Key points to remember:

• Tencent Music’s net profit jumped 38.7% in the third quarter to more than 1 billion yuan as its paid user base grew nearly 20%
• The company reduced its reliance on ads and other services by increasing its subscription services to give it a more balanced revenue mix.

By Ken Lo

After a turbulent time, the Chinese equivalent of Spotify is finally singing a business model that sounds like music to investors’ ears.

At first glance, Tencent Music Entertainment Group TME the latest quarterly earnings report looks a little worrying. Indeed, its revenue fell 5.6% to 7.37 billion yuan ($1.03 billion) in the third quarter, mainly due to a 20% drop to 3.94 billion yuan for its main income from social entertainment and other services. But a closer look showed that more and more users are realizing that good music comes at a cost, leading to a 19.8% increase in its paid music customer to 85.3 million and a similar growth of 18.3% in music subscription revenue to 2.25 billion yuan. This means that subscription revenue now accounts for two-thirds of the company’s total from online music services.

As its paid music business grew, Tencent Music recorded non-IFRS adjusted net profit and net profit of 1.41 billion yuan and 1.06 billion yuan, up 32.7% and 38, 7%, respectively, exceeding market expectations.

A report from BofA Securities said the company’s profits are set to increase further as it enters into profit-sharing agreements with more small and medium-sized music companies, cuts fixed costs with major music companies and achieves more balanced growth. With that kind of strong outlook, the bank gave Tencent Music an “overweight” rating with a target price of $8.30 for its New York-listed stock.

Investors hailed the upbeat report, with shares of Tencent Music soaring 30.6% in New York to $5.81 after its latest earnings release last week. Its Hong Kong-listed shares rose nearly 29% the next day, hitting a record high of HK$23.30 at one point. But the good news was muted by the subsequent announcement that Tencent Music’s parent, Tencent (700.HK), would distribute most of its stake in the internet takeaway giant Meituan (3690.HK) as a special dividend for its shareholders, which has the market worried it could make a similar reduction in its holdings in Tencent Music. As a result, New York shares of Tencent Music fell 9.3% in New York in the aftermath of the big rally.

safe at home

The saying goes “music knows no boundaries” and competition is fierce in the global music streaming industry. But Tencent Music has an advantage over global rivals by doing most of its business in its home market of China, where big names like Apple Music, Amazon Music and YouTube Music have little or no presence. As a result, most of the global big names are facing tough times to turn a profit, including the major live-streaming platform. Spotify Technology PLACE, which has recorded losses over the past three years. In contrast, Tencent Music has been profitable by becoming the top player in its home market in China, where a growing percentage of its users are willing to pay for its online music services. This helps the company reduce its heavy reliance on advertising and other revenue, which investors have welcomed.

Tencent Music’s latest financial data also shows that its gross profit rose 4.1% year-on-year in the third quarter to 2.4 billion yuan, and its gross margin rose three percentage points to 32, 6%, well ahead of Spotify’s 24.7%. The company attributed its improved gross margin to effective content cost controls, including revenue share costs for its live streaming business, improved operational cost efficiencies as well as rising revenue from album sales. digital.

Comparing the results of the third quarter of this year with those of 2019, the year before the Covid-19 pandemic, highlights the changes in the commercial structure of the company. Its music subscription revenue in the third quarter of this year totaled 2.25 billion yuan, more than double the same quarter three years ago. Meanwhile, its revenue from social entertainment and other services fell 15.5% over the same period, so the company’s total revenue grew only 13.2% in during this period.

The shift in business mix comes a year after Tencent Music was fined a relatively light 500,000 yuan for monopolistic practices that led it to sign China master licensing deals with many big names. global music labels, making it the guardian of all their music in the market. As a result of the fine, the company dropped all such agreements and must compete more directly with its domestic counterparts, although it got rid of the significant costs of master licensing agreements.

Price increase

Tencent Music CFO Hu Min said at the earnings briefing that the company’s average revenue per user (ARPU) fell from 8.5 yuan in the second quarter to 8.8 yuan in the second quarter. third, and that figure is expected to increase further in the fourth quarter as the company refines its pricing strategies. She added that she was confident the company’s gross margin for its online music business would also increase as its subscription revenue increased and cost-cutting efforts continued to bear fruit.

Live music platforms relied heavily on advertising, encouraging them to expand their user bases to appeal to advertisers. But high costs have kept many people from enjoying the benefits. To get closer to profits, many global music companies are now stepping up their user subscription services and raising prices in hopes of creating a more sustainable and profitable revenue structure. Although already profitable and not competing with global companies, Tencent Music is also part of this wave in an increasingly competitive Chinese music landscape.

In January, the French live music platform Deezer (DEEZR.PA) raised prices in its local market. Apple Music, the most expensive service provider in the industry, has increased the monthly fee for its family plan to $16.99. And Amazon Music has raised the price to $15.99, remaining $1 cheaper than its main competitor Apple Music.

Most of Tencent Music’s global peers are owned by global tech giants, leaving Spotify and Deezer as the only two independent companies for direct valuation comparisons. The pair has price-to-sales (P/S) ratios of 1.38 times and 0.95 times, respectively, which is lower than Tencent Music’s 1.76 times. But that’s probably because Tencent Music is the only one of the group to be profitable due to its dominance in a lucrative Chinese market that is relatively closed to major global operators.