Earnings Call Transcript - TME Q4 2020

Operator, Operator

Ladies and gentlemen, good evening, and good morning, and thank you for standing by. Welcome to the Tencent Music Entertainment Group 2020 Fourth Quarter and Full-Year 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, Ms. Millicent T. Please go ahead, ma'am.

Millicent T., Speaker Host

Thank you, operator. Hello, everyone, and thank you all for joining us on today's call. Tencent Music announced its quarterly financial results today after the market close. An earnings release is now available on our IR website at ir.tencentmusic.com as well as via Newswire services. Today, you'll hear from Mr. Cussion Pang, our CEO, who will start the call with an overview of our recent achievements. He will be followed by Mr. Tony Yip, our CSO, who will offer more details on our operations and business developments. 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 the company's control, which may cause actual results, performance or achievements of the company to be materially different from the results, performance or expectations implied by these forward-looking statements. All forward-looking statements are expressly qualified in their entirety by the cautionary statements, risk factors and details of the company's filings with the SEC. The company does not assume any obligation to revise or update any forward-looking statements as a result of new information, future events, changes in market conditions or otherwise, except as required by law. Please also note that the company will discuss non-IFRS measures today, which are more thoroughly explained and reconciled to the most comparable measures reported under the international financial reporting standard in the company's earnings release and filings with the SEC. You are reminded that such non-IFRS measures should not be viewed in isolation or as an alternative to the equivalent IFRS measure, and other non-IFRS measures are uniformly defined by all companies, including those in the same industry. Now with that, I'm very pleased to turn over the call to Cussion, CEO of Tencent Music. Cussion?

Cussion Kar Shun Pang, CEO

Thank you, Millicent. Hello, everyone, and thank you for joining our call today. 2020 was an extraordinary year, with the pandemic impacting all walks of life and the macro economy. Yet, it also brought opportunities, expediting Internet penetration, causing a paradigm shift in online content consumption, and presenting potentials for online concepts.

Cheuk Tung Tony Yip, CSO

Thank you, Cussion. Hello, everyone. Apart from the key developments discussed by Cussion just now, I will provide additional highlights for our online music services before I move on to the discussion of our social entertainment services. During the fourth quarter, core users are increasingly engaged with our platform. Despite the sequential decline in music MAUs, average daily time spent for users has increased. This is a result of our concerted efforts to enrich both music and audio content offerings as well as the launch of innovative products, features and services for Putong Community and TME Live.

