Earnings Call Transcript - TME Q1 2021

Operator, Operator

Ladies and gentlemen, good evening and good morning, and thank you for standing by. Welcome to the Tencent Music Entertainment Group's 2021 First Quarter Earnings Conference Call. Today you will hear discussions from the management team on Tencent Music Entertainment Group followed by a question-and-answer session. For the benefit of all the participants on today's call, please limit yourself to one question. And if you have additional questions, you can re-enter the queue. Please be advised that the conference is being recorded today. Now I will turn the conference over to your speaker host today, Ms. Millicent T. Please go ahead, ma’am.

Millicent T., Speaker Host

Thank you, Amanda. 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 via Newswire services. Today you will hear from Mr. Cussion Pang, our Executive Chairman, who will start the call with an overview of our recent achievements. He will be followed by Mr. Ross Liang, our CEO; and Tony Yip, our CSO, who will offer more thoughts on our product strategies, operations and business development. Lastly, 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 management’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 filings with the SEC. You are reminded that such non-IFRS measures should not be viewed in isolation or in as alternative to the equivalent IFRS measures 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?

Cussion Pang, Executive Chairman

Thank you, Millicent, and hello, everyone. Thank you for joining our call today. In line with the reorganization of the Tencent digital content ecosystem and TME's next development phase, we recently announced a leadership change. As the Executive Chairman of TME, I will be responsible for our long-term strategy and overall coordination and management of the Board and the company. My focus will be on building the most comprehensive music and audio content ecosystem in China. Joining us today is Mr. Ross Liang, TME’s new CEO, who will oversee QQ Music, Kugou, Kuwo Music, and the long-form audio business. Having worked closely with Ross in the past, we share the same vision for TME's strategic goals. Ross has a deep understanding of our business, having served as the GM of QQ Music from 2014 to 2016 and as a key member of the WeSing team. I warmly welcome Ross back to the TME family and look forward to collaborating as we execute our strategy and grow the business. Since TME’s establishment in 2016, we have remained committed to creating value for users, musicians, the industry, and society. We pioneered a model that supports the long-term development of China’s music and entertainment industry. Our extensive services now encompass online music, online audio, and social entertainment, positioning us as a comprehensive music and audio destination for millions of users. We are strong proponents of upholding digital music copyright and improving income for China’s indie musicians while nurturing the original music ecosystem. We have been pushing the boundaries of the music entertainment landscape, seeking innovative ways to enhance content production. This dedication has led to many chart-topping songs coming from our platform, and we have expanded our capabilities in artist incubation and promotion. We also launched TME Live, which has gained a solid reputation in the industry. Despite lingering impacts from the COVID-19 pandemic and existing uncertainties, China’s music industry is thriving, and we are focused on creating a one-stop online music and audio ecosystem. We will collaborate to drive TME's next development phase. Now, regarding our quarterly performance, in the first quarter of 2021, we saw strong growth with a 24% year-over-year increase in total revenues, achieving multiple milestones across our business. We added a record 4.9 million music paying users in the first quarter, showcasing our strong momentum and inspiration to enhance the role of music in people’s lives. For our long-form audio sector, we reached significant milestones, with MAUs exceeding 100 million by the end of 2020 and MAU penetration surpassing 20% in the first quarter of this year, establishing us as a key player in China’s online audio industry. Our content ecosystem is becoming more robust and dynamic. In the past quarter, we witnessed increasing engagement from younger users due to our broader genre offerings, including hip-hop, Chinese ancient style, and music for various entertainment formats like popular television shows and online games through licensing and self-production. Recently, QQ Music launched the Rappers’ Alliance, which attracted emerging and established rappers and helped the Rapper Variety Show become well-regarded in China. These efforts have resulted in increased engagement from young hip-hop listeners on QQ Music, who surpass their overall platform presence by more than 15 percentage points. In another instance, we collaborated with Tencent Games to create the well-received theme song, Battle For Glory, for PUBG Mobile. In 2021, as a vital part of Tencent’s platform and content group, we plan to enhance collaboration with the broader Tencent ecosystem. Supporting indie musicians is another strategic focus. In the first quarter, the Tencent Musician program has seen industry-leading growth, with the number of artists on our platform doubling year-over-year to over 200,000. The music streaming volume from Tencent Musicians has increased on both a sequential and year-over-year basis, reflecting musicians’ trust in our promotional support and comprehensive services. The Tencent Musician platform also contributes to social welfare, as demonstrated by our partnership with a leading logistics company in promoting music usage in southwestern China, including Sichuan, Guizhou, and Yunnan Provinces. Additionally, we expanded our content ecosystem to include live concerts. TME Live celebrated its first anniversary in March, having hosted 60 live concerts with over 100 artists and generating 18 billion social interactions, solidifying TME Live’s strong industry presence. In 2021, we will introduce more interactive features such as ticketing, VIP privileges, enhanced visuals, and virtual gifting to elevate the user experience and unlock the potential of online live performances. Long-form audio is also crucial as we evolve into a leading all-in-one music and audio platform in China. We have become a significant player in the growing long-form audio market, offering a wide array of categories, including drama, comics, Chinese comedy, parenting, relationships, and education. The consolidation of Lazy Audio in March provided us with access to a vast library of high-quality audiobooks. In the first quarter, the number of licensed titles increased more than fourfold year-over-year. We are also accelerating the addition of user-generated content, delivering both professional and long-tail podcast content to our users. Our collaboration with Xiaoyuzhou, a leading podcast app in China, marks our commitment to enhancing podcast creation. Our dual strategy aims to unlock considerable value from our music and long-form audio applications, leveraging our large music user base and nearly quadrupling our long-form audio MAU penetration to 20% in the first quarter compared to 5.5% the previous year. Long-form audio content contributes positively to user engagement, encouraging additional audio content consumption. New audio users are streaming more music than before, and our standalone app, Lanren Changting, aims to deliver a complete visual and audio experience through comics and interactive features tailored for audio enthusiasts. Lastly, we launched ad-based monetization to provide users with access to high-quality audio content through advertisements and task completions. We believe this model will rapidly expand our user base and create additional revenue opportunities. China's long-form audio market is currently underserved compared to music and video, and we are dedicated to fostering listening habits to drive the growth of online audio. Now, I will pass the call to Ross, who will discuss the strategies for our key business lines. Ross, please go ahead.

