Spencer Platt
Elevator Pitch
My investment rating for Tencent Music Entertainment Group’s (NYSE:TME) [1698:HK] stock is a Hold.
I did a review of Tencent Music Entertainment’s earnings for the second quarter of this year with my earlier August 19, 2022, write-up. With the current article, I preview TME’s upcoming Q3 2022 financial results which are expected to be released in mid-November. Given that I expect Tencent Music Entertainment’s third quarter earnings to be in-line without any surprises and its valuations are on par with its peer, I see no reason to change my Hold rating for TME.
Completion Of Hong Kong Listing
Prior to previewing TME’s third quarter earnings, it is relevant to discuss an important development for the company.
On September 20, 2022, Tencent Music Entertainment disclosed that its shares have been “successfully listed on Hong Kong Stock Exchange.” Notably, TME emphasized in the announcement that the company’s Hong Kong-listed shares with the 1698:HK ticker “are fully fungible with the ADSs (American Depositary Shares) listed on the NYSE.”
I have previously highlighted in my prior August 19, 2022, article for TME that the company “faces the risk of being required to delist from the US in the future, assuming that it is unable to comply with the Holding Foreign Companies Accountable Act.” PricewaterhouseCoopers’ chairman was quoted in an October 4, 2022, Reuters news article mentioning that “it could be months before the conclusions” relating to “U.S. regulatory inspections of audits of” US-listed Chinese companies “are known.”
In other words, there is still substantial uncertainty with regard to the issue of Chinese companies like TME being able to remain listed in the US. As such, the success of Tencent Music Entertainment’s Hong Kong listing is critical in mitigating the risk of a US delisting.
Third Quarter Financial Results Preview
I mentioned in my previous update for Tencent Music Entertainment published in August 2022 that “the near-term outlook for TME is mixed, with topline contraction expected to be offset by higher profit margins.” This is exactly what has been reflected in the sell-side consensus financial projections for Tencent Music Entertainment.
Based on S&P Capital IQ’s consensus data, Tencent Music Entertainment is expected to generate a Q3 2022 revenue of RMB7,118 million, which will be equivalent to a YoY contraction of -9.9% in RMB terms. Nevertheless, this represents an improvement as compared to TME’s revenue decline of -15.1% and -13.8% for Q1 2022 and Q2 2022, respectively on a YoY basis.
With respect to profitability and the bottom line, analysts are of the view that TME should be able to deliver higher profit margins and robust earnings growth in the third quarter of the year. The consensus financial estimates taken from S&P Capital IQ point to Tencent Music Entertainment’s normalized net profit margin improving from 13.5% in Q1 2022 and 14.9% in Q2 2022 to 16.3% for Q3 2022. This is expected to translate into a +16.0% YoY (in RMB terms) growth in TME’s normalized EPS to RMB0.71 in the third quarter.
In my opinion, the Q3 2022 consensus financial estimates for TME are reasonable and realistic. Specifically, I think that cost optimization will be the key factor that helps Tencent Music Entertainment to achieve earnings that are in line with the market’s expectations. TME had stressed at its Q2 2022 earnings call in mid-August that it will “implement cost control in areas” like “content royalties”, “headcount-related costs”, and “marketing expenses” going forward.
In the next section, I touch on the prospects for TME’s online music services and social entertainment services businesses.
Strength In Online Music Offset By Weakness For Social Entertainment
I have a favorable view of TME’s online music services business, but I am much less optimistic about the outlook for its social entertainment services business.
I expect Tencent Music Entertainment’s online music services business to grow strongly going forward.
There is room for TME to grow the number of paying users. The music business’ paying users grew by a strong +25% QoQ to 82.7 million as of end-Q2 2022, and this represented about 13.9% of its monthly active users in the recent quarter. As TME has the intention to put more content behind the paywall over time, this should boost the music business’ paying user base in the future.
On the flip side, TME’s social entertainment services business’ near-term performance is expected to be weak.
Specifically, its live streaming services face substantial regulatory headwinds. According to a June 23, 2022 South China Morning Post article, “China has issued new regulation on the live-streaming industry that lists 31 banned behaviors” which is seen as “the government’s latest effort to regulate the booming digital economy.” Tencent Music Entertainment cited “industry adjustments” as a factor with a negative impact its social entertainment services business at its Q2 2022 results briefing, which I view as an acknowledgment of regulatory challenges.
In summary, I think that the strength associated with Tencent Music Entertainment’s online music services business will be offset by the weakness relating to its social entertainment services business in the short term.
Concluding Thoughts
My rating for TME stays as a Hold. I don’t expect Tencent Music Entertainment to record a significant earnings beat or miss when it releases its Q3 2022 results in the middle of November. Moreover, TME’s valuations are reasonably fair. TME currently trades at 1.04 times consensus forward next twelve months’ Enterprise Value-to-Revenue as per S&P Capital IQ data, which is roughly on par with Spotify’s (SPOT) consensus forward Enterprise Value-to-Revenue multiple of 1.09 times.
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