Shirley Hu, CFO

Thank you, Tony. Hello, everyone. Let's now discuss our financial perspective. In the fourth quarter of 2020, our online music services continued their outstanding growth trajectory, particularly in musical subscriptions and advertising. While social entertainment services continue their sales growth, despite the economic uncertainty and the changing competitive environment. Our total revenues for Q4 2020 reached RMB 8.3 billion, up 4.3% year-over-year. In Q4 2020, our music subscription business continued to grow rapidly, with revenues of RMB 1.6 billion and a year-over-year growth of 42%. As a result of user retention improvement and effective paywall strategy execution, paywall users grew 40% while monthly ARPPU remained relatively stable year-over-year, as we are dedicated to high-quality user growth and the protected value of the music industry. Advertising is our key strategy. During the quarter, we continued to increase the ad availability on our platform, enhance product quality for our advertisers, improve interfaces, and expand our Salesforce. As a result, our advertising revenues more than doubled year-over-year for the second consecutive quarter. Consequently, our online music revenues reached RMB 2.8 billion this quarter, up 29% year-over-year. Social entertainment services and ad revenues were RMB 5.6 billion, up 8.2% year-over-year, primarily due to growth from online karaoke. Total entertainment monthly ARPPU increased by 26%. The number of ARPPU users dropped 14.3% on a year-over-year basis. The significant growth of our annual gala contributed to this quarter's increase. As we discussed last quarter, we have always been focused on monetization improvement. In Q4 2020, our advertising revenues have continued to grow, while the number of paying users increased sequentially, leading to our overall monetization growth on the platform. Gross margin was 32.4% in Q4 2020, unchanged sequentially, and about 1.7% compared to last year. The year-over-year decrease was primarily due to increased investments in new products and the content offerings, such as long-form audio, and higher revenue sharing costs to strengthen our platform's competitiveness. Online revenue services continue to positively impact our overall module. Now moving on to operating expenses. Total operating expenses for Q4 2020 were RMB 1.7 billion and was 20% as a percentage of total revenue, compared to 90% in the same period last year. Selling and marketing expenses were RMB 773 million, up 50% year-over-year. The increase was due to higher promotional spending and acquisition defenses to strengthen our products and solidify our advantage in music-centric live streaming. Higher costs associated with annual gala events also contributed to the increase. General and administrative expenses were RMB 906 million, up 21% year-over-year. The increase was driven by increased investment in product enhancement and technological innovation, such as long-form audio and related developments, leading to higher employee-related costs. Our effective tax rate for Q4 2020 was 5.5%, a decrease from 9.3% last quarter. Some of our operating entities in China became qualified for certain tax benefits in the quarter ended, resulting in a community impact recorded in Q4 2020. Our effective tax rate for the year 2020 was 9.8%. Our net profit attributed to equity holders of the company was RMB 1.2 billion. Non-IFRS net profit attributed to equity holders of the company was RMB 1.3 billion, and the non-IFRS net profit margin was 16.4%. For the full year 2020, our total revenues were RMB 29.2 billion, up 14.6% year-over-year. Net profit attributed to equity holders of the company under IFRS and non-IFRS was RMB 4.2 billion and RMB 5 billion, respectively. As of December 31, 2020, our combined balances of cash, cash equivalents, and term deposits were RMB 28.9 billion, representing an increase of RMB 1.2 billion from Q3, primarily driven by cash flow generation operations. Looking forward, we continue to be optimistic about the future of the broad music and audio industry. We are confident in the overall ecosystem and product pipeline we are building in the long run. We will keep focusing on new products and future monetization improvements on our platforms while maintaining core company investments. Maintaining is always our key strategy, and we will continue to improve our product quality effectively. Additionally, we are investing in activity on long-form audio and are excited that Lazy Audio joined us, which will further accelerate our long-form audio business development. This concludes our prepared remarks. Operator, we are ready to open the floor for questions.

Operator, Operator

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

Eddie Leung, Analyst

Hey, good morning, guys. Thank you for taking my questions. Two fairly quick questions. The first one is about just the proportion of songs you guys have moved across the paywall? Do you feel we are reaching a high level, which means going forward it is increasingly less easy to move an incremental number of songs to the paywall? If not, why not? And then secondly, it's very interesting that you guys, I think, first time mentioned about a user base on so-called Internet of Things devices, right, in-car audio speakers, etc. So could you give us an idea whether these users are basically the same users on your mobile app? Or are we addressing a different set of user base? Thank you.

Cheuk Tung Tony Yip, CSO

Thank you for your question, Eddie. In terms of the paywall, at the end of 2020, we are just over 20% in terms of our streaming share of content that's sitting behind the paywall. And we actually don't see a ceiling in the near-term, and we continue to expect that by the end of this year, 2021, we will continue to increase our paywall at a similar pace as the previous years, which would take us to just over 30% by the end of the year. We wanted to note that in the fourth quarter, our net ads delivered a very solid performance of over 4 million, 4.3 million net ads. We continue to expect our net adds to be strong, particularly in Q1, where we expect the net adds in Q1 to be even stronger than Q4, driven by a very successful paywall strategy and our various marketing campaigns. In terms of your second question on IoT, there's actually a different user group. We see that the majority of them are non-overlapping because it's a different use case. People who listen to music on smart speakers or in-car have slightly different MAUs and DAUs compared to the music platform. So effectively, our IoT strategy is helping us broaden our user base. We note that while the overall MAU saw a slight decline, which is mainly attributable to a higher churn of non-core users, our core users actually increased their level of engagement on our platform. If we look at the average daily time spent for our DAU, which is more representative of our core users, it actually increased year-over-year. This is a result of the product enhancements we've been investing in over the past year, such as long audio, embedded MVs on the streaming page, Putong Community, and TME Live. Importantly, our reported music MAU figures do not include IoT devices, such as smart speakers in cars and Smart TV, and the IoT devices MAU actually recorded strong double-digit growth year-over-year in the fourth quarter. That presents additional opportunities for us, which we'll share more about in the future.