Ross Liang, CEO

Thank you, Cussion. Hello, everyone. I want to start off by saying how exciting and honored I am to join TME as the CEO. I see tremendous trends and future upside potential in TME, particularly in its leadership in driving industry growth through innovative business models and, last but not least, a remarkable team consisting of our talented group of people in the industry. I firmly believe that the pandemic has changed and continues to change the content distribution and the interaction in the online music industry in China. TME, from a position of strength, is in the forefront of this paradigm shift, leveraging the growth momentum of the realization and socialization of music platforms. We plan to launch the TME Radio account to further strengthen interactions between artists and fans. There's a significant upside to music-centric social activities through the completion of private dominance for music, musicians, and for music content promotion on each social platform. I will streamline resources to enhance middleware and architecture sharing among all online music services to pursue R&D and technology breakthroughs. As we highlight cutting-edge technologies under innovative operation models, the main driver will be to provide a more immersive online karaoke and concert experience, making virtual reality as well as offline experiences possible. Our multi-products portfolio puts us in a strong position to offer differentiated services for the diverse and nuanced needs of users nationwide, with QQ Music cementing its position as a young and trendy brand while Kugou Music serves a diverse user base by offering versions customized for different verticals and senior citizens. Kuwo Music will focus more on catering to users' intrinsic demand for music streaming and providing a superior experience with easy to use music streaming features. We have also established a tighter and more streamlined collaboration with Tencent's stronger product portfolio to enhance music content promotion. By working more closely with the broader Tencent ecosystem, we will foster interactions between music and social platforms, innovate content production, and artist incubation with digital content platforms and promote the development of long-form audio leveraging our partnership with online literature platforms. We are dedicated to finding the power of music and opening up monetization opportunities while expanding efforts on international expansion and have appointed the Group Vice President, Dennis Hau, to lead this effort. Dennis was previously in charge of the operations and management of QQ Music. Under his leadership, QQ Music successfully launched the Putong Community to enhance social interaction between music fans and their idols, developed industry-leading music discovery technology and substantially transferred promotional capability for trending hip music. With the support of Dennis and a deep bench of senior managers and leveraging my prior experience with QQ Music and WeSing, I will personally take a more active role in driving the growth of QQ Music and WeSing. I look forward to working in close partnership with Cussion and side by side with other TME management members, staying laser-focused on efforts to enhance product features and services to elevate user experience. Now, I would like to turn the call over to Tony, who will discuss the business highlights and important areas of focus. Tony, please go ahead.

