Looking for the Music in Tencent Music

The Tencent Music Entertainment (TME) F1 filingmakes for highly interesting reading, but don’t expect copious amounts of data to give you an inside track in the way that Spotify’s F1 filing did. Instead TME’s F1 bears much closer resemblance to iQyi’s F1, namely a basic level of KPIs, lots of market narrative and even more space assigned to explaining all of the risks associated with investing in a Chinese company. But, perhaps the most significant thing of all is that TME isn’t really a music company or investment opportunity, but is instead a series of social entertainment platforms, of which music – and much of it not even streaming music – is one minor part.

Risk factors – there’s a lot of them

As with iQiYi’s F1 filing, a lot of the document is taken up with outlining the risks associated with investing in a Chinese company, particularly with regard to the various ways in which the Chinese government can potentially put the business out of existence. Evidence of just how real this threat is for Tencent is very close to home. The Chinese authorities are currently refusing to authorise any new Tencent games – and have not done so since March,  while it brings in new restrictions on game playing for kids.Tencent’s shares tumbled as a result. The problem for Chinese companies providing due diligence for overseas investors is that they have to admit that they might not be compliant with all Chinese laws. With the PRC (People’s Republic of China) government not having democratic checks and balances, Chinese companies have to face the real possibility of unpredictable, unchallengeable, draconian intervention, such as is happening with games.

Two particular areas of potential difficulty that the TME F1 highlights are social currency and overseas interests:

  1. TME makes much of its money from social gifting and virtual items. TME argues this does not constitute virtual currency, so should not be subject to tight PRC regulations. The PRC government may disagree.
  2. TME is registered in the Cayman Islands and does not actually own many of its Chinese streaming services but instead has shareholdings in, and contractual relationships with, them. This is a risk-laden approach at the best of times, but is given extra spice by the fact the PRC could determine TME to be a foreign interest, which would put it in breach of a whole bunch of PRC regulations.

Other notable risk factors are:

  • UGC:TME explains: “Under PRC laws and regulations, online service providers, which provide storage space for users to upload works or links to other services or content, may be held liable for copyright infringement”. It goes on to say: “Due to the massive amount of content displayed on our platform, we may not always be able to promptly identify the content that is illegal.” There are two potential outcomes: 1) things carry on as they are 2) rights holders get itchy feet and TME needs to find someone to help it monitor and police copyright infringement.
  • ADS: TME is not offering shares for sale but instead American Depositary Shares (ADS), which in heavily simplified terms means that investors’ money is deposited in US banks in USD and then can in principle be converted into RMB shares at the prevailing currency exchange rate, which may be higher or lower than when the ADS was purchased.

What’s in a number?

Prior to this filing, Tencent had only released one audited music subscriber number – back in Q1 2016 it announced 4.3 million QQ Music subscribers. After that came a succession of press cited numbers that got a lot bigger, but nothing audited. Finally we have a whole collection of numbers to play around with (though see the PS at the end of this post for a health warning on interpreting Chinese company numbers reported in SEC documents).

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In 2016, TME was very much a music company, with music accounting for nearly half of its RMB 4.4 billion revenues. But by 2017 that picture had changed…and some…with just 29% of its revenues classified as ‘online music services’. Online music revenues grew by 47%, which is impressive enough in isolation, but is much slower growth than the rest of the Chinese paid content market. Video, which parent company Tencent is a key player in, is a major growth area. One sub strand of this is social video, where TME is also market heavyweight. Luckily for TME, it has eggs in many baskets. Social video, which largely comprises live streaming in China, contributed to TME’s social entertainment services revenue growing by 253% (i.e. five times more quickly than online music) in 2017 to reach RMB 7.8 billion – 71% of TME’s total RMB 10.9 billion.

This revenue was driven in large part by live streaming services Kugou Live and Kuwo Liveand by social karaoke app Quanmin K Ge, known as WeSing in the west. WeSing is arguably the biggest ‘music’ app many people don’t know about. Music doesn’t play the same cultural role in China as it does in western markets, thanks in part to the legacy of the oxymoronically named Cultural Revolution, which limits the potential opportunity for music services in China. Karaoke, however, is huge, and WeSing does a fantastic job of converting this demand. By putting social centre stage, TME is able to monetise social in a way that would make Facebook green with envy. As TME explains:

“We provide to our users certain subscription packages, which entitle paying subscribers a fixed amount of non-accumulating downloads per month and unlimited “ad-free” streaming of our full music content offerings with certain privilege features on our music platforms.

We sell virtual gifts to users on our online karaoke and live streaming platforms. The virtual gifts are sold to users at different specified prices as pre-determined by us.” 

