Earnings Call Transcript - TME Q2 2021

Operator, Operator

Ladies and gentlemen, good evening, and good morning, and thank you for standing by. Welcome to the Tencent Music Entertainment Group 2020 Second Quarter Earnings Conference Call. Today, you will hear discussions from the management team of Tencent Music Entertainment Group, followed by a question-and-answer session. Please be advised that this conference is being recorded today. Now, I'll turn the conference over to your speaker host today, Ms. Millicent T. Please go ahead, ma'am.

Millicent T., Speaker Host

Thank you, operator. Hello, everyone, and thank you all for joining us on today's call. Tencent Music announced its quarterly financial results today after the market close. An earnings release is now available on our IR website at ir.tencentmusic.com as well as via Newswire services. Today, you'll hear from Mr. Cussion Pang, our Executive Chairman, who will start the call with an overview of our recent updates. He will be followed by Mr. Ross Liang, our CEO; and Mr. Tony Yip, our CSO, who will offer additional thoughts on our product strategies, operations, and business developments. Finally, Ms. Shirley Hu, our CFO, will address our financial results before we open the call for questions. Please note that this call may contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and observations that involve known and unknown risks, uncertainties, and other factors not under the company's control, which may cause actual results, performance, or achievements of the company to be materially different from the results, performance or expectations implied by these forward-looking statements. All forward-looking statements are expressly qualified in their entirety by the cautionary statements, risk factors and details of the company's filings with the SEC. The company does not assume any obligation to revise or update any forward-looking statements as a result of new information, future events, changes in market conditions or otherwise, except as required by law. Please also note that the company will discuss non-IFRS measures today, which are more thoroughly explained and reconciled to the most comparable measures reported under the international financial reporting standard in the company's earnings release and the filings with the SEC. You are reminded that such non-IFRS measures should not be viewed in isolation or as an alternative to the equivalent IFRS measure, and other non-IFRS measures are not uniformly defined by all companies, including those in the same industry. With that, I'm very pleased to turn over the call to Cussion, Executive Chairman of Tencent Music. Cussion, please.

Cussion Pang, Executive Chairman

Thank you, Millicent. Hello, everyone, and thank you for joining our call today. As we announced on July the 26th, Tencent recently received an Administrative Penalty Decision issued by the State Administration for Market Regulation of the People's Republic of China to SAMR. We sincerely assess the decision and we'll continue to strengthen our operations in accordance with all regulatory requirements, drive innovation and fulfill our social responsibilities. In compliance with the requirements of copyright license exclusivity, we will operationally focus on the dual flywheels of content and platform to deliver high quality products and services to users and foster innovation. We have taken several important steps in this regard. Specifically, as Executive Chairman, I'm responsible for enriching our content ecosystem whether licensed or self-produced, as well as expanding our capability within the music industry to provide additional value services and solutions to artists and users. Our CEO, Ross, oversees our platform and product strategies and is responsible for further deepening TME's partnerships with Tencent's ecosystem. Ross will elaborate on this in a moment. We will continually deepen our partnerships with hundreds of music labels to expand our licensed content cost base in alignment with the new requirements and work to provide more and better content offerings to over 600 million music users across our multi-brand product portfolio. We are pleased to report that we have been consistently making breakthroughs in diverse music verticals, including new hits, Chinese ancient style, hip-hop, and music for gaming, movies, television programs and variety shows, as demonstrated by a comprehensive coverage of songs and particularly full coverage of hip-hop variety shows. We are also enhancing our profile among the younger generation by expanding cooperation with leading content IPs, whose programs, such as the collection of Chinese ancient style performances, have resulted in a sequentially increasing user engagement from young users. While broadening our offering of copyrighted music, we have also been working closely with our upstream value chain, artists, and other partners to create and produce more differentiated content. For example, we began to work extensively with Tencent across multiple businesses. I'm also pleased to share our progress in counterfeiting and promoting indie musicians. During the second quarter of 2021, through the Tencent Musician Program, our roster of indie artists achieved triple-digit year-over-year growth with a strong stream showing consistent increases both year-over-year and quarter-over-quarter. Musicians view us as a reliable partner, given our well-structured financial incentives, which for the first time include a revenue-sharing mechanism for the artists and songwriters. They are also attracted by our efforts to enhance copyright protection based on blockchain technology, helping the musicians uphold copyright without imposing financial burdens on them. On top of that, our attitude toward cultivating blockbusters on the Tencent Musician Program Platform has grown strongly. For example, within three months of its release, the collaborative song titled 'Coming in Late' has accumulated more than one billion streams. In the future, we will build a closed-loop system for musician discovery and management through multi-dimensional support, including more financial rewards, copyright protection, and education and training for musicians—all which reflect our desire and determination to help musicians grow and succeed. We have also upgraded our platforms' promotional capabilities and further developed our artists and repertoire (ANR) capabilities. For example, we connected artists and musicians with entertainment program producers and helped our musicians perform on variety shows. TME Live, our online-merged-offline performance brand, continues to bring new opportunities to the company, with a strategic focus on omni-channel promotion and monetization. On the online side, we host monthly concerts for top artists that include interactive monetization options, such as ticketing, VIP privileges, and merchandise. On the offline side, TME Live is expanding its footprint with a plan to launch offline initiatives, including daily live performances in key cities, such as Beijing and Shanghai, and collaboration with the Tencent Musician Platform and the local tourism industry. We are also working with Playhouse to organize weekly indoor music festivals, merging the offline party experience with rich online features. With that, I will pass the call to Ross who will share more about our platform strategies. Ross, please go ahead.

