Tencent Music Entertainment is set to be the latest Chinese tech stock to list in the US, seeking access to international capital to build on its ambitious plans to dominate China’s online music entertainment space.
The business has been automatically thrown into the same pool as music streaming services like Apple Music and Spotify, the latter of which listed in New York earlier this year, but Tencent Music is a very different business operating in a very different market. It is more a blend of music streaming, video content and social media – combining characteristics shared by firms like Spotify, YouTube and Facebook.
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Although Tencent Music boasts a leading position in a market that has only just started to take off, there is considerable risk in its strategy. Some have raised their eyebrows at the fact that parent company Tencent Holdings, the Internet giant, is hyping up and spinning off its music arm only weeks after unveiling a huge restructuring that is centred on growth from business customers, not the music listeners and karaoke singers that Tencent Music attracts. Some query the motive behind Tencent Music’s separation, particularly when its platforms are so heavily intertwined with the parent company’s messaging and social media services, as well as its IT infrastructure.
We have a look at Tencent Music and how it operates, and whether it will be able to hit the right tune with investors.
What is Tencent Music and how does it make money?
Tencent Music dubs itself as an ‘all-in-one music entertainment destination’ boasting over 800 million monthly active users (MAUs) to make not only the biggest platform of its type in China, but in the world. Although it is easy to start drawing comparisons to Western peers like Spotify, the company is very different, as is the market it operates in.
Tencent Music has four core platforms under its belt: QQ Music, Kugau, Kuwa and WeSing. Broadly speaking, it has four revenue streams to match:
- Online music services: this is the element where Tencent Music is comparable to Western peers like Spotify. Through three leading platforms – QQ Music, Kugou Music and Kuwo Music – the company offers 20 million tracks secured through 200 labels, including the ‘Big Three’ (Sony Music Entertainment, Universal Music Group and Warner Music Group). It also has Emperor Entertainment Group and China Record Group on board, which are big players in the domestic market.
- Online karaoke: this is where it starts to get a little different and the part where some US and European investors may become befuddled. It cannot be understated how big karaoke is in Asia. China, Japan and South Korea are rife with karaoke rooms and the area is a big business. In its simplest form, users can record their own performances and watch others on the WeSing platform, but at its heart this is a social network built around karaoke that encourages users to challenge one another to sing-offs and hold online parties in virtual karaoke rooms. Tencent Music claims it had a staggering ‘40 billion connections’ between users of WeSing at the end of June. The content produced here is then made available on its other platforms, bolstering its music library for QQ, Kugou and Kuwo.
- Live music streaming: this element sees performances by artists streamed live primarily through Kugou Live and Kuwo Live, which in turn compliment the online music services
- Social entertainment: bundling this music-centric social network together then provides further opportunity to flog virtual products – emoji hearts and online gifts for example – that users purchase and send to karaoke or live performers. Tencent Music then shares a slice of the virtual sales with the artists or users that receive them, increasing engagement and providing income for content providers.
Surprisingly, Tencent Music currently makes over 70% of its revenue by selling virtual gifts and premium memberships. The other 30% comes from its online music services, which operate under a similar model as Spotify by offering ad-supported tiers and ad-free subscriptions.
This shouldn’t be the case longer-term, as the core subscription element of the business should grow in what is a very immature Chinese market, but this is not to say that selling virtual gifts and the like will not remain a fundamental part of the business in the future. For Tencent Music, all of its services form one ‘virtuous cycle of value creation’ – a flywheel that sees its music library attract users, which in turn encourages them to engage and provide further content that helps make its platforms even more attractive to new users.
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Why is Tencent Music listing and why is it being spun out of Tencent?
Tencent Music is being spun out of its parent company Tencent Holdings, the Chinese giant dominating internet gaming and operating the country’s largest mobile messaging service WeChat. The music industry in China had, until Tencent began consolidating the market and bundling them all into Tencent Music, been highly fragmented.
Tencent is a hugely diverse company with fingers in all sorts of pies helping support their growth, and it seems to be the right time for Tencent Music to go it alone. The parent company’s e-book company China Literature listed in Hong Kong earlier this year and soared after joining the market and food delivery service business Meituan Dianping, backed by Tencent, earned a valuation of $53 billion to become one of China’s most valuable tech firms.
However, not all have been successful, with Chinese electric car maker NIO having experienced a tough start to life as a public company after listing in the US.
Learn more about NIO and what you need to know
Why is Tencent Music listing in the US?
Tencent Music is listing in the US to access global capital markets outside of China and gain recognition in financial markets. Listing in the US will bring it to the attention of analysts and investors, and listing alongside the likes of Spotify will help support its valuation - the Swedish firm has soared over 27% since listing in early April 2018 and currently boasts a valuation of $30 billion.
What is Tencent Music likely to be valued at?
Tencent Music will be one of the biggest US listings by a Chinese company this year but the price of the initial public offering (IPO) has not yet been confirmed. Reports suggest the company will look to join the market with a valuation of between $29 billion to $31 billion – matching Spotify’s current worth. Based on the middle of the reported valuation range, Tencent Music would be worth about 18 times its annual sales last year when it joins the market.
For registration purposes it has set a placeholder amount of $1 billion, which should be regarded as a minimum target considering the firm is reportedly aiming to raise closer to $2 billion. That would be only half the rumoured $4 billion figure circling earlier this year, although the valuation has remained stable to suggest it now plans to sell fewer shares under its IPO than before. That would be understandable considering it has over $1.4 billion in the bank following positive cash flow and significant fundraisings this year.
The IPO price per share will be higher than what existing investors have paid and with that in mind, Tencent Music this year has sold off 67.4 million shares for $239 million to new strategic investors at an average price of around $3.50 and 52 million shares for $210 million to existing investors for about $4 per share.
Tencent Music IPO: parent company to retain ultimate control
Tencent Music has filed for a possible IPO in the US involving the issuance of American Depositary Shares (ADS) but has not yet decided whether it will list on the New York Stock Exchange (NYSE) or Nasdaq. However, like many tech giants that come to market over the years the company will ultimately remain under the control of the parent company Tencent Holdings, which owns 58% of Tencent Music pre-IPO. How much control Tencent Holdings will retain after the IPO is not yet known, but it will hold a majority of the voting power.
The support from Tencent Holdings has been invaluable, not only aiding the music arm financially but also in vital areas including traffic acquisition, advertising and IT infrastructure, demonstrating how Tencent Music’s reliance on its parent firm goes far beyond money.
The lead sponsors of the Tencent Music IPO are Bank of America, Deutsche Bank, Goldman Sachs, JPMorgan and Morgan Stanley.
Is Tencent Music profitable?
Tencent Music is not only in the black but delivering sustained levels of profit growth, making it one of the only upcoming tech giants to go public without accounts awash in red ink. What’s more interesting is the reason why, unlike Spotify, it has been able to remain profitable while rapidly growing - in the first half of 2018 pre-tax profit quadrupled year-on-year (YoY), operating cash flow rose 6% and total net investment was almost two-thirds lower.