Earnings Call Transcript - TME Q1 2024

Millicent T., Head of IR

Good evening, good morning, and welcome to Tencent Music Entertainment Group's First Quarter 2024 Earnings Conference Call. I'm Millicent T., Head of Investor Relations. We announced our quarterly financial results today before the U.S. market opened. An earnings release is now available on our Investor Relations website and through Newswire services. Today, you'll hear from Mr. Kar Shun Pang, our Executive Chairman, and Mr. Ross Liang, our CEO, who will share an overview of our company strategies and business updates. Following that, Ms. Shirley Hu, our CFO, will discuss our financial results before we open the call for questions. Before we proceed, I refer you to our safe harbor statement in our earnings release, which is relevant to this call as we make forward-looking statements. Please note that the company will discuss non-IFRS measures today, which are explained and reconciled to the most comparable measures reported under IFRS in the company's earnings release and filings with the SEC. Additionally, please be advised that today's call is being recorded. With that, I'm pleased to turn the call over to Kar Shun, Executive Chairman of TME.

Kar Shun Pang, Executive Chairman

Thank you, Millicent. Hello, everyone, and thank you for joining our call today. 2024 is off to a great start. Strong execution of our dual-engine content and platform strategy is yielding impressive results and pushing vitality industry-wide. In the first quarter, the number of music-paying users increased to 113.5 million, totaling 43% of the overall growth in online music revenues. Our high-quality growth strategy also drove a robust net profit margin expansion. Subscriber growth in this quarter significantly exceeded our expectations, with a quarterly historic high of 6.8 million net additions, while we maintained the ARPPU at a healthy level. All the achievements demonstrate our keen understanding of users' needs and our knack for anticipating and meeting their demands operationally. As you have seen in our earnings release, supported by our strong fundamentals, we are very pleased to announce an annual cash dividend policy and USD 210 million in cash dividends for the year of 2023. On top of our ongoing buyback program, this reflects our confidence in future growth and commitment to sharing our success with shareholders. Next, I would like to share an overview of this quarter's content development efforts. Through a balanced combination of copyright music and original content, we enable users to discover the latest and trendiest content and enjoy a superior experience on our platform. Let me go over a few highlights. First, we renewed and reinforced the partnership with record labels to broaden our music library's comprehensiveness and popularity. Our innovative value-added features and promotion services expand from licensing, further unlocking the value of music content industry-wide. We renewed our cooperation with Time Fengjun Entertainment, featuring 30-day head start benefits on new songs and adding Dolby Atmos upgrades for popular groups like TFBOYS and Tintin Times. We also expanded our agreement with HIM International Music, incorporating an industry-first component authorizing PME to use licensed AI features to promote HIM's iconic C-pop content. This will ensure the authentic and responsible use of AI, showcasing TME's commitment to protecting artists' rights and interests in the ITC era. Active benefits from TME's tech-powered promotions and copyright protection, while users enjoy the latest in interactive features, which is a win-win. One recent success for its premiere on our platform is our AI initiative, enhancing fan interaction within new scenarios. We enriched our K-pop content and relining offerings with various artisan activities, digital albums, and active merchandise for new generation groups like ILEC, Baby Monster, and Rice in the first quarter. K-pop user engagement and streams both grew year-over-year. Next, we expanded our original content, a key differentiator to attract users and enhance engagement. Based on our key graphs of trends, we delivered an array of features catering to users' ever-changing tastes this quarter. We produced original content for hit TV dramas, such as The Legend of Shen Li, including 17 songs and 30 episodes, featuring tracks by TME's strategic partner artists, such as Jesse, Itai, and Wangjing. These initiatives create a massive social media buzz that boosts the streams and viewerships. Their outstanding performance showcases our ability to support and set content trends while maximizing the value of content. Our OST for the region of SME produced by Tencent Video also highlighted the power of collaboration within the Tencent ecosystem. It's matched to webcasts with over 150 million streams within 30 days of release, making it the #1 OST debut for this year. We also partnered with strategic artists and Indian musicians on music production and promotion to build our high-quality music offerings. Our collaboration produced remarkable results on social media this quarter. Moving on to our commitment to social responsibility, we cooperate with Tencent Charity for the third consecutive year on our FIM program to drive autism awareness. If music has a shape this year, more than 60 other renowned artists and groups, including well-known entities have also shared songs in support of children with autism. We then hosted an exhibition featuring artwork by children with autism inspired by these musical works, leveraging multimedia to amplify our caring message and boost music's social value. In conclusion, by expanding content and introducing more tailored platform offers that resonate deeply with users, we continue strengthening our relevance to drive industry development. We are confident that our powerful content and platform dual engines and ever-deepening understanding of content will propel our sustainable growth in 2024 and beyond. Now I would like to turn the call over to Ross for more insight on our platform development. Ross, please go ahead.