Ross Liang, CEO

Thank you, Cussion. Hello everyone. Since I became CEO in April, my focus has been on strengthening our platform's competitiveness and finding new ways to serve users through video content, socialization, and community building. Over the past few months, we have made good progress on this front. Based on video content, we are applying shared middleware and architecture which is crucial to further enhance our video content offerings across our platforms. Kugou Music continued to enrich the embedded music videos on its streaming page, and we are pleased to say that its stereo penetration is increasing quarter-over-quarter. QQ Music launched a new version feature in August, with expanded user cases and more diverse content, which we anticipate will increase video views and the amount of time spent by users on our platforms. Our socialization and community building efforts include our renewed initiatives, which are still works in progress. We are upgrading the synchronizer listings feature in QQ Music to encourage interaction among friends. We recently launched Putong Planet, which connects users with common tastes in music more efficiently through targeted matches to inspire connection among strangers. We are upgrading our online karaoke rooms to make the online experience more fun and socially engaging. The new version we offer a broader scale of online singing experiences, including solo and duet songs and catering to different needs, such as singing on demand, singing along on demand, singing practice, inter-room matches, and cross-room activities. We have also launched a WeSing virtual live streaming room to provide a new entertainment experience combining live streaming functionality with unique interactive features. In the future, we will expand live streaming to more use cases and provide richer interaction opportunities and a more imaginative virtual reality experience. We have also made progress in partnering more closely with the broader Tencent ecosystem, which supports our long-term prospects. During the second quarter, we expanded our collaboration with Weixin Video Account, which is crucial for enriching the music video content on both TME platforms. Our collaborations leverage Weixin to fund our promotional compatibility and drive traffic back to TME platforms. For the first time, QQ Music joined forces with Weixin Video Account to present an online event featuring well-known musicians and bands. This initiative will strengthen our connection between artists and users by driving user engagement on our platforms. We'll further enhance user engagement and music-focused collaboration with Weixin by allowing users to update their Weixin status with the songs they are listening to. Last but not least, we worked with Tencent Video to enhance exposure of video content, receiving half a billion views on social platforms for an album released by a well-known Chinese singer shortly after launch. We look forward to sharing more examples in future quarters. Long-form audio is an effective complement to our music product as well, enhancing user engagement. During the second quarter, we restructured our content offering to further diversify our service portfolio. We continue to enrich our license agreements and actively engage with sports brands through our partnership with NBA China as their official music partner. As one of our industry-leading innovators, we launched our NFT digital platform based on blockchain technology. This may offer more exposure and unlock monetization opportunities for artists and active users. In conclusion, there's still a lot of work to be done, but we believe we made a good start. Now I would like to turn the call over to Tony to discuss business highlights and key areas of focus. Tony, please go ahead.

