Please ensure Javascript is enabled for purposes of website accessibility

Tencent Music’s Biggest Growth Engine Sputters Out During the COVID-19 Crisis

By Leo Sun – Updated May 13, 2020 at 4:11PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Fewer people are buying virtual gifts for live streamers as the pandemic throttles discretionary spending.

Tencent Music (TME 2.46%), China's top music streaming company, recently posted its first-quarter earnings. Its revenue rose 10% annually to 6.31 billion yuan ($891 million), which beat estimates by $3 million but marked its slowest growth since its IPO in late 2018.

Its net income fell 10% to 887 million yuan ($125 million). Its adjusted net income, which excludes stock-based compensation and other variable expenses, dropped 8% to 1.1 billion yuan ($156 million), or $0.09 per ADS, which still matched analysts' expectations.

Tencent Music's numbers weren't terrible, but they suggest it wasn't immune to the COVID-19 headwinds. The pandemic tossed a wrench into its core growth engine, the social entertainment segment that houses its live streaming business.

A young woman listens to music on her headphones.

Image source: Getty Images.

How did COVID-19 hurt TME's social entertainment unit?

Tencent Music generated 68% of its first-quarter revenue from its "social entertainment and others" unit, which makes most of its money from live-streamed karaoke performances on its WeSing platform. Viewers buy virtual gifts for their favorite performers, who receive a cut of the revenue.

This business attracted new mobile monthly active users (MAUs) during the quarter, but its sequential growth in paid users remained sluggish and its average revenue per paid user (ARPPU) declined sequentially and annually.

Social Entertainment

Total

Growth (QOQ)

Growth (YOY)

Mobile MAUs

256 million

15%

13%

Paid Users

12.8 million

3%

19%

ARPPU

111.1 yuan

(20%)

(13%)

Revenue

4.27 billion yuan

(17%)

3%

QOQ = Quarter-over-quarter. YOY = Year-over-year. Source: TME Q1 report.

It attributed its declining revenue per user to weaker viewer spending during the pandemic, adjustments related to inactive users, and a tough sequential comparison to its annual awards gala last December.

A young woman sings karaoke into her phone.

Image source: Getty Images.

WeSing continued to attract viewers and performers, but it also relied more heavily on aggressive promotions aimed at paying users and higher revenue-sharing agreements with broadcasters -- which both dented the segment's gross margin.

But on the bright side, CEO Cussion Pang noted the social entertainment unit experienced a "moderate recovery" as the Chinese economy reopened, and it expected "healthy" ARPPU growth for the rest of the year.

It's also expanding the platform's ecosystem with a video game streaming partnership with Tencent (TCEHY -0.06%) Games, which started in April, and the upcoming launch of QQ Music Live, a new streaming platform tethered to Tencent's QQ messaging platform, in June. However, those efforts could also dilute WeSing's identity and force Tencent Music to compete more aggressively against other live streaming platforms in China.

What happened to the online music business?

The rest of Tencent Music's revenue came from its online music business, which sells streaming subscriptions and digital downloads to consumers, and sub-licenses its songs to other companies. The online music unit grew its MAUs, paid users, and ARPPU in the first quarter, but its total revenue still dipped sequentially:

Online Music

Total

Growth (QOQ)

Growth (YOY)

Mobile MAUs

657 million

2%

0%

Paid Users

42.7 million

7%

50%

Subscription Revenues

1.21 billion yuan

9%

70%

ARPPU

9.4 yuan

1%

13%

Revenue

2.04 billion yuan

(5%)

27%

QOQ = Quarter-over-quarter. YOY = Year-over-year. Source: TME Q1 report.

That decline occurred as its sub-licensing business, which was scrutinized by regulators after rivals like NetEase (NTES 1.14%) and Alibaba (BABA 0.57%) accused it of gouging prices, experienced a slowdown that offset its stronger growth in subscription and advertising revenue.

That growing mix of higher-margin subscription revenue is gradually boosting the segment's gross margin and reducing its dependence on lower-margin ads. However, the company's total gross margin still contracted 410 basis points annually to 31.3% during the quarter as the social entertainment unit's margin contraction offset the online music unit's gains.

Are Tencent Music's high-growth days already over?

Tencent Music didn't provide any guidance for the rest of 2020, but analysts expect its revenue to rise 18% and for its earnings to dip 5% this year. Those growth rates are mediocre for a stock that trades at nearly 30 times forward earnings, and it explains why Tencent Music remains below its IPO price of $13 a share.

Tencent Music's jarring drop-in social entertainment revenue indicates its core growth engine isn't immune to macro headwinds. Meanwhile, its online music business faces an uncertain future if its sub-licensing business is forced to further lower its fees.

I called Tencent Music a coronavirus-resistant stock two months ago, but its messy first-quarter report raises too many red flags. It's still a more profitable streaming company than Spotify, which owns a major stake in Tencent Music, but the stock remains too pricey relative to its near-term growth potential.

 

Leo Sun owns shares of Tencent Holdings. The Motley Fool owns shares of and recommends Alibaba Group Holding Ltd., NetEase, Spotify Technology, and Tencent Holdings. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Tencent Music Entertainment Group Stock Quote
Tencent Music Entertainment Group
TME
$4.16 (2.46%) $0.10
NetEase, Inc. Stock Quote
NetEase, Inc.
NTES
$76.46 (1.14%) $0.86
Tencent Holdings Limited Stock Quote
Tencent Holdings Limited
TCEHY
$33.80 (-0.06%) $0.02
Alibaba Group Holding Limited Stock Quote
Alibaba Group Holding Limited
BABA
$80.45 (0.57%) $0.46

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
326%
 
S&P 500 Returns
102%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/04/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.