TME-SW(01698): The path of musicification is becoming clearer, how to leverage new growth in the new era?

TME-SW (01698) is becoming an increasingly pure online music platform. According to Tencent Music's Q3 financial report for the three months ending September 30, 2023, the company's revenue was 6.57 billion yuan, a year-on-year decrease of 10.8%, and net profit was 1.26 billion yuan, a year-on-year increase of 15.6%. Among its two main businesses, online music services continue to "take off," far outpacing the declining social entertainment and other services, contributing nearly 70% of revenue. After the release of its performance, many institutions are optimistic. BOCOM INTL issued a research report stating that Tencent Music's Q3 performance was slightly better than expected by the bank and the market. The target price was raised from $8.7 / HKD34 to $9 / HKD35. It continues to be bullish on the steady growth of online music in the next two years and the prospects for profit/cash flow expansion. Management maintains the same pace of shareholder returns and recommends buying. Bank of America Securities restated a "buy" rating for Tencent Music, raising the target price from HKD34 to HKD35. In the capital market, Tencent Music's Hong Kong stock opened sharply higher after its performance announcement, but gave up some gains by the end of the day, closing at HKD29.3, up 3.9%, with a turnover of approximately HKD1.0491 million. Online music services heading left Social entertainment services heading right As a leading enterprise in online music, Tencent Music's development has always been highly regarded. In recent years, Tencent Music's revenue growth rate has been declining year after year. From a revenue growth rate of 151.8% in 2017, it slid to -9.3% in 2022. In Q3, the company's revenue decreased by 10.8% year-on-year. Tencent Music was prepared for the revenue decline. "The performance of our social entertainment services in the second quarter was weaker than expected, and this business will continue to face pressure in the second half of 2023. Therefore, we expect the total revenue for the third quarter of 2023 to decrease by a low double-digit percentage year-on-year, and the total revenue for 2023 to decline by a low single-digit percentage year-on-year." It is understood that Tencent Music's revenue decline comes from the significant "cooling down" of its previously main revenue driver, social entertainment services. Before 2022, Tencent Music's revenue from social entertainment services and other services was higher than its online music revenue. From 2021 to 2022, revenue from social entertainment services and other services decreased by about 3.9 billion yuan from 19.777 billion yuan to 15.856 billion yuan. In the third quarter of this year, this business segment experienced another significant year-on-year decline of 48.8%. Specifically, the average monthly active users and ARPPU (average revenue per paying user) of the company's social entertainment services both declined by 16.8% and 51.4% year-on-year, respectively, with only the number of paying users maintaining a growth of 5.4% year-on-year. It is worth noting that the average revenue per paying user of social entertainment services in the third quarter dropped from 177.3 yuan in the same period last year to 86.2 yuan, which had a significant impact on the revenue of social entertainment services. Correspondingly, when social entertainment services declined, online music services experienced strong growth. From 2021 to 2022, Tencent Music's online music service revenue increased by about 1 billion yuan, from 11.467 billion yuan to 12.483 billion yuan. In the third quarter of 2023, the company's online music service revenue grew strongly by 32.7% year-on-year, reaching 4.55 billion yuan, accounting for 69% of total revenue. The significant growth in online music services is attributed to the accelerated growth of online music subscription revenue and CKH Holdings' advertising service revenue. Online music subscription revenue was 3.19 billion yuan ($438 million), a year-on-year increase of 42.0%, mainly driven by the further improvement in the scale of online music subscription users and the average revenue per paying user. Specifically, the number of online music paying users increased by 20.8% year-on-year, reaching 103 million, and the average monthly revenue per paying user reached 10.3 yuan, achieving continuous growth for six consecutive quarters, reaching a new historical high. However, it is worth noting that Tencent Music's online music service user base has decreased by 4.2%. More importantly, the issue of user attrition has persisted for a long time. Data shows that in the second quarter of 2023, the monthly active users of online music services were 594 million, a year-on-year decrease of 4.7%; in Q1, the monthly active users of online music services were 592 million, compared to 636 million in the same period last year, a year-on-year decrease of 6.9%. Due to factors such as anti-monopoly, Tencent Music has lost its exclusive copyright advantage, which is likely one of the reasons for the continuous decline in monthly active users. Therefore, although the online music business as a whole maintains a good development momentum, Tencent Music seems to lack a good solution to the "user attrition" issue. Furthermore, it is difficult to prove the true growth of Tencent Music through the improvement in conversion rates. Profit Optimization Where is the new growth point? Peter Drucker, the father of modern management, once said, "In business, the only thing that exists is cost." This quote is particularly important for organizations of a certain scale. Tencent Music has been maintaining profit growth through cost control measures. In the third quarter, Tencent Music Entertainment implemented effective cost control measures. Although total revenue decreased, net profit achieved a year-on-year increase of 15.6%. Specifically, Tencent Music Entertainment's income cost in the third quarter decreased by 14.8% year-on-year to 4.23 billion yuan. The main reason for the decrease was the decline in revenue sharing expenses due to the decline in social entertainment service revenue, partially offset by the increase in content costs from licensing fees and advertising agency fees. In terms of operations, Tencent Music Entertainment's total operating expenses in the third quarter decreased by 11.8% year-on-year to 1.27 billion yuan, and the percentage of operating expenses to total revenue also decreased from 19.5% in the same period last year to 19.3%. Among them, sales and marketing expenses were 219 million yuan, a year-on-year decrease of 10.6%; general and administrative expenses were 1.05 billion yuan, a year-on-year decrease of 12.0%. However, while cost-cutting measures have helped to increase profit, they also expose Tencent Music's sustainability issues. The fluctuations in the two main businesses, social entertainment services and online music services, the erosion of exclusive copyright barriers, and the continuous decline in the scale of monthly active users all indicate the cracking of Tencent Music's ecosystem.Seam appears.In fact, the decline in Tencent Music's social entertainment business is a normal phenomenon in the industry. It is understood that Tencent Music's social entertainment services mainly include features like karaoke and live music streaming, where users can sing, watch and engage in social activities on the platform. The decline in this aspect of the business is partly related to Tencent's proactive risk management and adjustments to live streaming. Additionally, it is also related to the competition for traffic with short video platforms. As Tencent Music, with a focus on music, its live streaming business naturally faces challenges competing with platforms that have more abundant traffic. Therefore, in the face of the declining trend in social entertainment business and the loss of traffic for online music services, growth now relies solely on price increases. The question of how Tencent Music can explore new growth spaces has become a pressing issue for the company. However, Tencent Music seems to have also noticed this. Currently, the company is not only deepening its efforts in the online music and social entertainment sectors, but also further developing innovative businesses such as long-form audio, TME live, and metaverse social. These explorations may not yet have a significant impact on the financial reports, but they could potentially become new growth drivers for the company in the future.