Tony Yip, CSO

Thank you, Ross. Hello everyone. Online music mobile monthly active users (MAUs) were 623 million in the second quarter, with a slight year-over-year decline but an increase on a sequential basis. Our core music users have become more engaged, with total user time spent increasing year-over-year and quarter-over-quarter. Additionally, paying users have become more active on our platforms after subscribing to our services, which signifies that as our paying user base grows, so does monetization and user engagement from this core group. We continue to expand our scope of services to the IoT market, resulting in IoT MAUs recording a year-over-year growth of 43% during the second quarter. As a new music content consumption channel, IoT enhances our ability to roll out and promote music content to a wider audience in users' daily lives. Growth momentum in our online music services continued into the second quarter, driven by effective marketing and our progress in adding high-quality music content into the subscription plan. The number of paying subscribers to our online music services grew to 66.2 million during the quarter, with record high net adds of 5.3 million. Our paying subscriber ratio grew to 10.6%, up from 7.2% during the same period last year. On a year-over-year basis, user retention continued to improve, and average revenue per paying user remained healthy, indicating users’ growing willingness to pay for high-quality music content. Advertising revenues also demonstrated robust year-over-year growth in the second quarter, benefiting from an expanding pool of advertisers and increased inventories. However, growth was lower than expected due to regulatory guidance on app launch splash screen ads. We will work to comply with this guidance while continuing to improve the user experience of our ads. Turning to our online music products, we refined product positioning within our multifaceted portfolio. We bolstered QQ Music's image as a youthful brand, adding popular content to cater to younger generations' demand for Chinese ancient style music, hip-hop, and other genres. Moreover, we deepened our presence in schools and college campuses through online and offline activities, such as competitions and graduation ceremonies. Our QQ Music Graduation Concert spurred significant social buzz. Our new functions, such as synchronized listening and Putong Planet, further enhance user interactions. Meanwhile, our social entertainment services saw a decline in MAUs and paying users due to intensified competition. In response, we remain focused on strengthening our competitiveness, as discussed earlier. For WeSing, we have adopted technology to include immersive effects and advanced recording tools, enhancing user experience while recording songs. Our live streaming services are also evolving as we adapt to the competitive landscape. We aim to promote a healthy ecosystem for our users and performers while steadily enhancing our capabilities. Overall, we are on track to scale up our social entertainment services in the second half of the year. With that, I would like to turn the call over to Shirley, our CFO, for a closer review of our financials.

Shirley Hu, CFO

Thank you, Tony. Hello, everyone. Let’s discuss our results from a financial perspective. Our total revenue for Q2 2021 was RMB8 billion, up 16% year-over-year, driven by strong growth in online music services, particularly in music subscriptions and advertising. Our online music revenue was RMB3 billion this quarter, up 33% year-over-year, with music subscription revenues of RMB1.8 billion, reflecting a year-over-year growth of 36%. Net additions of paying users reached 5.22 million in Q2 2021, marking a new record high for net adds. This growth is attributed to improvements in products, expanded sales channels, and effective marketing campaigns. Our average revenue per paying user was RMB9 billion this quarter compared to RMB9.3 billion in the same period last year. Our Q2 advertising revenues showed strong growth year-over-year, although it was lower than expected due to regulatory guidance on splash ads, intended to enhance user experience. However, we are directing resources to explore new advertising formats while balancing revenue growth. Social entertainment service revenues were RMB5.1 billion, up 3% year-over-year, primarily driven by live streaming revenues in a competitive landscape. We’re working on retaining existing performers and attracting new talent while enhancing efficiency in directing traffic from music platforms to live stream platforms. Additionally, advertising revenue on music platforms contributed to the year-over-year growth. However, the growth rate has slowed due to regulatory impacts. Gross margin was 30.4% in Q2 2021, reflecting a nearly 9% year-over-year decline due to increased revenue sharing and investments in new products and content offerings, such as long-form audio. Our total operating expenses for Q2 2021 were RMB1.7 billion, accounting for 21% of total revenue compared to 19% in the same period last year. Our selling and marketing expenses were RMB669 million, up 15% year-over-year, primarily due to higher promotional spending for new products. General and administrative expenses were RMB1 billion, up 39% year-over-year, driven by hiring and technology innovations. For instance, we applied shared middleware architecture and launched new features, with share-based compensation expenses contributing to higher G&A expenses. Our effective tax rate for Q2 2021 was 11.5%. Our net profit was RMB871 million, while net profit attributable to equity holders of the company was RMB827 million. Non-IFRS net profit was RMB1.16 billion, with a margin of 14.5%. Our cash balances stood at RMB26 billion as of June 30, 2021, after a decrease of RMB1 billion from Q1 2021 primarily due to stock repurchases. Looking ahead, we will continue our investments in the Tencent Musician Program and innovation within the online music streaming industry. We'll maintain our focus on new products such as long-form audio and enhancing existing offerings for long-term growth. This concludes our prepared remarks. Operator, we are ready to open the call for questions.

