Thrifty Tencent Music Sings New AI Growth Story

Key Takeaways:

• Tencent Music’s revenue fell slightly in last year’s fourth quarter, but its profit more than doubled thanks to aggressive cost cuts
• Following positive response to its self-developed virtual idols, the company hopes to explore new opportunities using AI generated content

By Fai Pui

A double-whammy of Covid restrictions and regulatory tightening has forced China’s tech titans – once accustomed to the freewheeling ways of China’s internet – to change their tune by controlling costs as growth slows. Tencent Music Entertainment Group TME, China’s equivalent of Spotify, is a case in point of a new theme song coming from the group, seeking to boost profits through frugality.

The company’s fourth-quarter earnings report released last Tuesday may have delighted some investors with its bottom line, as its net profit soared 115% year-over-year to 1.15 billion yuan ($167 million). But its top line revenue moved the other way, declining 2.4% year-on-year to 7.43 billion yuan.

Its full-year performance showed similar trends, with profit up 21.4% to 3.68 billion yuan even as its revenue slumped by 10% to 28.34 billion yuan. Such profit growth without revenue gains wasn’t what investors were looking for. Tencent Music’s shares plunged up to 14% in New York the day the results came out, and closed down 9.2%, even as the company announced a new $500 million share buyback.

Major Cost Cuts 

Tencent Music could boost its profits so much in the face of declining revenue due to aggressive cost cuts. The company’s operating expenses fell 25.1% to 1.36 billion yuan in the fourth quarter, with sales and marketing expenses down by an even sharper 64.5% year-on-year, mainly due to some optimization initiatives.

Tencent Music has shifted its strategy this past year from winning new subscribers to boosting the quality of existing subscribers. That’s reflected in the 16.1% growth in paid subscribers for its three platforms, QQ Music, Kugou Music and Kuwo Music, in the fourth quarter, which reached a record 88.5 million during the period. Average revenue per paying user (ARPPU) from those paid subscribers also rose 4.7%, driving online music services revenue growth of more than 20%.

While all that may look good for the company’s longer-term prospects, analysts used to breakneck growth by China’s tech firms are more mixed on Tencent Music. Citi has a “neutral” rating on the company, even though its fourth-quarter revenue and profit performance beat its expectations and company managers were confident that revenue and profit would grow more in tandem this year, with online music services revenue expected to rise by more than 20%.

Daiwa was more upbeat with a “buy” rating on the company, encouraged by its improved fundamentals and the announcement of the new buyback plan. It maintained a target price of HK$42 for Tencent Music’s Hong Kong shares, implying 40% upside from the stock’s current level.

Tencent Music’s latest price-to-earnings (P/E) ratio is around 23 times, while its price-to-sales ratio is 3.2. That’s far higher than the P/S ratio of 1.4 for rival Cloud Music (9899.HK), which is still in the red. Tencent Music is also valued more highly than international peers Spotify SPOT and Deezer (DEEZR.PA), at 2 times and 0.54 times, respectively. That indicates that even though investors weren’t so happy with the company’s latest results, they still see it as China’s clear industry leader.

Tencent once had a near-lock on China’s massive online music market until about two years ago, when Beijing forced it to end its practice of signing exclusive China rights with most major music labels. Competition has become more intense since then as its rivals signed their own music licensing deals. Cloud Music was a major beneficiary, posting nearly 30% revenue growth last year. Other rising challengers include Apple Music, Migu Music and TikTok.

Power Of AI

One of Tencent Music’s biggest growth engines has been social entertainment services like online karaoke and music-based live streaming, where the company earns money by letting viewers buy virtual gifts for their favorite hosts and then takes a cut. But that business is also under fire as it faces competition from short video and other social platforms. As that happens, revenue from that part of the business plunged nearly 20% last year, and paid users fell by 24.3%.

While cost cuts can boost profits, you can only cut so much. Instead, Tencent Music is moving its focus back to expanding its revenue streams in the new, more competitive environment.

South Korea’s Yonhap News Agency reported company executives recently visited South Korean music production companies, in hopes of bringing the country’s popular “K-pop” music back to China. Most South Korean pop cultural products, including music and TV shows, were banned for seven years in a show of Beijing’s displeasure over the country’s deployment of a sophisticated U.S.-supplied missile system to protect against potential attacks from North Korea.

More recently, China has begun to relax restrictions on Korean TV dramas and games. Korean singers are still unable to perform in China, though record sales and online fan clubs have resumed.

Technology-powered products and services will be another important growth engine for the company as it seeks to differentiate itself from rivals after losing its exclusive music licenses. Tencent Music had licensing deals with 33 record labels at the end of last year. Cloud Music had 29, though 15 of those were the same as Tencent Music. As platforms increasingly have similar musical offerings, user generated content (UGC) and artificial intelligence generated content (AIGC) may become a new future battleground for music platforms to differentiate themselves from one another.

Last July Tencent Music launched its “TME Producer Alliance” program, allowing artists to price and release digital albums on their own over the open platform. By the fourth quarter of last year, independent musicians had created more than 2.3 million tracks on the platform, with nearly 1,000 receiving more than 100 million plays last year.

Tencent Music is also dabbling in AIGC. Its QQ Music subsidiary has launched an AI drawing function to generate binary images and exclusive background music for users, and also uses “AI lyrics poster” and “AI vinyl player” functions to enhance visual effects. Last year the company also announced the debut of its first virtual idol, Lucy, who has released her first single and can communicate with fans in the metaverse.

With global sensation ChatGPT taking AI to a new level, Tencent Music has also said it will continue to explore how to use AI in areas such as graphics, video and music for more new business opportunities. That means we should stay tuned for some new AI music from this industry stalwart, as it tries to revive its growth and hold on to its industry-leading position.