Investors have largely ignored Tencent Music Entertainment Group (NYSE: TME) stock ever since the company went public, earlier this year, concentrating largely on much sexier Spotify (Nasdaq: SPOT) in the music streaming space. That may not change anytime soon, but now that Spotify is once again gaining favors among investors, Tencent deserves a closer look and the business offers enough promise to help stock follow the Spotify’s lead, if not overtake.
Some amount of Wall Street’s indifference towards Tencent Music’s stock is due to the difference between Tencent Music’s business model, driving revenues from subscriptions and virtual goods, compared to non-Chinese music streaming companies – Spotify, Apple (Nasdaq: AAPL), Google Music (Nasdaq: GOOG), Pandora (NYSE: SIRI), et. al.
What the market seems to be ignoring, looking at the trading multiple assigned to the stock, is that the company has a dominant market share in China, business model is profitable, the company plays a key role in executing parent company Tencent’s (Nasdaq: TCEHY) music strategy, and the company can defend as well as thrive as music steaming wars intensify.
Music streaming wars are deciding winners
Music is gaining place on almost every major tech major’s agenda in terms of grabbing share of what some analysts call – ‘attention economy’, especially with companies that offer consumer facing services or applications.
Over half of the music industry’s revenue comes from streaming services, even though paid streaming service penetration rates are still small in most geographies, including developed markets like Sweden where 30% of the population subscribes to a paid streaming service, US where 25% of Americans have subscribed or Germany where just 16% of Germans have subscribed to paid streaming services.
Not just the lure of subscription revenues, it’s also the use of smart speakers to stream music that is pushing Amazon, Apple and Google to get aggressive in the garnering share of the streaming business.
Not all streaming services are same
|Paying user||Market Cap (B)||Mkt. Cap. / Paying User|
Its easy to shrug off Tencent Music, if one just measure the two biggest publicly traded pure-play businesses – Spotify and Tencent, on subscriber metric alone. As the chart above shows, Tencent Music looks almost 50% more expense than Spotify on market capitalization/ paying user or the price you pay to acquire each paying user. But this way to value the business will be misleading.
Investors love subscription business model for its ability to predict future revenues trends and profitability, because subscriber base tends to be sticky and investors believe that the company can keep spending less on operating expenses thus driving the margins higher.
But that isn’t happening in the market. Average price for Spotify is declining, which the company blames on fast growth of subscribers in geographies like India where price much lower than established market like US or Sweden.
Price increases in developed markets are extremely difficult, if not impossible, given Apple, Amazon and Google don’t have to generate profits from music streaming. Music streaming is more of a strategic fit for them, be it for expanding into the smart speaker market or barricading their existing franchises in the consumer space.
Indeed, given every music streaming service have to pay a fixed percentage of its revenue to music labels like Warner Music (NYSE: WMG), these three tech majors can end up squeezing Spotify further, if they start competing aggressively among themselves.
Tencent Music dominates its markets and has barricaded them well too
In the meantime, Tencent Music, as the largest online music entertainment platform in China, has refined itself over the years as per the Chinese consumer preferences thus driving growth and profits from different sources.
The platform, comprising of top four music mobile apps in terms of mobile MAUs, offers online music, online karaoke and music-centric live streaming products. All four major product brands – QQ Music, Kugou, Kuwo and WeSing, cater to different segment of online music and music-centric Social Entertainment services.
|% of Total Revenue||Paying Ratio|
|Online music services||28%||5%|
|Social entertainment services and others||72%||5%|
As the chart above shows, online music is actually a much smaller portion of the total business, thus comparison with Spotify alone doesn’t do justice to the long-term potential of the company. The bigger Social Entertainment Services segment includes sales from virtual gifts on WeSing and premium memberships that allow access to live-streaming concerts.
With more than 75% market share, Tencent Music has a dominant share of the music business in China. More importantly, being exclusive sub-licensor arrangements with Universal, Sony and Warner Music in China provides the company edge over competitors.
Another major edge that the company enjoys is its relationship with parent – Tencent Holdings Limited, which still owns close to 60% of Tencent Music. Tencent Holdings also owns WeChat, the biggest mobile messaging app in China with more than 1 billion MAUs, providing perfect knowledge and customer base to Tencent Music excel in Social Entertainment segment.
|Next Yr PE||P/ Sales||Market Cap (B)||Gross margins 2019||Operating expense||Sales Growth 2019|
Now here again, the stock may not look cheap on price/ sales basis, but when the two businesses are compared on profitability, Tencent Music shows its edge.
|Next Yr. PE||P/ Sales||Market Cap (B)|
Secondly, the right way to look at the stock will be to measure the 70% Social Entertainment Services business against social media companies like Snap and Facebook, both of which trading at significant premium.