Earnings Call Transcript - TME Q2 2024

Millicent Tu, Head of IR

Good evening, and good morning, and welcome to Tencent Music Entertainment Second Quarter 2024 Earnings Conference Call. I'm Millicent Tu, Head of IR. We announced our quarterly financial results earlier today before the U.S. market opened. The earnings release is now available on our IR website and via PR Newswire services. During today's call, you will hear from Mr. Cussion Pang, our Executive Chairman; and Mr. Ross Liang, our CEO, who will share an overview of our company strategies and business updates. Then Ms. Shirley Hu, our CFO, will discuss our financial results before we open the call for questions. Before we continue, I refer you to the safe harbor statement in our earnings release, which applies to this call as we'll make forward-looking statements. Please note that we'll discuss non-IFRS measures today, which are more thoroughly explained and reconciled to the most comparable measures reported under IFRS in our earnings release and filings with the SEC. All participants are muted at this time. After management's remarks, there will be a Q&A session. And please be advised that today's call is being recorded. With that, I'm very pleased to turn the call over to Cussion, Executive Chairman of TME. Cussion?

Cussion Pang, Executive Chairman

Thank you, Millicent. Hello, everyone, and thank you for joining our call today. We are excited to report another solid quarter underpinned by a 28% year-over-year growth in online music services as well as a 26% year-over-year growth increase in adjusted net profit. The outstanding net addition of over 10 million music subscribers in the first half of 2024, coupled with a rise in ARPPU, once again demonstrated our strong ability to bring new brands within China's streaming landscape. We remain optimistic about the music industry's long-term potential and are committed to our mid to long-term goals. In the meantime, we are consistently adjusting ourselves to better adapt to changing external environments, evolving user mindsets, and our different business development stages to continuously innovate and achieve sustainable growth at a healthy pace and with the right balance. Let me now share some recent highlights on our expansive content ecosystem, which is getting increasingly rewarding. First of all, we continue to expand and reinforce partnerships with artists and record labels to enrich our music library and to bring the best content available to our users. Our long-standing and extensive win-win partnerships with music labels enable us to secure more content-centric privileges for users, including but not limited to early access to the latest hits. This quarter, we extended our collaborative licensing agreements with some well-known Chinese bands, such as Sodagreen and a top Korean label, CJ ENM, which represents the highly popular K-pop boy band, ZEROBASEONE. All these contract renewals include a 30-day head start pre-phase of their new songs. Overall, we are pleased to see that such pre-phase has effectively improved membership's conversion and engagement. Second, we continue to explore more engaging ways for users to enjoy music. During the quarter, we combined the proprietary fan-artist interaction benefits, such as live video calls, digital album releases, and it effectively increased sales. Shenself, the new digital album of popular Chinese singer Zhou Shen, is a recent success. It features artist-streamed in-app decorations and virtual souvenirs and exceeded 1 million copies in sales within 3 months of release, ranking as a top seller year-to-date on our platform. We have also seen solid digital album sales results from other artists, such as Chinese singer Lay Zhang and the popular K-pop girl group, aespa. Third, as the demand for offline live performances continues to surge, we stepped up our efforts to host concerts and music festivals with more value-added services. In July, we hosted our upgraded flagship annual event, TMEA, Tencent Music Entertainment Awards 2024 in Macau. We broadened our horizons this time featuring A-listed domestic singers, rising musicians, as well as international idols. Notably, over 60 household names, including Zhou Shen, Tia Ray, Jane Zhang, and the K-pop girl group BABYMONSTER performed at this year's event. TMEA 2024 sparked billions of social media buzz, showcasing our elevated industry influence. We are also bolstering our capabilities to organize large-scale concerts for top noted singers. For instance, we hosted Tia Ray's landmark concert tour and helped her achieve a milestone of over 10,000 attending fans. We are happy to see a significant year-over-year growth in our revenues from offline performances in the second quarter. This quarter, as a new initiative, we customized the event-themed artist merchandise for Karen Mok’s concert with head-start sales on our platform. We also provide our subscribers with member-only access to the online premier concerts of popular Chinese band, Teens In Times as a remarkable benefit. Fourth, our self-produced content continues to win popularity and boost user conversion. We strategically leveraged our extensive resources as an advantage in TV, films IPs, and artists to elevate the production, promotion, and success of our self-produced content. For example, we invited popular artists, Zhou Shen, Kenji Wu, and MIKA to perform the original soundtracks for Tencent Video's blockbuster TV series Joy of Life 2, Shenghuo lequ, and The Tale of Rose. This self-produced songs amassed over 200 million streams in total on our platform within 3 months of their release, ranking top 3 on OST charts until today. In addition, our self-produced pop songs, Heard of You, and Who Am I, went viral on short video platforms soon after they featured on the National Music Variety show, The Treasured Voice Season 5, which significantly boosted streams on our platform. Our high-quality original content combined with unique fan-artist interactions fulfills diverse music tastes and entertainment needs, bolstering an increasingly dynamic content ecosystem. We always strive to inspire society and share our love through music. In the second quarter, we jointly launched another Little Red Flower Concert with Tencent Charity, partnering with volunteer artists and teachers to support the local education for children in rural areas through online and offline performances. We amplified its online reach and social influence this time by deeply collaborating with Weixin Video Accounts to live stream the concerts. In summary, we record a solid second quarter performance, finishing the first half of the year on a strong note, both operationally and financially. We believe the power of our platform, the value of premium music content, and expanding members' privileges will have a snowball effect, leading to healthy and sustainable growth. Guided by our long-term view, our goal is to lay a strong, solid foundation for future progress and to promote a vibrant win-win development of the industry. Now, I would like to turn the call over to Ross for more details on our overall platform development. Ross, please go ahead. Thank you.