Putting social centre stage

But TME’s social skills are not limited to WeSing. Social seeps from virtually every pore of its music services, with features such as likes, comments, shares, ability to create and share lyrics posters from a song, ability to sing along to songs, see local trending tracks, get VIP packages etc. TME has worked out how to bake true social behaviour into the centre of its music services in a way few western companies have (YouTube and Soundcloud are rare exceptions). Both Soundcloud and YouTube built their services without having to play by the record label rule book. Read into that what you will.

The social power of TME’s end-to-end social music offering is illustrated by this case study:

Ada Zhuang (  ). Ada started out as a talented singer on our live streaming platform. A few months later, she released her debut album on Kugou Music. Since then, Ada has released over 200 songs that have won numerous music awards. Her popularity continued to grow through concerts held across China. A single released by Ada in October 2015 has since then been played over three billon times on our platform. 

TME2

Through its acquisition of competitor services Kugo and Kuwou, TME has built a music empire, giving it a 76% music subscriber market share and leaving two key competitors: Apple Music and NetEase Cloud Music. TME pointedly makes no reference to Apple Music, despite it having 2.6 million Chinese subscribers in 2017. NetEase, however, does get a name check.

TME reported its combined (net) mobile music MAUs to be 644 million in Q2 2018, though defining its users as unique devices rather than unique users. (Interestingly, it defines its social users on an individual basis.). What is clear is that TME’s music users and social users are mirror opposites in user tally and the revenue they generate; social users are just 26% of users but account for 71% of revenues. Clearly, TME has identified there is a lot more money to be made from social experiences than streaming music. Few western companies saw this opportunity. Musical.ly, founded by Alex Zhu and Luyu Yang, did, and was predictably bought for $1 billion by Chinese company Bytedance, home to Douyin (known as TikTok in the west).

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TME’s ARPU numbers hammer home the scale of success for its social segment versus its music side. In Q2 2018 TME was earning RMB 122 a month from social users, against a paid user base of 9.5 million, while its paid music base of 23.3 million was generating an ARPU of just RMB 9.

 

Interestingly, international expansion is not mentioned once in the 198,984 words of the TME F1 filing. TME explains exactly how it intends to spend the money from the IPO but international is not spelt out. Our bet though, is that TME is playing its cards close to its chest and will indeed go west.

Wildcard

TME is one of a number of Chinese tech firms listing a portion of their stock on US exchanges. Should the US economy topple into a downward trend at some stage, for example as a resulting of an escalating trade war with China, then stocks like TME could give US investors a seamless way of transferring their holdings out of US companies into Chinese ones, without having to change their portfolio mix (ie one tech stock for another) and without having to change jurisdiction. And with China sitting on $3 trillion of foreign currency reserves – with USD the largest part – China could even hasten things along by flooding US currency into the markets, triggering a tumbling exchange rate.

PS

There is an international jurisdictional loophole between the SEC in the US and the CSRC in China. Which in overly simplified terms means that Chinese companies can falsely report numbers in SEC filings,withtheSEC unable to prosecute Chinese miscreant companies and the CSRC unable to take action over the SEC filing.This has resulted in a significant number of fraudulent filings by Chinese companies reverse listing onto US exchanges via dormant US companies, with SEC filings showing numbers up to 10 times higher than their CSRC filings. The only watertight way to validate Chinese company SEC filed numbers, is to corroborate them with CSRC filings. Unfortunately, TME is not a separate entity in China so has not filed any numbers, and, as stated above, Tencent has rarely reported any numbers for its music division. This does not mean that TME’s should not inherently be taken at face value, but it does suggest extra scrutiny might be wise.

Emerging Music Markets: Streaming’s Third Wave

MIDiA has just published a new report that deep dives into how streaming is, or in some cases is not, lifting off in emerging markets. The regions we focused on were Russia, the Middle East, sub-Saharan Africa, China and India. The report ‘Emerging Music Markets: Streaming’s Third Wave’ is immediately available to MIDiA subscription clients and can also be purchased, along with its full dataset (including service- and country-level subscriber and free users numbers, as well as consumer data for India and China) on our report store here.

Here are some of the key findings and themes of the report.

emerging markets midia streaming

With streaming growth set to slow in mature western markets by 2019, the next wave of fast growth will come from a mixture of mid-tier markets such as Mexico, Brazil, Japan and Germany. The lower income mid-tier markets such as Brazil and Mexico are so populous that the urban elites have been big enough to generate paid user bases that are comparable to those of smaller European markets. The real scale opportunity, however, exists in monetising lower income groups with much cheaper propositions. Beyond that, the streaming market will need to look towards emerging markets for growth. Emerging markets in Asia and Africa present a diverse variety of opportunities, but current evidence suggests that the outlook for these markets is far from uniform.

The rule that defines emerging markets for streaming music is that there isn’t one. China has a large base of free users and a solid base of subscribers. India has large numbers of free users, but a tiny paid base. Russia and the Middle East both have a solid ratio of free-to-paid users while Africa has the lowest per capita metrics for both paid and free.

