China's music streaming market is projected to reach $3,46 billion in 2024 and is expected to grow at a compound annual growth rate of 4,87 % until 2027. These numbers are conservative compared to the $12,28 billion music streaming market in the United States. If you believe that the music streaming market in China will grow faster than projected, it could be an interesting market to invest in. Especially because Tencent Music Entertainment is a prominent market leader. In this analysis, I will investigate whether it is a good idea to buy shares in Tencent Music Entertainment.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
Before I begin the analysis, I want to clarify that I do not currently own any shares in Tencent Music Entertainment. I previously owned shares in Tencent Music Entertainment that I bought at $3,98 and sold at $8,06. Currently, I own shares in Tencent (both directly and through Prosus) which owns 51% of Tencent Music Entertainment. If you would like to view or make a copy of my portfolio, you can find instructions on how to access it here. If you want to purchase shares or fractional shares in Tencent Music Entertainment, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
Tencent Music Entertainment Group operates online music entertainment platforms that offer music streaming, online karaoke, and live streaming services in the People's Republic of China. Tencent Music Entertainment is often described as the Chinese Spotify. While Tencent Music Entertainment owns shares in Spotify, and Spotify owns shares in Tencent Music Entertainment, the two businesses cannot be directly compared. Tencent Music Entertainment offers QQ Music, Kugou Music, and Kuwo Music, allowing users to discover music in personalized ways. The platform also provides long-form audio content such as audiobooks, podcasts, and talk shows, along with music-oriented video content like music videos, live performances, and short videos. Additionally, WeSing allows users to sing along to a library of karaoke songs and share their performances with friends in audio or video formats. The company also offers music-centric live streaming services primarily through the Live Streaming tab on QQ Music, Kugou Music, Kuwo Music, WeSing, Kugou Live, and Kuwo Live. These services provide an interactive online stage for performers and users to showcase their talent and engage with a diverse audience base. Additionally, the company operates Lazy Audio, an audio platform. In addition, it sells music-related merchandise and artist-related items, such as branded apparel, posters, art prints, and accessories. It also provides integrated, technology-driven music solutions to assist IoT device manufacturers in creating and managing their branded music services on their devices. Furthermore, the company offers advertising services on its online karaoke platform and music apps. Tencent Music Entertainment is the largest online music and audio entertainment platform in China, with 576 million users and a market share of 60%, according to Statista. I believe it is safe to say that once a company has a market share of 60%, they have established a strong brand moat. Tencent Music Entertainment also owns shares in Warner Music and Universal Music Group.
The CEO is Zhu Liang. He became the CEO in April 2021. He has extensive experience from Tencent, where he has held various positions since joining the company in 2003. Prior to joining Tencent, he worked for Huawei. He has a doctorate degree in signal and information processing from Tianjin University. We don't have much information on Zhu Liang, as he has only been the CEO for a few years. These years have been particularly challenging, especially in China. Therefore, we cannot draw any meaningful conclusions from the results of Tencent Music Entertainment. However, he was chosen because he has a proven track record from Tencent in building successful online entertainment platforms and social ecosystems. He is known for delivering strong results by expanding into new business areas. One reason I am quite confident in Zhu Liang is that he is an internal candidate who has been with the organization for many years. Hence, I believe that he has worked his way up and deserves an opportunity like this. Luckily, he also receives support from the former CEO, Cussion Kar Shun Pang, who is now the Executive Chairman of the board. Nevertheless, since the management is still new, it is relatively unknown how they will perform in the future.
I believe that Tencent Music Entertainment has a moat. Despite some uncertainties surrounding management, I still have confidence in their abilities. Now, let's analyze the numbers to determine if Tencent Music Entertainment meets our criteria for possessing a competitive advantage. If you need an explanation of what the numbers represent, you can refer to "MY STRATEGY" on the website.