Millicent T., Speaker Host

Great. Next question, please.

Operator, Operator

Thank you. Your next question comes from Alicia Yap from Citigroup. Please go ahead.

Alicia Yap, Analyst

Hi, good morning, management. Thanks for taking my questions. My question is related to your long-form audio, even at the 15% penetration rate. Could you share more details regarding the user profile and any overlap of the existing music subscribers and their content of interest? In relation to that, can you also elaborate on the various monetization models that you plan to push more aggressively this year? Would that be more on the subscription or would that be more on the online app to drive growth in 2021? Thank you.

Cheuk Tung Tony Yip, CSO

Okay, thank you so much for your questions. Actually, long-form audio is a very important strategy for TME. We are fully committed to invest in this area. This is a very natural way for TME to do it because we have strong competitive advantages compared to other vertical players in the industry right now. First of all, we’re seeing that this is a very natural extension of music consumption because a lot of our music users nowadays, besides listening to music, are easily extending their time to listen to more audio programs. So this makes it easy for us to convert our existing users into long-form audio users, thus saving user acquisition costs. Additionally, we have set up many content partnerships, especially with renowned companies like China Literature, with whom we established a strategic partnership last year. We are also starting to team up with other content providers in the industry, not just professional content, but also extending our footprint into the podcasting, as well as UGC and PGC areas. Our TME long-form audio strategy is unique in the industry for taking a two-pronged approach: on one side, we leverage our music application to have a long-form audio section, and on the other side, we will also launch our standalone long-form audio application. With the acquisition of the Lazy Audio team, which we announced at the end of last year, we have further strengthened our capability in the standalone long-form audio side. This unique strategy positions us well against the competition. Additionally, we are pulling in financial resources and have set up a core team to work on long-form audio business. I am sure that 2021 will be a significant year for us. We strongly believe that long-form audio will create long-term value for the entire group. First, it will enhance user engagement because the time spent on our platform will increase as users enjoy more content. Second, we have different monetization models, such as premium content and monthly subscriptions. We will further introduce monetization opportunities to drive strong revenue growth in the future.

Millicent T., Speaker Host

Next please.

Operator, Operator

Thank you. Your next question comes from John Egbert from Stifel. Please go ahead.

John Egbert, Analyst

Great, thanks for taking my question. Advertising clearly has a ton of momentum. I think you each highlighted a few of the key drivers of recent strength there. But I wonder if you could dig deeper into the runway for future advertising growth by maybe looking at the current state of your business there versus what you might think is possible in the next few years in terms of ad coverage on your various services, ad load within the screens that you're actively monetizing today, and the potential for new ad formats to change your capabilities—anything worth calling out there?

Cheuk Tung Tony Yip, CSO

Yes, sure. Advertising grew at a very rapid pace of over 100% year-over-year for two consecutive quarters. In the fourth quarter, advertising now accounts for the majority of non-subscription revenue, with online music accounting for just over 50%. The rapid growth is a result of the investments we made in advertising technology and solutions over the last year. We also leveraged Tencent’s overall strong ad sales capabilities, which enabled us to penetrate into an increasing number of advertisers. Additionally, we see room to increase our ad load, as there is more real estate on our various platforms, providing us with ample inventory. While our ad formats have been relatively homogenous, primarily consisting of traditional banners and splash screens, we do intend to broaden our ad formats into others such as audio ads and reward ads. Thus, we expect strong growth in advertising to continue in the near to mid-term.

