Tencent Music Entertainment Group (TME) Q2 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, good evening, and good morning, and thank you for standing by. Welcome to the Tencent Music Entertainment Group Second Quarter 2019 Earnings Conference Call. . Today, you'll 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. If you have any objections, you may disconnect at this time.

Thank you, operator. Hello, everyone, and thank you, all for joining us on today's call. Tencent Music Entertainment Group announced its financial results for the second quarter 2019 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 will hear from Mr. Kar Shun Pang, our CEO, who will start the call with an overview of our recent achievements and growth strategies. He will be followed by Mr. Tony Yip, our Chief Strategy Officer, who will offer more details on our business developments. Lastly, Ms. Shirley Hu, our CFO, will address our financial results before we open the call for questions. Before we proceed, please note that this call may contain forward-looking statements made pursuant to the safe harbor provisions for 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 as law. Please 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 Standards 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 measures, and other non-IFRS measures are not uniformly defined by all companies including those in the same industry. With that, I'm very pleased to turn over the call to Mr. Kar Shun Pang, CEO of Tencent Music. Kar Shun?

Thank you, Millicent. Hello, everyone, and thank you for joining our call today. In the second quarter of 2019, TME recorded solid financial results with revenue growth of 31% year-over-year and healthy operational performances in both online music and social entertainment services. In our online music services, first of all, one of the most recognizable achievements in the second quarter was the re-acceleration of growth in both paying users and subscription revenues. As the largest online music services platform in China, we added 2.6 million paying users on a sequential basis, the highest number over the past 5 quarters. Paying users increased by 33% year-over-year, up from 27% year-over-year from last quarter.

Thank you, Kar Shun. Apart from the encouraging results with our online music business, another key highlight of the second quarter was that social entertainment mobile MAU rose almost 5% year-over-year to 239 million, while ARPPU expanded by nearly 17% compared to the same period last year. These increases came after a series of initiatives that we said we will execute on to reinvest in user growth, and we're pleased to see that those efforts have proved effective and helped improve social entertainment MAU growth. So we think we made efforts to lower the threshold of use and attract prospective entry-level users. This included scaling up the WeSing mini program in WeChat, which has grown rapidly during the quarter. We only introduced a WeSing lite version app, which has streamlined functionality that is designed to attract users in China's lower-tier cities who may have phones with lower processing capacity and slower Internet connections as well as first-time users who may appreciate a simpler interface.

Thank you, Tony. Hello, everyone. In the second quarter of 2019, our revenues increased by 31% year-over-year to RMB5.9 million. This increase was driven by the steady growth in both our online music and social entertainment business. Revenues from online music services increased by 20% year-over-year to RMB1.6 billion. The increase was mainly driven by strong growth in revenues from user subscription and sales of digital music albums, which was partially offset by the decrease in sublicensing revenues from other music service companies. Revenues from music subscription were RMB798 million, up from RMB605 million in the second quarter of 2018. During Q2, the number of our online music subscribers increased by 2.6 million from Q1, the highest over the past 5 quarters. The growth was mainly driven by improved subscriber retention ratio and encouraging user acceptance of our trial of the pay-for-stream model. In addition to the growth in subscriber number, our subscriber ARPPU rose to RMB8.6 in Q2 from RMB8.3 in Q1. This increase was the result of higher percentage of premium membership subscribers. Revenues from social entertainment services increased by 35% year-over-year to RMB4.3 billion, primarily driven by revenue growth in our online karaoke and live streaming services. Our ARPPU in social entertainment services increased by 16.8% to RMB130 year-over-year, while paying user base increased by 16.5%.

. First question comes from John Egbert with Stifel.

The Internet of Things device integrations seem like a really interesting opportunity. Are those available to free listeners today? And do you view those devices, some of the categories or all of them, as potential paywall features to drive increased conversion in the future. And separately, is there any color you can provide on the growth of the trends on other online music service segment between app downloads and sublicensing? That's been, I think, one of the trickier areas to model recently. I'm just wondering if you can give us any help there.

