Tencent Music Entertainment Group (NYSE:TME) Q3 2023 Earnings Call Transcript

Tencent Music Entertainment Group (NYSE:TME) Q3 2023 Earnings Call Transcript November 14, 2023

Tencent Music Entertainment Group beats earnings expectations. Reported EPS is $0.89, expectations were $0.12.

Millicent Tu: Good evening, good morning. Welcome to Tencent Music Entertainment Group’s Third Quarter 2023 Earnings Webinar. I am Millicent Tu, Head of IR and the company. TME announced its quarterly financial results today before the U.S. market opened. Earnings release is now available on our IR website and via Newswire services. Today, you will hear from Mr. Kar Shun Pang, our Executive Chairman, who will start the call with an overview of our company’s strategies and business updates. Next, Mr. Ross Liang, our CEO, will share additional thoughts on our platform strategies and developments. Finally, Ms. Shirley Hu, our CFO, will discuss our financial results before we open the call for questions. Before we continue, I refer you to Safe Harbor statements in our earnings release, which applies to today’s call as we will make forward-looking statements.

Please note that the company will discuss non-IFRS measures today, which are more thoroughly explained and reconciled to the most comparable measures reported under IFRS in the company’s earnings release and filings with the SEC. [Operator Instructions] And please be advised that today’s webinar is being recorded. With that, I am very pleased to turn over the call to Kar Shun, Executive Chairman of the company. Kar Shun?

Kar Shun Pang: Thank you, Millicent. Hello, everyone and thank you for joining our call today. We are pleased to report another quarter of strong growth in our online music services despite the top line headwinds of the social entertainment business while adjusting certain industry-wide live streaming interactive features represented some challenges for the quarter. It ultimately placed us on an even stronger footing for our long-term sustainable development. As a case in point, our evolving businesses have become more resilient, illustrated by group-wide margin expansion and strong cash flows for the quarter. What’s particularly worth mentioning is our online music subscriptions. This business has registered accelerated year-over-year revenue growth.

Growth momentum carried into the third quarter with expansion in both of our subscriber base and ARPPU. Our paying user base grew further to 103 million, a strong testament to the broad appeal and high value of our music products and services. Our impressive content offerings, compelling subscribers’ privileges and interactive product features, together with strong execution, enabled us to attract new subscribers while retaining existing ones. We are also pleased to see that monthly ARPPU expanded to RMB10.3, thanks to disciplined promotions, effective member acquisitions and our high subscriber retention rate. These achievements will result from the solid execution of our dual engine content and platform strategy. It further unlocks the value of music and pave the way for our long-term success.

I’d like to share a few highlights. First, we cultivate deeper mutually beneficial partnerships with record labels and artists. Our insights across content and users as well as our holistic approach to growing the industry, supported our strengthened co-operations with music partners. For instance, we strengthened our collaboration with TFBoys on the 30-day head start release of their 10-year anniversary single, See You Tomorrow, as well as the sale of their themed album, 10 Years. To amplify user engagement and strengthen their bond with the artists, we launched several online song guessing contest and music-based interactive features for this single. We expanded our partnership with YG Entertainment into ticketing, where we opened a dedicated channel for users to purchase BLACKPINK’s concert tickets, further expanding subscriber purchases.

In addition, we formed a new partnership with Cube Entertainment, bringing in a prominent line of brands and groups such as B2B, Pentagon, (G)I-dle and like some. This collaboration not only enriched our music catalog, but also granted us the privileges of a 30-day head start period on new song releases. Each of these examples strengthens our ratio cycle and creates a win-win situation. Our evolved relationships with artists enables fortify our music ecosystem, bringing more enjoying privileges to our users, while also creating prosperity for all stakeholders along the industry value chain. Second, leveraging TME’s integrated resources and expertise, we expanded our industry influence by assisting artists at different stages with their career growth.

With respect to top-tier artists in August, we host an online/offline concept for Jay Chou celebrating the 9-year anniversary of its debut, highlighted by sales of sought-after tickets and social media buzz of nearly 2 billion event views in just 3 weeks. This event generated great excitement and acclaim among users. As for our strategic partnership artists, this quarter we assisted TIA RAY with her appearance at the mid-autumn festival gardens organized by CCTV and Hulan Satellite TV successfully increasing her influence nationwide. Among our emerging musicians, we have [indiscernible], our India musicians performed and showcases talent on the reality show, the [indiscernible]. Through music exposure and social media, we help team attract more users to explore its original sounds on our platform.