Ross Liang, CEO

Thank you, Kar Shun. Hello, everyone. Strong execution once again resulted in solid online music growth, record high net subscriber rates, steady ARPPU, and robust performance across our platform. Our efforts to attract and retain users were the driving force behind this, utilizing our extensive industry experience and insights into users and content. We are laser-focused on anticipating and meeting users' needs with enhanced experiences across the 200 mini-car journeys. First, I want to talk about user retention. We have taken a multipronged approach to engaging users through constant innovation in transitioning features. I will walk you through a few examples. Our new AI applications make music discovery more fun, engaging, and accommodating. In the first quarter, we launched a large audio model that increases promotion accuracy, helping users discover more high-quality music content. Initial results show that the live streaming share of promoted songs increased notably following the model's release. We also tested an AI system that supports text and voice rating for a more customized search experience as well as an AI playlist assistant to curate playlists, which strengthens users' stickiness. Recently, we introduced an indicative rewards program. Users can exchange the points they earn for benefits such as trials, subscriptions, digital icons, and personalized privileges. While enhancing user experience, the program also opens new avenues for commercialization for the future. Ongoing platform upgrades continue to reinforce our product efficiency. This quarter, we introduced a light listing mode to facilitate a streamlined experience in low bandwidth environments. Our enhancements allow greater interface customization, driving increased user adoption of our platform players. Beyond the user experience, we captivate users with a variety of interactive activities, including same-song guessing, contract subscriber budgets, and more. These interactive features not only boosted strong streaming volumes but also resulted in more artist follows and additions to favorites. Aside from personal music assets, our platform continues to grow and deepen their loyalty to TME. Moving now to user acquisition, our focus here is on discovering and cultivating users with long-term paying potential through refined marketing and operations. During Chinese New Year, riding under favorable seasonality, we utilized our deep understanding of users across various demographics to roll out a series of effective promotional activities. Our targeted multichannel promotions with e-commerce entities, telecom operators, and video platforms contributed to stronger-than-expected subscriber growth in the first quarter. We also teamed up with auto companies to launch holiday-specific playlists and share promotions. This all organically broadened our reach to new users and increased user activity, contributing positively to the sequential MAU recovery in our online music services. On partnerships, we recently focused on a pre-installation partnership with Xiaomi, and we also enhanced our collaboration with rideshare leader, Total Cushing. Our new self-service real estate music selection features offer rideshare passengers easy-to-navigate music experiences, further extending our reach. Our initiatives in the upcoming second quarter for the first time will include both online and offline offerings, participation in active online features rewarded with tickets to Artists Meet, artist merchandise, and more. Thanks to our lineup of popular artists and inspired performances, this event reinforced our appearance among our core young user base. In short, our rich content and versatile product offerings continue to drive user acquisition and engagement. With user needs at the heart of everything we do, we remain committed to creating a music platform that users trust. With that, I will turn the call over to Shirley Hu, 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 success in effective monetization for music services and operational efficiency management continues to lead to solid financial results in the first quarter of 2024. IFRS net profit increased by 28% year-over-year to RMB 1.5 billion, and net profit rose by 24% to RMB 1.8 billion. Our total revenues were RMB 6.8 billion, down by 3% year-over-year. Our online music services achieved significant revenue growth, which largely offset the decline in revenue from social entertainment and other services. In the first quarter of 2024, our online music revenues increased by 43% to RMB 5 billion on a year-over-year basis. This surge was driven by strong expansion of our music subscription and growth in the advertising business, supplemented by increases in revenues from offline performances. Music