Earnings Call Transcript - TME Q3 2022

Operator, Operator

Ladies and gentlemen, good evening and good morning and thank you for standing by. Welcome to the Tencent Music Entertainment Group Third Quarter 2022 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 will turn the conference over to your speaker host today. Mr. Tony Yip. Please go ahead, sir.

Tony Yip, CSO

Thank you, operator. Hello, everyone, and thank you all for joining us on today's call. TME announced its quarterly financial results today after the market close. Today you'll hear from Mr. Cussion Pang, our Executive Chairman, who will start the call with an overview of our recent updates. Next, Mr. Ross Liang, our CEO, and I, Tony Yip, the CSO, will offer additional thoughts on our product strategy, operations and business developments. Finally, Ms. Shirley Hu, our CFO, will address our financial results before we open the call for questions. Before we continue, I refer you 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 more thoroughly explained and reconciled to the most comparable measures reported under IFRS in our earnings release and SEC filings. With that, I'm pleased to turn over the call to Mr. Cussion, Executive Chairman of TME. Cussion?

Cussion Pang, Executive Chairman

Thank you, Tony. Hello, everyone, and thank you for joining our call today. I would like to begin by acknowledging all of the hard work that went into our successful listing on the Main Board of the stock exchange of Hong Kong under stock code 1698 on September the 21, in addition to our primary listing on the New York Stock Exchange. We are truly grateful to our users, employees, partners and investors who have been with us along the way, and helped us reach this important milestone. From this vantage point, we plan to further refine our dual engine content and platform strategy to support original content on our platform, expand our innovative business models, work with more partners to tap into the music market potential and fulfill our social responsibilities, thereby comprehensively promoting the healthy, diverse, and sustainable development of China's music industry. Providing differentiated content, particularly by way of original content production, is our bread and butter. And further explains our already large and diverse content library that appeals to cross-generational audiences. To that end in the third quarter, we rolled out our voice synthesis technology, Lingyin Engine, to quickly and vividly replicate a seamless voice for use in original songs of any style and language. Utilizing this patented technology, we have developed the synthetic voice memory of legendary artists, such as Teresa Teng, the Legend, and Anita Mui, and create an AI singer lineup with the voices of trending stars such as Yang Chaoyue among others. As of the end of the third quarter, we have launched over 1,000 songs with AI synthetic voice, notably, the female songs version of today has become the first song by an AI singer to be streamed over 100 million times across the internet. Additionally, we paid tribute to Anita Mui by creating an AI code Space on Earth for the 2022 charity song of the new Sunshine Charity Foundation, may you be treated differently by the world, which is also the hold music for today's earnings call. It was well received by a wide range of listeners, showcasing the bold response to our social commitment to technology and music. As the digital music industry evolves, music lovers' tastes in music have grown increasingly varied. We are thrilled that the concept album, Endless Farewell, by our Indian musicians Akini Jing, was recognized as the monthly pick by Pitchfork, a worldwide authority in music reviews. In the first quarter, he also produced a number of original singles, which went viral on the internet and each recording over 100 million streams, such as HURTS!. All these achievements demonstrated our ability to expand the influence of our original work by bringing them to both domestic and overseas audiences. Furthermore, in deep collaboration with the broader Tencent ecosystem, we explored the chemistry between music and popular IPs, including League of Legends, QQ Speed Mobile, QQ WeChat, and Assault Fire, along with renowned artists such as Stephanie Jing, Angela Zhang, Zhang Xiao Han, and Jason Zhang to create entertainment music in the third quarter. Through these stimulating collaborations, as well as both online and offline promotions, we have further risen the popularity of Indian music on our platform. Next, let's look at the Tencent Musician platform, leveraging our robust technology to innovate and augment our one-stop service offerings for musicians. In the third quarter, we launched a new feature TME Artists Album, which helps musicians release Digital Albums on all TME platforms at the prices they set, with automatically generated sales pages. By the end of the third quarter, 281 of our musicians had utilized this new feature and received the income generated by their album sales, shortening the release time and lowering the barrier for them to forge closer connections with their audience. Second, we continued to launch a broader array of activities and initiatives to support our musicians and help them shine on stage. In the third quarter, we discovered Wang, a young musician, providing him with comprehensive guidance from song selection towards styling and personal expressions and signing him up for the Think China show. From starting his career as a musician, within just two months, we also recommended a diverse group of our musicians to various shows and events hosted by TME and sponsored by various companies, demonstrating our commitment to providing substantial promotion and commercial resources for our musicians. These endeavors empower our musicians to build a full lifecycle career while also facilitating the communication and connection with their fans. By the end of the third quarter, we have served a total of 350,000 musicians, which also allowed us to attract more active and vibrant creators to our platform, further pushing the prosperity of our ecosystem. Our content strategy also includes a keen eye towards improving the diversity of collaborations with top music labels and artists, both domestically and internationally. In the third quarter, we collaborated with YG Entertainment to provide our users with benefits in the 30 days head start period following the release of their new songs. We have seen significant digital album sales, recorded sales of close to 7 million copies by the end of the third quarter, while popular international artists' work also achieved remarkable sales, reflecting our users' pent-up demand for engagement with artists from home and abroad. Ongoing cooperation with professional institutions and industry partners also helped bolster our reputation as a go-to destination across diverse music verticals such as gaming, classical, and relaxing music. In the third quarter, we cooperated with the music label of NCPA Classics, among others, to build head start benefits for their releases. We also collaborated with the world's top 100 DJs and over 30 domestic and international electronic music labels to launch Tomorrow Drop, helping to bring electronic music into the limelight. Our comprehensive online and offline performances blend, which has consistently provided music entertainment, innovative interactive format, and monetization avenues. In the third quarter TME Live hosted 32 online and offline performances by various A-list stars. We unveiled multiple innovations to refresh the user experience. For example, we invited online concert audiences to vote on the concert's closing song, creating a customized offline interactive experience for our online users and successfully accumulating close to 15 million unique viewers within the Tencent ecosystem. Going forward, we will incorporate more interactive formats in TME Live moments during performances. That concludes our update on our growing content capability. Now I'd like to turn the call over to Ross, who will share more about our platform strategies. Ross, please go ahead.