Okay. Sure. So in respect to Internet of Things strategy, our strategy is to provide our music services to as many smart device as possible so that our music service becomes ubiquitous in all of our users' daily lives, whether they are trying to listen to music through a smart speaker at home or whether they are trying to listen to music in their cars or while they're on the go through other wearable devices. At the moment, depending on the specifics of future partnerships, some partnerships are where music services are available for the free users with the exception of some of the content that is sitting behind the paywall. When that happens, it is consistent across multiple devices. You mentioned the point about conversion. You are correct. It is definitely one of the very strong tool or potential levers that we could add to in addition to our paywall strategy to help convert free users into paying users. To give you one example, in the future, our price plan -- the premium price plan could evolve into one that offers premium paying users to listen to content behind the paywall across multiple devices, beyond the mobile handset. And so at the moment, our conversion strategy is still at -- it's making good progress through the paywall. But over time, we actually have a very well-planned strategy and steps that we would continue to add to the paywall strategy and to add to other things -- other tools that can help with the conversion.

And about the other revenues of online music services, that is including advertisement revenue and sales of digital albums revenue and sublicense revenues. And the sublicense revenues is the biggest part of this. So we have told you that sublicense revenue will decrease, and we expect in the second quarter -- second half of this year, the total -- the other revenues of online music will be stable compared to last year.

Your next question comes from Alex Yao with JPMorgan.

I have two questions. One is regarding the online music services. We understand your current strategy is to gradually and steadily increase the content behind the paywall such that the paying ratio will gradually improve over time. In terms of the revenue growth rate, this quarter the revenue growth rate slowed down to 20%. How would that such operating strategy translate to revenue growth rate? Should we be expecting further deceleration into the coming quarters? Or at some point, shall we be expecting an acceleration for online music revenue? And the second question is regarding the social entertainment operation. The financial and operating results clearly suggested that you prioritized the user growth in the quarter while partly sacrificed the monetization. Can you walk us through what are the initiatives you have introduced such that the user growth rejuvenizes 90-odd bps? And why were these initiatives negative to the monetization? More importantly, can you talk about the strategy and outlook into second half this year?

Okay. Thank you, Alex, for your questions. And actually, we are really encouraged to see a healthy momentum in our music subscriber growth. Regarding to your first question, I think that right now, the key drivers to make us have a really good revenue growth is because we are doing improvements in our retention rate such as all the renewal programs that we have introduced and also the enhanced content offering that improved our user experience and which is as a result of the very good results driving our revenue growth in the online music services. In the future, while we are putting more and more content behind the paywall in a step-by-step process, I think in 1 to 2 years, which means 2019 to 2020, which is our education process that we have to educate the market, and we are expecting that the revenue growth is going to be a linear growth rate. But we are going to reach an inflection point in 2 years' time. And by then, we are expecting that we are going to have a bigger growth of the online music revenue. So we are pretty in line with what we have been communicating to every one of your during the IPO period. And we are very positive on the long-term growing of our online music services. Regarding to the second question of the social entertainment part, yes, you are right that we are putting more focus on driving our user base at the moment because we are seeing that even though we have a very good user base for the social entertainment part, we want more users to get involved, get a sense and also started to pay even a small amount of money. So this is very important because we are also learning from the experience of gaming. So once you got more users get involved and participate and then they started even paying a small amount of money, they will get more satisfaction and start enjoying the service a lot more than before. So once we got all these kinds of momentum going, we are seeing that we do have a very good chance to have more monetization methods in the future to capture the actual value of the more revenue growth as well.

