Tencent Music: What supports performance after the net increase in members slows down? (2Q24 performance conference call minutes)

The following is the summary of the second quarter performance conference call of Tencent Music in 2024. For financial report analysis, please refer to "Tencent Music: Minor Flaws but a Sharp Decline, Was the Beauty Wrongly Killed?"

1. Key Points from Management:

1) Financial Data: IFRS net profit increased by 33% year-on-year to RMB 1.8 billion; non-IFRS net profit increased by 26% year-on-year to RMB 2 billion.

Total revenue was RMB 7.2 billion, a 2% year-on-year decrease. Strong growth in online music service revenue largely offset the decline in social media and other service revenues. In Q2 24, online music revenue increased by 28% year-on-year to RMB 5.4 billion. This growth was mainly driven by strong growth in music subscription revenue, advertising revenue, and offline performance revenue.

In Q2 24, music subscription revenue reached RMB 3.7 billion, a 29% year-on-year increase and a 3% increase from the previous quarter. Monthly ARPPU was RMB 10.7, higher than RMB 9.7 in the same period last year. The number of online music paying users was 117 million, an 18% year-on-year increase, with a net increase of 3.5 million paying users in the quarter.

Advertising revenue also achieved strong year-on-year growth, mainly driven by the growth of advertising-supported ads.

Social entertainment services and other revenue were RMB 1.7 billion, a 43% year-on-year decrease.

The gross profit margin in Q2 24 reached 42%, an increase of 7.7 percentage points year-on-year. Firstly, the expansion of paying user base, the increase in monthly ARPPU of online music, and the growth of advertising revenue had a favorable impact on our gross profit margin. Secondly, we have always regarded ROCE as a key indicator of cost management. Thirdly, the increase in the proportion of self-made content is beneficial to improving the gross profit margin. Finally, we have strengthened the monetization of membership and social entertainment advertising, which has had a positive impact on our gross profit margin. All these factors have contributed to a healthy gross profit margin.

Operating expenses in Q2 24 were RMB 1.1 billion, accounting for 16% of total revenue, compared to 17.2% in the same period last year. Sales and marketing expenses were RMB 0.21 billion, relatively stable compared to the same period last year.

Administrative expenses were RMB 0.938 billion, a 10% year-on-year decrease, mainly due to a reduction in employee-related expenses.

The effective tax rate in Q2 24 was 19.4%, compared to 12.2% in the same period in 2023. The main reason for the increase in the tax rate was the provision of RMB 0.111 billion in withholding tax when the Chinese subsidiary remitted profits to overseas entities In Q2, the company's IFRS net profit and non-IFRS net profit attributable to company shareholders were RMB 1.8 billion and RMB 1.7 billion, respectively. The non-IFRS net profit and non-IFRS net profit attributable to company shareholders were RMB 2 billion and RMB 1.9 billion, respectively.

During this quarter, diluted earnings per ADS reached RMB 1.07, a year-on-year increase of 30%, reaching a historical high. Non-IFRS diluted earnings per ADS increased to RMB 1.19, a 23% year-on-year increase. In May, we announced the new cash dividend for the 2023 fiscal year and paid USD 212 million in June 2024. As of June 30, 2024, the total balance of cash, cash equivalents, time deposits, and short-term investments was RMB 35 billion, compared to RMB 34.2 billion as of March 31, 2024, with the balance affected by changes in the RMB to USD exchange rate.

2) Content Ecosystem: Firstly, we continue to expand and strengthen our partnerships with artists and record companies to enrich our music library and bring the best content to our users. We have established long-term and extensive win-win partnerships with music record companies, allowing us to obtain more content-centered rights content for users, including but not limited to exclusive access to the latest popular songs. This quarter, we renewed cooperation authorization agreements with well-known Chinese bands like Sodagreen and top K-pop boy band ZEROBASEONE represented by CJ ENM, a leading record company in Korea. All these renewals include a 30-day new song pre-release phase. Overall, we are pleased to see that this pre-release phase effectively increases member conversion rates and engagement.