Ross Liang, CEO

Thank you, Cussion. Hello, everyone. Moving along to our platform strategy, we continued to enhance our users' interactive experience by enabling new ways to listen, watch, sing and play on our platform, and offering more satisfying experiences that address their diverse music tastes and nuanced needs. To meet the users' demand, we zeroed in on providing our newer user interface and type-oriented professional listening experience. In terms of sound effects, improvements in this quarter, we became the first music platform domestically to offer an immersive audio experience with Dolby Surround song to our Super VIP memberships and the entire users as well as in these music releases on our Tencent emulation platform. In August, QQ Music also revealed adaptive fun which addresses the song volume listening a particular song based on human auditory perception characteristics to maintain our smooth listening experience. To simplify the listening process QQ Music and Google Music launched the Lock Screen widgets on the iOS 16 system, which are essentially one click shop carts. As another pioneering we also upgrade our playlist function, which allows users to generate playlists in a single click by importing the songs referenced in types of pictures and the web links. QQ Music and Kugou Music now support automatic matching of playlists with customized sound effects under customize the playlist posted to inspire more sharing among users. For faster music discovery experiences, we further optimized our smart recommendations with an upgraded algorithm in the third quarter. As a result of this refinement QQ Music and Google Music recommendations streaming volume and the timespan produced both rated year-over-year increases. As increasing virtualization takes hold, we have been adding more exciting and fun music in the Tencent scenarios. We are unlocking abundant monetization opportunities. In the third quarter, TMELAND our virtual theme park teamed up with Pepsi under its virtual idol group, Team Pepsi to host another immersive virtual 3D live show. The show registered over 4 million times, rolling TMELAND's new built Lighthouse Station, our brand new landmark venue. In addition, we debuted Music Zone, our 2D virtual interactive music community for users to listen, purchase, play musical instruments and interact with others at their self-decorated virtual homes. We also launched an entertainment feature on QQ Music, Tan Go which allows users to play with a truly rich selection of songs by touching the button on the screen following the tempo of the songs. As a pioneer in the application of our innovative listening, watch, sing, and play functions QQ Music has continued to improve experience year-over-year indicating healthy user engagement with all our flagship products. Now turning to long-form audio, to supplement the podcaster ecosystem we unveiled the Shingbo app, putting on one stop audio creation assistant in our podcasters' pockets. On the back of TME's massive library of copyrighted books, our podcasters can now easily join the studio for auditions and distribute their content through all of TME’s platforms with a single click. We are managing their podcast programs with access to operations data as well as generating income. In addition, we achieved a breakthrough in Text to Sound (TTS) technology, facilitating AI audio creation and increasing word processing efficiency by 12 times and the growing content synthesis speed of our virtual authors by fourfold in the third quarter. As a starting point of deploying our TTS technology, we have launched our virtual authors to provide a differentiated slate of audio content, which has received wide acclaim from our users. With that I'd like to give the floor to Tony to reveal our business operations. Tony, please go ahead.