Arguably, the single most important reason for these differences is mobile data network availability and affordability. In China and India mobile data use is increasingly widespread, making streaming a compelling proposition, while in most sub-Saharan African countries coverage is patchy and expensive.

Despite their differences, these regions will be crucial to the long-term outlook for streaming growth. So, mapping their respective trajectories helps to forecast long-term global market growth for streaming. Rights holders will need to innovate out of their comfort zone if they are to truly seize the emerging markets opportunity. The fact that Nigeria’s MTN only gets a retail ARPU of around $2 a year across sub-Saharan Africa for its music products, including ringtones and downloads, hints at where ARPU expectations may have to be set.

Companies and brands mentioned in the report:Baidu Music, Gaana, Hungama, iRoking, Jio Music, Kugou, Kuwo, Mdundo, Mkito, MTN, MTN Music+, Mzliki, Netease Cloud Music, QQ Music, Quan Min K G, Saavn, Simfy Africa, Vkontakte, Vkontakte Music, Vuga, Wynk Music, Yandex, Yandex Music, Zvook

Click here to view the report on MIDiA’s report store.

Just What Is Tencent Up To With Streaming?

Tencent is building a global streaming empire. Back in December 2017 Tencent Music did a 10% equity swap deal with Spotify and now it has led a $115 million investment round for India-based streaming service Gaana. India may only be a small subscription market, with just 1.1 million paid subscribers at the end of 2016, but it one dominated by local players and has massive free streaming potential. Tencent now has major streaming stakes that give it reach across Asia, Europe and the Americas. The key missing parts are the Middle East and North Africa (Anghami is probably waiting for the phone to ring). Right now, Tencent has a streaming foothold in the world’s three largest countries:

  1. China: population 1.4 billion. 100% ownership of QQ Music, Kugou and Kuwo which together account for 70% of subscribers
  2. India: population 1.3 billion. Undisclosed ownership of top three streaming service Gaana
  3. US: 330 million. 10% ownership of leading subscription service

What Tencent is doing is building a global network of strategic positions in the streaming market that individually might not have global influence, but, collectively could be brought to bear to in an impactful way. Much like John Malone’s Liberty Media, Tencent is taking minority stakes in a strategically selected portfolio of companies. This provides it with the ability to exert some degree of influence and extract some benefit without the risk and resource required for a majority ownership. Minority stakes can also be used as beachheads for majority ownership further down the line.

In some respects, Tencent does not have a huge amount of choice in the matter. Last year the Chinese government placed restrictions on the amount Chinese companies could spend on overseas companies, in order to slow the outflow of capital from China. But, rather than let this be a hindrance Tencent is now using the policy to shape a bold internationalisation strategy. Coupled with other minority investments (12% in Snap Inc., 5% of Tesla) Tencent is positioning itself to be king maker in the future of digital media.

Spotify, Tencent And The Laws Of Unintended Consequences

spotify tencent midia

News has emerged that Spotify and Tencent Holdings could be swapping 10% holdings in each other’s companies ahead of Spotify’s public listing. There are some obvious implications for both enterprises, as well as some less immediately obvious, but even more interesting permutations:

  • Spotify gets a foothold in China: Tencent is the leading music subscription company in China with QQ Music, Kugou and Kuwo accounting for 14.7 million subscribers in 2016. Apple Music has got a strong head start over Spotify with 3.5 million Chinese music subscribers. Tencent, with its billing relationships, social reach (WeChat, QQ Messenger) and rights holders relationships (Tencent sub-licenses label rights) provides a potential China launch pad for Spotify. So, the obvious implication is that Spotify could use Tencent as an entry point into the market. But this is where things get complicated. Tencent is planning a $10 billion flotation of Tencent Music. How would this valuation be impacted by Tencent aiding the entry of a direct competitor – which is a leader in virtually every market it is currently in, into the market of? A joint venture could be the way to square the circle.
  • Spotify continues its narrative building: As I have long argued, Spotify needs to construct a compelling narrative for Wall Street. It needs to be able to show that it is making strong progress on many of its weak points. Getting better deals from the labels was one such move. Now it has ticked the ‘what about China’ box too.
  • Tencent gets a foothold in the US: Earlier this year the Chinese government put in place restrictions on Chinese companies investing in overseas companies, in order to slow the outflow of Chinese capital. (It slowed a potential investment by Alibaba in UMG). Swapping equity is a way to get round this restriction. It also builds on Tencent’s move extending its stake in Snap to 12%. Tencent is pushing the rules to the limit in order to become a key player in US digital consumer businesses (Spotify of course will become, in part at least, a US company when public). The intriguing question is whether Tencent will get any access to Spotify’s western billing relationships.
  • Valuation disparities: Tencent Music has around a 3rd of Spotify’s subscriber base, a fraction of its revenue and half of its market valuation. Yet a 10% swap deal is on the table. Which suggests that Spotify really, really feels that it needs that entry point into China….

