Earnings Call Transcript - TME Q4 2022

Tony Yip, CSO

Good evening and good morning. Welcome to Tencent Music Entertainment Group’s Fourth Quarter and Full Year 2022 Earnings Webinar. TME announced quarterly financial results today after the market close, and the earnings release is now available on our investor relations website at ir.tencentmusic.com as well as through Newswire Services. Today, you will hear from Mr. Cussion Pang, our Executive Chairman, who will begin the call with an overview of our recent updates. Next, Mr. Ross Liang, our CEO, and I, Tony Yip, CSO, will share additional thoughts on our product strategies, operations, and business developments. Finally, Ms. Shirley Hu, our CFO, will discuss our financial results before we open the call for questions. Before we proceed, I would like to direct your attention to our Safe Harbor statement in our earnings press release, which applies to this call as we will make forward-looking statements. Please also note that the company will discuss non-IFRS measures today, which are explained in more detail and reconciled to the most comparable measures reported under IFRS in the company’s earnings release and filings with the SEC. Please be advised that today’s webinar is being recorded. With that, I am pleased to turn the call over to Cussion, Executive Chairman of TME. Cussion?

Cussion Pang, Executive Chairman

Thank you, Tony. Hello, everyone and thank you for joining our call today. Looking back on 2022, firm execution of our dual engine content and platform strategy built solid progress in a fast-changing macro environment. With a keen focus on high-quality growth and product innovation as well as our highly effective cost optimization measures, we led the industry in the rebound of bottom line growth and delivered steady growth in online music subscriptions throughout the year. Our diversified suite of monetization tools expanded and made progress during the year such as ad-supported mode, long-form audio, as well as audio live streaming and our international expansion, among many more. With our confidence in the long-term prospects of the company, we had completed the $1 billion share buyback program approved by the Board in 2021. Looking ahead into 2023, as we are repositioning ourselves to better capture future growth areas, we currently expect our quarterly revenues from online music services will exceed those from social entertainment services at some point within this year. Meanwhile, with our relentless focus on executing our growth strategies and operating efficiencies, we are confident to achieve year-over-year growth in total revenues and profitability as well as continuous improvement in user quality in 2023 while fueling the thriving music industry. Next, I would like to talk about remarkable achievements we have made in many aspects of our business to build a point our insistence on excellence and innovation. One integral part of our strategy in 2022 was to continue improving TME’s content ecosystem. First, we are building extensive collaboration with top artists, labels and industry partners, both at home and abroad to bring our users and artists’ most compelling content and experiences. We have recently reached an agreement with JVR to extend our close strategic partnership and will continue to provide our users with the high-quality music created by JVR, accentuated by the extraordinary experience on our platform. In the fourth quarter, we deepened our strategic cooperation with leading records such as B'in Music, providing users with songs from Mayday and other renowned singers. Our content library in various music verticals also reinforced our reputation as a go-to destination for music lovers. Importantly, we began extensively teaming up with Billboard, the industry bellwether. In addition to co-producing the playlists, we jointly released the 2022 Annual Music Report, which attracted participation from a record high number of unique visitors. Most recently, we announced the integration of TME Uni Chart on Billboard as its only music chart for Mainland China, introducing Chinese music to a global audience. Second, as our growth increased the breadth and depth