Millicent T., Speaker Host

Okay, next question please.

Operator, Operator

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

Alex Poon, Analyst

Good morning. Thanks for taking my question. I want to return to the music subscription business. I want to understand the effectiveness of the paywall. You mentioned just over 20% by the end of last year. Last year, on average, we added about 4 million per quarter. I want to understand if we go from 20% to 30%, the organic conversion outcomes would increase from 4 million to something like 5 million, which would be faster than before. Additionally, with the paywall, you have better user engagement through long-form audio, premium model promotions, and other new tools to drive conversion. Could you clarify how much additional growth could come from these new tools that can convert subscribers? Thank you.

Cheuk Tung Tony Yip, CSO

Yes, sure. Music subscription revenues continue to deliver strong growth at around 42% year-over-year. Specifically, the number of paying users recorded strong growth at over 40% year-over-year, with solid net additions of 4.3 million, bringing the total number of paying users to 56 million, or a 9% paying ratio, which is a substantial increase compared to just about 6% last year. Beyond the paywall strategy we've mentioned, we have many other products and marketing campaigns that are now delivering benefits. We observe the retention rate of our paying users continue to improve, which has been the case for the past eight quarters—since Q1 of 2019. Once we've converted users from free to paying, they are remaining as paying users for a longer period of time than before. We achieved all this in 2020 while seeing an increasing trend in ARPPU. We are very optimistic about our subscription growth. We expect net ads in Q1 to be stronger than in Q4 this year. For 2021, we expect average net ads to be approximately between 40 to 45 million per quarter, which will be a strong growth driver for our overall business.

Millicent T., Speaker Host

Next question please.

Operator, Operator

Thank you. Your next question comes from Alvin Neo from JPMorgan. Please go ahead.

Alvin Neo, Analyst

Good morning management. Thank you for taking my question. I have a follow-up question regarding your paywall strategy. Can you share with us how you strike a balance between the size of the paying ratio and the platform users? Theoretically, you can achieve 100% paying ratio if you adopted a pay-for-music type of monetization model. However, that will likely come at a significant cost in terms of platform usage or MAU. Your current strategy is gradually increasing your paywall while driving up the paying ratio. Can you share with us how you strike this balance philosophically, and what key considerations make you more or less aggressive in increasing the size of the paywall? What is the long-term equilibrium level of the paying ratio that you anticipate? Thank you.

Cheuk Tung Tony Yip, CSO

Thank you. We do need to strike a balance between paywall strategy and the free user experience. Currently, we continue to see the paywall strategy as very effective without substantially hurting the free user experience. However, we are investing in new monetization capabilities, like various forms of advertising, to help monetize free segments of users, who may be difficult to convert to premium. For those users, our monetization strategy would be advertising. We could provide them with advertising as a way to unlock certain benefits, allowing them to access a limited volume of songs behind the paywall. That’s an example of how we can balance free and pay users effectively. We expect the pace of our paywall strategy to be in line with the previous two years. We anticipate net adds this year to continue performing well, around 45 million per quarter.

Cussion Kar Shun Pang, CEO

One more point I would like to add is, as we mentioned before, educating the users that music holds great value is essential. We are super excited because over the last two or three years, we have succeeded in making our users treasure music and feel willing to pay for it. Nowadays, when we educate our users to buy a monthly subscription, they are happy with the experience of having unlimited access to songs without worrying about which songs they can listen to. At the same time, we’re also providing other privileges, such as participating in TME Live events exclusively for our monthly subscribers. We are also focusing on a test-based economy, meaning that monthly subscribers will enjoy some privileges as well. All of this works together to create a new type of experience for TME Live, which will help our VIP monthly subscribers receive more privileges. We are seeing encouraging results; our retention rates for monthly subscriptions continue to improve. This is a positive signal for us. We strongly believe that a consistent strategy of placing songs behind the paywall, combined with premium offerings, will yield healthy revenue development in the future.

