Tencent Music: Reappeared "Little Happiness" in Resilience Period

On March 18th, Beijing time, after the Hong Kong stock market closed and before the US stock market opened, Tencent Music ( $Tencent Music(TME.US); $TME-SW(01698.HK) ) released its financial report for the fourth quarter of 2024.

Due to the previously provided poor subscription guidance and the gradual end of cost reduction and efficiency improvement efforts, the short-term fundamentals of Tencent Music are expected to be lackluster in the market. This has also led to Tencent Music's nearly 30% increase from the low point in this round of Chinese concept stock revaluation being relatively lagging among its peers.

So, how did the fourth-quarter financial report perform? Does it reveal any new opportunities or risks?

Specifically:

1. Subscription numbers "as expected" under pressure: The most concerning issue for the market regarding short-term fundamentals—the number of music subscription users—indeed remains under pressure, as indicated by the guidance. In the fourth quarter, there was a net increase of 2 million subscription users, which is the same as in the third quarter.

During the conference call, management is expected to disclose some performance from the beginning of the year to date, as well as the subscription growth target for 2025, which can be a key focus.

2. Surprising profitability reconstruction: To eliminate the impact of interest and investment income, Dolphin Research mainly looks at the operating profit of the core business (the significant underperformance under Non-IFRS is mainly due to non-operating items). Q4 exceeded consensus expectations by nearly 200 million, with an operating profit margin exceeding 2 percentage points.

Given the relatively stable business model and competition, Dolphin Research has never doubted Tencent Music's ability to generate profits. However, this time Dolphin Research was surprised that, in addition to the gross profit margin steadily increasing as expected, operating expenses could be further compressed (the three expenses in Q4 all accelerated their year-on-year decline). This not only reflects the excellence of the business model but also indicates that the company's internal operational efficiency continues to optimize. It can be said that as long as competition remains relatively stable, this profit-generating ability is worry-free.

3. New round of shareholder return plan announced: This quarter, a new buyback was approved (USD 1 billion over 2 years) and a dividend for 2024 (USD 273 million, with a dividend payout ratio of 26%), resulting in a current shareholder return yield of 3.5%, which is neither high nor low.

4. Traffic decline, seasonal impact, or competition?: In the fourth quarter, monthly active users were 556 million, with a loss of 20 million users quarter-on-quarter, which is below market expectations. Although there is a seasonal impact, competition cannot be completely ignored.

Speaking of competition, before this year, Dolphin Research tended to underestimate it, whether it was Cloud Music or Soda Music. However, when Soda Music resumed its offensive in the second half of last year, promoting heavily and doubling its MAU in the latter half of the year, approaching the critical user milestone of 100 million at the beginning of this year, Dolphin Research began to pay attention to the competition risk After all, for any C-end entertainment content traffic business, ByteDance, which has a large amount of free traffic, uses a completely different approach. Therefore, as long as they want to do it, it is not impossible to catch up later. This is true for online literature and short dramas as well.

5. Business Revenue Situation:

(1) Subscription price increase logic continues, how much room is there?: With a 13% growth in subscription numbers, music subscription revenue in the fourth quarter increased by 18%, relying on the improvement of internal ARPPU, including reducing green diamond discounts, promoting SVIP, and penetrating high-priced membership packages such as in-car memberships.

This has also been the main growth driver discussed by management since last year. The logic and implications behind it have been discussed in detail by Dolphin Research last quarter; you can refer back to last quarter's commentary on “Tencent Music: How far can the price increase logic go?.” At least from the mid-term guidance and comparisons with peers and across industries, ARPPU could optimistically increase from the current 11.1 yuan to 13 yuan or even 15 yuan/month, still having potential for realization under relatively stable competition.

(2) Live streaming "purifies" users, unexpectedly rebounding: In the fourth quarter, social entertainment accelerated out of its slump, with revenue year-on-year decline narrowing to 13%, significantly better than market expectations. Although there are no signs of a halt in the decline of paid users for live singing, the business focus has further filtered out loyal users, leading to a rebound in average revenue per user.

Tencent Music's core logic has shifted to music subscriptions, but if social entertainment can quickly recover from dragging down overall performance, although it may not contribute much to valuation, it can at least alleviate some pressure on profitability and cash flow for the group.

6. A solid cash cow: As of the end of the fourth quarter, Tencent Music had net cash of 25 billion yuan (cash + short-term investments - short and long-term interest-bearing debts), equivalent to 3.5 billion USD. As Tencent Music uses part of its cash to steadily increase shareholder returns, the previously unvalued net cash can also be expected to contribute to valuation when market sentiment is good.