diversity of our music library, our ability to empower original content production has significantly improved with new tools launched. We have been investing in intelligent tools to support music-related content production with technology and have delivered promising results. With virtualization setting the trend, one strategic move in 2022 was to build a lineup of virtual performances. In the fourth quarter, we unveiled our first hyper-real virtual pop idol, Lucy with Xiaoqin, who is also the new presenter for today’s call. With a record-grade, automatically generated vocal print developed by TME LYRA LAB’s LyraSinger Engine, Lucy, as a highly productive segment, has created three chart dominating original songs across different styles within just one month of her debut and has already received partnership interest for fashion shops or joint performances from a broad array of global brands, including Elk, Coca-Cola and KFC. At the forefront of the cutting-edge virtual idol field, our virtual performance also includes Xiaoqin, Shanbao, and Anko, who we brought to life with original content, unique voices, dance moves, and more. Musicians are also increasingly focusing on our Tencent Music platform, driving content prosperity both on our platform and in the industry. By the end of the fourth quarter, we have empowered our indie musicians to create more than 2.3 million musical works. Meanwhile, we consistently pay close attention to music ecosystem development. In the fourth quarter, we launched more smart features and tools for indie musicians to accelerate song composition and release and enhance interactions with their fans. For example, in December, we unveiled a record release feature, which allows indie musicians to upload their original albums and earn revenue from listeners who want to show extra gratitude in addition to album sales. The tech tools we launched during the quarter enabled our musicians to generate album covers and assist in singing enhancement and song valuation, which help modularize and automate music production processes. We are proud that our end-to-end services have been instrumental in realizing a year of harvest for the creation of close to 1,000 original blockbusters, leading the streams exceeding 100 million each in 2022. In the fourth quarter, the content ranked on our platform and took the market by storm, ranking in nearly 0.5 billion streams. Analysis was turning to fireworks and four for you, which has been extensively used as background music and generated over 5 billion social media discussions. Meanwhile, we deepened our collaboration with the Tencent ecosystem and launched a total of 111 songs in the gaming and animation category in 2022. A number of our co-produced songs have garnered awards this year. Notably, Fairytale Love, made for Peacekeeper Elite, was among the finalists for the Best Original Song in the Mobile Video Game Category of the 13th Hollywood Music in Media Awards. Third, behind this high-quality musical work, more up-and-coming artists are finding opportunities and stages to shine and realize their music dreams on the back of TME’s all-around promotional resources. One example in the fourth quarter was a strategic musician partner we cultivated, Krystal Chen. We invited well-known producers to launch her first EP from which the song Skylight topped QQ Music’s Best New Release music chart, helping her build her profile as a high-quality singer. Another standout was the campus musician featured on the cover of Billboard’s December issue with her first single and also came in third place in 2022 SING! China. In addition, we collaborated with Coca-Cola to create a large scale new music event and promote emerging musicians such as Pan Yunqi to the world stage through Billboard’s global network. Many newly joined musicians have grown quickly into rising stars with our support, representing just a few of our success stories among a strong pipeline of emerging talents we are grooming to drive the music industry. That concludes my review of our growing content strategy. Now I would like to turn the call over to Ross who will share more about our platform updates. Ross, please go ahead.