Secondly, we continue to explore more ways to attract users to appreciate music. This quarter, we combined video live calls, digital album releases, and other exclusive fan-artist interaction benefits, effectively increasing sales. The new digital album "Fan Shen Pronouns" by popular Chinese singer Zhou Shen is a recent successful case. The album sold over 1 million copies within 3 months of its release, becoming the annual sales champion on our platform. We also see good sales performance of digital albums by other singers such as Chinese singer Jane Zhang and Korean pop girl group aespa.

Thirdly, with the increasing demand for offline live performances, we are stepping up efforts to hold concerts and music festivals and provide more value-added services. In July this year, we held an upgraded version of our annual flagship event TMEA in Macau, namely the "Tencent Music Entertainment Awards 2024". This time, we brought exciting performances by domestic A-list singers, emerging musicians, and international idols. Notably, over 60 well-known stars including Zhou Shen, Yuan Yawei, Jane Zhang, and K-pop girl group BABYMONSTER performed at this year's ceremony. TMEA 2024 sparked discussions on social media platforms with billions of engagements, showcasing our increased industry investment. We have also strengthened our ability to host large concerts for top famous singers For example, we hosted TIA RAY's milestone tour concert, helping her achieve a milestone of over 10,000 fans attending. We are pleased to see a significant year-on-year increase in offline performance revenue in the second quarter.

This quarter, as a new initiative, we have customized event-themed artist merchandise for concerts by Yuan Yawei and Karen Mok, which have started selling on our platform. We also provided users with a members-exclusive online debut concert of a popular domestic band, which is also a remarkable benefit.

Fourthly, our self-produced content continues to gain popularity, increasing user conversion rates. We strategically leverage our extensive resources in television, film, IP, and artists to enhance the production, promotion, and success rate of our self-produced content. For example, we invited popular artists to compose original music for Tencent Video's hit TV dramas "Ode to Joy 5" and "The Story of Roses". These self-produced songs have accumulated over 200 million total views on our platform within 3 months of release, ranking top three on the OST charts. In addition, our self-produced pop songs "Heard You Say" and "Who am I" gained popularity on short video platforms shortly after airing on the national music variety show "The Voice of China 5", greatly boosting our platform's streaming views. Our high-quality original content combined with unique fan artist interactions caters to different music tastes and entertainment needs, promoting an increasingly active content ecosystem.

We have always been committed to inspiring society through music and sharing our love. In the second quarter, we partnered with Tencent Charity to launch the "Little Red Flower Concert", joining forces with artist volunteers and teacher volunteers to support education for rural children through online and offline performances. This time, through deep cooperation with WeChat video accounts, we live-streamed the concert, expanding online coverage and social impact.

3) Products and Services: Firstly, as part of our premium products, we have further enhanced sound quality and effects. For example, QQ Music upgraded its self-developed Audio 3D 2.0; Kugou Music introduced Viper Ultra Sound, both with ultra-clear sound quality. We also provide users with new ways to enjoy music, including certain Hi-Fi sound quality and the best sound quality for playlists. These improvements not only increase user engagement but also boost music consumption.

Secondly, we meet users' personalized needs. We have launched a series of benefits, including custom players and ringtones based on well-known IPs and singers. These features resonate with users' desire for self-expression, achieving good results in user conversion and retention rates.

Thirdly, our premium SVIP members are gaining more attention, providing a comprehensive, seamless auditory experience across various devices and scenarios. SVIP combines music with long audio and online karaoke services, always maintaining excellent sound quality. It has won the favor of active members with comprehensive online and offline privileges, such as priority access to digital albums and reservation of live music event tickets, including our TMEA We are pleased with the early progress of the SVIP membership system and look forward to sharing more exciting news with everyone.

Next is our more personalized music discovery and optimized listening experience. We have upgraded the recommendation component in the music app, allowing users to better discover songs and conduct tests. In this quarter, nearly 40% of the streaming comes from recommendations. As our large-scale audio models continue to evolve, we will continue to import more necessary music distribution and discover new long-tail content.

We have also enhanced the overall experience of the platform with the AIGC application. For example, we have introduced a data-saving, AI-enhanced SQ Lite mode. We have maintained excellent sound quality, and features like Kugou Music's virtual DJ and QQ Music's 3D avatars provide users with a sense of companionship. In terms of visuals, we have improved the streaming UI design to provide users with a more comfortable and relaxed experience. For instance, QQ Music has launched the industry's first multi-device matching playback feature and a compact half-screen music player. Now, users can enjoy seamless music streaming across different devices and apps.