Tony Yip, CSO

Thank you, Ross. Hello, everyone. I'll begin by discussing the key operational and financial performance in the first quarter. The growth rate of online music services continued to accelerate for the second consecutive quarter. We had another strong quarter for the subscription business, achieving a record high net addition of 4.9 million paying users for online music. This strong subscriber growth was mainly driven by improved content offerings, effective marketing campaigns, and better retention rates. We also made significant progress with advertising in online music services. Advertising revenues more than doubled year-over-year in the first quarter for the third consecutive time due to an increasing number of advertisers from various industries attracted to our platform, alongside triple-digit year-over-year growth in ad inventory and double-digit year-over-year growth in effective cost per mille (eCPM). We continue to innovate with advertising products to maximize the growth potential in this area. In 2021, we are focusing on developing creative advertising solutions and enhancing in-house capabilities to increase our advertising revenues, complementing our subscription models. The number of mobile monthly active users (MAUs) for online music was 615 million in the first quarter. Although there was some churn of casual users resulting in a year-over-year decline in MAUs, the total time that music users spent on our platform increased year-over-year, showing greater engagement from our core users. In terms of expanding our services beyond mobile phones, we are broadening our presence in the Internet of Things (IoT) space and finding innovative ways to interact with our users. The opportunities in the IoT market are exciting, and we are actively expanding use cases for users to enjoy all our services. We will continue to solidify our leadership position through extensive collaboration with major automakers, smart speaker manufacturers, television, and other connected device producers. In the first quarter, our IoT MAUs reached 69 million, reflecting a 50% year-over-year increase. The IoT market will serve as a new channel for distribution and promotion, as well as a potential driver for future subscription growth. Turning to visualization and socialization, our efforts to enhance both music and audio offerings, along with innovative features and services like music communities and video content, have contributed to a higher engagement level among users, as shown by a 10% year-over-year increase in average daily time spent by mobile users in the first quarter. For the Putong Community, we introduced more social themes, such as synchronized music and podcast listening and improved messaging features, catering to our users’ desire for interactive social connections. Consequently, both the daily active user (DAU) participation and retention rate of Putong Community have both steadily increased. The Kugou Fans Club has also attracted many prominent artists, labels, and content IPs, with recent highlights including a well-rated domestic animation series. Fans Club is becoming increasingly popular among the younger generation, demonstrated by a growing proportion of young users and increased time spent per user in the first quarter. Now let's discuss our social entertainment services. In the first quarter, we experienced solid performance, with both online karaoke and live streaming showing steady year-over-year growth. Our strategic shift towards focusing on monetization efficiency has led to significant advertising revenue growth for WeSing. QQ Music live streaming gained further momentum during the quarter, and we are on track to expand it throughout 2021. Social entertainment MAUs improved quarter-over-quarter to 224 million, as the QQ Music live streaming user base grew and our efforts to enhance the content ecosystem and social attributes for WeSing progressed. Paying users of social entertainment services also saw a sequential recovery, reaching 11.3 million in the first quarter, an increase of 4.6%. Our online karaoke services improved their core singing and entertainment functions, achieving notable improvements in monetization through advertising. Our continuous efforts to enhance the experience through video engagement, personalization, and community resulted in an increase in users’ willingness to participate in singing and recording, further distributing content and driving an increase in average daily time spent in WeSing, which improved daily active user metrics from the previous quarter. With a dual approach in splash screen ads and news feed ads, WeSing’s advertising revenue more than doubled year-over-year in the first quarter, marking it as a significant revenue stream. For the rest of 2021, we anticipate continued strong growth in advertising revenue, becoming a crucial top-line driver for social entertainment services. In the music-centric live streaming segment, our initiatives such as full-screen live streaming and content expansion in various categories maintained a healthy interactive ecosystem, evident from a steady quarter-over-quarter improvement in retention rates for both performers and users. The synergy between online music and music-centric live streaming was highlighted by increased streams of Chinese ancient style music during the quarter. Inspired by the rising interest in this genre on our online music services, Kugou Live hosted a live show featuring over 80 Chinese ancient style singers, blending traditional themes with modern elements. This event resulted in a 17% increase in streams of music by the participating singers during the show. In conclusion, we began 2021 with a strong move forward in our development into a comprehensive online music and audio entertainment destination in China for users and artists. With that, I will now turn it over to our CFO, Shirley, for a detailed review of our financials.