Ross Liang, CEO

Thank you, Cussion. Hello, everyone. With our refined mission in 2022 to create synergy with music and technology, 2022 was a year of our continued exploration of TME with a level of creative efforts to satisfy our users’ nuances and diverse music tastes and to provide all-round musical companionship to our users through each of our four entertainment pillars: listen, watch, sing, and play. We have been deploying and developing breakthrough AIGC tools to further empower music-related content creation and enhance production efficiency. In addition to the LyraSinger engine, which we used to develop our virtual idols, as Cussion mentioned, we rolled out the Muse Engine in the fourth quarter, which enables automatic large-scale music posters production based on melody and lyrics. We have also expanded use cases for our patented technology, Lingyin Engine to launch several popular audiobooks read by the synthetic voice of notable figures. What’s more, ahead of the new year, receivers of QQ Music’s newly launched VR greeting card can walk into the gift generated automatically and receive blessings as avatars in an exquisite virtual space. In the future, we will continue to explore the application of large language models in the field of pictures, texts, video, and other content as well as music recommendation and search to meet the massive demand for music-related content. Next, one of the biggest advancements in the year was to holistically improve our sound quality and sound effects for premium users, offering a clearer and more vivid listening experience, which also contributes to the growth of music subscriptions as we add this companion privilege to our memberships. For example, nearly half of our QQ Music music tracks now support super quality or above, and our high-rise standard has also been upgraded to high-rise specifications, which parallels the top studio quality for mass resolution of 192 kilohertz, 24 bit. Second, we continue to optimize our proprietary technology for the Premium Sound series, launching premium master type, premium strong song, and the premium sound quality features to enhance sound clarity and expressiveness. We also extended the application of these premium sound quality features to TME Live’s online concert, concentrating on building a new benchmark in sound quality for the domestic streaming industry. More users are opting for songs with high sound quality. On QQ Music, the number exceeded 5 million on a daily basis, totaling nearly 100 million daily streams. We also launched and enhanced a number of features to allow users to flexibly customize their listening experience. Kugou Music and QQ Music unveiled a pitch and tempo alteration feature, allowing users to remix their favorite songs. Our algorithm upgrades also contributed to a more personalized listening experience, leading to sustained healthy year-over-year growth in QQ Music and Kugou Music, recommendation streaming volumes, and the time spent per user in the fourth quarter. Specifically, QQ Music recommendations inspired more listening than searches which continue to increase the percentage of streams coming from our recommendations. Another focus in 2022 was to enrich users’ virtual experiences on our platforms, particularly through comprehensive collaboration with Weixin Video Accounts in the Tencent ecosystem. First, through TME Live, our performance brand, which hosted 63 online and offline events throughout 2022, we partnered with Weixin Video Accounts to innovate in active formats and build new avenues for distributing music and video content. For instance, at Hacken Lee's concert, nearly 20,000 users cast their votes on either our platform or Weixin Video Accounts to select the final setlist. We also attracted over 23,000 paying viewers at the recent concert, which is the highest number to date among TME Live’s musical installments. Second, we further applied our song recognition feature to automatically identify the background music of videos from Weixin Video Accounts and direct users to QQ Music to listen. By the end of 2022, over 60,000 indie musicians on our Tencent musicians' platform have used the one-click release feature to publish their original songs on Weixin Video Accounts. Beyond professional music content, during the fourth quarter, we also promoted user engagement by allowing our Weixin users to share music videos of their own theme on Weixin Video Accounts. A famous song on Weixin Video Accounts racked up nearly 100 million music streams on TME’s platforms in the fourth quarter, a stronger testament to the vibrancy of our jointly built music ecosystem with virtual elements. The singing features have also been upgraded to create more enjoyable experiences for our karaoke users. In the fourth quarter, we rolled out several real-time features namely the one-player model, SingMaster, two-player model, Karaoke King, and the multi-play model to ensure users experience the excitement of simultaneous singing and competition. On top of these new entertainment choices during the fourth quarter, we also continued to engage Weixin users with singing effect updates, such as the vocal enhancement feature for Weixin VIP users to create studio quality in our immersive singing environment. Music lovers, particularly the young, are getting attracted by our music-based virtual use cases. At TMELAND, our immersive virtual singing park, 8 million users joined Coca-Cola and KFC virtual parties to celebrate the new year alongside artists during the fourth quarter. We also released an interactive content experience in TMELAND, which brings users' avatars together to listen to content in virtual scenarios such as in-game events and a New Year celebration. Lastly, to incubate a vibrant young and trendy karaoke community, we upgraded the Kugou concept, two of our music products designed for Gen Z users. During the fourth quarter, these updates include more real-time interactive features to help the young generation identify people with shared music tastes and encourage them to actively create, share, and socialize. Thanks to the warm receptions and the adoption of their diverse functions, these two apps both tripled their MAUs year-over-year. With that, I’d like to give the floor to Tony to review our business operations. Tony, please go ahead.