And I'd also add that with regards to the online music services revenue, if you break that down into music subscription revenue compared to nonsubscription music revenue, the music subscription revenue part actually reaccelerated growth this quarter compared to last quarter. This quarter, our music subscription revenue grew by 32% year-over-year, which is meaningfully higher compared to the 26% year-over-year in Q1. And you're seeing similar trends and very encouraging trends in terms of the online music paying users, which grew 33% year-over-year this quarter compared to 27% year-over-year last quarter, which is why as a result, we're actually very confident as to -- we're very encouraged by the progress that we're making in terms of the paying user conversion, and we're very confident that this growth momentum will actually continue into the second half and even has the potential of being slightly higher in the second half compared to this quarter.

Your next question comes from Eddie Leung from Bank of America Merrill Lynch.

Just two quick follow-ups of Alex' questions. On the pay subscription pieces for online music, could you share a bit of color in how you guys decide on which contents to be put under the paywall? Maybe talk about the decision process. And then secondly, going back to the social entertainment pieces, could you give us a little bit more color on the different user trends and potentially ARPPU trends between WeSing and live broadcasting getting into second half of the year?

Sure. In terms of the first question, it's obviously a gradual process, as we keep mentioning, that we started upon in the beginning of 2019 where, as we mentioned, we'll gradually be adding a selection of content and putting that behind the pay-for-streaming paywall. The amount of content being put behind the pay-for-streaming paywall at the moment is still a very small percentage of our total as this is just the beginning, and we will continue to do more. In terms of the process, it's a combination of different factors that we take into consideration, which includes, for example, the conversion impact and also what type of content allow us to attract the more diversified new paying users as opposed to cannibalizing existing paying users. We also consider the popularity and -- of the song and the popularity defined not just as sort of new hits but also all-time hits that may be quite lasting and with a lot of history and following. And so I think we took a combination of those factors. Ultimately what we're trying to strike the balance for is user experience. We want to make sure that while user can continue to enjoy vast majority of their -- of the content for free, but at the same time, we want to spend this year and next year as investment years to educate our user base to buy into the concept of paying for an all-you-can-eat music streaming service for a very reasonable price. That is -- and that goes beyond just paying for a particular song or a particular album or a particular artist. It really comes down to educating the user to getting used to paying for the service that is convenient, that allows them to enjoy the most comprehensive content offering in the market. And that's what we will continue to do in the next -- this year and next year. And we're actually seeing very encouraging progress, as we keep mentioning about the reacceleration of our paying user growth. I also want to reiterate that the music net adds, music paying user net adds this quarter is actually the highest for the past 5 quarters, which actually shows a combination of our pay-for-streaming strategy and our retention strategy working quite well. In terms of the second question about WeSing as well as live streaming, I think actually both WeSing and live streaming are growing at a very healthy pace. Previously, there was a question about user growth -- the trade-off between user growth and monetization. I want to just reiterate that our social entertainment revenue grew by a very healthy 35% year-over-year. And just another recap in second quarter 2018, the social paying users actually declined sequentially in the second quarter 2018. But in this quarter, the social paying user grew at a very healthy pace. And not just the paying users. We also saw very healthy growth in ARPPU, which is a reflection of the increasing penetration of the existing paying use cases that we have implemented, an increasing penetration of those use cases among existing users such as the online karaoke room that we mentioned in the past. We're still seeing growth in the paying users penetration there. We continuously invent new paying use cases that are fun and engaging for users, especially for those who pay such as the multi-mic singing room that we introduced towards the end of last year, early this year as well as the content improvements relating to live streaming that we keep making progress on by attracting high-quality live streaming performers to provide entertaining content for our users and through our investment in personalized recommendation, which allows our platform to recommend the most relevant content to our social entertainment user base based on their watching preference or listening preference. So a combination of these factors actually allow us -- allow our social entertainment revenue to grow at a continued healthy pace, and we expect that to continue into the second half.

Your next question comes from Piyush Mubayi with Goldman Sachs.

