subscribers. This will drive revenue growth for Tencent Music.
Quelle: https://ir.tencentmusic.com/financial-Results
Quelle: https://s22.q4cdn.com/540910603/files/doc_financials/2021/q2/Shareholder-Letter-Q2-2021_FINAL.pdf
The reason Tencent Music has a very low paying ratio compared to Spotify is due to different consumer behavior in China than in other developed countries. Users in China have historically had a relatively lower willingness to pay for music than in other developed markets. Therefore, in the past, Tencent Music mainly focused on providing attractive music content and features for its online music services to cultivate users’ habits and willingness to pay in the long term. I believe that as the Chinese economy grows, the company’s payment rate will also continue to increase.
Growing market
Der chinesische Markt für Online-Musikunterhaltung besteht hauptsächlich aus Online-Musikdiensten, Online-Karaoke, musikbezogenem Live-Streaming, Online-Werbung und Online-Musik-Urheberrechtsgeschäften. Zu den Online-
Music entertainment services include online music services, online karaoke, and music-centric live streaming. It is also a very dynamic market that allows Chinese consumers to interact with music in a variety of ways, such as discovering, listening, watching, singing, and socializing.
According to iResearch, the total size of China’s online music market will reach approximately RMB 215.2 billion in 2023, representing a CAGR of 24.8% from 2021 to 2023. In my opinion, a market that grows at a rate of 24.8% is considered to have a very high growth rate. It is likely that the market will continue to grow at a double-digit rate in the future. One reason for this is the growth in prosperity in China, which I will explain in the next section.
Tencent Music generates RMB29 billion in FY2020, accounting for 27.5% of the total Chinese online music entertainment market. This is a huge market share, and I believe Tencent Music’s market share will continue to grow due to their dominance in the industry. There is still room for them to tap into.
Growing middle class
With over 1.4 billion people, China has a large sales market with a growing demand for music entertainment. However, many people in China did not see value in paying for music.
Spending on music entertainment has been relatively low in China.
This is because many Chinese still live in rural areas compared to developed countries like the United States. Rural areas are mostly in the mountains, and these areas lack basic amenities. As a result, they do not think it is necessary to spend money on music entertainment. If we compare the urbanization rates of China and the United States, we can see that China’s urbanization rate reaches only 60.6% in 2019, while the urbanization rate of the United States is 82.46% in 2019, according to Statista. As more and more cities become urbanized and people’s purchasing power increases, I believe the Chinese music entertainment market will grow rapidly.
Quelle: https://urbantransitions.global/wpcontent/uploads/2020/05/China%E2%80%99s_New_Urbanisatio
Quelle: https://www.statista.com/statistics/269967/urbanization-in-the-united-states/
A look at the Chinese government’s policies shows that it is lifting more and more people out of poverty. The country has invested nearly 1.6 trillion yuan in poverty alleviation in the last eight years of the Xi JinPing era. As a result, Xi JinPing declared in 2021 that extreme poverty has been eradicated in China, and this is a remarkable path that no other country in the world has been able to achieve. The graph below shows that the percentage of rural residents living below the poverty line has dropped from 10.2% in 2012 to 0% in 2020.
Quelle: https://news.cgtn.com/news/2019-10-17/Graphics-Ending-China-s-poverty-by-2020-KREfWKGkIU/index.html
Since Xi Jinping was elected General Secretary of the Communist Party of China (CPC) Central Committee in late 2012, he has conducted more than 80 inspections in rural areas. Xi said that eradicating poverty has always been one of his government’s main tasks.
Having succeeded in lifting people out of extreme poverty, the CP’s next goal will be to achieve general prosperity in the country, where there is no person who is extremely rich or extremely poor. A person with a middle income is one of the most important factors for the growth of the country. This is to increase the purchasing power of the country and thus boost the country’s economy for a longer period of time.
Quelle: https://www.bloombergquint.com/china/xi-doubles-mentions-of-common-prosperity-warning-china-s-rich
I believe that as more and more people move up into the middle class and their purchasing power grows, they will realize the value of paid music entertainment and spend more money on entertainment. The Chinese government’s policies will benefit not only Tencent Music in the long run, but also the country’s economic growth.
Of course, the prerequisites for this are that the Communist Party continues to allow largely free trade and does not severely restrict the economy.
Risks
Government regulation
China has been cracking down on tech companies lately, and Tencent Music has also been hit due to its dominance in the country’s online music streaming business. Tencent Music was ordered by Chinese antitrust authorities to end its exclusive music licensing agreements with global record labels within 30 days and fined 500,000 yuan.
TME has maintained its competitive advantage in an expensive music library through alliances with the world’s biggest music companies. Tencent Music, Sony Music Entertainment and Warner Music Group have all sold exclusive rights to their catalogs to Tencent Music, which can then be sublicensed to other music streaming competitors through Tencent. Competing platforms such as NetEase must pay two to three times the reasonable cost of the content in such agreements. In order to limit this unfair competition, Chinese antitrust authorities have decided to intervene and prevent Tencent Music from taking such a step again. Tencent Music must give up its exclusive music rights within the next 30 days, as well as its high upfront payments and other copyright fees for music content.