Tony Yip, CSO

Thank you, Ross. Hello, everyone. During the fourth quarter, the surge in COVID cases and churn of our casual users amid competition led to the year-over-year decline in online music mobile MAUs. Along with cost optimization measures aimed at boosting monetization efficiency as a platform of scale. Meanwhile, we continue to strengthen our monetization capabilities with improved operating efficiency and have achieved high-quality growth in both subscription and non-subscription revenue during the fourth quarter. Most excitingly, our subscription revenue delivered healthy growth year-over-year and quarter-over-quarter, reflecting our balanced approach. Online music paying users, a high-quality user cohort, maintained a strong growth trend and ARPPU also continued to improve sequentially for the third consecutive quarter and increased year-over-year. The strong paying user and ARPPU momentum was driven by our improved operating strategy, leading to optimized content quality, more attractive member privileges, broadened sales channels, and more effective promotions. Subscribers to our Super VIP membership continued to grow during the fourth quarter as we expanded our offerings to provide premium sound quality and premium master tape and added a wealth of privileges such as long-form audio, digital albums, and karaoke to the membership package. On the non-subscription side, its revenue also improved year-over-year and quarter-over-quarter during the fourth quarter. Revenues from our advertising business continued to recover quarter-over-quarter. Specifically, the ad-supported model delivered strong performance during the quarter with sequential growth in its revenues. Through our music with Brand's partnership, leading advertisers embraced TME Live and TMELAND as innovative channels for musical format advertising in the fourth quarter, particularly given their appeal to young users. On the merchandising side, we work with a wide range of A-list artists this quarter to release physical albums, digital albums, vinyl records, or customized artist merchandise with head start benefits. Moreover, during the fourth quarter, we launched Artist Collection cards, a new series of photo cards as collectibles in Putao Mall. We commenced the rollout, which became highly sought after among young users, demonstrating our end-to-end content release advantage, spanning head start and benefits, artist-related products, and multichannel promotion. Moreover, we have strengthened our long-form audio content offerings with more audiobooks based on novel IPs and self-produced paid children’s literature. Subscribers doubled year-over-year to surpass 10 million during the fourth quarter, driving solid year-over-year growth of revenues from long-form audio subscription. Our IoT service MAUs achieved double-digit growth year-over-year, thanks to our expanded model coverage as well as a diversified content library with Dolby Surround Sound library and TME Live content added respectively, on selective electric vehicle and smart TV terminals. Moving on to our social entertainment services. During the fourth quarter, as a result of macro headwinds, increased competition from other platforms, and the surge in COVID cases, social entertainment services MAUs and paying users declined year-over-year. Against this backdrop, we will focus on product innovation and content differentiation while exploring fresh ways to fulfill users' social and entertainment needs. For WeSing, its multiperson singing room in both video and audio settings have continued to enrich real-time interaction scenarios on the platform, resulting in increased penetration rates and user time spent in these rooms, and we are planning to roll out the feature to our other platforms in the future. Meanwhile, we took the operation experience from our singing and social products and our proven monetization models to the international market, expanding our presence through both organic growth and M&A. Revenues from our overseas business continued to increase year-over-year in the fourth quarter. For live streaming services, although the macro environment continued to weigh on our revenues from traditional video live streaming, we focus on providing differentiated content and entertainment experiences to explore new value generators. Specifically, we are fostering a tighter connection between audio live streaming and our music platforms. Following the successful expansion into live streaming by QQ Music, Kugou Music has also started to build up its audio live streaming service, which has a huge growth potential given its massive music user base. What’s more, leveraging our expertise in cultivating rising talent, we are creating more room for our indie musicians to grow into promising live streaming performances. For instance, in the fourth quarter, our self-produced hit songs helped their singers grow their number of fans substantially, thereby increasing both copyright revenue and live streaming income. Another example is our musician, whose original song has attracted high streaming volume and landed a spot on many of our music charts as we are building a bridge between performance and the fan base revenues from audio live streaming increased by double digits year-over-year with solid growth in paying users and ARPPU year-over-year. Last but not least, during 2022, we continue to fulfill our social responsibilities with an innovative model to translate music’s emotional expression and influence into social practices. The spirit of Chinese song, our core cultural project is now in its 4th year. In the fourth quarter, it launched an initiative for the Guangxi music style and partnered with Singer’s Fox Hu and XIN Liu to promote Chinese traditional culture through the power of digital music. In December 2022, many of the musical works from the spirits of Chinese Song 2020, a public welfare album we released previously officially entered the first digital collection of the national archives of publication and culture, supporting the preservation and inheritance of Chinese culture. In conclusion, we exited 2022 with solid performance across our business where we made significant advancements in content and platform upgrades, refined user experience, pushed forward with monetization models and optimize costs, all together, laying a solid foundation to fuel growth in revenues and profitability into 2023.