I've got three questions, if I may. They're all short. First, you talked about the IoT revenue model and how it's being embraced. Could you talk us through how it works with the Tesla case, for example? The second question relates to the margins we're observing in the second quarter and in particular the gross margins of 32.9 as well as the sales and marketing spend that have come in lower than we thought at 7.1. Are these trends sustainable for the rest of the year? And the third is a bigger question -- a bigger-picture question related to the Tencent Group, which is the Tencent's interest in UNG. And I wondered if you could comment on that.

Sure. I'll take the first question relating to IoT. The revenue model comes in different arrangements depending on the partnerships. In some cases, TME generates revenue by actually charging a per device fee where the hardware device manufacturer would pay us a per device fee for music service essentially subsidizing their users. In other models, we provide a small or limited content library for the free users and only provide the full library for the premium paying users and thereby driving conversion. So we actually actively exploring different alternatives, monetization models through IoT. But at this stage, our core strategy is to expand the user base and expand coverage and penetration into as many devices as possible first. And once we have made inroads in covering and broadened our coverage in as many devices as possible across cars, speakers as well as other wearables, then we can start being a bit more aggressive in terms of the conversion. I also want to just highlight that the IoT channel can ultimately become a fairly powerful conversion tool for us because it is very possible for us to offer a single premium plan across multiple devices, meaning across mobile app, across speaker, across cars. So if a user is a premium user on the mobile app, they can equally enjoy the listening privileges of content behind the paywall across other devices. So that could actually potentially be a powerful tool for us to drive conversion. That hasn't happened yet. But as I mentioned earlier, this is part of our structure plan to sequentially and thoughtfully roll out different levers as we go into the future in terms of keep driving our paying users higher. I'll let Shirley take the question on gross margin.

Okay. So this quarter, our gross margin is 32.9%. Actually, we think this outperformed our expectation. Compared to the last year, the gross margin decreased 7%. There are several reasons. The first, sublicensing revenue decreased. In last year at the second quarter, we have recorded one of the sublicensing revenues. And then the upside, this quarter, some -- the third-party music platform gave up sublicensing from us. So sublicensing revenue decrease will heavily impact our gross margin. And second, the content on music -- the content cost of music has increased. One reason is the market price is increased. And we find more amount to license with the labels, and we made some sales -- made music content. And for the social entertainment, we give some small incentives to the users to encourage them to interact in our platform. So both of these effects impact our gross margin decrease. And for the last half of the year, we believe we can have a stable margin compared to last -- compared to the first half of this year and reach our expectations we have said in last quarter, yes.

Okay. Regarding the third question that you just mentioned about UMG, right now Tencent is leading the discussions with Vivendi. And since the transaction is still at its early stage, and TME has not made any final decision in terms of our participation in this transaction. But there's going to be more discussion internally, especially in the Board level of TME, and we are going to have more discussion in that. Again, I think that TME is really open to explore and evaluate strategic partnerships from time to time, especially as we have mentioned before, we launched a joint venture with a label, with Sony Music. We also have some other strategic partnership with Warner Music as well. So we will continue to evaluate and explore new opportunity in this area. Thank you.

Your next question comes from Chong, Thomas with Jefferies.

I have questions regarding our mini program initiatives. Can management comment about how many users or in terms of the revenue, how we should think about the trend in the second half? Should we expect it to be more back-end loaded? And my second question is about competition. Given our competitiveness recently, you also talked about some capability or cloud-related features. How will we enhance our social features? Or do we think this is something that is already embraced in TME?

