Spotify (NYSE:SPOT) and Tencent Music Entertainment (NYSE:TME) are two of the world's largest streaming music companies. Spotify, which is based in Sweden, serves 365 million monthly active users (MAUs) across most of the world, but doesn't operate in mainland China.
That's because Tencent Music, which hosts 623 million mobile MAUs on its streaming music platform, dominates the mainland Chinese market. Its social entertainment platform, which revolves around its live streaming karaoke app WeSing, hosts an additional 209 million mobile MAUs.
Spotify and Tencent Music's markets don't overlap, but they're invested in each other through a share swap deal. However, Spotify has fared much better since its public debut than Tencent Music.
Spotify went public via a direct listing in April 2018. Its stock opened at $165.90, far above its reference price of $132, and is currently worth about $220 per share. Tencent Music went public at $13 per share in Dec. 2018, but it's now trading at less than $8 per share. Let's see why Spotify generated stable returns while Tencent Music's stock collapsed, and whether or not it's still a better long-term investment.
Spotify's business is stable but unprofitable
Spotify's revenue rose 16% to 7.88 billion euros ($9.24 billion) in 2020, then grew 20% year over year to 4.48 billion euros ($5.25 billion) in the first half of 2021. Spotify generates most of its revenue from paid subscriptions, which remained stable throughout the pandemic, but the crisis temporarily throttled its growth in ad-supported revenue.
Spotify's MAUs rose 22% year over year to 365 million in the second quarter of 2021. Its paid premium subscribers rose 20% to 165 million. Both growth rates decelerated slightly from the previous quarter.
Spotify's net loss widened from 186 million euros ($218 million) in 2019 to 581 million euros ($682 million) in 2020. But in the first half of 2021, its net loss narrowed from 355 million euros ($416 million) to 84 million euros ($99 million) as its advertising business recovered, it benefited from a revenue shift from lower-margin licensed music toward higher-margin podcasts, and reined in its marketing expenses.
For the full year, Spotify expects its total MAUs to grow 16%-18%, and for its number of premium subscribers to rise 14%-17%.
Spotify believes its full-year revenue should rise 18%-23%, but also for its operating losses in the second half to wipe out its slim operating profit of 26 million euros ($30 million) in the first half of the year. In short, Spotify's growth should remain stable, but it won't turn profitable anytime soon.
Tencent Music's business is profitable but unstable
When Tencent Music went public, some investors considered it to be a better streaming music stock than Spotify because it was firmly profitable.
Tencent Music stayed in the black by subsidizing its online music platform with its social entertainment platform. Simply put, it let its live streaming and karaoke fans purchase virtual gifts for their favorite entertainers, and used that higher-margin revenue to offset its higher music licensing costs.
Unfortunately, its social entertainment segment has posted year-over-year declines in mobile MAUs for five consecutive quarters, while its number of paying users has fallen for three straight quarters. That ugly slowdown can be attributed to competition from short video apps like ByteDance's Douyin (known as TikTok overseas) and other live streaming platforms.
That slowdown pressured Tencent Music to aggressively convert the online music segment's free users to paid ones. That strategy consistently boosted the platform's paid users, but it's also been losing mobile MAUs over the past five quarters, and its average revenue per paying user remains stagnant.
Tencent's revenue rose 34% to 25.43 billion yuan ($3.65 billion) in 2019, then grew 15% to 29.15 billion yuan ($4.47 billion) in 2020. Its revenue rose 19% year over year to 15.83 billion yuan ($2.45 billion) in the first half of 2021 as it gained more paying online music subscribers.
Its adjusted earnings grew 18% in 2019, rose 1% in 2020, and only increased another 1% year-over-year in the first half of 2021. Analysts expect its revenue to rise 11% this year, but for its earnings to drop 21% as it loses more higher-margin social entertainment users and surrenders its exclusive music licensing rights to appease China's antitrust regulators.
The valuations and verdict
Spotify trades at about four times trailing 12-month (TTM) sales, while Tencent Music trades at less than 7.3 times sales. Both stocks look cheap, but Tencent Music deserves to trade at a low valuation because its profit engine has stalled out and its loss of exclusive licensing music rights will narrow its competitive moat. Meanwhile, Spotify's shift toward higher-margin podcasts -- which generate more ad revenue and reduce its dependence on costly music licensing agreements -- could pay off.
I'm not a big fan of either stock right now. But if I had to choose one over the other, I'd stick with Spotify, which should remain the world's largest paid streaming music platform for the foreseeable future.