Shirley Hu, CFO

Thank you, Tony. Hello everyone. I’ll discuss our results from a financial perspective. The fourth quarter of 2022 marked another quarter to evidence our firm commitment to cost control and operating face improvements with continuous growth in IFRS and non-IFRS profit for the 4th consecutive quarter. In Q4, our net profit was RMB1.2 billion. Non-IFRS net profit was RMB1.5 billion, up by 71% year-over-year and by 6% sequentially. Total revenues were RMB3.4 billion, up by 0.8% sequentially. In Q4 2022, music subscription revenues grew to RMB2.4 billion up by 21% year-over-year and by 5% sequentially. Online music paying users grew to 88.5 million, up by 16% year-over-year, representing 3.2 million net adds sequentially. Monthly ARPPU in Q4 was RMB8.9, up by RMB0.1 sequentially and by RMB0.4 from Q4 2021. The strong paying user and ARPPU growth were driven by more attractive member privileges, such as improved sound quality, broadened sales channels, more effective promotions, optimized content quality, and high-quality services. This also resulted from our ongoing efforts to cultivate users’ willingness to pay for music and improvements in operating businesses. Revenues from advertising continued to recover and grew sequentially as markets started to recover and we launched new monetization models. To give our users more options, we launched the ad-supported model and provided more inventory, which contributed to our revenue growth. With increased interest in innovative advertising channels, TME Live and TMELAND became popular and an attractive choice for leading advertisers for music format advertising. We remain confident about the long-term growth potential in the advertising business. Social entertainment services and other revenues were RMB3.9 billion, down by 18% year-over-year due to evolving macro headwinds, competition from advertising platforms, and the surge in COVID-19 cases in the fourth quarter of 2022. To adapt to the changing environment and stabilize revenue scale, we continue to differentiate our content offerings by enriching our virtual interactive product offerings and cross-platform collaboration. Gross margin in Q4 was 33%, up by 4.2% year-over-year and by 0.4% sequentially. The increase was primarily due to improvement in monthly ARPPU for music subscribers, growth of paying users, lower revenue sharing fees for live streaming services, and improved operating cost efficiencies. Now moving on to operating expenses. Total operating expenses for Q4 were RMB1.4 billion or 18.2% of total revenues, down by 5.6% from 23.9% of total revenues in the same period last year. Selling and marketing expenses were RMB266 million, down by 65% year-over-year. This is our fourth quarter with more than a 50% cut in selling and marketing expenses on a year-over-year basis. The reduced spending on user acquisition has impacted our MAUs. Our core music subscription services continued their rapid and healthy growth trajectory. We continue to closely monitor the ROI of each promotion channel and adjust our external promotion channels to attract users and promote our brands more effectively. General and administrative expenses were RMB1.1 billion, up by 2.6% year-over-year. The increase was mainly due to increased investment in research and development in areas such as international expansion and support for the ad-supported model. Our effective tax rate for Q4 was 12.2% compared to 11.5% in the same period of 2021. The increase in the effective tax rate was mainly because some of our entities were entitled to different tax benefits in 2021 and 2022. For Q4, our net profit and net profit attributed to equity holders of the company were RMB1.2 billion. Non-IFRS net profit and non-IFRS net profit attributable to equity holders reached a record high of RMB1.5 billion. Non-IFRS net profit margin was 20.1%. Our basic and diluted earnings per ADS continued to grow in the fourth quarter of 2022. Based on diluted earnings per ADS for RMB0.73 and RMB0.72 respectively, up 121% and 125% on a year-over-year basis. Non-IFRS basic and diluted earnings for ADS were RMB0.92 and RMB0.91 respectively, up 82% year-over-year. Such results demonstrate our initial successes in operating business improvements as well as the impact from our share repurchase program. As of December 31, 2022, our combined balances of cash, cash equivalents, term deposits, and short-term investments were RMB27.4 billion, as compared with RMB25.4 billion as of September 30, 2022. The increase was due to our healthy operating cash flow of RMB2.1 billion for the fourth quarter of 2022. This combined balance was also affected by the change in the exchange rate of RMB to USD at different balance sheet dates. Lastly, I’ll briefly discuss our performance for the full year 2022. Total revenues were RMB28.3 billion, down 9% year-over-year. IFRS net profit was RMB3.8 billion. Non-IFRS net profit was RMB4.9 billion, up by 13% year-over-year. Revenues from online music services were RMB8.7 billion, up by 9% year-over-year, with music subscription revenue being the largest contributor. Our music subscription business grew rapidly throughout the year. Revenues from social entertainment services declined by 20% year-on-year due to changing macro headwinds, increased competition, and the impact related to COVID-19. Gross margin in 2022 was 31%, up by 0.9% year-over-year. The increase was primarily due to our effective control of content costs, including revenue-sharing fees for live streaming services and improved operating cost efficiencies. Total operating expenses for 2022 were RMB5.6 billion, down by 7% year-over-year, especially selling and marketing expenses in 2022 decreased by 57% from 2021 as we reduced investment in user acquisition costs and promotional activities during the year. Net profit and net profit attributable to equity holders of the company were RMB3.8 billion and RMB3.7 billion, respectively. Non-IFRS net profit and non-IFRS net profit attributable to equity holders of the company were RMB4.9 billion and RMB4.7 billion, respectively. Finally, I will close with some comments and an outlook for 2023. Built upon the success of effective cost and expense controls and operational efficiency improvements in 2022, we will focus on monetization expansion and revenue growth in 2023 while maintaining cost and expense management. Our core online music services, particularly music subscriptions, will continue to be our key growth driver, with paying users and monthly ARPPU expected to continue to grow. We also plan to expand the suite of monetization tools such as the ad-supported model, customized artist merchandise, Super VIP, and other offerings, expecting them to become important revenue contributors in 2023. For social entertainment services, with challenges from competition and changing macro headwinds, we expect to face pressures in keeping revenue stable and will continue to invest in audio live streams and extend our international footprint for long-term growth. Furthermore, we will keep investing in high-quality content and original content production, as well as new products and technologies, such as AIGC. We are confident about the long-term sales growth of our company and the overall music industry and remain focused on providing high-quality investment returns for our shareholders. This concludes our prepared remarks. Operator, we are ready to open the call for questions.

