Spencer Platt
Elevator Pitch
I continue to have a Hold investment rating assigned to Tencent Music Entertainment Group (NYSE:TME) shares.
My prior initiation article for TME was written on May 8, 2021. I touch on Tencent Music Entertainment’s recent quarterly financial results and its outlook in this latest update. Tencent Music Entertainment achieved a much better-than-expected net profit for Q2 2022. But this doesn’t translate into an improved revenue growth outlook, as this earnings beat was more attributed to lower-than-expected rather than significantly higher-than-expected revenue. The mixed Q3 2022 outlook for TME (i.e., revenue decline and better margins) has overshadowed the company’s Q2 2022 earnings beat. As such, my Hold rating for TME stays unchanged.
Q2 2022 Earnings Beat Driven By Good Cost Management
Tencent Music Entertainment reported the company’s earnings for the second quarter of 2022 on August 15, 2022 after the market closed. Both TME’s Q2 2022 topline and bottom line declined as compared to as a year ago, but its recent quarterly revenue and earnings came in above market expectations.
TME’s revenue contracted by -14% YoY from RMB8,008 million in Q2 2021 to RMB6,905 million in Q2 2022, but the company’s topline turned out to be +3% higher than the sell-side’s consensus sales forecast of RMB6.7 billion according to S&P Capital IQ.
The performance of Tencent Music Entertainment’s online music services business segment was reasonably stable, as its revenue derived from its online music services segment declined slightly by -2% YoY from RMB2,950 million for Q2 2021 to RMB2,878 million.
Instead, it was TME’s social entertainment services and others business segment that performed better than what investors would have expected. Revenue for the company’s social entertainment services business decreased by -20% YoY to RMB4,027 million in Q2 2022, which was a lower rate of YoY contraction than the market feared. Furthermore, TME’s social entertainment services revenue growth was flat on a QoQ basis when a decline was expected. Due to “China’s crackdown on the entertainment industry” which started in late-2021 as reported by the South China Morning Post, the expectations for Tencent Music Entertainment’s social entertainment services business prior to the Q2 2022 earnings release were muted.
More significantly, Tencent Music Entertainment achieved an even stronger earnings beat (as compared to above-expectations revenue) for the recent quarter. While TME’s adjusted net profit attributable to shareholders decreased by -8% YoY from RMB1,117 million in Q2 2021 to RMB1,029 million in Q2 2022, the company’s adjusted net profit margin actually improved from 13.9% to 14.9% over the same period. Moreover, Tencent Music Entertainment’s Q2 2022 topline beat the market’s consensus net income projection of RMB910 million by +13%.
TME has done well in controlling its expenses, and this was the key factor that led to the company’s excellent +13% earnings beat.
Tencent Music Entertainment’s operating costs, which comprised of selling & marketing expenses and general & administrative expenses, declined by -16% YoY from RMB1,677 million in Q2 2021 to RMB1,417 million in Q2 2022 in absolute terms. In percentage terms, TME’s operating expenses as a proportion of its topline decreased by approximately -1 percentage point YoY after adjusting for the effects of costs relating to its planned Hong Kong secondary listing (discussed in a subsequent section of the article).
Separately, TME’s gross profit margin expanded by +190 basis points QoQ from 28.0% for Q1 2022 to 29.9% for Q2 2022. At its Q2 2022 results briefing on August 16, 2022, Tencent Music Entertainment highlighted that the decline in content costs as it “restructured the agreement with some music labels” and targeting expenses relating to “bandwidth and storage capability” and increasing “the utilization of our service and equipment” drove its higher-than-expected gross margin.
Mixed Outlook Caps The Upside For TME’s Shares
Tencent Music Entertainment’s stock price increased by +3% from $4.67 as of August 15, 2022 to $4.79 as of August 16, 2022, following its announcement of above-expectations results for Q2 2022. But TME’s shares subsequently corrected in the next few trading days to close at $4.60, which is below its pre-earnings release share price.
In my opinion, TME’s positive post-results share price momentum couldn’t be sustained as the market is worried about the company’s near-term prospects. Based on forward-looking consensus financial estimates sourced from S&P Capital IQ, Tencent Music Entertainment is predicted to deliver negative YoY revenue growth in the third quarter of 2022, just as it did in Q2 2022. Specifically, the sell-side analysts estimate that TME’s topline will decrease by -9% for Q3 2022 on a YoY basis. On the positive side of things, Tencent Music Entertainment’s normalized net profit margin is projected to improve from 13.0% in Q3 2021 and 14.9% in Q2 2022 to 15.8% for Q3 2022.
In a nutshell, the outlook for Tencent Music Entertainment is mixed. On one hand, the growth for the online music services business might have peaked (i.e., monthly active users for the music segment contracted for the third consecutive quarter in Q2 2022), and its traditional livestreaming business for its social entertainment services segment is facing stiffer competition from short-form video, implying weaker revenue growth prospects. On the other hand, TME’s cost management initiatives should continue to pay off in the form of better profit margins going forward, as they did in the recent quarter.
Spotlight On Planned Hong Kong Listing
Apart from results, the spotlight is also on Tencent Music Entertainment’s planned listing in Hong Kong.
A Seeking Alpha News article published on March 21, 2022 mentioned that TME is “pursuing a secondary listing on the Main Board of the Hong Kong Stock Exchange, via a direct listing (by way of introduction).” At its second-quarter investor call, Tencent Music Entertainment revealed that it spent RMB44 million in relation to its proposed secondary listing in Hong Kong in the recent quarter, which suggests that its listing plans remain on track.
Like the majority of U.S.-listed Chinese companies, Tencent Music Entertainment faces the risk of being required to delist from the US in the future, assuming that it is unable to comply with the Holding Foreign Companies Accountable Act or HFCAA with respect to audit access issues. As such, it is important that TME successfully completes its Hong Kong listing in due course, which will provide its shareholders with the option to convert their US-listed shares to Hong Kong-listed ones.
Closing Thoughts
I continue to have a Hold rating for Tencent Music Entertainment. TME’s Q2 2022 earnings beat is not as impressive as it appears to be, as this is mainly the result of lower-than-expected costs. Looking ahead, it doesn’t seem that TME can see a re-acceleration of its revenue growth in the short term.
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