Ross Liang, CEO

Thank you, Cussion. Hello, everyone. Our focus on user-centric innovation has effectively increased the music subscribers and enhanced retention during this quarter. This reflects our ongoing efforts to advance our products and services, especially the focus on the high-value subscription plan, the Super VIP membership. Our approach to continuously delight users keeps us at the forefront of the streaming industry. A few quarterly highlights to share. First, we further enhanced sound quality and the effects as part of our premium offerings. For example, QQ Music upgraded its self-developed Audio 3D 2.0, and the Kugou Music launched the Viper Ultra Sound, all featuring ultra-clear sound quality. We also presented users with new ways to enjoy the music, including sound quality for certain high-end headphones and playlists with best-in-class audio quality. These improvements have led to not only higher user adoption but also increased music consumption. Second, we meet the users' personalized needs. We have launched a series of benefits, including customized players and the ringtones based on well-known IPs and artists. These features resonate with users' desire for self-expression and proved effective in user conversion and retention. Third, our premium SVIP membership is gaining more traction, employing a holistic and seamless listening experience across various devices and multiple scenarios. SVIP integrates music with long-form audio and online karaoke services, all with superior sound quality. It wins the hearts of our active members with comprehensive online and offline privileges, such as priority access to digital albums and ticket booking for live music events, including our TMEA. We are pleased with the early progress of SVIP membership adoption and are looking forward to sharing more exciting news down the road. Next, our more personalized music discovery and optimized listening experiences. A few key projects to spotlight. We upgraded our recommendation middleware across our music apps, enabling users to discover songs that better cater to their tastes. During the quarter, nearly 40% of streams were generated from recommendations. With our evolving large audio models, we continue to import more essential music distribution and the discovery of new and long-tail content. We also elevated our platform's overall experience with AIGC applications. For example, we introduced a data-saving, AI-enhanced SQ Lite Mode. We are preserving superior sound quality, and Kugou Music virtual DJ features and QQ Music’s 3D Avatar offer users a sense of companionship. On the visual side, we refined our streaming UI design to offer a more inviting and effortless experience. For example, QQ Music launched an industry-first multi-device matching playback feature and a compact half-screen music player. Users can now enjoy seamless music streaming when searching across different devices and applications. Last but not least, we further expanded our rewards program to include more benefits, such as artist merchandise. Its growing popularity among users has effectively boosted music content consumption and increased user engagement. To sum up, all the above efforts contributed to a high stickiness on our platform, as reflected by both year-over-year and quarter-over-quarter increases in time spent per user in the second quarter. Moving forward, we are committed to offering more compelling services that better align with the needs of diverse music lovers, ultimately to expand our paying user base and increase user loyalty. With that, I would like to turn the call over to Shirley, our CFO, for a deep dive into our financials.

