Despite the upside report, shares are getting slammed lower this morning, currently down by 9%. While the results look decent on the surface, a couple of fundamental issues have investors feeling more skittish on the name this morning. Furthermore, outside of the fundamental concerns, the stock had rocketed higher by more than 40% since its debut to hit post-IPO highs yesterday heading into the print, mainly fueled by recovery in the Chinese markets.
So, with traders sitting on sizable gains, and with investors uninspired by the nearly in-line report, the set-up for a profit-taking sell-off was present.
The disappointment is especially acute since this was TME's first earnings report since its December 12, 2018 IPO. Typically, firms involved with the IPO tend to take a more conservative approach to estimates for a company's first report out of the chute, oftentimes leading to comfortable upside reports. With that in mind, TME barely edging out estimates isn't garnering a whole lot of enthusiasm and confidence.
Perhaps the most significant fundamental concern is evident rapid deceleration in growth. When TME launched its IPO, the company had already hit peak growth; the company’s 152% surge in revenue in FY17 slid down to +84% over the first nine months of FY18. This free-fall in growth accelerated into Q4, with revenue up 51% for the quarter, leading to 72% growth for the year.
While that growth is still strong, and while a slowdown is expected as the company’s revenue base expands, the pace of the deceleration and the uncertainty over where TME's growth will stabilize is an issue. Will revenue growth get cut in half again this year, or, will it be able to sustain solid double-digit top-line growth going forward? That's one question on investors' minds.
Some of TME's key operating metrics aren't overly encouraging, either. For instance, Mobile MAUs for its music services segment declined sequentially to 644 mln from 655 mln last quarter. Also, monthly ARPU for online music slipped by 1.1% yr/yr to RMB 8.6 mln.
It's not all bad news, as paying users for online music jumped by 39.2% to 27 mln, demonstrating substantial improvement in terms of monetizing the platform. But when taken together with the sliding top-line growth overall, the dip in monthly MAUs and ARPU for the company’s online music segment doesn't bode well for a growth stock with loftier valuation metrics (P/E of 63x, P/S of 12x).
Another concern is that gross margin declined to 34% from 38.8% in the year ago quarter as cost of revenue spiked by 62.5%, driven by increases in content fees and revenue sharing fees. And therein lies one of the most pressing issues facing companies like TME and Spotify (SPOT). Royalties paid to music labels and content partners severely cut into the top line, making it more challenging to invest in other areas in the business (like technology and marketing) while still generating a profit.
Despite the 51% revenue growth, TME went to an operating loss of RMB (970) mln compared to an operating profit of RMB 650 mln in 4Q17. This was due to the sharp rise in content fees, which pressured the company’s margins. During the earnings call this morning, the company said that it expects to accelerate its investment in content in order to diversify its offerings. Consequently, it expects this to create further downward pressure on margins in the short-term.
To conclude, while TME managed to slightly outperform expectations, the stock is getting hit hard this morning on a combination of fundamental and technical factors.