Yes. In terms of the first question, I want to stress that as I mentioned in the last quarter earnings call, there is a series of initiatives that we have implemented that is focused on reinvesting in user growth. And we're actually very pleased to see those initiatives starting to pay off in terms of the MAU growth, and those initiatives included introducing the WeSing mini program within WeChat. And the key objective there is to be able to leverage WeChat's massive user base on the social network to attract new users that are not currently using WeSing or lower-frequency users and use it as a springboard to drive traffic back to the WeSing main app. It's more of a user acquisition channel for us as opposed to a revenue monetization channel. In addition to the mini program, we actually have actively introduced new product features within WeSing to also make the product simpler for entry-level users to sing. We mentioned in the last quarter also about the quick sing feature, right, allowing users to sing just part of the song as opposed to full song. And we're seeing very good conversion there that helps us improve MAU. In addition to that, the lite version is also very helpful to help us attract first-time users who prefer a simpler user interface or less Internet savvy, lower tier city users. So a combination of those initiatives have actually been quite successful. It's not just about the mini program. And then in terms of competition, I think we are by and large the largest social entertainment -- music-centric social entertainment network in China already. We didn't launch karaoke as a first entry -- as a first mover to the industry. As most of you know, there were an existing incumbent within karaoke. But within a short time span, we overtook the incumbent to become now the largest online karaoke platform. But more importantly, based on the number of social connections among users on WeSing, we have over 40 billion social connections among users on WeSing. And that's an extremely, extremely powerful asset and strength that is actually very hard for other players to replicate, which is why we keep focusing on the social engagement and social interaction of our social entertainment platform. It's not just a media consumption platform. It's a social interaction platform because users genuinely interact with one another after they sing a song or after another user perform a song through live streaming, and those engagements are extremely active. And with more engagement, it actually gives us a lot more user loyalty, which as a result provide a lot of monetization opportunity for us. And in addition to that, we also have actually continued to innovate our own products above and beyond social entertainment. As Kar Shun mentioned, the 9.0 version of QQ Music has been very well received by our users. And with its brand-new personalized recommendation, which is a very, very key highlight for this new version, we substantially strengthened our recommendation algorithm. And we're actually seeing very good volume being driven through music streaming volume based on recommendation with very high sequential increase. In addition to that, another example of product innovation that we continue to do is we've added what we can claim pioneering feature in the industry, a short video watching feature while user is listening to music through the music streaming page. Nowhere else in the market will you find this feature, where users can actually enjoy watching a series of short video while listening to and enjoying to music. So this is a very innovative feature. And we are also seeing very good conversions on the back of that.

Your next question comes from Hans Chung with KeyBanc Capital Markets.

So I have a couple of questions. One, so just a follow-up to the operating cost. So it seems like the operating expense came in lower than expected in the second quarter, and then just wonder what drove the result. And then would that be sustainable going forward? And then secondly, regarding the international expansion strategy. So can you elaborate a little more what's your strategy and then also what potential user TAM you are targeting? And then any financial implication for the content cost, gross margin or sales and marketing expense?

For the first question about operating expenses, this quarter, our operating expenses have operating average because we are focused on our -- how to spend based on promotion expenses. And for the second half of this year, we have said we need, too, some resources on acquiring content for social entertainment. But we will also focus on the ROI. So we expect in the second half of this year, the operation expense will be increased. But we will control this ratio of revenues of expenses at the same rate as for the last year. For the second question...

In terms of our international expansion, as we think about expanding beyond China, we obviously have a choice of expanding our music service or our social entertainment service, namely online karaoke. It was a very clear strategy for us to prioritize expanding WeSing. And that's because WeSing is by far the largest online karaoke platform globally. We have not seen any large player of scale that is comparable to where WeSing is today. We have several years of operating know-how and track record that we have accumulated through a lot of experience. And we're actually actively looking to leverage that know-how and operational expertise to broaden the footprint of WeSing beyond China. And the reason we decided to first tackle the Southeast Asia region is because of cultural similarities with China, with a fairly sizable Chinese population in some of the countries as well as similarly high-frequency karaoke activities as a way to social -- as a common social activity in the countries that we're targeting. For example, Philippines, as I think we all know, the country -- people love to sing. And in that country specifically, WeSing is actually seeing early success in terms of being a very top-rated music app on the App Store. It is still early days. We only started embarking on this international expansion this year. As we continue down this path, we do expect to spend, on a very prudent scale, some sales and marketing expenses to help promote the service. But as consistent with our overall sales and marketing spend, we will track our ROI quite closely to ensure that our margin profile are not impacted.