subscription revenues in the first quarter reached RMB 3.6 billion, marking a 39% increase year-over-year and a 6% rise sequentially. Our refined operation and effective pricing strategy enabled us to achieve higher-than-expected growth in music subscribers while maintaining a healthy monthly ARPU. Monthly ARPPU was 10.6%, up from 9.2% in the same period last year. Taking the difference in the number of days into consideration, our monthly ARPPU would have remained relatively stable sequentially. The number of online music-paying users was 113.5 million, representing a 20% increase year-over-year and a record-breaking quarterly net addition of 6.8 million users. Our enriched content offerings and enhanced member privileges such as exclusive upgrades have made our products more attractive and improved user stickiness. Advertising revenue also experienced strong year-over-year growth, primarily due to the expansion of ad-supported advertising. We upgraded our incentive ad experience and provided more engaging and appealing features to our users, which helped improve our entry rates. We continue to innovate and diversify our product suite and advertising formats. Social entertainment services and other revenues were RMB 1.8 billion, down by 15% year-over-year. This was mainly due to adjustments in certain live streaming and active functions and more stringent compliance procedures as we implemented several service enhancements and risk control measures since the second quarter of 2023. As these adjustments and procedures are largely completed, we expect our social entertainment services to remain relatively stable. Our gross margin for Q1 reached 40.9%, marking an increase of 7.8 percentage points year-over-year due to several factors: first, the growth of revenues in online music subscription and advertising has generated the benefits of economies of scale. Over the years, we have made significant efforts and investments in the music industry and have built win-win relationships with labels and artists, allowing these efforts and investments to start bearing fruit. Additionally, the ramp-up of our own content continued to positively impact our margin. Lastly, we have optimized the revenue-sharing ratio for live streaming and also improved monetization in racing membership and advertising, which benefits our gross margin. All the above factors have collectively enabled us to maintain a healthy market model. Moving on to operating expenses, in the first quarter of 2024, they amounted to RMB 1.1 billion, representing 16.8% of our total revenues compared with 70.5% in the same period last year. Selling and marketing expenses were RMB 187 million, down by 2% year-over-year. We will continue to invest in areas such as online music with a long-term growth perspective, as well as content promotions. General and administrative expenses were RMB 949 million, down by 7% year-over-year, primarily driven by lower employee-related expenses. Our effective tax rate for Q1 was 19.9% compared to 12.2% in the same period of 2023. This increase was primarily attributable to the backlog of reporting tax related to earnings limited by our reinvestment into offshore entities. Additionally, changes in corporation tax rates for certain entities also impacted our effective tax. For Q1 2024, our net profit and net profit attributable to shareholders of the company were RMB 1.5 billion and RMB 1.4 billion, respectively. Non-IFRS net profit and non-IFRS net profit attributable to active holders of the company were RMB 1.8 billion and RMB 1.7 billion, respectively. Our diluted earnings per ADS reached a record high this quarter at RMB 0.91, up 25% year-over-year. Non-IFRS diluted earnings per ADS increased to RMB 1.1, 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 of March 31, 2024, our combined balances of cash, cash equivalents, and term deposits were RMB 34.2 billion, compared with RMB 32.2 billion as of December 31, 2023. This combined balance was also affected by changes in the exchange rate of RMB to USD at different balance dates. The share repurchase program was announced in March 2023. As of March 31, 2024, we had repurchased 32.2 million shares from the open market for a total cash consideration of USD 235.5 million, of which approximately USD 61 million were repurchased in the first quarter. Looking forward, we will continue to invest in high-quality content and original content productions as well as new products and technologies, such as AI initiatives. We remain confident in the prospects of the music industry and our subscription and advertising business. This concludes our prepared remarks. We are now open to taking your questions.

Millicent T., Head of IR

Thank you, Shirley. The first question comes from Alicia Yap from Citigroup.