Shirley Hu, CFO

Thank you, Ross, and greetings to everyone. I will now turn to our financial results. Our effective monetization of online music services and operational efficient management continued to drive strong financial results in the second quarter of 2024. IFRS net profit increased by 33% year-over-year to RMB1.8 billion, and the non-IFRS net profit rose by 26% to RMB2 billion. Our total revenues were RMB7.2 billion, down by 2% year-over-year. Revenues from online music services had strong growth, largely offsetting the decline in revenues from social entertainment and other services. In the second quarter of 2024, our online music revenues increased by 28% to RMB5.4 billion on a year-over-year basis. This increase was driven by the strong expansion of our music subscription revenues supplemented by growth in advertising revenues as well as growth in revenues from offline performances. Music subscription revenues in the second quarter of 2024 reached RMB3.7 billion, marking a 29% increase year-over-year and a 3% rise sequentially. Monthly ARPPU was RMB10.7, up from RMB9.7 in the same period last year. The number of online paying users were 117 million, representing an 18% increase year-over-year with quarterly net adds of 3.5 million paying users. With a large scale of music subscribers, our focus is to manage music subscription revenue growth with the right balance and pace to achieve growth in both subscribers and monthly ARPPU. Our enriched content offerings and enhanced member privileges, such as QQ Music introducing Audio 3D 2.0 and Kugou Music rolling out Viper Ultra Sound have made our products more attractive and improved user stickiness. And our SVIP membership program is our strategic focus operationally and will lead to ARPPU improvement in the long run. Advertising revenues also had strong year-over-year growth, primarily due to the growth in ad-supported advertising. We provided more attractive interactive features to our users, which helped improve entrance rate for our ad-supported advertising. Promotions for the 618 mid-year shopping festival also contributed to increased advertising revenues. Moreover, our interactive rewards program opened new avenues for commercialization in advertising for our users. Additionally, we continued to innovate and diversify our product offerings and advertising for mass, while deepening the integration of brand sponsorships with our offline performances. Social entertainment services and other revenues were RMB1.7 billion, down by 43% year-over-year. We will continually monitor market conditions, the competitive landscape, regulatory environment, and our product features for social entertainment services. Our gross margin for Q2 reached 42%, marking an increase of 7.7 percentage points year-over-year due to the following factors. First, the expansion in the paying user base and improved monthly ARPPU for online music, as well as increased advertising revenues had a favorable impact on our gross margin. Second, we have been focused on ROCE as a key metric to manage our costs. Third, the ramping up of our own content continued to help improve our gross margin. Lastly, we have enhanced monetization of recent membership and advertising within social entertainment, which positively impacts our gross margin. All above factors have collectively enabled us to move to a healthy margin. Moving on to operating expenses. In the second quarter of 2024, they amounted to RMB1.1 billion, representing 16% of our total revenues compared with 17.2% in the same period of last year. Selling and marketing expenses were RMB210 million and remained relatively stable compared with the same period of last year. We continue to maintain a ROI-focused approach for promotion expenses and will continue to invest in areas such as online music with a long-term growth perspective as well as in content promotions. General and administrative expenses were RMB938 million, down by 10% year-over-year, primarily driven by lower employee-related expenses. Our effective tax rate for Q2 was 19.4% compared to 12.2% in the same period of 2023. This increase was primarily attributable to the accrual of withholding tax of RMB111 million related to the earnings to be remitted by our PRC subsidiaries to offshore entities. Additionally, changes in preferential tax rates for certain entities also impacted our effective tax rate. For Q2 2024, our net profit and net profit attributable to equity holders of the company were RMB1.8 billion and RMB1.7 billion, respectively. Non-IFRS net profit and non-IFRS net profit attributable to equity holders of the company were RMB2 billion and RMB1.9 billion, respectively. Our diluted earnings per ADS reached a record high this quarter at RMB1.07, up 30% year-over-year. Non-IFRS diluted earnings per ADS increased to RMB1.19, up 23% year-over-year. These results underscore our robust financial performance, enhanced operating efficiency, and the beneficial impact of our share repurchase program. As discussed during the Q1 2024 earnings call, we declared a new cash dividend for the fiscal year 2023 in May and made a payment of US$212 million in June 2024. As of June 30, 2024, our combined balance of cash, cash equivalents, term deposits, and short-term investments was RMB35 billion as compared with RMB34.2 billion as of March 31, 2024. This combined balance was also affected by changes in the exchange rate of RMB to USD at different balance sheet dates. Looking forward, we will continue to focus on high-quality growth in our music business, such as expanding SVIP membership as well as operating efficiency improvement. We will continue to invest in high-quality content, original content production, and innovative technologies to further improve user engagement and enhance user experience. This concludes our prepared remarks. We are now ready to take your questions.