Tony Yip, CSO

Thank you, Ross. Hello, everyone. I would like to discuss our operating results for the third quarter. This quarter, our online music monthly active users were 587 million, which is a decline from the previous year primarily due to casual users leaving amid competition from entertainment platforms and our cost optimization efforts focused on improving monetization. However, the daily active users of QQ Music showed a year-over-year increase, reflecting strong user engagement with our key product. Importantly, the number of paying users for online music, representing high-quality users, continued to grow significantly, bringing the paying ratio to a new high, while the average revenue per paying user also improved sequentially due to our expanded content offerings, product upgrades, wider sales channels, and moderated promotions. Consequently, our subscription revenue displayed strong year-over-year and quarter-over-quarter growth. Our Internet of Things monthly active users continued to grow at a double-digit rate year-over-year as we enhanced content and forged new partnerships. We also expanded our presence in the auto industry by supporting new electric vehicle models. To enhance the in-car music experience for users, we released updates for our in-car app in the third quarter, featuring a refreshed user interface and improved sound effects and content. Our online music service revenues saw healthy growth in the third quarter, marked by a 19% increase in subscription revenue year-over-year. We have been encouraging higher-value super VIP memberships that offer an elevated experience, which includes premium sound features and customized content. For example, our TME Live online concert generated massive social media attention, with over 2 billion mentions. Super VIP members received various privileges, leading to a 20% rise in the number of Super VIP subscribers. Looking ahead, we will introduce more exclusive content and high-quality sound features to enhance membership conversion and retention. Additionally, we enhanced our artist subscription offerings by bringing on more artists, whether emerging, established, or even AI artists, and expanded the benefits in these packages to include perks like personalized live streaming events. By the end of the third quarter, we had successfully launched subscriptions for 28 artists. Also, in the third quarter, we debuted merchandise for 21 artists, coinciding with the launch of Jay Chou's digital album, resulting in the sale of 100,000 related merchandise items while engaging audiences with promotional activities that boosted our music library's appeal. Our advertising business saw improvements from the second quarter thanks to our innovative and diverse advertising products. For instance, our ad-supported free listening mode has shown initial success, leading to combined growth in revenue and user engagement. Moving forward, we aim to increase user coverage for this free listening mode while enhancing engagement and revenue. We also made progress in developing innovative advertising formats for TME Live and TMELAND, attracting significant sponsorships from prominent domestic and international advertisers. In the third quarter, we explored various business models. First, on the sublicensing front, our SaaS-based music copyright licensing service has expanded beyond live streaming to other sectors needing legitimate music licensing. Additionally, we launched the first professional data platform in the industry that provides high-frequency data updates, enabling music label partners to monitor the performance, popularity, and listener demographics of artists and copyrighted songs and helping music professionals gain valuable insights from this data. Now, turning to our social entertainment services, we saw a decline in monthly active users and paying users year-over-year due to broader economic challenges. We remain committed to innovating our products and pursuing initiatives like audio live streaming, international growth, and virtual interactive offerings. In WeSing, we continue to provide unique tools and content to enhance the singing experience. In the third quarter, we introduced multi-person singing and chat rooms in both video and audio formats. Revenues from audio live streaming increased by double digits year-over-year in the third quarter. While pursuing growth, we also strive to meet our social responsibilities through innovative music-driven charity initiatives that have attracted attention from leading media, creating significant buzz. In conclusion, we are continually expanding and building connections through music. Leveraging innovation and technology, we