The first metric we will investigate is the return on invested capital (ROIC). I would like a 10-year history demonstrating a minimum annual growth of 10%. Tencent Music Entertainment made its IPO in 2018, so we do not have numbers before 2018. Tencent Music Entertainment has delivered an underwhelming Return on Invested Capital (ROIC) since its IPO, as it has not exceeded 10% in any of the six years for which we have data. Tencent Music Entertainment was on track to achieve a Return on Invested Capital (ROIC) above 10% in 2019. However, the company has encountered challenges due to the pandemic and a difficult business environment in China, which could account for the disappointing performance. It is encouraging that there has been a recovery in ROIC in 2023, but it is still below the required 10%, which is underwhelming.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The numbers are a bit mixed as the equity has decreased in two out of five years. However, these years of decline were particularly challenging for all Chinese companies due to new regulations and lockdowns, which had a negative impact on Chinese consumer spending. It is encouraging that Tencent Music Entertainment has reached its highest level in 2023, and hopefully, its equity will continue to grow moving forward.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Free cash flow has reached its highest level in the past two years, which is encouraging despite a slight decrease in free cash flow in 2023. Tencent Music Entertainment has maintained a levered free cash flow margin above 20% in four out of six years, which is very encouraging. The levered free cash flow margin decreased slightly in 2023 but is still higher than the six-year average. Nonetheless, I would like to see both free cash flow and levered free cash flow increasing moving forward. Free cash flow yield is around the six-year average, indicating that Tencent Music Entertainment shares are neither cheap nor expensive. However, we will revisit this later in the analysis.
Another important aspect to consider is the level of debt. It is crucial to determine if a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After analyzing Tencent Music Entertainment's financials, I found that the company has 1,15 years' worth of earnings in debt. It is less than three years' worth of earnings in debt, which means that debt is not a concern for me when investing in Tencent Music Entertainment. It is also worth noting that this is the lowest earnings-to-debt ratio that Tencent Music Entertainment has had in the past four years.
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Based on my findings so far, I find Tencent Music Entertainment to be an intriguing company. However, no investment is without risk, and Tencent Music Entertainment also has its fair share of risks. One risk is that Tencent Music Entertainment relies on third-party licenses. Significant portions of Tencent Music Entertainment's music and long-form audio offerings are licensed from their content partners, including leading publishers and labels in China and internationally, with whom they have entered into distribution and licensing agreements. There is no assurance that the licenses currently available to Tencent Music Entertainment will continue to be available in the future at royalty rates and on terms that are favorable, commercially reasonable, or at all. The royalty rates and other terms of these licenses may change due to various reasons beyond Tencent Music Entertainment's control, such as shifts in their bargaining power, changes in the industry, or alterations in the legal or regulatory environment. If Tencent Music Entertainment's content partners are no longer willing or able to license content to Tencent Music Entertainment on terms acceptable to them, the breadth or quality of Tencent Music Entertainment's content offerings may be adversely affected, or its content acquisition costs may increase. This could potentially impact the business of Tencent Music Entertainment. Regulations. China's internet, music entertainment, and long-form audio industries are extensively regulated. Chinese regulators extensively oversee the internet industry, including regulations on foreign ownership of companies within the sector and the corresponding licensing requirements. If Tencent Music Entertainment fails to obtain and maintain the approvals, licenses, or permits required for their business, they could be subject to liabilities, penalties, operational disruption, and their business could be materially and adversely affected. In addition, if new laws, regulations, policies, or guidelines are introduced to impose additional regulatory approvals, licenses, permits, and requirements, as we have seen, especially in 2021 in China, Tencent Music Entertainment's business may be disrupted, and their results of operations may suffer. Competition. Tencent Music Entertainment operates in a competitive industry. They compete for users' time and spending primarily with the online music services provided by other providers in China. Tencent Music Entertainment also faces general competition from online offerings of other forms of content, including long-form audio, karaoke services, live streaming, radio services, literature, games, and videos provided by other social entertainment service providers. In particular, Tencent Music Entertainment is increasingly facing noticeable competition from emerging forms of content that have been rapidly growing in popularity in recent years, such as live streaming and user-generated short videos.