Millicent Tu, Head of IR

Thank you, Shirley. If you're asking questions in Chinese, please repeat them in English. The first question comes from Alicia at Citigroup.

Alicia Yap, Analyst

Congratulations on the solid results. I would like to first ask in Chinese, and then I will translate it myself. Can management share with us the outlook for the second half of 2024 regarding top line growth, profitability trends, and online music growth rates? Which will be the more important growth driver, net additions or ARPPU?

Cussion Pang, Executive Chairman

Thank you, Alicia, for your questions. Our view and outlook for 2024 remain unchanged, as we expect to achieve healthy and positive revenue and profit growth this year. In our online music business, we've added over 10 million net subscribers in the first half of 2024, and the ARPPU has increased to RMB10.7, up from RMB9.7 in the same quarter last year, providing a solid foundation. We are confident that our online music growth will continue strongly, driven by both net additions and ARPPU expansion. Recently, our net adds have exceeded expectations due to the accelerated growth in paid content and effective marketing strategies. As the net add pace normalizes and stabilizes, we will focus on growing ARPPU, which is anticipated to grow faster than net adds. We are pleased to see increased popularity of our enriched privileges and holistic service offerings among existing users. Our SVIP plan is gaining good momentum, boosting our confidence in future ARPPU growth. Consequently, we expect the net adds in the second half of 2024 to be smaller compared to the first half, but ARPPU is expected to expand significantly moving into 2025, enhancing our margins as well. Regarding advertising revenue, we anticipate strong performance in the coming quarters fueled by growth in ad-supported advertising and offline event sponsorships. For social entertainment, we foresee ongoing challenges from competition, macro factors, and others. However, if this segment becomes a smaller portion of our total revenue, its impact will be largely offset by robust growth from the online music business. Regarding profitability, our strategy focuses on high-quality growth with proven effectiveness, and we now expect a slightly better full-year net profit than previously forecasted.

Millicent Tu, Head of IR

And the next question comes from Lincoln Kong from Goldman Sachs.

Lincoln Kong, Analyst

Congratulations on a strong quarter. I would like to follow up regarding ARPPU and net additions. You mentioned that we can anticipate a more significant increase in ARPPU for the second half. Can management provide more details on how this will be implemented? Will it involve a price increase, reduced promotions, or more information on the Super VIP program and other high-value services? What kind of ARPPU increase should we expect, and could this lead to higher member attrition, especially given the current weak economic conditions?

Shirley Hu, CFO

Could management provide more details on how we plan to achieve a more significant increase in the second half, such as through price hikes or reductions in promotions? Additionally, can we discuss the progress of Super VIP and other high value-added services? What level of increase in ARPPU do we anticipate and could this lead to a higher attrition rate among members due to the overall weak macroeconomic environment?