In quarter three this year, we also had over 20 up and coming musicians forming at Line Music Festival. Many rising musicians form our Tencent Musician program showcased that their talents at the Coca-Cola sponsored the 2023 Summer Limited Refreshing Music Festival. Such activities with high-quality brands also encourage us to further explore sponsorship advertising opportunities. Third, we enhanced our technology capabilities in content creation, promotion and distribution. Some of this content also recorded initial success overseas. In the third quarter, [indiscernible] introduced AI-powered music production tool, featuring fast and convenient generation of a user’s AI voice to produce musical works. Kugou Music’s vocal producer also upgraded its functions to allow AI-generated music content in multiple languages.

Through a brief training section, it can effectively and efficiently produce songs in Mandarin, Cantonese, English, Korean and Japanese. Both tools substantially boosted creators’ creativity. TME’s music promotion and distribution to kids, such as the TME Music Cloud and Kugou’s ToMoreMusic platform, big advancement in helping record labels, creators and musicians efficiently promote their musical work. Our deep industry insights, enhances data and enable us to successfully promote Chinese songs overseas. For example, we help [indiscernible] chart on various popular music lists in Singapore during the quarter. Moving on to our continued efforts on ESG. In the third quarter, we joined hand with Tencent’s SSV and launched our 2023 Music Tech X program inviting high school students to explore our technology inspired music journey.

Working side by side with the student, we commissioned a theme song, the most beautiful song in the world to campaign the public and support the hearing inspiring the senior citizens. In addition, we organized a special music education project, Music Garden Space, to help children from ethic minorities and remote areas appreciate the beauty and power of music. These initiatives demonstrate the value and positive influence we can bring to a wide range of communities. In summary, our holistic and strategic approach is strengthening and expanding our capabilities, making our platform and ecosystem increasingly robust. We continue to grow our music subscriptions and strengthen our partnership with label and artists, enriching our content and perpetuating our virtual cycle.

We are also fostering new talent and leveraging our adviser technology to support our efficient school. This powerful combination and evolution will drive our company’s sustainable development in the long run and support the broader industry advancement. Now, I would like to turn the call over to Ross for more color on our platform development. Ross, please go ahead.

Ross Liang: Thank you, Kar Shun. Hello, everyone. Music is the heart and soul of TME. I would like to begin by commenting that quarter three results highlighted the efficiency gains across our platforms. Specifically, our ecosystems are strong platform, scale and AI important technology, have enabled us to transition into an increasingly robust music house. From the operational level, one key highlight is our effort to expand the application of AI technologies across our products and services based on our upgraded music IRM. This quarter, we integrated our IRM integration platform, allowing third-party models to be better integrated with an adaptive to the music vertical. With support of AI, we enhanced the music discovery and the consumption efficiency, creating a more engaging user experience.

First, better content connection and discovery. This quarter, we continued to upgrade our recommendation middle platform and enhanced personalized recommendations on each of our music apps. As a result, we reached a new record in the share of streams from recommendations as well as an increase in the number of songs added to users’ personal series. We also significantly allowed the barriers to music discovery. For example, QQ Music introduced its Quick Listen mode, which allows users to listen to a song’s chorus and then quickly look at the full song. Another example is Kugou Music’s revamped version featuring faster discovery of multiple songs, song covers as well as AI run versions played by different installments. Second, better facilitating music consumption through more user cases and entertainment scenarios.

In the in-car use test, we extended our mobile and offerings, such as our seamless user interface, premium song quality and a tailored playlist to enrich in-cabin music consumption. To increase our coverage, we recently signed additional car models including Mercedes-Benz smart and more BYD models. Partnering with the hardware manufacturers, we led the industry by leveraging Qualcomm’s latest AI computer capabilities to enhance users’ music listening experience with richer details and more sensations. In terms of broadening entertainment content consumption, we customized our music services, including content production, promotion and data analysis across in the areas of film and television, gaming and animation. Through tailored music works, we create unique touch points for original IPs, unlocking their value.

For example, the call produce boast the same and songs for the blockbuster, No More Bets, [Foreign Language]. We also produced the original soundtracks for mobile games, including Peacekeeper Elite, Crossfire and Dungeon and the Fighter, all of which have received widespread acclaim. Third, for our immersive user connections, we have created a thriving community, where music lovers can bind medley making their experience on our platform more enjoyable and long lasting. For example, QQ Music launched over 30 interactive song-guessing contests featuring artists such as Jay Chou, BLACKPINK and the Teens in Times. These events quickly went viral across social media platforms and our in-app community and Funko groups, amplifying TME’s influence.