7. Detailed Financial Report Data Overview

Dolphin Research's Viewpoint

Overall, Dolphin Research's feedback on Tencent Music's fourth-quarter performance is relatively positive. Profitability, especially reflecting the advantages of the business model and exceeding expectations in internal efficiency, will be more likely to gain recognition and favor from foreign capital. If this conference call can provide relatively positive guidance (especially with a rebound in music subscription numbers), then in the short term, even with the looming threat from Soda Music, Tencent Music can continue to enjoy a period of "revaluation," for example, repairing from the current 17x Non-GAAP P/E to 18x-20x. But even if the emotions are in place, to further raise the valuation on a 20x basis, it still depends on ByteDance's attitude. Although Tencent's ecosystem traffic is comparable to ByteDance's, during the phase of two tigers wrestling, the original profit margins are bound to be unsustainable. Especially since ByteDance is adept at using "free/low price" for a devastating invasion, as copyright music duration continues to be divided among independent musicians and Douyin's hit songs, Tencent Music's copyright advantage also requires other investments to fill the gap and increase user retention costs—such as leveraging technology or the advantages of a pan-entertainment ecosystem to provide a better product experience, increase promotional spending, etc.

Therefore, the key issue to focus on this year is ByteDance's offensive rhythm. Through a large amount of promotion within Douyin over the past six months, under the miracle of strong efforts, Soda Music's MAU has approached 100 million (an increase of nearly 30 million in three months compared to the last quarter), and DAU has directly reached 26 million, with a DAU/MAU ratio of around 30%, indicating very high user stickiness.

For now, it is comforting that the high stickiness and user expansion here are more about "passive guidance," as the average daily usage time for Soda Music is only 6 minutes, lower than Cloud Music's 8 minutes and Tencent Music's 15 minutes, indicating that there is still a gap in user mindset. However, the unfavorable trend direction is that, whether in total traffic, stickiness, or user duration, Soda Music is on the rise. Regardless of the circumstances, one should not underestimate the magic of Douyin and the ease with which ByteDance conducts its traffic business.

The following is a detailed analysis

1. Seasonal decline in ecosystem traffic requires gradual attention to competition

In the fourth quarter, Tencent Music's online music monthly active users decreased by 20 million. Live streaming and other social entertainment continue to be passively "purified," with a seasonal decline of 8 million.

Regarding competition among peers, before this year, Dolphin Research tended to actively underestimate both Cloud Music and Soda Music. But when Soda Music resumed its offensive in the second half of last year, doubling its MAU after a large amount of promotion, and approaching the critical user metric of 100 million at the beginning of this year, Dolphin Research began to pay attention to competitive risks.

Through a large amount of promotion within Douyin over the past six months, under the miracle of strong efforts, Soda Music's MAU has approached 100 million (an increase of nearly 30 million in three months compared to the last quarter), and DAU has directly reached 26 million, with a DAU/MAU ratio of around 30%, indicating very high user stickiness.

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II. Subscription Price Increase Logic

With a 13% growth in subscriptions, the music subscription revenue in the fourth quarter increased by 18%, relying on the improvement of endogenous ARPPU, including reducing green diamond discounts, promoting SVIP (penetration rate of about 8% by the end of September), and in-car memberships (deep cooperation with Baidu, BYD, and XPeng) and other high unit price membership packages.

This has also been the main growth driver discussed by management since last year. The underlying logic and implications have been detailed in last quarter's discussion by Dolphin Research, and can be reviewed in last quarter's commentary “Tencent Music: How Far Can the Price Increase Logic Go?”. At least from the mid-term guidance, as well as comparisons with peers and across industries, ARPPU is expected to increase from the current 11.1 yuan to 13 yuan or even higher in an optimistic scenario.

Other online music revenues are still mainly driven by advertising, especially with the introduction of a model that allows users to listen to music for free by watching ads.

Ultimately, online music revenue grew by 16% year-on-year, with a natural slowdown quarter-on-quarter (due to a high base last year). The sustainability of subscription revenue growth has been the mainstream narrative recognized by investors in Tencent Music over the past two years. Therefore, when user growth reaches a plateau, the valuation has been under pressure for a period. It is recommended to pay attention to the conference call; if this call can provide a relatively positive guidance (especially if music subscription numbers rebound from the bottom), then in the short term, even with the competitive threat from Soda Music, Tencent Music can continue to enjoy a period of "revaluation."

A further breakdown shows that:

Subscription revenue increased by 17.6% year-on-year, with a quarter-on-quarter slowdown. Among them, the growth rates of paid users (+13% yoy) and average payment amount per user (+3.7% yoy) have both slightly slowed down. By the end of the fourth quarter, the music subscription paid penetration rate reached 21.8%, an increase of 1 percentage point compared to the third quarter The company's medium to long-term goal is to align with long video levels, which is 25% to 30%.

Other online music services that include digital copyright sales, advertising, and other revenues saw a continued slowdown in revenue growth to 13% in the third quarter, mainly due to last year's high base effect. Currently, Tencent Music still relies mainly on brand advertising, concerts, and sponsorship of offline events, while the revenue contribution from incentivized ads for free music listening should be minimal.

III. Passive "purification" of live streaming, recovery exceeds expectations

In the fourth quarter, social entertainment accelerated out of its slump, with the year-on-year decline in revenue narrowing to 13%, significantly better than market expectations. Although there are no signs of a halt in the decline of paid users for live-streaming karaoke, the business focus has further filtered out loyal users, leading to a rebound in average revenue per user.