Ross Liang, CEO

Thank you for your question. Yes, I believe the main factor driving ARPPU growth in the second half of this year will be the SVIP plan we are set to launch. In the SVIP plan, in addition to offering content privileges, we also aim to provide additional benefits that will enhance the value for our members. We’re discussing the main factors driving the SVIP business. There are three key points. Firstly, our established digital outbound business enables SVIP to offer early listening privileges. This feature allows us to connect with high-value customers. If our SVIP customers want to experience certain music before it officially launches, it will significantly enhance the value of their membership. Well, my second point is that high-value customers who are SVIPs also seek better sound quality and audio effects. Our operational data shows that they have a very high adoption rate for high-quality sound and sound effects. We plan to continue enhancing the sound quality and audio effects in the near future. Well, from the application perspective, in the first half of this year, we launched Dolby Atmos and also launched Audio 3D 2.0. In July, we introduced ETS. All these premier sound quality offerings will further enhance the value for our SVIP members. However, in terms of content creation for SVIP, we ensure that members can enjoy long-form audio content as part of their privileges. We offer them a premiere service, allowing for a seamless listening experience across devices. Specifically, SVIP members on the TME platform can access muted content and long-form videos while enjoying this seamless experience from any device. For SVIP, the membership fees are around RMB40 per month, allowing us to offer better benefits and experiences to SVIP members compared to regular subscribers. But at the same time, our paying users still make up the majority of our user base. We will continue to refine the content and operations to ensure they experience steady growth within aura. I believe in next quarter's earnings call, we're going to share with you more data and more strategies within SVIP.

Millicent Tu, Head of IR

And the next question comes from Alex Poon of Morgan Stanley.

Alex Poon, Analyst

My question is related to Super VIP. How should we think about the penetration as a percentage of total paying users and the trajectory in the coming few years?

Ross Liang, CEO

Thanks for the question. I want to emphasize that for SVIP, due to the upgrades in sound quality and effects, along with other factors, we expect to maintain a relatively fast growth rate for SVIP members. It's important to note that we started SVIP from almost nothing, and so far, the growth has been quite satisfactory. However, we need to allow some time before sharing additional details. What I can tell you is that the growth of SVIP is still meeting our expectations. Looking ahead, as you've mentioned, users who used to pay RMB8 a month have transitioned to Kugou and QQ Music paying users, and they now make up the majority of our user base. This is the current situation. We are optimistic about the next decade and believe that SVIP could become a significant driver of our growth moving forward. We hope to maintain steady and solid growth of SVIP, and we will share the relevant data at the appropriate time.

Millicent Tu, Head of IR

The next question comes from Zhang Lei from Bank of America Merrill Lynch.

Lei Zhang, Analyst

Congrats on the solid quarter. I want to follow up on the trend of net additions to our membership. Is 3 million per quarter a number we can expect? I believe we have entered a phase of steady growth, and how should we view our long-term penetration of paying users?

Ross Liang, CEO

Thanks for your question. Cussion has already shared his thoughts. When we examine the graph, we hope to see improved growth in net adds soon. In the first half of this year, following a few holidays, we noted strong net add growth, and in the second half, growth remains solid. Our operational strategy aims to sustain good growth while naturally increasing net adds. However, it's crucial to always prioritize revenue and profit. We anticipate that, as discussed, revenue and profit will meet our annual targets. Achieving this will enable us to continue growing our subscriber base in a quality manner, and you can expect positive results. We've made it clear that we strive for steady growth in our user base. In addition to net adds, we need to focus on user retention; maintaining high-quality subscribers is essential for strong retention. This approach will significantly aid in expanding our business. Well, regarding the subscriber penetration rate, we still aim to uphold our previous commitments to the market. We are confident that we will achieve our mid and long-term subscriber goals. For the second half of this year, in addition to expanding our subscriber base, we plan to enhance our sales and promotion strategies to attract new customers and further increase our subscriber numbers. We remain optimistic about reaching our subscriber targets in the long term and are committed to honoring our promises to the market.