are introducing more products and services to the dynamic music market in China, elevating the entire industry and bolstering our competitive advantage and resilience. Now, I would like to turn the call over to Shirley, our CFO, 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. In the third quarter of 2022 our total revenues were RMB3.4 billion, up by 7% sequentially. With the success of our effective cost control and improved operating investment our profit position continued its growth trajectory since Q4 last year. Average net profit for Q3 2022 was RMB 1.1 billion. In Q3 2022 user subscription revenue grew to RMB2.2 billion, up by 18% year-over-year, and up by 7% sequentially. Online music paying users grew to 85.3 million, up by 20% year-over-year, representing a 2.6 million high sequentially. Monthly ARPU in Q3 2022 was RMB8.8, up from RMB8.5 in the second quarter of this year. This evidenced our strategy to grow the music business healthily and sustainably has shown initial success. Our ongoing efforts are bearing fruit. Revenues from advertising grew both on a year-over-year basis and sequentially. We remain confident about the long-term growth potential. In addition, with the launch of new digital albums, especially the successful launch of digital urban for Jay Chou, we had revenue growth in sales of Digital Albums. Social entertainment services and other revenues were RMB3.9 billion down by 20% year-over-year, mainly due to the evolving macro environment and intense competition. We have differentiated our content offerings by enriching our interactive product offerings, and we'll continue to invest in audio live streaming and expand our international footprint for long term growth. Gross margin in Q3 was 32.6% up by 3% year-over-year and 2.7% sequentially. This will result from the effective control and revenue increase as well as improved operational cost efficiency. The growth in advertising revenues and the revenues from sales of digital albums also contributed to this growth. We will continue to manage costs effectively. Now moving on to operating expenses, total operating expenses for Q3 were RMB1.4 billion, or 19.5% as a percentage of total revenues, down by 1.5% from 21% as a percentage of total revenues in the same period last year. Excluding the impact from expenses related to our application for secondary listing, operating expenses as a percentage of total revenues would have decreased by 2% year-over-year. Sales and marketing expenses were RMB245 million, down by 58% year-over-year, achieving a more than 50% cut in selling and marketing expenses in the last quarter. Our core music subscription services continue their rapid growth trajectory. We continue to monitor ROI on each promotion channel. General and administrative expenses were RMB1.2 billion, up by 13% year-over-year. For Q3 2022, our net profit and net profit attributable to equity holders of the company were RMB1.1 billion. Non-IFRS, net profit margin was 19.2%. For the third quarter of 2022, basic and diluted earnings per ADS were RMB0.6 billion and RMB0.66 respectively, up 49% year-over-year. Our results demonstrate the commitment and initial success of leading indicators improvement from our share repurchase program. We endeavor to provide high-quality investment returns for our investors and shareholders and remain confident about our financial performance and the overall industry. As of September 30, 2022, our combined balances of cash, cash equivalents, term deposits, and short-term investments were RMB25.4 billion. Looking forward, we will continue to grow our core business and invest mindfully in new products and services, including long-form audio and international business to maximize our investment returns and the future growth potential. Meanwhile, we will adhere to tightened controls on costs and expenses to achieve excellent performance. This concludes our prepared remarks. Operator, we are ready to open the call to questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. 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. We will pause momentarily to assemble our roster. And today's first question comes from Alex Poon with Morgan Stanley. Please go ahead.

Alex Poon, Analyst

Hi, good evening management. Thank you for taking my question. Congrats on very strong results. My question is about our music segment gross margin and net margin in Q3. Roughly what levels are those two numbers? And going forward how should we think about the pace of these two margins expansion considering we have a lot of levers including advertising revenue, music ARPU, music content cost, long-form audio cost, etc. Thank you very much.

