Tencent Music Draws In New Buyers With Unique Tune

Tencent Music Entertainment Group - ADR TME saw sharp volatility in its first month on the market. Now settled below its IPO price, the stock is more harmonious than investors think, according to a trio of Street analysts. 

The Analyst

Bank of America Merrill Lynch initiated coverage of Tencent with a Buy rating and $17.10 price target.

KeyBanc Capital Markets initiated with an Overweight and $19 price target.

Deutsche Bank initiated with a Hold and $14.50 target.

Opportunity In Breadth, Depth

By Bank of America’s estimates, Tencent’s 2020 price-to-earnings multiple lies in-line with the peer average and indicates 30-percent return potential.

“Tencent Music has over 800 million monthly active users, which is significantly more than other industry peers and represents an early mover advantage amid a slowdown in Internet user growth,” according to BofA. “The scale attracts content providers, enables monetization in more than one way and offers some leverage at the operating expense level.”

Tencent capitalizes on its user base through both music and social entertainment services. The former generates 30 percent of total revenue in subscriptions, digital album sales, sublicensing and advertising, while the latter’s karaoke and live broadcasting segments contribute the other 70 percent.

“The profitability allows TME to take a gradual approach to monetize on music subscription and to focus on user penetration and engagement,” BofA said. “TME has ample opportunities to further monetize music services in the longer term as paying user ratio and average revenue per paying user are fairly low at the current stage.”

Booming Pay Ratio

KeyBanc expects the online music paying ratio to expand beyond 40 percent in 2028 with a social entertainment ratio that surpasses 10 percent. Together, the two represent revenue of 117 billion yen — six times the 2018 rate.

“We expect the paying ratio [for music] to increase significantly in the long run and view a Western adoption level as in a high likelihood eventually, driven by: consumers' greatly increased willingness to pay for content; TME’s gradual transition to a ‘pay-for-streaming’ model from ‘pay-for-download;’ great pricing power on the consumer given TME's dominant scale and content resource; and increasing per capita income in China," according to the sell-side firm. 

Deutsche Bank offered a similarly bullish outlook on the metric.

“TME is uniquely positioned in the global music entertainment scene with significant runway for growth on a multiyear basis,” analyst Han Joon Kim said. “In TME’s music subscription business alone, we see room for the current 3.8-percent music subscription paying ratio to inflect along a hockey stick S-curve toward the 30-percent level that we see worldwide.”

Greater Growth Expectations

KeyBanc also forecast gross-margin growth to 40 percent as subscription ramps outpace aggressive investments in original content.

Given expanding paying-user ratios, increasing ARPU in social entertainment, gross margin stability and general operating leverage, BofA expects 49-percent compound annual growth between 2017 and 2020.

Price Action

Tencent shares were down 2.88 percent at $12.82 at the close Monday. 

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Photo via Wikimedia.