Shares of Tencent Music Entertainment (TME 3.19%) recently stumbled after the Chinese streaming music giant posted its second-quarter numbers. The headline numbers weren't too bad: Its revenue rose 31% annually to 5.9 billion RMB ($859 million), topping expectations by $18 million, as its adjusted net profit rose 6% to 1.1 billion RMB ($164 million), or $0.10 per ADS, beating estimates by two cents.
However, Tencent Music's slowing growth, contracting margins, and murky expansion plans spooked the bulls. Let's dig deeper into its second-quarter report to see if those concerns are justified.
Image source: Getty Images.
The online music business is losing momentum
Tencent Music generated 26% of its revenue from its online music streaming apps (QQ Music, Kugou, and Kuwou) and digital downloads during the quarter. However, revenue at the unit fell 3% sequentially as it lost monthly active users (MAUs), and that drop wasn't offset by an increase in its paid subscribers and monthly average revenue per paid user (ARPPU).
|
Online music |
Total |
QOQ growth |
YOY growth |
|---|---|---|---|
|
Mobile MAUs |
652 million |
0% |
1% |
|
Paid users |
31 million |
9% |
33% |
|
Subscription revenues |
798 million RMB |
12% |
32% |
|
ARPPU |
8.6 RMB |
4% |
(1%) |
|
Revenue |
1.6 billion RMB |
(3%) |
20% |
QOQ = Quarter-over-quarter. YOY = Year-over-year. Source: TME Q2 report.
Tencent Music's growth looks dismal compared to that of its closest rival, NetEase's (NTES -2.04%) Cloud Music. NetEase stated that users of its mobile app rose 50% annually to 800 million last quarter and that its subscriber base grew 135%, although it didn't disclose an exact number.
Tencent Music is gradually converting its MAUs to paid subscribers, but its low monthly ARPPU of 8.6 RMB ($1.22) indicates that it doesn't have much pricing power in this market. Spotify (SPOT 16.30%), which also owns a stake in Tencent Music, charges subscribers $5 to $10 per month in most markets.
On the bright side, the unit's 32% annual growth in subscriber revenue marked an acceleration from its 26% growth in the first quarter. Tencent Music stated that it will support that growth by launching more "membership privileges and differentiated services" for its paid members and expanding its services to other platforms like connected cars, smart speakers, and smartwatches.
It also believes that a recent redesign for QQ Music will improve its music recommendations and boost listener engagement rates, as tighter ties to Tencent's (TCEHY 3.22%) other services -- including Tencent Video, Tencent Pictures, and Tencent Games -- could tether more listeners to its apps. It's also looking for ways to expand its digital music services beyond China, but it could face a lot of competitors in that crowded market.
The social entertainment unit is still a growth engine
The remaining 74% of Tencent Music's revenue came from its social entertainment business, which generates most of its revenue from the live streaming karaoke app WeSing. Like other Chinese live video platforms, WeSing makes money when viewers buy virtual gifts for their favorite broadcasters.
Image source: Getty Images.
That business is still booming, with solid sequential and annual growth in MAUs, paying users, and monthly ARPPU -- which hit a whopping 130.2 RMB ($18.48) during the quarter.
|
Social entertainment |
Total |
QOQ growth |
YOY growth |
|---|---|---|---|
|
Mobile MAUs |
239 million |
6% |
5% |
|
Paid users |
11.1 million |
3% |
17% |
|
ARPPU |
130.2 RMB |
2% |
17% |
|
Revenue |
4.3 billion RMB |
4% |
35% |
QOQ = Quarter-over-quarter. YOY = Year-over-year. Source: TME Q2 report.
WeSing is integrated into Tencent's WeChat, the biggest mobile messaging platform in China with 1.1 billion MAUs worldwide. That integration, along with the rising popularity of its top streamers and in-app singing games, is boosting the app's engagement rates in China and new markets across Southeast Asia.
However, the unit's 17% year-over-year growth in ARPPU still marked a deceleration from its 28% growth in the first quarter. If that deceleration continues, the social entertainment unit's growth probably can't offset the ongoing slowdown at its online music business.
Declining margins and slowing profit growth
Unlike most other music streaming platforms, Tencent Music remains consistently profitable thanks to its higher-growth social entertainment unit and favorable licensing and investment agreements with record labels.
However, its gross margin still declined both sequentially and annually to 32.9% as it increased its ecosystem investments, licensed more content, and generated less revenue from its sublicensing business (which sublicenses songs from its record labels to other Chinese platforms).
That pressure caused its adjusted net profit growth to drop to the single digits for the first time since its December IPO, and that could be the new normal unless its revenue growth accelerates again. That's why investors weren't impressed by Tencent Music's second-quarter report, and why it's only hovering about 10% above its IPO price.
The company also didn't provide any guidance for the full year, which makes it tough to gauge its ability to counter growing challengers like NetEase Cloud Music. Therefore, I think investors who want exposure to Tencent Music should simply stick with Tencent, which retains a majority stake in the company within its well-diversified portfolio of businesses.
