What happened
Shares of Tencent Music Entertainment (TME 4.76%) fell hard Tuesday, declining 9.2%.
The company reported fourth-quarter results on Tuesday morning, and while it beat analysts' expectations on the revenue side, its top line still declined by 2.4% year over year to $1.08 billion. Its adjusted (non-GAAP) earnings per American depository share of $0.13 were in line with expectations. And in the wake of a share price run-up since mid-November that saw the stock more than double, it appears investors were ready at this point to lock in some of their profits.
So what
While Tencent Music's stock may have disappointed Tuesday, the company has impressively navigated through the macroeconomic headwinds in China this year.
Its top line fell because of a steep drop in the company's "social entertainment" revenues. Unlike some music streaming platforms in Western countries, Tencent Music actually makes the majority of its revenue from social entertainment -- basically, revenue-sharing the tips users give each other for singing online karaoke and other interactive activities. That revenue slumped this year as economic pressures hit China amid widespread zero-COVID lockdowns and a downturn in the country's property sector.
On the other hand, Tencent Music grew its online music subscription revenue despite the economic headwinds. While the overall number of monthly active users (MAUs) actually declined by 7.8% last quarter, the number of paying users increased by 16.1%, and monthly average revenue per user (ARPU) increased by 4.7% on top of that. While social entertainment continues to be Tencent Music's largest revenue source, after 2022's business shift, it only amounts to about 56% of the total, with online music services accounting for the rest.
Importantly, profitability has also surged since management took a hatchet to marketing spending, which plunged 64.5% in the quarter. General and administrative expenses increased by 2.6% in Q4, but were down for the full year. Those cost controls and a focus on attracting quality high-margin revenue helped the company more than double its operating profit year over year.
Now what
Like many Chinese stocks, Tencent Music looks fairly cheap -- it's trading at around 15 times this year's expected earnings. In addition, the company has about $2 billion in net cash on its balance sheet -- about 15% of its market cap.
The outstanding question is whether Tencent Music will be able turn around its struggling social entertainment segment. Management noted not only macro headwinds in 2022, but also increased competition in short-form video. Still, it is the leading streaming brand in China, and its ability to better monetize traditional music subscriptions is a big positive.
Another issue is that investors need to be comfortable investing in Chinese companies in general. Geopolitical tensions can cause lots of volatility in U.S.-listed Chinese stocks. That's why most Chinese companies trade at significant discounts to their U.S counterparts, but perhaps deservedly so.