Alicia Yap, Analyst

Congratulations on the solid results. My question is for the 2024 outlook. So after achieving a strong set of results, especially with record-high quarterly net additions, what should we expect for the net addition trend for the second quarter and also the ARPPU trend for the second quarter as well as the overall growth rate expectation for total online music revenue?

Ross Liang, CEO

Thank you so much, Alicia, for your questions. For the full year of 2024, our online music and subscription revenue are well on track, and profitability is also expected to be slightly better than previously anticipated. For the subscription side, I think that we are pleased to see that in Q1, the net additions really exceeded our expectations. So it really gives us a strong start for this year. Therefore, we are confident that the total net additions for 2024 will exceed our initial projections indicating to be a total greater than the year of 2022 and yet slightly slower than last year, which is 2023. But on the other hand, we remain committed to the healthy long-term growth of our business. For full-year ARPPU, we expect it to continue to expand year-over-year, although at the moment, I think a more modest growth rate compared to 2023. To recap, last year's rapid year-over-year growth was primarily due to the scaling back of discounts. Based on last year's healthy ARPPU level and the benefits of some of the operational optimizations introduced throughout this year, we expect slight ARPPU growth in the second half of this year when compared to the first half. However, we will remain unchanged and confident in long-term ARPPU expansion potential, supported by our experience in user education and a variety of operational strategies. A couple of points that I would like to add is that we had better than expected Q1 primarily due to a couple of reasons. First, Q1 is typically the peak season for the entire year, especially due to the Chinese New Year, so users are more willing to pay for entertainment. Secondly, we are also expanding effective promotional activities that attract more high-potential users. We launched multichannel promotions across various areas, significantly driving the growth of our user base. However, as we communicated and observed in the 2023 pattern, we anticipate rolling offers strong seasonality, and the net additions should return to more normalized and sustainable levels over the next few quarters. Besides the subscription business, the loan subscription business also had a strong start in Q1 this year, and we expect solid growth for the remainder of this year as we continue to innovate advertising products and expand merchandise sales with labels and artists as well.

Millicent T., Head of IR

The next question comes from the line of Alex Poon from Morgan Stanley.

Alex Poon, Analyst

Congratulations to management on a very strong quarter. My question is related to gross margin. In Q1, while we had negative seasonality for both advertising and social entertainment, we still expanded the gross margin significantly sequentially from 38% to almost 41%. Can management share how the revenue and cost structures have changed on a sequential basis? How should we think about gross margin in the rest of 2024?

Shirley Hu, CFO

The gross margin is 40.9% in Q1, increased by 7.8% year-over-year, an increase of 2.6% quarter-over-quarter. There are several reasons for this. First, subscription and advertising revenues have seen significant growth. Second, we have made considerable efforts and investments in the music industry and built relationships with labels and artists. Additionally, we focused on ROCE to manage content costs more efficiently. Our online music revenue growth ratio was higher than the net growth ratio of content costs. Third, we are gradually ramping up our self-owned content, which continues to have a positive impact on our gross margin. Fourth, even with a decrease in live stream revenue, we optimized our live streaming revenue sharing strategy. The live streaming revenue sharing ratio decreased, while revenue and advertising on the leasing platform increased, all benefiting our gross margin. Our gross margin has improved for eight consecutive quarters. Looking forward to Q2, we expect subscription revenue and advertising revenue to continue growing healthily.

Millicent T., Head of IR

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

Lincoln Kong, Analyst

Congrats on the strong quarter. My question is about online music services, specifically advertising. Can management comment on what you have seen in terms of advances in the first quarter and into the second quarter? What are the new advertising formats the company intends to implement?

