Chinese tech giant Tencent (TCEHY 1.32%) plans to spin off its streaming music unit, Tencent Music Entertainment (TME), in a U.S. IPO, according to a recent company filing. This move would be surprising, since shares of Tencent and its digital books spin-off, China Literature, only trade in Hong Kong.
Tencent hasn't released any additional details about TME's IPO yet, but previous reports suggested that the IPO could raise $1 billion and value the company at $30 billion. That would be comparable to Spotify's (SPOT 2.25%) market cap of $31 billion. Here are five main things investors should know about TME.
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1. It's China's largest music streaming platform
Tencent spun off its music division and merged it with China Music Corporation in 2016 to create TME. TME owns the top three music streaming platforms in China -- QQ Music, Kugou, and Kuwo -- which together generated 78% of the industry's market revenues in 2017, according to Soochow Security. Tencent owns 62% of TME.
2. It has fewer paid members than Spotify
TME has over 700 million monthly active users (MAUs). That makes it much bigger than Spotify, which finished last quarter with 170 million MAUs. However, TME only has 15 million paid subscribers, who pay fees of just $1 to $2 a month. Spotify had 75 million paid subscribers last quarter, who pay about $10 per month (depending on the region).
This indicates that TME still rakes in most of its revenues from advertising, which usually generates lower revenues per listener than premium subscriptions.
3. It's growing at an impressive rate
Tencent Music reportedly generated about $714 million in revenues in 2016. Internal filings cited by Chinese media outlets forecast 40% sales growth in both 2017 and 2018, which means the company could generate $1.4 billion in sales this year.
If those numbers are accurate, a $30 billion valuation could be too high since it would value the company at 21 times this year's sales. Spotify trades at just six times this year's sales.
Analysts believe TME posted and will post a net profit of $85 million in 2016, $227 million in 2017, and $358 million in 2018. Those growth figures are impressive, but the official numbers might look much different in TME's upcoming IPO filing.
4. It's Spotify's third-largest investor
Tencent tried to acquire Spotify last year, but those talks eventually broke down. Instead, TME and Spotify agreed to swap equity stakes in each other last December. TME now holds a 7.5% stake in Spotify, which makes it the company's third-largest shareholder after founders Daniel Ek and Martin Lorentzon. That stake is now worth about $2.4 billion.
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Spotify holds a 9% stake in TME, which could be worth about $2.7 billion if TME makes its market debut at $30 billion. Spotify stated that the deal would let it "invest in the long term potential of the music market in China and, in turn, TME to invest in the long term potential of the music market outside of China."
5. It has half as many songs as Spotify
TME offers 17 million songs, which is much smaller than Spotify's portfolio of over 35 million songs. However, TME is continuously expanding its portfolio with new streaming deals.
TME already owns streaming rights to songs from the three largest record labels in the world: Sony Music Entertainment, AT&T's Warner Music, and Comcast's Universal Music. It also owns the streaming rights to songs from South Korean label YG Entertainment and Taiwan's JVR Music and LOEN Entertainment.
Last year, TME granted Alibaba's Ali Music access to all its songs in exchange for the shared streaming rights to Alibaba's songs from Taiwan's Rock Records, HIM International Music, B'in Music, and Hong Kong's Media Asia. That move significantly expanded its collection of Chinese pop music.
The key takeaways
TME's IPO could represent a promising long-term investment, but investors should pay close attention the stock's valuations. They should also see if TME's profitability is still dependent on Tencent's support, or if the platform is strong enough to stand on its own. It TME looks like a wobbly investment, it might be smarter to just stick with Tencent instead.