If this deal pans out the way it has been slated, it will potentially save Spotify and Tencent from a resource-draining clash of Titans for when (not if) Spotify would enter the Chinese market. It also provides Spotify with a potential long-term insurance asset. When Yahoo acquired a stake in Alibaba it was very much the senior partner. But, as Yahoo’s business imploded its Alibaba stake became its core asset.

Spotify obviously won’t be thinking that way but history shows us to never say never.

UPDATED: This post has been updated to reflect that the 10% equity swap is with Tencent  Music, not Tencent Holdings Ltd

Is QQ Music Worth $10 Billion?

Western appetite for the Chinese market has long been based upon accessing the 1.4 billion consumers. This has in turn impacted valuations of Chinese companies, particularly when eager western investors are involved. However, there is a growing realisation that market potential does not always translate to [performance]. Now we have Chinese tech major Tencent seeking pre-IPO investment in its music streaming service QQ Music, against a valuation of $10 billion. That is only $3 billion less than Spotify’s valuation. So, is QQ Music worth $10 billion?

qq music.png

Valuations in isolation can be misleading and therefore need context and scale. For example, Deezer had a valuation of $1.25 billion for its aborted IPO, while Spotify’s valuation is nearly 10 times higher. Moreover, Spotify’s subscriber count (60 million) is nearly 10 times higher than Deezer’s was (6.5 million), leading up to the aborted IPO. So, the best way to make meaningful comparisons between streaming music valuations is to look at the valuation divided by the number of subscribers, to give us a valuation per subscriber metric (see above). Here are a few ways to assess the value of QQ Music compared to other streaming services:

  • Valuation per subscriber: On the valuation per subscriber basis Spotify and Deezer’s valuations per subscriber are quite similar ($217 for Spotify, compared to $198 for Deezer). Tidal is significantly higher at $300 (well done that man Jay-Z for talking up the value of his service to Sprint), while QQ Music with its reported 10 million subscribers comes in at $1,000. This obviously begs the question, are QQ Music subscribers worth 5 times more than Spotify subscribers?
  • Subscriber revenue: The headline consumer retail price for Spotify is $9.99, while the headline price for QQ Music is $1.60. Spotify’s actual average revenue per user (ARPU) in 2016 was around $6.10, so if we scale QQ Music by a similar rate we get an ARPU of $0.98. If we multiply those ARPUs by the current subscriber number for each company, we end up with a monthly subscription revenue of $366 million for Spotify and $9.8 million for QQ Music. Therefore, rather than QQ Music subscribers being worth 10 times more than Spotify subscribers, they actually generate just 3% of Spotify’s subscriber revenue each month.
  • Addressable market: Valuations are of course based on potential, not just actual. China has 717 million smartphone owners (30% of the global total) and a GDP of $11.2 trillion (14% of the total). Given QQ Music’s Chinese positioning, that is its addressable market. By contrast, Spotify is a global service, though pointedly not in China, so its addressable market (excluding China) is technically 1.7 billion smartphone owners, and $67 trillion of GDP. QQ Music’s addressable market is in fact smaller, unless of course it decides to roll out to more territories. Likewise, Spotify could also roll out to China.
  • Like-for-like comparisons: We also need to be careful about the numbers behind QQ Music. 10 million QQ Music subscribers may not be the same as 10 million Spotify subscribers. Firstly, QQ Music [subscription] includes karaoke features, such as Bullet Screening, which many would not consider to be music subscribers as such. Additionally, 10 million might not actually be 10 million. Back in Q1 2016, Tencent reported to the markets that it had a little under four million QQ Music subscribers. Then in July 2016, in a Mashable piece, it claimed to have 10 million subscribers. Then nothing until January 2017, when it did another media push, announcing…10 million subscribers. If we take these reports at face value, it means QQ Music had an incredible Q2 2017 then did absolutely nothing, and I mean nothing, thereafter. Whatever the subscriber number actually is for QQ Music, the 10 million figure, at the very least, merits some scrutiny.

So, to answer the opening question, is QQ Music worth $10 billion? That depends. Compared to other streaming music services, the metrics suggest that it isn’t. But, to Tencent’s local investor market, maybe so. 80% of Chinese stock market transactions are from small retail investors, i.e. not institutional investors. So, while a $10 billion valuation might look high to institutional investors, to enthusiastic local retail investors who know QQ Music and have read all the stories about the booming streaming music market, this will appear to be a golden opportunity to get in on the great streaming boom.

Is QQ Music worth $10 billion? It depends on who you are!