Lastly, we have further expanded our reward program, adding more benefits such as artist merchandise. It is becoming increasingly popular among users, effectively promoting music content consumption and increasing user engagement. Overall, these efforts have led to high user stickiness on our platform, as reflected in the year-on-year and quarter-on-quarter growth in user usage time in the second quarter.

2. Analyst Q&A

Q: Could management share with us the performance growth, profit trends, and prospects for online music growth in the second half of this year and 2024? Will net additions or ARPPU become a more important growth driver?

A: Our view and outlook for 2024 remain unchanged, which means we expect healthy and positive revenue and profit growth this year. In terms of online music business, as mentioned earlier, we have added over 10 million net users in the first half of 2024, and ARPPU has increased from 9.7 yuan in the same period last year to 10.7 yuan, laying a very good foundation for us. With confidence in the dual drive of net user growth and ARPPU expansion, we expect our online music business to continue to maintain steady growth.

Therefore, in the past few quarters, our net additions have far exceeded expectations, mainly due to the accelerated growth of paid content and effective marketing strategies. As the pace of net asset growth returns to normal levels and grows at a more stable rate, we will focus more on ARPPU growth, expecting it to grow faster than net additions of subscribers.

One good news is that we are pleased to see that our rich privileges and overall service products have begun to gain more popularity among existing users. Therefore, our SVIP plan is doing very well, giving us confidence in the future growth of ARPPU. Therefore, in the short term, I believe that the net additions of users in the second half of 2024 will be lower than the first half, but ARPPU will show more significant growth in 2025, which will also help further improve our profit margin In terms of advertising revenue, I believe that due to the growth of the ad-supported tier and offline event sponsorships, there will be a good performance in the coming quarters. In the social entertainment sector, we expect to face continued challenges from competition, macroeconomic factors, and other elements. However, as this portion of revenue contributes less to our total income, the steady growth of our online music business will largely offset this impact. Therefore, in terms of profitability, our strategy is to focus on providing effective high-quality growth, and it has been proven that our strategy is effective. We now expect full-year net profit to be slightly higher than previously forecasted.

Q: Congratulations on achieving solid performance this quarter. I just want to follow up on the net addition. Regarding ARPPU, you mentioned that we will see a more significant growth in the second half of the year. Could management provide more details on how we plan to achieve this in terms of pricing, promotions, discounts, or provide more details on the progress of SVIP or other high-value-added services? How much growth do we expect in ARPPU, and will this growth, [I mean] in this overall soft background, lead to an increase in membership numbers?

A: Yes, indeed, I believe that the main driver of ARPPU growth in the second half of this year comes from the SVIP plan we launched. In the SVIP plan, in addition to providing content privileges, we also hope to offer other privileges to provide higher value to our members.

There are three key drivers for the SVIP business:

The first point is that our existing digital album business allows SVIP to enjoy the privilege of early listening, which can help us attract high-value customers.

The second point is that for those high-value customers of SVIP, they also pursue higher and better sound quality and effects. We can also say that from our actual operational data, their adoption rate of high-quality sound is also very high. This is also what we are going to do recently, to continue to improve sound quality and effects.

From the application perspective, in the first half of this year, we launched Dolby Atmos and Audio 3D 2.0. In July of this year, we just launched ETS. All these high-quality sound features will further create value for our SVIP members.

Thirdly, SVIP can enjoy value-added services for long audio content. Through other means, they can enjoy a seamless listening experience from device to device. In other words, for SVIP on the TME platform, they can enjoy content, long videos, and a seamless listening experience from device to device.

The membership fee for SVIP is about RMB 40 per month, which actually gives us more room to provide better benefits and more experiences for SVIP than regular users. At the same time, for our paying users, they are still the main body of our user group. We will continue to improve content and operations to ensure stable growth of SVIP users. I believe that in the next quarter's earnings call, we will share more data and strategies about SVIP with everyone

Q: My question is related to Super VIP. How should we view the proportion of Super VIP in the total number of paying users and the development trajectory in the coming years?