Operator, Operator

And today’s first question comes from Alicia Yap from Citigroup. Alicia, your line is open. Please unmute yourself and go ahead.

Alicia Yap, Analyst

Hi, thank you. Good evening, management. Thanks for taking my questions. And also congrats on the solid quarter. So with TME concluding 2022 with improving margins and also the fundamental trends, I think Shirley just also comment a little bit the 2023 outlook. So if management can elaborate a little bit more detail in terms of overall, what are you expecting for the online music revenue growth specifically, Is there any change in your music subscriber growth target or any ARPPU trend that you’re expecting? And also for the social entertainment, do you still expect the revenue as we begin the year-over-year declining trend into 2023? Thank you.

Cussion Pang, Executive Chairman

Thank you for your question. So overall, we currently expect that 2023 will be a year of positive growth for both top-line revenues of around mid-single-digit percentage as well as bottom-line net profit of around low-teens percentage. In addition, we expect quarterly revenue from our online music services to exceed that of social entertainment services to become a primary source of revenue at some point during this year. This is driven by growth from China’s pro-growth policies at the macro level as well as our continued investments to strengthen our operations. In terms of online music, we expect subscription revenue to continue to deliver healthy growth of over 20% year-over-year, driven by both growth in paying users as well as ARPPU. In addition, advertising, long-form audio, and IoT services are all expected to contribute meaningfully to the growth. In terms of social entertainment, while traditional video live streaming continues to face competitive pressure, our audio live streaming and international businesses can partially compensate by delivering healthy growth. Net-net, that means social entertainment is expected to see a milder rate of decline compared to last year. And combining all of the above with our continued focus on cost management to improve efficiency, we currently expect net margins to also improve into 2023.

Operator, Operator

Thank you. Our next question comes from Alex Poon from Morgan Stanley. Alex, your line is open. Please un-mute yourself and go ahead.

Alex Poon, Analyst

Congrats management on very strong results. My question is related to gross margin trends in 2023 and maybe even longer. In ‘22, because we have new segments growing faster than social segment, we were still able to achieve gross margin expansion. How sustainable is this in ‘23, maybe even ‘24, as the music segment's gross margin is still lower than the social segment, and music continues to grow faster than social. So, how will our gross margin profile change over the next year to two years?

Shirley Hu, CFO

Okay. I will talk about gross margin. Gross margin is 33% in Q3, increased by 4.2% year-over-year and increased by 0.4% sequentially. There are several positive factors affecting our gross margin. First, the increase of net adds, monthly ARPPU of music subscribers, and growth from long subscriber revenue sources such as digital albums, artist-related merchandise, and long-form audio will all positively impact gross margin. Second, we’ve been controlling the revenue sharing ratios of live streaming. Third, we increased the requirements for content costs and optimized our models; we restructured agreements with some music labels, switching from the Minimum Guarantee model to a revenue-sharing model, obtaining more reasonable agreements. Fourth, the optimization of technology and the operational strategy related to the utilization of our services and equipment has decreased our operational costs year-over-year. While the decrease in social entertainment revenue and the change in revenue mix has a negative impact, looking forward to 2023, all these positive factors will continue and we will focus on increasing efficiencies across all business units. Therefore, we expect our gross margin to increase year-over-year in 2023.