These antitrust regulations will undoubtedly affect Tencent Music’s dominance in the music industry, as the company has recently lost its competitive advantage over its network music rivals. However, Tencent Music is still the largest music streaming app in China in terms of monthly active users. I believe the company’s competitive advantages, such as the network effect and the Wechat ecosystem, can bring more users to its music platform. In my opinion, Tencent Music’s fundamentals are still excellent, and I believe the company will continue to dominate the industry. However, we must always keep an eye on the new regulations from China’s antitrust authority, as the regulations are not yet finalized. If we look at Tencent’s Q2 Earning Call Transcript 2021, they are warning investors that more regulation will come from China, and that is something investors need to watch out for when investing in Chinese companies.
Quelle: Tencent Q2 2021 Earning Call Transcript
As long as the government’s antitrust policy does not have too much impact on the company’s fundamentals, I think it will be fine in the long run. Should the Chinese antitrust authorities force the company to split up one day, the thesis would have to be re-examined.
VIE structure
Almost every Chinese company listed in the United States uses a variable interest entity (VIE) structure. Investors who purchase shares in Chinese companies on the U.S. stock exchange do not have a stake in the underlying company. They merely receive a certificate that provides for profit sharing. However, they do not have ownership rights. Theoretically, the Chinese state government could nationalize companies without paying compensation, as investors would not be entitled to it.
A delisting of Chinese companies from the U.S. stock exchange could be a severe blow to investors, as it would be difficult for them to get their money back because they only own the contract and not the underlying shares of the company.
No global expansion
Tencent Music’s operations are essentially in China. It is good that Tencent Music is well positioned in a country whose economy has experienced significant growth in recent decades. However, the lack of diversification of its business outside of China makes the company dependent on economic and regulatory conditions in China. Chinese government policies or laws and regulations in China could have a material adverse effect on the Company’s business.
Currently, Tencent Music has no intention to expand overseas. Therefore, we need to study the government policies and economic conditions of the country to assess the risk of investing in Tencent Music.
Fundamentals
Looking at the company’s history over the past five years, the company’s revenue growth is amazing. The company increased its revenue from RMB 4,361 million in FY16 to RMB 29,153 million in FY20, representing an average growth rate of 60.8% from FY16 to FY20, which is huge.
Apart from that, the company is one of the largest music streaming companies that is profitable, unlike Spotify which is still losing money.
We can see the company’s net profit increase from RMB68 million to RMB2,845 in FY2020. This represents a CAGR of 154% from FY16 to FY20.
The company’s gross profit margin has also increased since FY16, from 28% in 2016 to 31.9% in 2020, indicating that the company is becoming increasingly efficient as it is able to generate more revenue with fewer resources. Currently, the company’s gross profit margin is above 30%, which I think is a good sign as it is higher than the industry average. Looking at Spotify’s gross profit margin from FY 2020, it is currently around 25%, which is lower than Tencent Music. In addition, the company’s net profit margin has increased from 1.5% in 2016 to 9.7% in 2020. This is a good sign that the company is doing well and is able to generate more income for its shareholders as the company becomes more efficient.
Quelle: VI Apps
The company’s return on equity in 2020 is 5.9%, which is considered rather low. This low return on equity may be due to Tencent Music’s business model. Acquiring music licenses requires a large amount of capital, so the return on equity is depressed. Of course, it may also be due to management’s inability to use equity as efficiently as possible.
In summary, it is a very good P&L with increasing sales, revenues, profit margins and net profit margins. Only the ROE figure is rather disappointing.
As of the second quarter of 2021, the company has a current ratio of 2.88, meaning that current assets exceed current liabilities by more than double.
TME currently has a net cash position of $22,338 million, which can cover its $5,443 debt. Tencent Music’s balance sheet is very strong, and I do not see any financial risks.
Quelle: VI Apps
The company has very strong cash flow position with a steady increase in free cash flow in recent years from RMB832 million in FY16 to RMB4,777 million in FY20.
However, the company’s free cash flow decreased slightly in FY20, but this is not yet a cause for concern as the company continues to invest its money in its business. The balance sheet shows that TME is a very good cash-generating company.
Quelle: VI Apps
Valuation
The best way to value the company is to use DCF and PE ratios, as it is profitable and the company’s free cash flow is growing steadily
Assuming an average P/E of 20 for the company in 2025 in the base case scenario, the target price in 2025 is $11.49.
In the best-case scenario, which assumes an average P/E ratio of 25 for the company in 2025, the target price in 2025 is $14.3.
DCF-Analyse
Projecting free cash flow at a required rate of return of 10% and a perpetual growth rate of 2.5% for the DCF valuation yields a fair value of $8.27, or $10.13 if cash held by the company is included.
Conclusion
Tencent Music Entertainment Group is the largest online music entertainment platform in China and has a broadly diversified product portfolio.
The Group has more than 60 million music titles on its platform, giving it a dominant market position. The company’s strategic investments in other industry players mean that it holds exclusive licenses for many music titles.
The low paying ratio shows that there is still room for Tencent Music to monetize its users and turn them from free to premium subscribers. Also, the rising affluence in China, would greatly benefit the group.
Fundamentally, the company is very well positioned and undervalued at the moment. This discount to the fair value has its reason in the Chinese policy, which is classified by the market as risky for investors. It is not possible to give a general answer as to whether this discount is justified, but everyone must decide for themselves how high they want to weight political risks.
Personally, I attach above-average importance to legal certainty. Therefore, I generally avoid VIE structures and have never invested in Chinese stocks.
Here, however, I make no claim to truth that must apply to everyone. If you are aware of the political risks and are prepared to take them, you can generate above-average returns if the fundamentals continue to develop well.