Your last question comes from Gary Yu with Morgan Stanley.

The first question is on online music. I saw that the paying views in that was very strong in the second quarter. Remember during the first quarter when management -- we expect sequential improvement in the paying user net adds in the upcoming quarters. So just wondering whether we expect this trend to continue to improve from what we saw, 2.6 million net adds in second quarter, in the next few quarters. Second question related to our retention rate that we also mentioned that the improvement in net adds was partly driven by a reduction in churn rate. Just wanted to see what kind of churn retention rate we are seeing today and what was it before the second quarter. Last question on social entertainment. We mentioned that in the second quarter, the company focused on MAU with monetization probably up a little bit later. Wanted to see whether that still remains the focus in the third and fourth quarter for this year or we should finally expect some improvement in both paid user and revenue growth for social entertainment going forward.

Okay. Thank you, Gary, for your questions. Regarding the online music services, yes, you're actually right that we are doing really good in the second quarter of this year. And we are having really encouraging and healthy momentum in driving this from time to time. Right now, I think as I mentioned before, there's a couple of reasons why we are doing that good this quarter, especially because the overall retention rates keep improving. As you understand, we are not disclosing our retention rate. But I can assure you that this keeps improving and we're having a very good, positive result. Besides that, we're also adding more and more content behind the paywall in a step-by-step process. I think it's more educational process, and it's going to be really going to pay off in the future. And I also mentioned before, it's the paywall, I think it's just the first lever that we are pulling to convert more paying users at this moment. But we do have many, many other tools in the toolbox in the future that we can use to drive more monetization like we have the advertising models going on. We also have many privileges and differentiations in our membership as well. So what we are selling in here is not just selling music content. We are selling the overall music VIP services, so which means that once our users are going to be adopted to this VIP privileges, they will be hassle-free and be able to enjoy the wonderful content and service that we are providing to them. So we are -- and you are right, we are really confident that the online music service side of our business will keep growing in the second quarter -- second half of this year.

Yes. And just to add to the music paying user side, as we mentioned, the growth rate of the paying user accelerated this quarter compared to last quarter. And we are very confident that this trend would continue into the second half, meaning we expect the growth rate of online paying user to -- the growth rate of that to continue to accelerate. And then coming to the social entertainment part of the question, we continue -- I think in the second half, we will continue to focus on providing an attractive content offering in the live streaming part of the business in terms of attracting high-quality live streaming performance onto the platform as well as through our recommendation engine, promote and recommend the most relevant live streaming content to our users based on their past watching experience and preferences. In addition to that, in terms of WeSing, we'll continue to provide interesting and fun and engaging paying use cases that attract people to pay. We talked about the online karaoke room. We talked about the multi-mic singing room. We also talked about lowering singing barrier to allow users to effectively sing more songs, which makes the karaoke community more vibrant, which actually also in turn could result in more paying activity. And in addition to that, the penetration of all these paying use cases continue to be relatively low. So there's still a lot more room for that to grow. And in addition to that, we -- I think a couple of quarters ago, we talked about the synergy between our music streaming page and the live streaming where while user is listening to particular song on the music streaming page, we actually signal to the user there is a live streaming performer that is singing this particular song that you're listening to at this very moment. And thereby, if you're interested in listening to an alternative version of that song, you click on that link and it drives you from the music listening page to a live streaming session. The penetration of that still have more room to grow. And so all of these actually will be key drivers for us to grow our overall social entertainment revenue into the second half. So we actually, continue to see very healthy growth for both WeSing and live streaming into the second half.

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

Thank you, everyone, for joining us today. If you have any questions, please feel free to reach out to us through the IR team. And this concludes today's call, and we look forward to speaking with you again next quarter. Thank you, and goodbye.

Thank you.

This conference has now concluded. You may now disconnect.