Operator, Operator

Thank you. Our next question comes from Lincoln Kong from Goldman Sachs. Lincoln, your line is open. Please un-mute yourself and go ahead.

Lincoln Kong, Analyst

Thank you, management. Congrats on the good results. My question is on the enterprise business. How do we see so far, let’s say, year-to-date, enterprise demand recovery for us? And we talk about this ad-supported model. So, in terms of the new format of ads or creating more ad inventory, how do we think about the progress here especially how to better monetize our game going into ‘23? What’s our outlook here?

Tony Yip, CSO

Yes. Thank you for your question. We continue to see a recovery in advertising revenues, especially following the reopening post-COVID. The splash screen advertisements continued to recover at a healthy pace. In addition to that, ad-supported model advertising continued to ramp up and currently accounts for roughly about mid-teens percentage of the advertising revenue. Regarding sponsorship advertising, during the fourth quarter, it temporarily weakened due to COVID. We do expect with the reopening there to be many more live events and as a result, advertising - sponsorship advertising opportunities. So, all-in-all, we do expect this year to be a strong recovery year and a year of positive growth for the ad business. In terms of verticals, in the fourth quarter, given the e-commerce seasonality, we did see a meaningful increase in the e-commerce vertical. In addition to that, Internet services in general, food and beverages, consumer electronics, as well as local services are also verticals where we saw continued demand from advertisers.

Operator, Operator

Thank you. Our next question comes from Lei Zhang from Bank of America Securities. Lei Zhang, your line is open. Please un-mute yourself and go ahead.

Lei Zhang, Analyst

Hi management. Thank you for taking my question and congrats on the solid results. My question is mainly regarding your sales and marketing investment plan in 2023 since we have pretty good cost control last year. So can you give us more color for 2023? Thank you.

Shirley Hu, CFO

Okay. Regarding selling and promotion expenses, we have maintained tight control over these expenses in Q4 continuously, resulting in a 65% decrease on a year-over-year basis. We balanced our MAUs and monetization when evaluating the healthiness of our business. We focus more on metrics such as user engagement, user retention, reach, and paying users. In 2023, we will operate selling and promotion expenses at a very low level and expect to continue to decrease on a year-over-year basis. However, the degree of cutting will be less compared to those in 2022. Furthermore, in 2023, we will invest in content promotion, which will be a new avenue for boosting our MAUs.

Operator, Operator

Thank you. Our next question comes from Wei Xiong from UBS. Wei Xiong, your line is open. Please un-mute yourself and go ahead.

Wei Xiong, Analyst

Hi. Good evening, management, and thank you for taking my question. I want to get some of your thoughts around AIGC. As management mentioned, we are exploring possibilities and leveraging technology in that area. So, how do we assess TME’s strategic positioning around AIGC? What are some of the potential benefits and business opportunities that we plan to pursue this year? And what could be the potential investment or cost implications related to that? Thank you.

Cussion Pang, Executive Chairman

We have always invested in AI, particularly with a recent focus on large language models. Clearly, that will lead to more applications. We will continue to leverage partnerships with Tencent. Examples of our applications would include recommendations as well as playlists in a more conversational setting. Other examples would include music posters, greeting cards, and synthetic voice, all of which are already currently being applied to our platform. Into 2023, we will invest in our own R&D in large language models to drive music-related conversational applications and also to help musicians dramatically reduce the barriers to their creativity. Overall, that should result in more creativity and high-quality content, which is good for the overall industry.

Operator, Operator

Thank you. Our next question comes from Xueqing Zhang from CICC. Xueqing, your line is open. Please un-mute yourself and go ahead.

Xueqing Zhang, Analyst

Hey. Thanks for taking the question. And just a follow-up on the pool of music subscription business. We noticed that the program music side continued to improve this quarter? And how does management think about the improvement in the first quarter in the content industry? You mentioned in the prepared remarks it may be driven by optimized content quality, more attractive member privileges, broader sales channels, and more effective promotions, so give us more color on this way. Thank you.

Tony Yip, CSO

Well, the short answer is yes. We do expect the ARPPU to continue to improve, driven by all the things that we mentioned. So, a combination of continued improvement in the quality of our membership offering, the quality and comprehensiveness of the privileges in our membership, more broadened sales channels which include internal and external channels, and more effective promotions will help ARPPU.