Shirley Hu, CFO

Thank you, Tony. Hello, everyone. Next, I’ll discuss our results from a financial perspective. Overall, we achieved outstanding growth in online music services, particularly in music subscriptions and advertising revenues this quarter, as well as the continuing healthy growth in our social entertainment business. Total revenues for Q1, 2021, were RMB7.8 billion, up 24% year-over-year. Our online music revenues reached RMB2.7 billion this quarter, up 35% year-over-year. Our music subscription business continued to grow rapidly in the first quarter of 2021, with revenues of RMB1.7 billion and a year-over-year growth of 40%. We had a record high net additions of 4.9 million in Q1, 2021, and the paying users grew 43% year-over-year, driven by user retention improvements and higher new additions of paying users. Monthly ARPPU remained relatively stable year-over-year. This was the result of our continuous improvement in product and content, expanded sales channels, and efficient promotions. We are very pleased to see that our efforts are starting to bear fruit and the value of quality music is increasing among our users. Additionally, on a year-over-year basis, our advertising revenue was more than doubled again for the third consecutive quarter due to increased ad availability and eCPM improvements. We also enhanced our products to improve ad efficiency and the fact that our customers are happy and engaged. Over the past year, we have made various efforts in expanding and educating our customers, resulting in both our customer number and average spending per customer expanding year-over-year. Social entertainment services and other revenue were RMB5.08 billion, up 19% year-over-year, driven by growth in revenues from live streaming and advertising services on our social entertainment platform. Social entertainment monthly ARPPU increased 36%, while our paying users jumped 2.4% on a year-over-year basis. Live streaming revenues saw a relatively higher growth year-over-year, as we had a lower base in Q1, 2020, due to the impact of COVID-19 and adjustments to our active users. Additionally, our improved ad business model in social entertainment provides better ad products on our platform, regarding the significant growth in ad revenues on our social entertainment platform. The gross margin was 31.5% in Q1, 2021, up 32% year-over-year and down 0.8% sequentially. The year-over-year increase was due to rapid growth in subscription revenue and other testing revenues. The sequential decrease in gross margin was because social entertainment revenues and advertising revenues were seasonally lower in the first quarter of 2021. Now moving on to operating expenses. Total operating expenses for Q1, 2021, were RMB1.6 billion and were 20% as a percentage of total revenue, compared to 18% in the same period last year. Selling and marketing expenses were RMB672 million, up 40% year-over-year. The increase was due to higher user acquisition expenses to enhance our product’s long-term positioning and spending related to our legacy TMEA event in general. The increase was also because we had a lower base in Q1, 2020, as we reduced spending on user operation during the pandemic. General and administrative expenses were RMB887 million, up 30% year-over-year, driven by a higher number of employees in R&D as we invested in product enhancement and project innovation, such as long-form audio, raising international versions of content library technology. Our effective tax rate for Q1, 2021, was 11.5%. Our net profit was RMB979 million and the net profit attributable to equity holders of the company was RMB926 million. Non-IFRS net profit was RMB1.25 billion and the non-IFRS net profit attributable to equity holders of the company was RMB1.18 billion. Non-IFRS net profit margin was 15.8%. As of March 31, 2021, our combined balances of cash, cash equivalents, term deposits, and short-term investments were RMB27 billion, representing a decrease of RMB2 billion from Q4, 2020. The decrease in balances was primarily due to the acquisition of Lazy Audio, investments in the consortium to purchase additional equity interest in Universal Music Group, and the repurchase of ordinary shares. Cash generated from operating activities had a positive impact on the combined finances. Looking forward, we’ll continue to invest in core content to further increase recognition of the value of quality music among our users and focus on new products and features such as long-form audio. We are optimistic about the future of the broader music and audio industry and are confident about the overall system and the product pipeline we are building in the long run. This concludes our prepared remarks. Operator, we are ready to open the call for questions.

Operator, Operator

Thank you. As a reminder, for the benefit of all participants on today's call, please limit yourself to one question, and if you have additional questions, you can reenter the queue. Your first question comes from Alex Yao from JP Morgan. Please go ahead.

Alex Yao, Analyst

Good morning management and thank you for taking my question. My question is around the regulatory environment. Can you comment on the recent news flow that you guys are being investigated by the regulator for anti-trust purposes and the worst-case scenario of the penalty could involve not only a fine but also a separation of the three music apps, i.e., QQ Music, Kugou, and Kuwo? Additionally, can you talk about what you expect to change in your operations in the next couple of years given the tightening regulatory environment in the general internet space? Thank you.

