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Tencent Music Entertainment: China's largest music streaming company.

Opdateret: 17. mar.

China's music streaming market is projected to reach $3,18 billion in 2023 and is expected to grow at a compound annual growth rate of 5,75 % until 2027. These numbers are conservative compared to the $10,2 billion music streaming market in the United States. If you believe that the music streaming market in China will grow faster than projected, it could be an interesting market to invest in. Especially because Tencent Music Entertainment is a clear market leader. In this analysis, I will investigate whether now is the right time to purchase Tencent Music Entertainment.

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

This analysis will be a bit different from what you are used to read in my blog. Tencent Music Entertainment did their IPO in December 2018, meaning I don't have access to the historical numbers dating back longer than that. So instead of using the principles I have learned from my Phil Town workshop, I use the principles I have learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to easily get the numbers you need from various companies.

Before I begin the analysis, I want to clarify that I do not currently own any shares in Tencent Music Entertainment. I previously owned shares in Tencent Music Entertainment that I bought at $3,98 and sold at $8,06. Currently, I own shares in Tencent (both directly and through Prosus) which owns 51% of Tencent Music Entertainment. If you would like to view or make a copy of my portfolio, you can find instructions on how to access it here. In the rest of the analysis, I will refer to Tencent Music Entertainment as TME, which is their ticker. If you want to purchase shares or fractional shares in Tencent Music Entertainment, you can do so through eToro. eToro is a user-friendly platform where you can get started for as little as $50.

TME is often described as the Chinese Spotify. And while TME owns shares in Spotify, and Spotify owns shares in TME, you cannot compare the two businesses one-to-one. TME is an online entertainment platform that offers various services including online music streaming, online karaoke, live streaming, and online concerts. Meaning, it is more like a social network where they have other forms of revenue besides subscriptions, such as advertising and value-added services (e.g., games). They have several apps, and the most well-known ones are KuGou Music, QQ Music, Kuwo Player, and WeSing. They are the largest online music and audio entertainment platform in China, with 567 million users and a market share of 60%, according to Statista. I believe it is safe to say that once a company has a market share of 60%, they have established a strong brand moat. TME also owns shares in Warner Music and Universal Music Group.

Their CEO is Zhu Liang. He became the CEO in April 2021. He has extensive experience from Tencent, where he has held various positions since joining the company in 2003. Prior to joining Tencent, he worked for Huawei. He has a doctorate degree in signal and information processing from Tianjin University. We don't have much information on Zhu Liang, and since he has only been the CEO for one year, we cannot draw any meaningful conclusions from the results of TME. However, he was chosen because he has a proven track record from Tencent in building successful online entertainment platforms and social ecosystems. He is known for delivering strong results through expansions into new business areas. One thing that makes me rather confident in Zhu Liang is that he is an internal candidate who has been with the organization for many years. Hence, I believe that he has worked his way up and deserves an opportunity like this. Luckily, he also receives support from the former CEO, Cussion Kar Shun Pang, who is now the Chairman of the board. Nevertheless, since the management is still new, it is relatively unknown how they will perform moving forward.

I believe that TME has a strong brand moat based on its market share. However, we still have a lot of unknowns when it comes to management. Later, I will perform a discounted cash flow model to calculate a price for TME. But before I do so, let's take a look at some key financial metrics.

Below, we can observe some key financial metrics for TME over the past three years. The first thing that we see is that revenue decreased in 2022, which was the first time in the last five years. Gross profit margin, operating margin, EBITDA margin, and EBIT margin all grew from 2021 to 2022. However, margins are still lower than they were in 2020. The higher margins resulted in TME generating a higher net income in 2022 compared to 2021, despite the lower revenue. EPS was also higher in 2022 compared to 2021. Thus, TME was more profitable in 2022 compared to 2021 despite the lower revenue. Nonetheless, the numbers from 2022 are still lower than what TME delivered in 2020, which is something that you would like to see improving. It isn't necessarily alarming, though. If you compare TME to other streaming services such as Spotify, TME is at least profitable, whereas Spotify is not. Furthermore, the gross profit margin for TME is higher at 31,0% compared to Spotify's gross profit margin of 25,0 %.