Millicent T., Speaker Host

Great. Next question please.

Operator, Operator

Thank you. Your next question comes from Zhijing Liu from UBS. Please go ahead.

Zhijing Liu, Analyst

Thank you, management, for taking my question. I have two questions. First, how do you think about the timing in promoting a premium model of music apps? Do we see any potential risk of balancing user experience and competition on premium models? Second, can you share some insights on how long-form audio contributes to overall engagement of our music apps? Thank you.

Cheuk Tung Tony Yip, CSO

Sure, in terms of timing, we continue making investments in various ad formats to monetize the free user base segments that may be difficult to convert to premium. That action is ongoing. We discussed this in the last one to two quarters, and we plan to implement some of that as beta tests this year. Regarding long-form audio, there are natural synergies between music and audio. Just like in the radio era, users were accustomed to listening to both music and audio content together. Offering audio content to our music users does not lead to a decline in music listening time; rather, it tends to increase the total time spent. This places us at a significant advantage as the leading music platform venturing into audio. With the addressable market expected to reach several hundreds of millions in the next few years, we are optimistic about the audio market. This is why, as Cussion mentioned, our content strategy within audio, our monetization strategy, and our two-pronged integrated music and audio app strategy support ample growth opportunities in the next few years.

Millicent T., Speaker Host

Great, we're ready to take the next question, please.

Operator, Operator

Thank you. Your next question comes from Vincent Yu from Needham and Company. Please go ahead.

Vincent Yu, Analyst

Hello. Thank you, management, for taking my question. My first question is also on long-form audio. Can you share some insights regarding the payment habits of users compared to music-only users? Regarding target penetration rates for the near term, do we have any numbers to share? My second question is about podcasts. Does the company have plans to sign creators for exclusive content in the podcast space? Thank you.

Cheuk Tung Tony Yip, CSO

In terms of target users for long-form audio, as Cussion mentioned, we reached about 10 million DAU and MAU reached about 90 million by the end of last year. We expect our user base to double by 2021. The overall addressable market, as I mentioned earlier, is very large for audio, similar in size to the music market, with a potential of several hundred million users over the next few years. We anticipate many monetization opportunities. The approach varies depending on the types of audio content; for example, audio books typically rely on subscription-driven revenue. Moreover, we could bundle our music subscription plan with an audio subscription plan. In terms of the podcast content you mentioned, we are actively in talks with different content providers to enhance our platform. We are targeting top-tier artists, podcasters, and various industries as well. We are also working on long-tail content because our platform is vast and provides competitive advantages in tailoring professional user-generated content to different audience needs.

Millicent T., Speaker Host

Right. So we'll take our next question please.

Operator, Operator

Thank you. Your next question comes from Vinny Wong from CICC. Please go ahead.

Vinny Wong, Analyst

Sorry, this is Vinny from HSBC. I have two quick questions. I want to follow up with Shirley regarding investments, because in the previous two years, we discussed that we are very interested in several acquisitions and new forms of business. I want to understand how much of these initiatives should we expect to see more meaningful revenue contributions in 2021? That’s one question. The second quick follow-up is regarding live streaming. We see some of your short video competitors also experiencing softening live streaming growth this year for certain reasons. But looking into 2021, how do we position live streaming? How can we maintain a competitive level concerning ARPPU and paying ratios in the live streaming business, and how will this shift in 2021, given that it's one of our most meaningful earning streams? Thank you.

