China’s equivalent of Spotify posted first-quarter revenue and profit declines, as it overhauls its business after being ordered to stop anti-competitive practices

Key Takeaways:

  • Tencent Music’s revenue and profit fell 15% and 34%, respectively, in the first quarter, after the company was ordered to stop its anti-competitive practices last year
  • Company is shifting focus to providing more products and services for music lovers in bid to create a sustainable business model in the current environment

By Doug Young

Singing the blues, or hitting all the right notes?

Those are two potential interpretations one could make based on the latest quarterly results from Tencent Music Entertainment Group (TME.US), China’s equivalent of Spotify (SPOT.US), which is the country’s dominant provider of online music services. Investors seem to be taking the former view, with Tencent Music shares falling 1.5% on Tuesday after the results came out, even as China tech stocks staged a broader rally.

But from our perspective, the report – while downbeat on the surface – is filled with positive signals showing a company working hard to build a sustainable foundation in China’s vibrant online music scene.

Industry watchers will recall that Tencent Music was among a group of Chinese tech giants that were fined last year and ordered to end their anti-competitive ways. The highest profile member of that group was e-commerce giant Alibaba (BABA.US; 9988.HK), which was ordered to pay a record $2.75 billion and end its practice of threatening to kick merchants off its popular marketplaces unless they agreed not to open shops on rival platforms.

Tencent Music, the music arm of gaming giant Tencent (0700.HK), got off with a much lighter fine of just 500,000 yuan ($74,000) – a pittance for a company that generated 3 billion yuan in profits last year. But more significantly, the company was ordered to end its practice of using its market clout to sign master licensing agreements for China with big music labels, which gave it the right to sign sub-licensing agreements for those labels’ music with smaller rival services from companies like NetEase (NTES.US; 9999.US) and Baidu (BIDU.US; 9888.HK).

As a result of that action, Tencent Music is now facing more serious competition from its smaller rivals. That showed up in its revenue, which fell 15% year-on-year to about 6.6 billion yuan in this year’s first quarter, according to its results announcement. That big-figure decline was repeated throughout the report, with many of the company’s key metrics also posting year-on-year contractions.

One of the most representative was a 1.8% year-on-year decline in monthly active users (MAUs) for the company’s online music services, which dropped to 604 million. MAUs for the company’s smaller social entertainment services division fell by an even larger 28% to 162 million. The company blamed the music user decline on reduced marketing spending and cost controls, while it attributed the social entertainment decline to “industry and macro headwinds.”

While total user numbers were down, the picture was brighter for users who actually paid for Tencent Music’s services. That shows the company is focusing on profitable users over simple big user numbers. Paying users for the company’s music services rose 32% year-on-year to 80.2 million during the quarter, helping to fuel an 18% rise in the company’s overall music subscription revenue that accounts for nearly a third of its total.

The company’s ratio of paying users for its music services also rose to 13.3% of its total from 9.9% a year earlier.

Still, the loss of its monopoly power took not only a toll on the company’s revenue, but also hit its profit, which fell 34% to 609 million yuan.

Life without monopoly

With those latest financials out of the way, we’ll spend the remainder of this space looking at how Tencent Music is trying to adapt to its new life in a more competitive landscape where it is still the industry’s undisputed leader. A couple of broader tech industry developments this week also underpin our assessment that this latest earnings report looks more like a company that’s singing the right tune rather than singing the blues.

The industry developments we refer to came in comments this week from Vice Premier Liu He, who told executives from China’s leading tech companies that relations between the government and the market need to be “properly managed,” according to a Reuters report. Many are interpreting that to mean a sweeping series of government clampdowns on various tech segments over the last two years could start to ease as Beijing tries to balance its desire for orderly development with a need to maintain support for some of its most dynamic companies.

Western media also reported that JPMorgan upgraded its outlook on Tencent, Alibaba, Baidu and several other big China techs to “overweight” from “underweight” on Monday. It cited diminished risks for its decision, referring to both easing domestic regulation and also the potential for being delisted from New York amid a Sino-U.S. dispute over information disclosure.

Those big moves helped to fuel a Tuesday rally for China tech stocks, though as we’ve noted, Tencent Music was not among the gainers.

We’ll close with a look at some of the things Tencent Music is doing to build a foundation for its new life in a more competitive landscape. The big theme is that the company is trying to build up its paying subscribers by offering a wider range of services for music lovers and aspiring musicians.

One of its bigger initiatives is encouraging users to create original content through its Xingyao and Galaxy plans. It is also promoting its Tencent Musician platform to cultivate budding young talents. And last but not least, the company said it launched a behind-the-scenes music producing service in the first quarter for people interested in that part of the industry.

In another PR-ish move designed to show it is contributing to China’s recent drive for more social equality, the company announced the launch of its “Shape of Music” program in the first quarter to support autistic people. China watchers will know that supporting such government campaigns is critical to doing business in the country, and most of China’s other big tech firms have launched similar programs lately.

All those initiatives do seem to be building a foundation that better conforms with the government’s goals of fostering companies that compete fairly and also give back to society. Still, it might take investors a while to realize that Tencent Music’s new song looks more sustainable than its previous one. The company’s stock is currently down 40% so far this year, and trades at a relatively low price-to-earnings (P/E) ratio of 16, with a price-to-sales (P/S) ratio of 1.5. By comparison, Spotify has no P/E because it’s losing money, but has a higher P/S of 1.8.

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