Shirley Hu, CFO

This quarter, our music gross margin from music keeps increasing, and our operating net profits are also growing. We have positive impacts from several factors. First, we increased the RMB requirement of content cost and optimized the model. We chartered agreements with some music labels, tried to switch the model to revenue-sharing model or got more reasonable fees, which has a positive effect on our gross margin. Second, our subscription revenue growth, especially our app increased continually. Third, advertising revenues recovery and digital album revenue increase have also positively impacted our gross margin. Therefore, we expect our gross margin with music service to continue to increase next quarter, as we anticipate our advertising revenue and subscriber revenue to also increase healthily.

Operator, Operator

Thank you. And our next question today comes from Lei Zhang with Bank of America Merrill Lynch. Please go ahead.

Lei Zhang, Analyst

Hi, management. Thanks for taking my question, and congrats on a solid quarter. My question mainly focuses on ARPU and music subscriber trend. I noticed another Q-on-Q improvement in music ARPU. How should we look at the ARPU trend? Given we have like two to three million subscribers, how do we maintain this trend? Overall, how do I look at the ARPU and the music subscriber growth in the following quarters? Thank you.

Tony Yip, CSO

Thank you, I'll answer the first part of the question regarding subscriber growth and then Shirley can chime in about the ARPU. We're very pleased with our subscriber growth this quarter. We continue to record high teens percentage year-over-year growth rate, and we expect this trend to continue in the near term. Our near-term goal is to reach the round number of 100 million subscribers, we are now at 80-something million, which is a very achievable target. Long term, we have a multi-year target to achieve a mid-20% paying ratio in the verticals. Shirley, please chime in on the ARPU side.

Shirley Hu, CFO

In Q3, the ARPU of music subscribers was RMB8.8, an increase from RMB8.5 in Q2, marking two consecutive quarters of increase. Increased promotional activities, content operations, and optimized pricing trajectory contributed to this growth. We expect our ARPU to increase gradually in the next quarter.

Operator, Operator

Thank you. And our next question today comes from Lincoln Khan at Goldman Sachs. Please go ahead.

Lincoln Kong, Analyst

Thank you for taking my question. So my question is about the advertising business. I think this quarter, we have a solid increase in the advertising business, which reversed the declining trend in the first half. Could management give us more color on the underlying driver of that? Especially in terms of the new format of ads, including TME Live, how are we positioned for these new formats going forward? Any outlook for the fourth quarter in terms of ad strength? Thank you.

Tony Yip, CSO

In terms of advertising revenue, we're pleased to see this quarter, a return to positive year-over-year growth, reversing the negative trend in previous quarters. We are seeing growth due to sponsorship ads, the ad-supported free listening mode, and improving macroeconomic conditions to support our optimistic outlook going forward.

Ross Liang, CEO

We will continue to work with WeChat video accounts team to provide high-quality offline and online TME Live events for users. As what Tony mentioned, this will help us attract more advertising sponsorships. In the third quarter, we have already successfully launched over 30 TME Live events, leading to increased advertising revenue.

Operator, Operator

Thank you. And our next question today comes from Alicia Yap with Citigroup. Please go ahead.

Alicia Yap, Analyst

Hi, good evening management. Thanks for taking my questions. Also congrats on solid results. I have a question related to the social entertainment business. Assuming if the economy rebounds and reopens in the next few months or next couple of quarters, should we expect to see positive impacts on the social entertainment business, or will this business continue to face competitive pressure? Any insights would be helpful. Thank you.

Tony Yip, CSO

Due to the impact of the challenging macro environment and increased competition, the social entertainment revenues recorded negative year-over-year growth this quarter. However, we are excited about opportunities in audio live streaming and virtual interactive product offerings, which continue to show healthy mid-double-digit year-over-year growth rates, helping offset some of the challenges in traditional live streaming. We also continue expanding into overseas markets to support growth.

Operator, Operator

Thank you. And our next question today comes from Xueqing Zhang with ICC. Please go ahead.

