In our opinion, had TME's IPO launched during a more favorable time, it would have generated considerably more interest and likely would have priced at the high end of the expected range -- or perhaps even better. However, as many IPO investors and traders surely know, timing is everything when it comes to pricings.
As the largest online music platform in China, backed by Chinese internet behemoth Tencent (TCEHY), TME has a lot going for it. The company has a dominant market position with over 800 mln monthly average users (MAUs), and due to its relationship with Tencent and its attendant access to the rest of Tencent’s massive user base, it is poised for continued strong user growth. Furthermore, TME's financials are strong, featuring such highlights as high double-digit revenue growth, expanding gross margin, and substantial cash flow generation.
Unfortunately, the volatile stock market and the sour sentiment on Chinese IPOs has overshadowed these positives. The silver lining for investors, though, is that these weak conditions for IPOs create an opportunity to accumulate some shares at more reasonable valuations.
That said, it would not be surprising to see TME open with a decent pop when it begins trading on the NYSE later this morning.
With over 800 mln monthly average users, Tencent Music Entertainment’s operation is the largest online music platform in China. Constituted in this platform are the company’s app offerings, which offer online music and karaoke and music-centric live streaming services. These apps have achieved widespread popularity; QQ Music, Kugou Music, Kuwo Music, and WeSing are the top four music mobile apps in China based on mobile MAUs as of the third quarter of this year. Social interactions such as sharing, liking, commenting, and virtual gift-giving are facilitated by the platform to enrich users’ engagement with TME’s content and with the entertainers who create that content.
TME also owns the largest and most comprehensive library of music content in China, consisting of over 20 mln tracks from over 200 music labels. The company implements a multi-faceted monetization platform that derives revenue from subscriptions, sales of digital music, virtual gifts, and premium memberships.
TME's MAU base continues to grow at a rapid pace and still has plenty of room for growth thanks to the platform's massive total addressable market. For perspective, the overall size of China’s online music pan-entertainment market reached approximately RMB33.0 bln in terms of revenue in 2017 and is projected to grow to RMB215.2 bln in 2023, representing a compound annual growth rate of 36.7% from 2017 to 2023. A few major catalysts that are expected to fuel this growth include strict copyright protection laws, which TME supports via developed technology that is designed to monitor infringement and thus protect copyrighted music; increasing market penetration of online music services; and consumers’ increasing willingness to pay for music.
One of the most compelling attributes to TME's IPO is its relationship to Tencent, its parent company and controlling shareholder. TME benefits from unique access to Tencent’s user base, which represents China’s largest online social community. Tencent's social networking app Weixin and its overseas mode WeChat combine to consist of over one billion MAUs while messaging service QQ supports 803 mln MAUs as of the third quarter of 2018; proximity to these substantial populations facilitates the organic growth of TME's user base.
Taking a look at TME’s results for the nine months ended September 30, 2018, revenue increased by 84% to RMB13.6 bln. Breaking it down by segment, revenue generated from online music services (29% of revenue) grew by 91%, mainly driven by increased revenues from user subscriptions; sales of digital music singles and albums to users on its platform; and sub-licensing music content to third-party platforms.
Revenue generated from social entertainment (71% of revenue) jumped by 81% year/year, fueled by increased revenues generated from its online karaoke and live streaming services. The platform accrues revenues by taking commission fees from virtual gifts transacted on its apps, and virtual gifting to performers is deeply integrated into the culture of the karaoke and live streaming aspects of the platform. Increase in revenues generated from online karaoke and live streaming services was brought about by increased average revenue per paying user, which was attributable to the introduction of additional functions, such as virtual karaoke rooms and premium memberships on WeSing, as well as by a growing user base and those users’ rising engagement with virtual gifting features.
For the period, gross margin also improved to 40.0% from 32.7% in the prior year period.
Meanwhile, total operating expenses climbed by 66% to RMB1,58 bln, mostly attributable to a 111% surge in Sales and Marketing expenses to RMB 1,17 bln. The ramp up in Sales and Marketing expense was mainly driven by increased spending to promote its brands, products and content offerings and increased spending on user acquisition channels. As a percentage of sales, Sales and Marketing expense is actually quite reasonable at 8.6%, although that is up from 7.5% in the year ago period.
As a result of the above, TME's operating profit surged by 219% to RMB3.0 bln.