Operator, Operator

Thank you. We will now start the question-and-answer session. The first question will come from Alicia Yap with Citigroup. Please go ahead.

Alicia Yap, Analyst

Hi, good morning, management. Thanks for taking my questions. I wonder to follow up on management remarks regarding the potential business operation impact that you are expecting post-regulatory changes. Would that be more on the subscription trend that you’re expecting or is it more on the difficulty to convert future paying users? And what kind of offsetting measures might you be planning to minimize the impact? Would it be possible to push more on the premium model with higher online ad revenue potential? Thank you.

Tony Yip, CSO

Thank you for your question. I’ll take the first part of the answer and then perhaps others for management can add. As you know, at the end of July, there was a penalty decision by the regulatory authorities, pursuant to which, among other things, we have to implement a rectification plan to terminate exclusive music copyright licensing arrangements within 30 days from the date of that decision. We acknowledge that decision and are committed to complying with all requirements timely. While the decision will impact our music business, all music available on our platform will continue to be available to our users. We will focus on strengthening our operations in accordance with regulatory requirements, better serving users through product innovation as elaborated by Ross and Cussion, and will also focus on fostering the healthy development of musicians and the music industry as a whole. Let me pause there and see if others in management have anything to add.

Ross Liang, CEO

Yes. I just would like to add, thank you for the questions. A key competitive edge of TME is that we employed the dual flywheel strategy, meaning we not only have the music platform but are also committed to developing our content ecosystem. We will continue to comply with regulatory positions, and while it may impact day-to-day operations, we do not expect it to shift our online subscriptions significantly. We believe users recognize the value of music and will continue to pay for it as long as we provide high-quality content. So, the long-term momentum of our online music services will remain healthy. We are also expanding our footprint and collaborating with various partners in the industry, not just upstream—on content production—but we are also organizing more online and offline music concerts with creative engagement methods.

Cussion Pang, Executive Chairman

Yes, we are also in discussions with Tencent Video to cooperate in the area of joint subscription. That’s a work in progress and we’ll update everyone in the next quarter.

Millicent T., Speaker Host

Thank you. Next question?

Alex Poon, Analyst

Thank you management for taking my question. My first question is regarding the exclusive content. Could management share roughly how much streaming volume overall and behind the paywall is driven by exclusive content? And what is the percentage roughly from independent musicians at this moment and how it makes change over time? My second question is regarding user acquisition; given we will have less exclusive licensed content, do we expect to spend more on user acquisition? How much are we spending right now to acquire new users? And apart from exclusive content, will we need to increase discounts to attract new users and how will music ARPU trend in the future? Thank you very much.

Tony Yip, CSO

Hi. I’ll answer the first part of the question and then regarding acquisition costs and ARPU, Shirley can address that. We historically have not disclosed the exact percentages of streaming share relating to the various types of content. However, we have exclusive content on the platform, which is also part of the subscription plan. It's worth noting that there is a significant amount of non-exclusive content within the subscription plan as well. Regarding indie musicians, their streaming share has been growing steadily, and we intend to continue to grow that as more musicians join our Tencent Musician Platform. As we discover promising new talent, we can work closely to jointly create music together, providing us opportunities in content creation. As for subscribers, users have been educated over the years to subscribe to the music service, creating a consistent monetization model across the industry. We believe regulators want to promote the overall healthy development of the music industry. Therefore, having a successful long-term monetization model is essential. We will continue to focus on providing high-quality products and services through the dual flywheel approach of content and platform. We continue to see healthy growth in our net adds and improvements in subscriber retention.