To sum up, these three dimensions of connections inspire us to further unlock music’s value. AI-powered technology is supporting us to provide better user experience and making the platform increasingly efficient. Our online music business has become diversifying and crucial growth pillar. Social entertainment services remain adaptive as part of our holistic music offerings. For 2024 and years ahead, we will stay laser focused on providing, enlightening user experiences while driving operational efficiencies across the platform. With that, I will turn the call over to Shirley, our CFO, for a deep dive into our financials.

Shirley Hu: Thank you, Ross. Hello, everyone. Next, I will discuss our results from a financial perspective. In the third quarter of 2023, revenues from online music increased by 33% to RMB4.6 billion on a year-over-year basis, driven by strong growth in our music subscription and advertising business. Our total revenues were RMB6.6 billion, down by 11% year-over-year due to decline of revenues from social entertainment services and other services. Music subscription revenues in Q3 reached RMB3.2 billion, up by 42% year-over-year and by 10% sequentially, driven by further expansion of both online music paying user space and the monthly app. Basically the number of online new paying users grew to 103 million, up by 21% year-over-year, representing net adds of 3.6 million users sequentially.

Monthly ARPPU was RMB10.3 billion, up at 17% year-over-year and 6% sequentially, marking its sixth consecutive quarters of growth and another record high amount. This was result from our products more appealing member privileges in the active product features, attractive music content and the promotion and member acquisition strategies as well as high subscriber retention rate. Additionally, revenues from advertising achieved strong growth on a year-over-year basis as our diversified product portfolio and innovative ad formats, including ad-supported model and sponsorship advertising are highly attractive to the advertisers. Our campus music contest, QQ Music 2023 young music contest [indiscernible] music competition and the Coca-Cola sponsored 2023 [indiscernible] music festivals were two good examples of how our portfolio of music IPs attracted various branded advertisers.

Social entertainment services and other revenues were RMB2 billion, down by 49% year-over-year. The decrease was mainly caused by our adjustments to certain live streaming interactive functions and more stringent company procedures as we implemented several enhancements and risk control measures. This is in line with our expectation about live streaming revenues as discussed previously. We believe these measures [indiscernible] beneficial to our users, which will help pave the way for the long-term sustainable development of our business. Gross margin in Q3 was 35.7%, up 3.1 percentage points year-over-year, primarily due to the following factors. First, our – subscription revenues had strong growth this quarter. Specifically, expansion in paying user base and improvement in monthly ARPPU, both had a favorable impact on our gross margin.

Second, our advertising revenues also had a strong growth, which also benefit our gross margin. Third, as we gradually ramp up our own content, it has positively impacted our margin. As you see here, shifting to win-win relationships with labels and artists and increasing subscription ARPPU, over the past several years, have a number – margin model and more than outside impact from decline in live streaming revenues. Now moving on to operating expenses. Total operating expenses for Q3 were RMB1.3 billion or 19.3% as a percentage of total revenue, down by 0.2% from 19.5% of total revenues in the same period last year. Selling and marketing expenses were RMB219 million, down by 11% year-over-year. As we closely monitor the ROI of each promotion channel and improve the effectiveness of promotions, general and administrative basis were RMB1 billion, down by 2% year-over-year.

This decrease was primarily due to those employee-related expenses as a result of improved headcount efficiency and expenses related to the Hong Kong – incurred in the same period 2022. Our effective tax rate for Q3 was 12.2%. For Q3, our net profit and net profit attributable to equity holders of the company were RMB1.3 billion and RMB1.2 billion, respectively. Non-IFRS net profit and the non-IFRS – attributable to active holders of the company were RMB1.1 billion and RMB1.4 billion, respectively. Diluted earnings per ADS were RMB0.74, up 12% on a year-over-year basis. Non-IFRS diluted earnings owners per ADS was RMB0.89, up 3% on a year-over-year basis. As of September 30, 2023, our combined balances of cash, cash equivalents and term deposits were RMB31 billion, as compared with RMB30.5 billion as of June 30, 2023.

Such combined balances was also affected by the change in exchange rate RMB to USD, a different balance sheet base. In March 2023, we announced a share repurchase program of $500 million. As of September 30, 2023, we had repurchased 13.8 million ADS from the open the market with cash for a total consideration of approximately $103 million. In conclusion, our music subscription business has demonstrated a strong growth trajectory prepared by quarterly growth in both ARPPU and the paying users, and we expect such trend to continue with a keen focus on our management and improve efficiencies in operating costs and promotional channels. We expect to continue driving our overall profitability. Last, but not least, keep investing in new products and services, high-quality content as well as new technologies through organic development and to solidify the foundation for our long-term growth.

This concludes our prepared remarks. We are ready to open the call for questions.

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Q&A Session

Operator: Thank you, Shirley. [Operator Instructions] And the first question comes from the line from Alicia Yap from Citigroup. Alicia, please go ahead.

