Tencent Music Stock: Monopoly Trading at an Updated Valuation

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Tencent Music Entertainment Group (NYSE: TME), China’s largest online music entertainment platform, has seen an extraordinarily weak share price performance over the past year as it shifts away from social entertainment amid a broadcast increased live regulation. That said, the stock is oversold, in my view – excluding its Spotify-listed holdings (SQUARE), UMG (OTCPK:UMGNF) and Warner Music (WMG) as well as its net cash position, TME stock is trading at a heavily discounted P/E of around 7x despite a net cash balance and growing long-term earnings stream. TME management appears to be in agreement – the company has already rolled out ~$553m in buybacks in 2021 of its $1bn authorization and could ramp things up even further given the share price decline since then. the beginning of the year. Basically, TME is also ready for a secondary listing in Hong Kong, having met the HKEX secondary listing requirements for companies with weighted voting rights (> HK$10 billion in market capitalization and > HK$1 billion in sales in 2021). Given that a secondary listing will convert ADRs into Hong Kong shares in the event of a US delisting, I expect confirmation of a HK listing to catalyze a re-listing in the coming months. .

Evaluation

millions of dollars

TME 100%

9,072

-Spotify 2.5%

765

-UMG 1%

491

-WMG 0.8%

156

– Net cash (2021)

2,745

= TME Base Market Cap

4,915

Core TME 2021 P/E adjusted

7.2x

Source: Market data (April 4, 2022), TME Disclosures, author

Massive TAM Online Music Opportunity Boosts TME’s Growth Potential

As a music-based entertainment platform (rather than a pure Spotify-like music streaming service company), TME offers investors exposure to a massive user base of >620 million users monthly assets (MAU) of online music and >200 million MAU of social entertainment. . Thus, TME’s track in China is far larger than that of pure music streaming companies like Spotify. In essence, TME is a monopoly – it dwarfs its only other competitor in China, NetEase Cloud Music, whose customer base is focused on smaller niche groups. The TME moat extends beyond its rich music library, given its close ties to parent company Tencent as well as cross-shareholdings with major labels and Spotify, paving the way for deeper collaboration opportunities at the future.

Basically, the Chinese customer base is growing, not only in numbers, but also in terms of disposable income and willingness to pay for music content. This rings especially true among the younger generation – the days when pirate music streaming was the go-to place for music in China are over, with most people now opting for music streaming services with licensed music content. Consistent with this trend, TME’s online music payout rate increased to 12.4% last quarter (from 2.9% in 2017), driven by a net addition of approximately 5 million QoQ users . Overall, subscription revenue remains the bright spot for TME at RMB 2 billion in 4Q21 (+23% YoY) thanks to strong paid user growth and stabilizing ARPU. While music licensing costs are set to decline as TME continues to grow, the online music segment is on track to break even in operating profit by the end of the year .

The social entertainment segment hits a speed bump

Unlike the fast-growing online music segment, the social entertainment sector is going through a tough phase – revenue suffered its second consecutive quarterly decline at -15.2% YoY, reaching RMB 4.7 billion in 4Q21 . The weakness was driven by a decline in the number of paying users to 9 million (-17% YoY) as user engagement worsened alongside a contraction in live streaming MAUs. While the year-over-year decline was partly attributable to an unfavorable base effect, the diminished effectiveness of monetizing the virtual donation model following tighter regulation is the primary concern, along with winds macroeconomic opposites for open-screen advertising. While revenue will likely be under pressure in the coming quarters, management is exercising discipline in cutting content and marketing spend to keep margins at 2021 levels. Although the additional revenue contribution from live streaming from QQ Music may provide some compensation, regulatory adjustments and competition from short-form video platforms mean that a single-digit decline is likely fair for TME’s social entertainment revenue outlook after 2022.

Long-term initiatives are optional; Reduces investment case risk

To its credit, TME management is mitigating the slowdown in live streaming by investing in innovative product features on social karaoke app, WeSing, as well as new initiatives across audio and streaming. long-term, virtual interactive products and international expansion. TME is also ramping up its original content production efforts, with No. 1 hits such as “Lonely City” in the “Chinese Ancient Style” category generating around 1 billion streams in 4Q21 alone. Its network of independent musicians is also on the rise – Tencent Musician Platform reached ~300,000 in its last quarter, paving the way for more live performances in the years to come. The main medium-term opportunity, in my view, is in Long Play Audio (LFA), where MAU has already exceeded 150 million (+63% YoY). Assuming this trajectory continues, TME looks set to break even at the gross margin level in 2022, although it continues to find ways to expand monetization and control content costs. Given TME’s support from Tencent and its net cash balance sheet, I also see many synergies and expansion opportunities from partnerships or external M&As (e.g. the recent acquisition of M&E Mobile, which operates Japan’s leading karaoke app, Pokekara). Finally, a potential secondary listing on the Hong Kong Stock Exchange is underway, likely through a direct listing (i.e. without offering new shares) – if successful, a listing in Hong Kong should insure against a potential delisting scenario in the United States and thus ensure continued access to capital markets in the future.

Online music entertainment monopoly trading at a heavily discounted valuation

TME’s latest quarter outlined all of the fundamental challenges it continues to face, as music net additions are guided to slow to a rate of 3.5-4 million/quarter in 2022 (from 5 million in 2021 ) in an environment of competition and regulatory headwinds. That said, context is key – this is still a company with a wide moat and a healthy earnings stream, so the current valuation is confusing, in my view. Excluding its listed holdings (Spotify, UMG and WMG) and net cash balance, TME stock trades at a discounted price of approximately 7x adj. P/E although still on track for earnings growth after a two-year transition into social entertainment. With management actively buying back shares and a potential secondary listing underway (TME already meets HKEX requirements), TME has no shortage of revaluation catalysts.

Tencent Music revenue and profit projections

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Source: TME Disclosures, author