Shirley Hu, CFO

Thank you for your question. In the first quarter, we experienced significant growth in our advertisement service, and I believe we will sustain this strong momentum into the second quarter. While we are not expanding our subscriber base, our main challenge lies in managing the traffic from non-subscribers, which has been declining as our subscriber numbers increase. Therefore, we need to optimize the solutions we offer to advertisers and develop attractive packages to manage and enhance traffic effectively. Since the beginning of 2023, our advertisement performance has been robust. For this year, our goal is to maintain stable growth in our advertisement business. From the fourth quarter to the first quarter of this year, we've seen substantial growth, particularly from key sectors such as e-commerce, gaming, content, information, and fast-moving consumer goods, partly due to revenues generated from large promotional events during the Chinese New Year. We are anticipating strong growth from the e-commerce sector for our advertisement business in the second quarter of 2024, with key events being the six online shopping festivals. We are preparing to capitalize on these events to support our e-commerce advertisers, aiming for improvement compared to last year. We have also developed various engaging solutions to continue assisting e-commerce advertisers. Additionally, we are utilizing our diverse music ecosystem to introduce more varied advertising formats and models. For instance, we launched a music-based advertisement model in the first quarter that is tied to concert attendance. Through these new models, we hope to keep users engaged while creating new revenue streams for our advertising business. Overall, we aim to provide a comprehensive range of advertisement solutions that will allow us to effectively mix products and continue optimal growth in our advertising sector.

Millicent T., Head of IR

And the next question comes from Lei Zhang, Bank of America.

Lei Zhang, Analyst

My question is mainly regarding the margin trend, especially the sales and marketing trend. I consider we have controlled our sales and marketing expenses in such a way to maintain the MAU reasonably stable. How should we look at the drivers and the overall sales and marketing and margin trend in the following quarters?

Shirley Hu, CFO

Thank you very much for your question. Regarding our gross profit margin, we experienced significant growth both year-over-year and quarter-over-quarter, which establishes a strong foundation for our performance. I believe we will continue to see this growth in the near future. In Q1 of this year, we reduced our marketing expenses on both a year-over-year and quarter-over-quarter basis. Traditionally, Q1 is a low season for marketing efforts, as most brand promotions occur in Q4 of each year. Therefore, in Q1, we launched fewer marketing events while our monetization on the music platform keeps improving. We anticipate our marketing expenses will increase to regain traffic for our channels while decreasing expenses related to canal-side streaming. We view self-commissioned content as a crucial driver for our future business, so we plan to invest in content promotion. Overall, we expect our marketing expenses to rise in Q2, but for 2024, they will align with what we observed in 2023.

Millicent T., Head of IR

Okay. In the interest of time, we will take the last question from Thomas Chong, Jefferies.

Thomas Chong, Analyst

My question is about our new initiatives, such as long-form media, IoT. Can management comment on the outlook in these areas? Also, can management shed light on our long-term targets?

Shirley Hu, CFO

Thanks for your question. Considering long-form media, from a business strategy perspective, it's going to complement our existing online music services. It will help us meet the diverse needs of users, especially from different entities. We are seeing promising performance in this area. Regarding our long-term targets, we endeavor to ensure that we continue enhancing our user services and overall performance. We aim to maintain a pace in driving our online user services effectively, with a focus on enhancing both subscribers and ARPPU. Furthermore, it is crucial for us to continue developing our content ecosystem, ensuring a strong library mix. We will continue directing more resources towards content and coproductions. We will also expand our footprint internationally, not just on the business side of the platform but also in terms of content. Going forward, we are committed to both short- and long-term sustainable development while providing good returns for our investors through dividends and share repurchase programs.

Kar Shun Pang, Executive Chairman

I think overall, we are on a very good pace in driving the performance of online user services. We will continue to drive improvements across our overall subscribers and ARPPU. Importantly, we must ensure that we have a comprehensive content ecosystem to support all our library coverage while continuing content production and project collaborations. Overall, we are not just sprinting; we are in this for the long haul, and we aim to manage quarter-by-quarter growth while focusing on the long-term sustainable development of our group. We also emphasize sharing our success with investors, ensuring a solid dividend policy and maintaining our share buyback program as needed. Thank you.

Millicent T., Head of IR

Thank you, everyone, for joining us today. If you have any further questions, please feel free to contact our IR team. This concludes today's call. Thank you so much again, and I look forward to speaking with you next quarter.

Liang Zhu, CEO

Okay. Thank you very much. Thank you.

Millicent T., Head of IR

Thank you. Bye.