Alicia Yap: Hi, thank you. Good evening, management. And thanks for taking my questions. Congrats on the solid result. I’m going to ask the questions and [indiscernible] reverse. I am going to translate myself. So I wonder if management can share your preliminary view on your expectations for the online music revenue growth in 2024 and how you expect the business and the competitive event gets to evolve in the next 3 years? In addition, wondering if management could share how you think the macro environment might affect the growth prospect in next year and also over the next 3 years? Thank you.

Kar Shun Pang: Thank you for your question, Alicia. And I think 2023 is a critical year for us. We have been transitioning and expanding our music ecosystem, making our business mix much more resilient. This is actually factored in a number of aspects. First, we responded quickly to the challenge facing, the live streaming industry, taking proactive actions to adjust our social entertainment business and making it more sustainable. Secondly, we continue to drive the prosperity of our music ecosystem while diversifying our revenue streams. And thirdly, our core business like the online music subscriptions and advertising record robust growth, mid and evolving macro environment. So you can see this in our second and third quarter financial results.

For 2022, I think that assuming we are going to have a stable external environment, and we see the opportunity to drive our overall top line growth and margin expansion compared to 2023, especially, we will continue to drive solid growth of our online music business with subscription revenue driven by the subscription growth and also ARPPU expansion as well. Outside of the subscription revenue, we expect the revenues from advertising and new initiatives such as artist merchandise to continue to grow healthily. For the social entertainment services, we will continue to execute our current operational strategy with the backdrop of the macro factors and competition. Before 2024, our primary target is to stabilize the business and better serve our core users.

As part of our holistic music ecosystem, we expect our social entertainment business to continue generating a healthy cash flow for us. For 2024 earnings, we aimed to point our strong results so far in 2023 and continue to drive both gross and net margin expansion. For the 3 years outlook, I think TME’s core businesses, especially our online music services still have lots of room to grow over the next 3 years. We are excited to see the growth opportunities in existing areas, including the subscription, ARPPU advertising and more potential from the long-form audio as well. In addition to the online music services as well, we have being – we extended our rich and expanding capabilities along the entire music value chain. We have successfully developed our new monetization models to increase our target addressable market with the diversifying revenue streams.

And these include the live performances like concerts and music festivals, artist merchandise and more. With all these initiatives still in the early stage, we believe that we have built a strong foundation to tap into more areas for the long-term growth. So in a nutshell, I think that we are glad that our core businesses like the online music service show great resilience amid the current macro environment. And we are confident that our content and platform dual-engine strategy will continue to capture more opportunities for our future healthy growth.

Operator: Thank you. The next question comes from the line of Alex Poon from Morgan Stanley. Alex, please.

Alex Poon: Congratulations management for a very strong quarterly results, especially the subscription business. My question is related to our ARPPU growth. So third quarter, we have achieved record high absolute number and also on a year-over-year and sequential growth basis. Going forward, because our blended ARPPU is still even lower than our Double 11 promotion price, and a lot of users are paying the auto renewal price of RMB15, so how should we think about the trajectory? How much visibility do we have for continuing this very strong ARPPU growth in the next 2, 3 years maybe because there is also a macro issue, deflationary environment also competition with NetEast, which is still charging at a lower price than us?

Shirley Hu: Thank you very much. Thanks for the question. Well, regarding the ARPPU, actually, we maintained our rep growth for six consecutive quarters. And for this quarter, it’s already RMB10.3. And because we also continue to downsize our promotional events and also make the membership benefits more attractive and we also adjusted the price policies. Well, at the same time, you can say that we actually make some concessions regarding the discounted rate for the consecutive subscription business but we’re also proactively adopting the effective operational strategies. Therefore, we will be able to retain our users. That’s raising our – in Q3 of this year actually show a very good performance. Well, at the same time, and we are still very confident regarding our future subscription business revenue growth.

You’re also asking about the Q4 performance, and we are also very happy and confident we’re going to grow the number. In the same part of your question, you asked about the outtake for the next 3 to 5 years. And you mentioned actually our fee is around RMB50 and we’re going to keep an eye on the industrial competition, our own operational and also factoring the elements you mentioned, for example, like inflation and then to further optimize our performance.

Operator: Okay. The next question comes from the line of Zhang Lei from Bank of America Merrill Lynch. Zhang?

Zhang Lei: Hi. Thank you, management for taking my question. Noticed that our gross margin is pretty on track in past quarters and reached the record high since 2019. And can you share with us the trend of music and social entertainment business in terms of gross margin? And how should we look at the margin trend going forward?