There are also numerous reasons to invest in Tencent Music Entertainment. One reason is the increase in paid subscribers. Tencent Music Entertainment's paid subscriber count surpassed the 100 million milestone in 2023. Tencent Music Entertainment added 18.2 million subscribers in 2023, up from 12.3 million in 2022, which indicates a positive trend. With the accelerating year-over-year growth in subscription revenues throughout 2023, Tencent Music Entertainment's online music services delivered faster-than-expected revenue growth. Music subscription revenue was up by 39% year-over-year in 2023, driven by growth in both paying users and average revenue per paying user. Management has mentioned that they are confident that the online music business will maintain solid growth in 2024, with subscription services serving as a primary driving force. Furthermore, the most active users are aged between 30 and 80 years old. This indicates that Tencent Music Entertainment will prioritize young user groups, as they have the greatest potential for growth. In-house and collaborative content. Tencent Music Entertainment's in-house and collaborative content continued to grow, which is significant because it comes with higher margins. This growth is one of the reasons why profit margins increased in 2023. Tencent Music Entertainment featured 10 songs at the China Media Group 2024 Spring Festival Gala, creating significant social buzz. This increased user engagement on their platform and significantly enhanced Tencent Music Entertainment's national influence. Tencent Music Entertainment aims to maximize the value of its in-house and collaborative content through innovation. For instance, they expanded their live performance business by incorporating various event formats in 2023. Capitalizing on the resurgence of offline music events, they hosted a growing number of music tours, festivals, and live-house performances to meet the strong demand. If Tencent Music Entertainment can continue to grow this segment, it will have a positive impact on margins. Partnerships. While relying on third-party licenses can pose a risk, it is also a strength for Tencent Music Entertainment. By leveraging and deepening partnerships with domestic and international record labels, Tencent Music Entertainment consistently reinforces its competitive edge with an ever-expanding selection of copyrighted music. By the end of 2023, Tencent Music Entertainment had over 200 million music and audio tracks on their platform. Tencent Music Entertainment recently renewed its multi-year partnership with Universal Music Group to provide its users with continuous access to its extensive and expanding music catalog. The partnership also includes a significant sound quality enhancement, offering music streaming in Dolby Atmos and high-definition formats. Tencent Music Entertainment believes it has established mutually beneficial relationships with labels and artists, as well as improved the efficiency of managing content costs, leading to higher profit margins in 2023.
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Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 0,44, which is from the year 2023. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 17,2% in the next five years, but 15% is the highest number I use. Additionally, I have selected a projected future P/E ratio of 30, which is double the growth rate. This decision is based on Tencent Music Entertainment's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $13,20. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Tencent Music Entertainment at a price of $6,60 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 1.034, and capital expenditures were 23. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 16 in our calculations. The tax provision was 116. We have 1.559 outstanding shares. Hence, the calculation will be as follows: (1.034 – 16 + 116) / 1.559 x 10 = $7,27 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Tencent Music Entertainment's free cash flow per share at $0,65 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $10,26.
After investigating Tencent Music Entertainment, I find the company intriguing. We don't know much about the management, but he was chosen because he has a proven track record from Tencent in building successful online entertainment platforms and social ecosystems, which is encouraging. There are some risks associated with Tencent Music Entertainment. One is that they rely on third-party licenses to deliver the music that their subscribers would like to hear. There is no assurance that the licenses currently available to Tencent Music Entertainment will continue to be available in the future at royalty rates and on terms that are favorable, as these companies will have their own interests in mind. Since 2021, there have been extensive regulations in China. If China introduces new laws, regulations, policies, or guidelines that impose additional regulatory approvals, it could negatively impact businesses. Competition is a long-term risk for Tencent Music Entertainment as it competes with various entertainment companies for subscribers. Tencent Music Entertainment's increase in the number of paid subscribers and average revenue per paying user is expected to enhance profit margins in the future. Another factor that can boost profit margins is Tencent Music Entertainment's in-house and collaborative content, which is constantly expanding. Finally, Tencent Music Entertainment consistently reinforces its competitive edge with an ever-growing selection of copyrighted music through its partnerships. Despite this, I am disappointed that Tencent Music Entertainment has not achieved a Return on Invested Capital (ROIC) above 10% since its Initial Public Offering (IPO). Therefore, I believe there are better investment opportunities, and I will not be investing in Tencent Music Entertainment at this time.
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