Cussion Pang, Executive Chairman

Yes, I would like to add more color on the Tencent Musician Program. We have achieved remarkable progress since its launch in 2017, reflected not only in the quality and number of songs produced but also in the value created for musicians and music creators. For example, our initiatives for IP rights protection and open platform capabilities support our artists in distributing and registering their music. We are focused on facilitating collaboration between our musicians and professional producers. Importantly, we strive to continue producing high-quality music and enhancing revenue-sharing systems, allowing younger musicians to earn a living on our platform. After four years' effort, we are making significant headway, and I'm confident about our direction.

Ross Liang, CEO

Regarding user acquisition, our strategy is to maintain a multi-product portfolio approach across QQ Music, Kugou Music, Kuwo Music, and WeSing. We will continue to explore new products to expand our footprint. For example, Kugou recently launched a feature allowing users to upload and generate video content for interaction around those videos. QQ Music has implemented an immersive video feed to enhance video content. Collectively, these efforts aim to attract more users. Now, Shirley, please go ahead.

Shirley Hu, CFO

As part of our music services, we expect subscription numbers to remain stable in Q3 compared to Q2. We believe our promotional campaigns and the subscriber growth will perform well in the third quarter.

Alex Poon, Analyst

Thank you management for sharing the full picture. Thank you.

Operator, Operator

The next question will come from Eddie Leung with Bank of America. Please go ahead.

Eddie Leung, Analyst

Good morning. Just a question on gross margins. We noticed a slight dip in the gross margin. Could you give us a bit more color on a few factors affecting your gross margin and how we should think about it in the upcoming quarter? Thank you.

Shirley Hu, CFO

Regarding gross margin, we noted that the reasons for the decrease included expanding content offerings, increased revenue-sharing ratios to live streaming hosts, and more investments in long-form audio content. In the near term, we believe the cost structure will stabilize, but expect margin pressure in the upcoming quarters due to continued revenue sharing and product investment.

Ross Liang, CEO

To add context for the full year 2021, we expect total revenue year-over-year growth rate to be approximately 10%, with online music revenue growth around 30%. We foresee continued operating leverage coming through for online music. However, for social entertainment revenue for the full year, we expect it to remain flat due to a combination of factors impacting live streaming.

Operator, Operator

The next question will come from Thomas Chong with Jefferies. Please go ahead.

Thomas Chong, Analyst

Hi, good morning. Thanks, management, for picking my question. My first question is about our long-term business trend, given the softness in the second half. Do we still expect to meet our long-term subscriber targets? Lastly, do you expect taxation impacts from the preferential tax rates on our net margin? Thank you.

Ross Liang, CEO

I’ll address your questions. We are confident in our long-term growth trends despite short-term weakness in certain areas, primarily live streaming. We remain focused on our long-term dual flywheel strategy of content and platform. Regarding data protection, we are committed to complying with the relevant regulatory requirements to enhance our data privacy and protection operations.

Shirley Hu, CFO

Our tax rate is expected to remain stable in the coming quarters, as we do not factor in preferential tax rate errors until applications are approved, thus having no impact on net margin.

Piyush Mubayi, Analyst

Thank you for taking my question. Could you just speak generally about competitive positioning in context of contract structure with labels and how that might evolve? Thank you.

Ross Liang, CEO

We plan to continue negotiating licensing contracts as we move from exclusive to non-exclusive arrangements. We aim to enhance our content library. We also emphasize self-produced content which generally offers superior margins. Shirley, could you also comment?

Shirley Hu, CFO

Additionally, we seek new content partnerships while focusing on self-produced music, which will provide opportunities to lower content costs.

Cussion Pang, Executive Chairman

We've implemented cross-platform live streaming events, allowing us to tap into new audience bases and enhance user interaction, significantly benefiting revenue generation. We’ll continue to explore these successful strategies moving forward.

Operator, Operator

We are now approaching the end of the conference call. I would now like to turn the call over to your speaker host today, Ms. Millicent T. for closing remarks. Please go ahead, ma'am.

Millicent T., Speaker Host

Thank you everyone for joining us today. If you have any further questions, please feel free to contact the IR team. This concludes today's call, and we look forward to speaking to you again. Thank you and goodbye.

Ross Liang, CEO

Thank you.

Tony Yip, CSO

Thank you everyone.

Shirley Hu, CFO

Thank you.

Operator, Operator

This concludes today's conference call. Thank you for attending today's presentation. You may now disconnect.