Xueqing Zhang, Analyst

Hey, good evening management. Thank you for taking my question. And congratulations on a strong quarter. So my question relates to long-form audio. We talked about this in later quarters. So I’m just wondering if management could share more about the long-form audio business, such as, what are the key drivers and KPIs for this business? How should we expect future investments and profitability? Thank you.

Tony Yip, CSO

Long-form audio has proven effective in complementing our music apps, converting music users into long-form audio users, and driving user engagement. We continue to expand and differentiate long-form audio content through licensed and self-produced content, working towards breaking even on gross margin basis by the end of next year.

Operator, Operator

Thank you. And our next question today comes from Wei Xiong with UBS. Please go ahead.

Wei Xiong, Analyst

Hi, good evening management. Thank you for taking my question. And also congratulations on a good quarter. I want to follow up on margin side. We have made a great deal of effort this year to improve overall operating efficiency. Just wanted to understand our cost planning for next year, especially around headcount and marketing strategy, and how much more room we can further improve our net margins for next year. Thank you.

Shirley Hu, CFO

Yes, we expect the gross margin and net profit margin can increase in the next year. We will continue to control sales and marketing expenses, focusing on ROI rather than setting goals for net expenses. Therefore, we believe we can improve ad efficiency. Overall, we expect to see healthy growth in music services, and stable social entertainment revenues, leading to an increase in gross margin and net profit margin.

Tony Yip, CSO

This quarter marks the second consecutive quarter of revenue growth Q-on-Q, with clear trends of improving profitability. Our goal going into next year is to achieve positive revenue growth, leading to positive profitability as well.

Ross Liang, CEO

A really strong financial result this quarter demonstrates our ongoing efforts in improving operational efficiencies. We are continuously working to control content costs and transitioning our revenue-sharing models with our partners to achieve further efficiencies. We will continue seeing improvements moving forward.

Operator, Operator

Thank you. Our next question comes from Thomas Chong at Jefferies. Please go ahead.

Thomas Chong, Analyst

Hi, good evening. Thank you management for taking my questions and congratulations on a solid set of results. My question is about the competitive landscape. How should we think about the competition with short-form video and other incumbents in the coming years? Additionally, regarding margin, could you comment on the online music margin excluding long-form audio? What is the trend looking forward? Thank you.

Tony Yip, CSO

With regards to short-form video platforms, our approach has been both cooperative and competitive. We have leveraged these platforms as marketing tools to promote our music successfully; however, we continue to monitor competition, especially given potential entries into the music market. We are prepared to react as necessary. Our margins for online music are improving due to various factors like healthy subscription revenue growth, ARPU increases, solid advertising growth, and effective content cost control.

Operator, Operator

Thank you. And our next question today comes from Liu Charlene with HSBC. Please go ahead.

Unidentified Analyst, Analyst

Hello, I'm Cathy on behalf of Charlene Liu from HSBC. I wanted to ask about potential revenue impacts next year.

Tony Yip, CSO

Sorry, can you repeat? Your line's not very clear. What is the question?

Shirley Hu, CFO

Could you please repeat your question?

Unidentified Analyst, Analyst

Sorry, apologies for the technical issue. My question was regarding the overall impact on revenues next year.

Tony Yip, CSO

I think we can move on. Next question, please.

Operator, Operator

Thank you. And our next question today comes from Su Long with TH Capital. Please go ahead.

Unidentified Analyst, Analyst

Yes, good evening, management, and thanks for taking my question. What is the collaboration status between TMELAND and WeSing Video and what else will be explored in the long-term cooperation?

Tony Yip, CSO

We continue to deepen our cooperation with WeSing to enhance music-focused collaborations and promotional capabilities. This includes music video-based content on both our platform as well as leveraging WeSing to expand our promotional channels for artists. We have co-hosted numerous live performances together and will continue to innovate and improve monetization avenues.

Cussion Pang, Executive Chairman

We discuss timelines and revenue sharing arrangements on a project-by-project basis. We have a pipeline of projects we’re currently working on.

Tony Yip, CSO

Great. Thank you everyone. If you have any further questions, please feel free to contact the investors relations team. This concludes today's call, and we look forward to speaking to you again next quarter. Thank you and goodbye.

Operator, Operator

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.