Millicent Tu, Head of IR

And the next question comes from Wei Xiong from UBS.

Wei Xiong, Analyst

My question is about our profitability and margin trend. Can management share how we should think about the pace of gross margin expansion in the second half of this year and next year? Additionally, what gross margin levels might we achieve in the medium-term? Regarding net margin, how should we consider any further opportunities for cost optimization as well as the net margin trend going forward?

Shirley Hu, CFO

You can see that both the gross margin and net margin of the company have continued to grow for the past nine quarters in a row. Overall, we remain very confident in our ability to achieve strong performance in both GP margin and net margin. Regarding the growth of the GP margin, from a revenue standpoint, both the subscription and advertising businesses are continuing to grow. Additionally, if our SVIP program is successfully executed in the near future, it will also positively impact our GP margin. Another point is that from the cost perspective, we remain committed to the music industry, having made significant investments there. We also have a strong collaboration with the copyright holder, and those substantial investments have yielded very fruitful results. Additionally, we managed the return on capital employed over the copyright and intellectual property, continually enhancing the utilization rate and effectiveness. A third point is that the contribution from our self-produced content continues to grow, which will also have a positive impact on our GP margin. A fourth point is that we are experiencing a slight decrease in our social business, but we are still increasing advertising and membership numbers, which will also benefit our overall gross profit margin. We are specifically talking about the operational cost. If we look at the sales expense, we have been quite disciplined and well-managed with the sales expenses over the past few quarters, which has yielded very good results. At the same time, we expect that market expenses for the year and their total contribution to revenue will remain consistent with what we experienced last year. But specifically, if we examine the G&A expenses, looking at the first half of this year, we can see that we experienced a slight decline compared to last year. We will continue to enhance our operational efficiency and manage expenses effectively. This year, we expect the ratio of G&A expenses to total revenue to be lower than last year's ratio. Overall, we believe that both the GP margin and the net margin will show significant improvement compared to last year. But at the same time, the net profit and the net profit margin growth would be better than the gross profit margin. In the longer run, as our online music business continues to grow steadily and positively, we also have every confidence in the future growth of the GP margin.

Millicent Tu, Head of IR

And the last question comes from Thomas Chong from Jefferies.

Thomas Chong, Analyst

My question is about macro headwinds. Considering the current macro uncertainties, how should we evaluate the impact on our various business segments, including subscription, advertising, and social entertainment? Additionally, are we noticing any shifts in the competitive landscape?

Cussion Pang, Executive Chairman

I'll take the first question about the macro environment. The downturn certainly presents challenges for various parts of the business. However, TME's online music offering is genuinely good value for money, making it an affordable entertainment option for all users. This means that our subscription business in online music is not significantly affected by the macro environment. In terms of advertising, we’ve been performing well over the past two quarters. While some advertisers might be cutting back on spending, we continue to excel, especially in sectors related to tourism and events linked to our offline concert sponsorships. Additionally, we're exploring new advertising formats that can help us further enhance our advertising business. Overall, the macro environment isn't having a major impact on TME, and we remain confident in our long-term growth prospects.

Ross Liang, CEO

In response to your second question about online music and the competitive landscape, it's clear that the key players in this market are expected to remain, and we still have them. Well, regarding the competition, this year marks our eighth anniversary of starting the business. Our focus remains on conducting our business correctly. We will continue to implement our strategy of offering both the content and the platform simultaneously. So we firmly believe that as long as we continue to enhance our content and strengthen our competitive capabilities, while also further refining and optimizing the user experience, we will maintain our position in this market.

Millicent Tu, Head of IR

Okay. Since there are no further questions in the queue, I would like to wrap up the call. Thank you, everyone, for joining us today. And if you have any further questions, please feel free to reach our IR team. And this concludes today's call. And thank you very much again, and look forward to speaking to you next quarter. Thank you, and goodbye.

Cussion Pang, Executive Chairman

Thank you. Goodbye.

Ross Liang, CEO

Thank you.