Shares of Tencent Music Entertainment (NYSE:TME), the largest music streaming company in China, recently plunged after Bloomberg claimed that China's antitrust regulators had been investigating the company since January.

A government agency has reportedly been looking into TME's exclusive licensing deals with the three largest record labels in the world: Access Industries' Warner Music, Sony (NYSE:SNE) Music Entertainment, and Vivendi's (OTC:VIVHY) Universal Music Group.

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TME owns exclusive rights to a large number of songs from the "big three" labels. Last year, antitrust regulators ordered all music streaming platforms in China to share 99% of their streaming rights with each other via sub-licensing agreements.

TME's complied by sub-licensing its songs to rival platforms like Alibaba (NYSE:BABA) and ByteDance -- but Bloomberg's sources claim that TME's sub-licenses could be "twice as expensive" as direct licenses from record labels. TME's exclusive deals, however, blocked those companies from buying direct licenses.

This is admittedly a bad look for TME, which owns China's three largest streaming music services: QQ Music, Kugou, and Kuwo. But was the sell-off an overreaction?

Understanding Tencent Music's business

TME's growth decelerated significantly last quarter. Its revenue rose 31% annually, but that marked its slowest growth rate since its IPO last December. Its adjusted net profit grew just 6%.

Its online music business, which accounted for 26% of its top line, posted a 3% annual dip in revenue as its mobile monthly active users (MAUs) rose just 1%, to 652 million. Its average annual revenue per paid user (AARPU) also dipped 1% to 8.6 yuan ($1.20). The unit gained more paid users, which rose 33%, to 31 million, but that still represented less than 5% of its mobile MAUs. The unit generates most if its revenue from subscriptions, sub-licensing revenues, digital album sales, and ads.

Its social entertainment business, which generated 74% of its revenue, fared much better with 35% revenue growth. That segment makes most of its money from WeSing, a live-streaming karaoke app. Mobile MAUs on that platform grew 5%, to 239 million; its paid users rose 17%, to 11.1 million; and its AARPU jumped 17%, to 130.2 yuan ($18.17) -- boosted by sales of virtual gifts for broadcasters. TME tries to leverage the growth of this newer platform to offset the weaker growth of its online music business, which is struggling with the saturation of the streaming music market.

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How this probe could affect Tencent Music

TME doesn't disclose its sub-licensing revenue separately. But during last quarter's conference call, CFO Shirley Hu stated that the sub-licensing business was the online music unit's second-biggest revenue stream after paid subscriptions (51% of revenue) -- making it more important than ads or digital downloads.

Hu also noted that a "decrease in sub-licensing revenues" during the quarter offset its growth in music subscriptions and sales of digital albums. Hu also warned that TME's sub-licensing revenue will continue to decline and "heavily impact" its gross margin -- which already fell sequentially and annually to 32.9% in the second quarter.

Hu didn't mention the antitrust probe at all, even though Bloomberg's report suggests that it's dragged on for over seven months. Therefore, TME's rivals could merely have been waiting for antitrust regulators to force the company to cut its sub-licensing fees -- a major risk factor that the Tencent Music failed to disclose.

That lack of transparency raises serious questions about TME's management and the future of its high-margin sub-licensing business. It also casts a dark cloud over TME's proposed acquisition of a 10% stake in Universal Music Group -- a deal that could lower its content costs and strengthen its sub-licensing business.

This sell-off was justified

Tencent Music already disappointed investors last quarter with its slowing growth, contracting margins, and anemic earnings growth. Its lack of clarity regarding its sub-licensing business is troubling, and that revenue stream's margins could crumble if regulators force it to lower its prices for rival streaming platforms.

That, in turn, could curb its competitiveness in the streaming market as its rivals gain access to the same popular songs. Regulators could also cite the ruling to block TME's investment in Universal Music Group. Therefore, I believe that this sell-off was justified. TME might look tempting at its IPO price, but I can't trust this company until it comes clean to investors and clearly discloses its sub-licensing revenue.