Tony Yip, CSO

In recent months, we have received increased regulatory scrutiny from relevant authorities and have been actively cooperating and communicating with the relevant regulators. At this point, we are not in a position to comment or predict potential outcomes of such dialogue with the regulators. However, we would like to say that we are committed to complying with all relevant laws and regulations, including those related to antitrust. As you know, the online entertainment industry is highly competitive and dynamic. Our goal is to deliver valuable products and services that provide more value to our users, to musicians, to the industry, and to society as a whole, and that will remain the case. We aim to establish ourselves as a healthy force in the industry that provides value to society as a whole. So I think that's all we could say and comment on with regards to the regulatory developments at this stage.

Operator, Operator

Thank you. Your next question comes from Eddie Leung from Bank of America. Please go ahead.

Eddie Leung, Analyst

Hi, good morning guys. I would just like to get insights on your plan to have better integration among the three music applications as we've seen from some media news. And any more color on the potential cooperation with other assets under Tencent? Thank you.

Tony Yip, CSO

Sure, I think, with regards to better cooperation within TME, as Ross mentioned in the early remarks, we plan to build a shared middleware and architecture that is shared across the three music platforms to improve R&D efficiency and improved data efficiency while at the same time finding the positioning of each of the music platforms for different target audiences. With QQ Music, we'll continue to cement its position as a young and trendy brand and establish strong endorsements among young users. Kugou Music serves as a diverse user base by offering multiple versions of customized services for different verticals, such as children or the senior population, and then Kuwo will focus on a more intrinsic and streamlined, easy-to-use music streaming service. In terms of cooperation with the broader Tencent Group, as Ross also briefly mentioned, TME will strengthen collaboration with the wider Tencent ecosystem. Examples could include utilizing Tencent social platforms as channels for better music content distribution and promotion, working more closely with Tencent Maps for in-car use cases, and joining forces with Tencent's digital content platforms such as Tencent Video in areas such as music variety shows, fan-based community operations, long-form and short-form video promotions, and commercial membership partnerships as well as improving the search and discovery experience for music within QQ Browser. Last but not least, we will deepen our partnership with China Literature, which we started last year.

Operator, Operator

Thank you. Your next question comes from Alex Poon from Morgan Stanley. Please go ahead.

Alex Poon, Analyst

Thank you management for taking my question. I have a question regarding long-form audio. Can you talk a little bit more about the time and investment needed to build the content library and to become similar or even better than the existing industry leaders in terms of revenue ramp-up trajectory and the impact on the margin of the overall company? Thank you very much.

Cussion Pang, Executive Chairman

Okay. Alex, thank you for your question and I'll try to answer it from a more business strategy perspective and then Tony and Shirley may add a little bit on the financial side as well. Regarding the long-form audio, there is definitely a lot of exciting opportunities out there. We see it as one of our core strategic moves not just this year; we actually launched it last year, and this is also the first anniversary after we soft-launched our new long-form audio platform. We are actually taking a two-pronged approach. We are not just promoting long-form audio from our music applications, but also after the acquisition of Lazy Audio, we merged with our Kuwo Changting and formed another standalone long-form audio app that will help to facilitate the needs of our core audio users. In terms of the content side, as we mentioned, we have a strong partnership not just with Chinese Literature, but also with most of the core leading long-form audio IP providers in the industry right now. Besides these, we are also rolling out some platforms and programs to acquire the podcasting providers to go to our platform and start providing services. So all of these we will be doing simultaneously. One of the latest updates I would like to share is that we are also in alliance with Xiaoyuzhou, which is our leading podcasting application in China nowadays. They are a very energetic and young team, and after having in-depth discussions with them, I believe we share the same vision and have already rolled out joint partnerships with Xiaoyuzhou on the QQ Music platform regarding podcasts. We have a lot of exciting projects going on. We will continue to pull in more resources, not just from a financial point of view, but also in the company structure organization, we have already formed a long-form audio business group, and we have a dedicated team focused on not just from a technical point of view to lay out a good foundation, but we are also working on the product and operations side as well. I will see if my team has any additional comments regarding the resources or the financials.

Tony Yip, CSO

Shirley can address the margin impact on the long-form audio investments.

Shirley Hu, CFO

About the gross margin of online music, we have seen improvement in the last two quarters, and we expect in 2021 that the gross margin of online music will increase year-over-year. However, how much long-form audio will drag the costs; we think the long-form audio library will be a factor impacting the gross margins because we cannot realize meaningful revenue at this stage, as the long-form audio monetization is at a very early stage. We believe that in 2022, meaningful revenue can come, which will raise our gross margin.

Operator, Operator

Thank you. We are now approaching the end of the conference call. I will now turn the call over to your speaker host today, Ms. Millicent T. for closing remarks.

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 next quarter. Thank you and goodbye.

Cussion Pang, Executive Chairman

Thank you so much.