Operator, Operator

Thank you. Our next question comes from Thomas Chong from Jefferies. Thomas, your line is open. Please un-mute yourself and go ahead.

Thomas Chong, Analyst

Hi. Good evening. Thanks management for taking my questions and congratulations on a good set of results. My question is about the competitive landscape. Given that in terms of sales and marketing spending and margin improvement, are we seeing the competitive landscape more stabilized and that there's less threat from short-form video? My second question is about online music services surpassing social entertainment at some point for this year. I just want to get some color regarding the long-term revenue mix, how should we think about online music services revenue contribution in the long-term? Thank you.

Tony Yip, CSO

I will tackle the second part first about the revenue mix. As we mentioned, we do expect the online music services revenue to surpass social entertainment. And so clearly, what that would mean over the long run, we expect that to continue. So, we do expect the online music services to be the primary revenue source going forward as opposed to being a one-off effect. Within online music services, obviously in the fourth quarter, you have seen that music subscription grew just north of 20% and then non-subscription revenue grow at a faster pace due to a low base in 2021. And then looking into 2023, we obviously think that the effects will be slightly different. Music subscription will grow at over 20% on a year-over-year basis, as I mentioned. And then non-subscription revenue, we will see pockets of growth in the areas of advertising which is growing very well, long audio IoT services, but somewhat offset by volatility in digital albums as well as sub-licensing.

Ross Liang, CEO

Also with the unique platform and content strategy of TME, we are now starting to generate some monetization through content reductions, content licensing, and also rising sponsorship associated with our events. Additionally, we began to see some artist-related merchandising revenue, which can help us explore further e-commerce opportunities. Those will also help us create new revenue streams in the future.

Operator, Operator

Thank you. Our next question comes from Charlene Liu from HSBC. Charlene, your line is open. Please un-mute yourself and go ahead.

Charlene Liu, Analyst

Thank you so much. I have two questions. First, can you share your expectations for subscriber growth for paid music? And how should we think about the impact from resumption of offline entertainment, first in terms of willingness to pay as macro recovers post reopening? That’s the first question. Separately, on gross profit margin, I think management mentioned that it still has room to improve further. What could be a mid-term target for GPM, and how would investments in large language models impact our P&L standpoint? Thank you so much.

Tony Yip, CSO

I will take the first part on the subscriber growth, and perhaps Shirley can add a bit of commentary on gross margin. Our subscriber growth has been following a secular trend. So, irrespective of COVID and reopening, we continue to see a secular trend behind the subscriber growth. Our focus is much more on subscription revenue as a whole, which is driven by both paying user growth and ARPPU. Regarding offline activities, I think bear in mind that this will also benefit us in the form of advertising monetization, as Cussion mentioned, due to our vast number of offline music events generating sponsorship advertising revenue. The opening will have a positive impact in sponsorship advertising revenue. In terms of gross margin, our long-term target will be 35.

Shirley Hu, CFO

Yes, and we expect to achieve that through additional improvements on our content costs, including revenue sharing fees for live streaming services and improved operational cost efficiencies.

Operator, Operator

Thank you, and we will take our last question today from Xueqing Zhang from CICC. Xueqing, your line is open. Please un-mute yourself and go ahead.

Xueqing Zhang, Analyst

Thanks for another question. And one more question on labels cooperation. And today, we announced that TME reached an agreement with JVR and B’in Music, so can management give more color on labels collaboration and how does it affect our gross margins? Thank you.

Ross Liang, CEO

Yes. We continue to work with many music labels and artists domestically and internationally. We insist on IP rights and strive for the healthy development of the Chinese music industry. We provide the most comprehensive music library and the best top-page music content for users in China. In the long-term, we will continue to work with music labels in content co-productions and combine our meeting technologies to promote the music better. Besides, we are also focusing on live events as the Chinese market reopens. We expect many live event opportunities this year. Our TME Live events are expected to include more offline concerts and collaborations with our music labels. We’ve demonstrated a trustworthy long-term partnership with most of the music labels worldwide and expect more in-depth cooperation in the future.

Operator, Operator

Thank you. We are approaching the end of the conference call. I will now turn over the call to our host, Mr. Tony Yip, for closing remarks.

Tony Yip, CSO

Thank you everyone for joining us today. If you have further questions, please feel free to contact our IR team. This concludes today's call. Thank you and talk to you next time.