Before we proceed with the discounted cash flow model, I would like to examine the risks and potential of TME. One risk mentioned in the paragraph above is the decreasing margins. The reason for decreasing margins is that lower-margin businesses, such as online music, are contributing more to the revenue. Social entertainment, which is a higher-margin business, contributed less to the revenue. According to management, the main factors contributing to this were competition and the macroeconomic environment. Margins improved in 2022, and management has previously indicatedthat margins will continue to increase in 2023 and beyond, citing the "ample long-term growth potential" in online advertising. It seems like they are on the right track, as the gross profit margin in Q4 2022 reached 33,0 %. However, it is still far below the gross profit margin in 2018, which was 38,3 %. Another risk is competition. Their competitors are strong companies, all vying for a share of the market. We already know that competition hurt margins in 2021 and 2022. With companies like NetEase, Baidu, Xiaomi, and China Mobile all vying for customers, TME needs to continue developing their business. Chinese regulations pose another risk. In 2021, Chinese regulators eliminated the exclusive rights for TME, which greatly benefited their competitors and harmed TME. While it seems that regulations in China are not coming as often as previously, it is still important to monitor it in the future. Delisting from the US stock exchange. TME was listed on the Hong Kong Stock Exchange in 2022. Nevertheless, delisting from the US stock exchange will exacerbate the negative sentiment towards Chinese companies. The Holding Foreign Companies Accountable Act is still an issue as I write this. However, we have seen improvements in the relationship between the Public Company Accounting Oversight Board (PCAOB) and the China Securities Regulatory Commission (CSRC), as the PCAOB is now able to conduct audit inspections in Hong Kong. However, until the audit issues are resolved, it could potentially impact the stock price of TME.

There are also potential opportunities for TME moving forward. One of them is gaining more paid subscriptions. Paid subscriptions have grown from 6,2 % (39,9 million) at the end of 2019 to 15,6 % (88,5 million) at the end of 2022. Nevertheless, 15,6 % paid subscriptions are still a very low number and give TME a significant growth opportunity. And it is something on which they are focusing. One way they want to do it is by allowing non-paying subscribers to watch a 30-60 second ad, which will unlock a 30-60 minute subscription service. It will not only generate advertising revenue but also increase the conversion rate for free subscribers to become paid subscribers. International Expansion. TME sees international expansion as a source of strong growth and monetization potential, and it will continue to expand its international presence for long-term growth. TME has made several international acquisitions. And according to management, they are constantly on the lookout for attractive M&A opportunities. TME has plenty of cash for acquisitions like these, which will diversify their business. Advertising. Management also sees advertising as a significant driver of growth. Advertising has been impacted by Covid lockdowns, but management has mentioned that advertising revenues are recovering at a healthy pace. They expect their advertising business to show growth after the Covid pandemic. Advertising is a high-margin business, and an increase in advertising should lead to greater profitability. The Metaverse. TME launched TMELAND, which is China's first virtual music festival. Management believes that it fits right in at the Metaverse, as an artist can perform through an avatar. They also see other possibilities in the Metaverse, such as an online karaoke room where users can interact with each other in a virtual setting, and individual rooms where users can showcase their own music, creating a virtual showroom.

I have now investigated the financials, risks, and potential of TME. I will now examine the price by utilizing a discounted cash flow model. To do so, I will need some numbers that you can see below. The numbers are the 2022 figures, which I found on Finbox. However, I have determined the perpetuity growth rate and the discount rate myself. The reason I chose a 3% perpetuity growth rate is that it typically falls between the historical inflation rate of 2-3% and the historical GDP growth rate of 4-5%. I decided to go with a middle option at 3%. The chosen discount rate of 12% is because it falls within the typical range of 9-12%. I decided to go with the highest option due to the current market conditions. Remember that all the numbers used in these calculations are in millions.

I also need to determine how much EBIT, Depreciation & Amortization, and Net Working Capital will change over the next couple of years. I decided to use an EBIT growth of 19% year over year. It is what the analysts at Finbox estimate, and I think it is realistic as it is quite conservative. I calculated a yearly growth of 15% in Depreciation & Amortization. It is lower than the median of 19,7% from the last five years, but it is a number I feel comfortable with.Finally, I have decided that Net Working Capital will decrease by 6% per year over the next five years. I haven't found a smart way to share my spreadsheet here, but once I did my calculations, I found that the intrinsic value of TME to be $10,0.

Having investigated TME, I find the company interesting. They are a company with a significant competitive advantage,and like other Chinese companies, they have been affected by the negative sentiment that has caused a decline in all Chinese stocks. There are concerns regarding the lack of information about the management and the declining profitmargins. Management believes that the margins will improve in 2023 and beyond, which is reassuring but not certain. Furthermore, we might see more regulations in China that could impact a company like TME. However, I believe they have the potential to grow, particularly in the online music segment as only 12,4 % of their customers currently have paid subscriptions. It also seems like the management has a plan for the Metaverse, so if you believe it will be huge, I think that TME is a solid bet. I believe that Tencent Music Entertainment is an interesting investment if you can acquire the shares at $5, which represents a 50% discount on its intrinsic value.

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