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:
China: population 1.4 billion. 100% ownership of QQ Music, Kugou and Kuwo which together account for 70% of subscribers
India: population 1.3 billion. Undisclosed ownership of top three streaming service Gaana
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 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