The core logic of Tencent Music has shifted to music subscriptions, but if social entertainment can quickly recover from its drag on overall performance, although it may not contribute much to valuation, it can at least alleviate some pressure on profitability and cash flow for the group.

IV. The cost control potential of cash cows has not yet ended!

In the fourth quarter, costs decreased by 1% year-on-year, which is attributed to the reduction in live streaming business and the corresponding decline in reward sharing. According to estimates from Dolphin Research, while subscription revenue maintains over 17% growth, copyright costs have not increased and may have even slightly decreased (estimated value). However, similar to the previous quarter, offline music events have also brought some incremental costs compared to last year.

Ultimately, the gross margin continued to increase by 1 percentage point to 43.6% quarter-on-quarter. Although the pace of increase has slowed, the underlying trend is basically in line with Dolphin Research's expectations (we have always emphasized the potential driving force of bargaining power in the industry chain on gross margin).

What surprised Dolphin Research is that Tencent Music's operating expenses can be further compressed (the three expenses in Q4 all accelerated their year-on-year decline), which shows the internal efficient operational management capability. As long as external competition remains relatively stable, this ability to generate profits is worry-free.

The final calculation shows that the operating profit of the core business reached 2.079 billion, with a profit margin of 27.9%, exceeding market expectations. Note that here, to exclude the impact of non-core projects, Dolphin Research generally focuses on the operating profit of the core business, which is calculated as = (gross profit of the main business - three operating expenses). Compared to the operating profit disclosed by the company, it does not include other gains and losses, interest income, and other items.

Non-IFRS net profit (which excludes the impact of amortization of intangible assets arising from acquisitions, equity incentives, and non-operating investment income from the original net profit) was 2.399 billion, a year-on-year increase of 43%, seemingly exceeding expectations more, mainly due to exchange rate fluctuations—financial costs in the fourth quarter showed positive returns. This is also a fluctuation caused by the company's capital management, so it is important to look at the performance of the main business. From a comparable perspective, Dolphin Research suggests focusing on the aforementioned "operating profit of the main business."

The continuous expansion of profits has also caused the profit-generating machine to spin rapidly. In the fourth quarter, the net cash inflow from operating activities was 2.5 billion, and the current investment was also a net inflow, resulting in the company's net cash on hand expanding to 25 billion RMB by the end of the year, equivalent to 3.5 billion USD. As Tencent Music uses part of its cash to steadily increase shareholder returns, the previously unaccounted net cash for valuation can also be expected to contribute to valuation when market sentiment is good.

Dolphin Research "Tencent Music" Related Research Review in the Past Year:

Earnings Season

November 12, 2024 Conference Call: Tencent Music: What is the next growth driver? How is SVIP progressing? (3Q24 Conference Call Minutes)

November 12, 2024 Earnings Review: Tencent Music: How far can the price increase logic go?

August 13, 2024 Conference Call: Tencent Music: After the slowdown in net member growth, what supports performance? (2Q24 Earnings Conference Call Minutes)

August 13, 2024 Financial Report Review: Tencent Music: Minor Flaws but a Plunge, Is the Brow Big and Eyes Bright Wrongly Killed?

May 13, 2024 Financial Report Review: Tencent Music: Is the Gold Mine Endless? The Charm of Small and Beautiful Niches

March 19, 2024, Conference Call: Tencent Music: The Customer Acquisition Effect of Early Year Promotions Exceeds Expectations (4Q23 Conference Call)

March 19, 2024 Financial Report Review: Tencent Music: The Leader Comes with a BUFF, Price Increase to Resist Cycles

November 17, 2023 Conference Call: The Space for Music Subscriptions is Still Vast (Tencent Music 3Q23 Conference Call Minutes)

November 14, 2023 Financial Report Review: Tencent Music: The Small and Beautiful Hidden by the Shadow of Live Streaming

August 15, 2023 Conference Call: The Impact of Live Streaming Adjustments is Expected to Stabilize by the End of Q3 (Tencent Music 2Q23 Conference Call Minutes)

August 15, 2023 Financial Report Review: Tencent Music: Business Adjustments, Continuing to Grind the Bottom

March 22, 2023 Conference Call: Performance Guidance Has No Hard Injuries, Just Overly Full Expectations (Tencent Music 4Q22 Conference Call Minutes)

March 21, 2023 Financial Report Review: [Tencent Music: Without Growth, Can "Saving" Support the Big Dream of Music?](https://longportapp.cn/zh-CN/topics/4444732? invite-code=)》

In-depth

On April 12, 2023, "Douyin and Tencent's Off-Market Marriage, Is There a Solution to the Deadlock in Entertainment Payments?"

On January 6, 2023, "Pan-Entertainment's 'Good Start', Who Will Have a More Lasting Rebound, Tencent or Bilibili?"

This article's risk disclosure and statement: Dolphin Research Disclaimer and General Disclosure