Cheuk Tung Tony Yip, CSO

Sure, in terms of live streaming, social entertainment revenue grew by 8% year-over-year, despite more difficult comparisons from pre-COVID Q4 last year, and the lingering weakness in the macroeconomic environment affecting the willingness of paying users to spend. However, we were encouraged to see a recovery in our traditional Kugou and Kuwo live segments. Additionally, we are broadening the content category including ACG China ancient style, which is focused on music. It's essential to highlight that our live streaming is uniquely music-centric compared to our peers, which differentiates us, attracting performers and users. We saw sequential growth in QQ Music live streaming, which will contribute to social entertainment revenue as we move into 2021. We expect total revenue growth for 2021 to increase at a faster pace, close to 20%, up from 14% in 2020, driven by faster growth rates in both online music and social entertainment services.

Cussion Kar Shun Pang, CEO

On the social entertainment side, besides live streaming, I want to highlight the leasing platform. It’s a unique platform that stands out in the industry. Last year was focused on evolving to meet current user needs. Singing remains a strong user demand, so we are prioritizing enhancements to make the singing experience better. We have lowered the barriers for content production and created many tools to help users improve their content, encouraging them to share on social platforms. We emphasize user interaction and engagement, and we are seeing a positive trend building. I foresee that user engagement will strengthen further, allowing us to maintain our competitive advantage.

Millicent T., Speaker Host

In the interest of time, we will take our last question, operator.

Operator, Operator

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

Thomas Chong, Analyst

Good morning. Thanks, management, for taking my questions, and congratulations on a solid set of results. I want to discuss the 2021 revenue growth and the margin side. How should we think about the trend concerning expenses, particularly with our investment strategy? Can you also comment on our M&A strategies and the regulatory environments in China as we further expand our scale? Thank you.

Cheuk Tung Tony Yip, CSO

To touch upon regulations and M&A, we maintain a constructive and close working relationship with relevant authorities. Whenever new regulations are issued, we work closely with them to comply with applicable laws. Our overall goal is to promote healthy growth in the China music industry. TME has been operating for over 16 years, during which we've experienced various regulations. We are well-equipped to adapt. Regarding M&A, as demonstrated by our recent acquisition of Lazy Audio, this aligns strategically with our long-form audio ambitions, which we are committed to. We continue to form joint ventures for content development with key partners. Announcing our joint ventures with Universal and recently with Warner Music reflects our commitment to enhancing content creation and promotional capabilities, which synergizes with our distribution business. We will keep exploring M&A opportunities revolving around our core music and audio platforms and deploy capital in a disciplined manner.

Cussion Kar Shun Pang, CEO

Regarding M&A, this journey excites us because we are not just making financial investments but rather solid business collaborations. The partnerships with all three major labels are crucial. We have successfully rolled out many excellent songs recently, including collaborative projects with Tencent Games, creating theme songs for popular titles. We are working with renowned artists and it’s incredibly rewarding to witness our efforts yielding positive results. We are progressing well with our ongoing joint venture with Universal Music and anticipate more innovative content for our users in the future.

Shirley Hu, CFO

In Q4 2020, our gross margin stood at 32.4%, relatively stable compared to Q3 and in line with our expectations. The rapid growth of subscriber and advertising revenue positively affected our gross margins. In Q4, we implemented additional promotional activities, boosting the revenue-sharing ratio in social entertainment. Looking ahead to 2021, we expect significant growth in subscription and advertising revenues to positively impact our gross margin. We will remain vigilant to control revenue-sharing fees while also investing in new products and features, such as long-form audio and passive ecosystem components to pave the way for long-term growth.

Cheuk Tung Tony Yip, CSO

In closing, we are very pleased with this quarter's results, with online music subscription revenue continuing its rapid growth. We believe that China's online music industry is in a long-term secular growth trend, offering us ample future opportunities. The outlook in 2021 is positive; we expect total revenue growth to accelerate compared to 2020, reaching close to 20% driven by faster growth rates in both online music and social entertainment services.

Millicent T., Speaker Host

Thank you, everyone, for joining us today. This concludes today's call, and we look forward to speaking with you again. Thank you and goodbye.

Cheuk Tung Tony Yip, CSO

Thank you so much.

Shirley Hu, CFO

Thank you.