The COVID-19 pandemic is crushing stocks globally, since the only apparent way to curb its spread (keeping people away from each other) is pausing economic growth. Yet there's a pocket of growth many investors are overlooking during the downturn: Chinese tech companies that generate most of their revenue from domestic streaming services.

One such company is Tencent Music Entertainment (NYSE:TME), the largest streaming music platform in China. TME isn't dependent on supply chains or consumer spending and it wasn't surprising when its fourth-quarter numbers beat analysts' estimates with accelerating revenue and earnings growth.

A young woman wearing headphones

Image source: Getty Images.

Its revenue rose 35% annually to 7.29 billion yuan ($1.05 billion), beating estimates by $40 million and marking its strongest growth in three quarters.

It posted a net profit of 1.04 billion yuan ($150 million), compared to a loss of 876 million yuan in the prior-year quarter. On a non-IFRS (adjusted) basis, its net profit rose 47% annually to 1.34 billion yuan ($193 million), or $0.12 per share -- which also beat expectations by two cents. Those numbers were solid, but the story gets even better when we dig deeper into its numbers and its guidance regarding the ongoing coronavirus crisis.

Converting free listeners to paid subscribers

TME generated 29% of its revenue from its online music unit, which offers streaming subscriptions and digital downloads.

The platform's annual growth in monthly active users (MAUs) stalled out at 644 million during the quarter, but its growth in paid users, subscription revenue, and ARPPU (average revenue per paid user) all accelerated from the third quarter. As a percentage of its MAUs, its paid users rose annually from 4.2% to 6.2%.

Online Music

Total

Growth (QOQ)

Growth (YOY)

Mobile MAUs

644

3%

0%

Paid users (millions)

39.9

13%

48%

Subscription revenue

1.11 billion RMB

17%

60%

ARPPU

9.3 RMB

4%

8%

Revenue

2.14 billion RMB

16%

41%

QOQ = Quarter-over-quarter. YOY = Year-over-year. Source: TME Q4 report.

CEO Cussion Pang attributed that growth to big licensing partnerships with music labels, strong sales of digital albums, robust ad sales, and the expansion of its portfolio with audiobooks from China Literature. Those growth engines easily offset a decline in its sub-licensing revenue, which comes from licensing its songs to other streaming platforms.

Those growth rates indicate that TME, which controls roughly three-quarters of China's online streaming music market, with its QQ Music, Kugou, and Kuwou platforms, isn't losing listeners to smaller rivals like NetEase's (NASDAQ:NTES) Cloud Music.

A stabilization in the social entertainment business

TME's social entertainment business, which includes its live-streaming karaoke platform WeSing, generated the other 71% of its revenue during the quarter.

The platform's user base shrank sequentially and annually, but its base of paid users continued to expand and they spent more money on virtual gifts and other value-added services. As a percentage of its total MAUs, its paid users rose from 4.5% to 5.6%.

Social Entertainment

Total

Growth (QOQ)

Growth (YOY)

Mobile MAUs

222 million

(8%)

(3%)

Paid users (millions)

12.4 million

2%

22%

ARPPU

138.5 RMB

9%

9%

Revenue

5.15 billion RMB

11%

33%

QOQ = Quarter-over-quarter. YOY = Year-over-year. Source: TME Q4 report.

That growth in paid users, which was supported by new content creators and live events, supported the unit's revenue growth of 33% -- which matched its growth rate in the previous quarter.

Improving margins and stable profits

TME's higher-margin social entertainment revenue offset the lower margins of its streaming and digital music platform, as well as its declining (albeit higher-margin) sub-licensing revenue. That balance enables TME to achieve consistent profitability -- a goal which Spotify (NYSE:SPOT), one of its top investors, still hasn't achieved. TME's dominance of China's streaming music market also gives it tremendous clout in negotiating favorable licensing fees from record labels.

Those tailwinds boosted TME's gross margin 10 basis points annually to 34.1% during the quarter. Its operating margin of 16.5% also marked a huge improvement from its negative operating margin of 18% (which included a one-time accounting charge) in the prior-year quarter.

TME doesn't offer guidance, but analysts expect its revenue and earnings to rise 25% and 36%, respectively, this year. Those are stellar growth rates for a stock that trades at less than 30 times forward earnings estimates.

During the conference call, Chief Strategy Officer Tony Yip stated that TME's first-quarter revenue would be pressured by lower ad spending during coronavirus-related lockdowns and adjustments to its live-streaming platform for compliance reasons, but that it was "taking steps to mitigate these impacts" and expects its "revenue growth to improve into the second half." That forecast suggests that the coronavirus crisis is passing in China as businesses come online again.

Is it the right time to buy Tencent Music?

Tencent Music currently trades below its IPO price of $13, and its core market is gradually recovering from the coronavirus crisis. It dominates the streaming music market, its growth rates remain robust, and its margins and profits are improving.

Therefore, I believe investors should accumulate shares of TME throughout the market swoon, since it deserves to go much higher once the crisis finally ends.

 
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.