A: For SVIP, as I mentioned in my previous answer, due to continuous upgrades in sound quality, audio effects, and other driving factors, we will be able to maintain a rapid growth of SVIP members. At the same time, I have to say that our SVIP was almost starting from scratch. However, I believe that we still need some time before revealing more information to everyone. What I can tell you is that the growth of SVIP still meets our expectations.

Looking ahead, users who used to pay 8 RMB per month have now converted to Kugou users and QQ Music paying users, and they are now the mainstay of our user base. This is the current situation we see. Looking at the future 10 years or even longer, I believe SVIP will become a driving force for our future growth trajectory. We hope that SVIP will continue to maintain stable and solid growth, but we will disclose the corresponding data at the appropriate time.

Q: I would like to follow up on the trend of net increase in members, which is 3 million per quarter. I believe we have entered a stage of stable growth. How should we view our long-term penetration rate of paying users?

A: We hope that in the near future, the growth will be much better than our current net increase. But what can be certain is that in the first half of this year, after several holidays, we saw a comprehensive growth in net additions, but in the second half of this year, we still have steady growth.

From an operational strategic perspective, we still hope to maintain the growth of subscription users. However, the most important thing we must always remember is revenue and profit. As we have discussed with everyone, we do hope that revenue and profit can meet the annual target. If we can achieve this, then we can continue to expand our user base in a high-quality manner. So, you can expect the results.

From an operational strategic perspective, I think we have made it very clear. We hope to maintain stable and good growth in the number of users. In addition to focusing on net user additions, we should also pay attention to user retention rate, because only by achieving high-quality user growth can we maintain a strong retention rate of high-quality users. This will help our business to further grow significantly.

Regarding user penetration rate, we still hope to maintain our past commitments to the market. We are also confident in achieving our medium to long-term user number targets. So, for the second half of this year, besides increasing the number of users, we will continue to strengthen our sales and promotion strategies to ensure that we can attract new customers and then further increase our user base. This is also what I mentioned just now. In the long run, we are still very confident in reaching our user numbers and hope that we can fulfill our commitments to the market.

Q: My question is about our profitability and profit margin trends. I just want to know, can the management tell us how to view the speed of gross margin expansion in the second half of this year and next year? What is the mid-term gross margin level we may reach? For net profit margin, how should we view the further space for cost optimization and the future trend of net profit margin? **

A: It can be said that in the past 9 quarters, the company's gross profit margin and net profit margin have been continuously increasing. Therefore, overall, we still have great confidence in achieving good performance in terms of gross profit margin and net profit margin. Regarding the growth of profit margins, on one hand, from the perspective of revenue, both subscription business and advertising business revenues are continuously increasing. However, at the same time, in the near future, if our SVIP plan can be well executed, it will also make another positive contribution to our gross profit margin.

Another point, from the perspective of costs, we will continue to focus on the development of the music industry and have made significant investments in this industry. We also maintain very close cooperation with copyright holders, and it can be said that these substantial investments have yielded very fruitful results. We have also managed the return on capital employed for copyrights and IT expenses, continuously improving utilization and efficiency.

The third point is that the contribution of our self-produced content will continue to grow, which will also have a positive impact on our gross profit margin.

The fourth point, even though we have seen a slight decline in social business, the number of members continues to grow, which will also benefit the overall gross profit margin.

Regarding further optimization space for operating costs (operating costs & operating expenses). If we look at sales expenses, it can be said that in the past few quarters, our management of sales expenses has been quite disciplined and effective, achieving very good results. At the same time, we expect the sales expense ratio for the whole year to be the same as last year.

As for general and administrative expenses, if you look at the performance in the first half of this year, you can see that there is still a slight decrease compared to last year. We will continue to improve operational efficiency and expenditure management efficiency. In other words, we believe that the proportion of general and administrative expenses to total revenue this year will be lower than last year.

Therefore, overall, we believe that we will see good improvements compared to last year, whether in gross profit margin or net profit margin. However, the increase in net profit and net profit margin will be better than the growth of gross profit/gross profit margin. In the long run, as our online music business continues to maintain stable and positive growth, we are also confident in the future growth of gross profit margin and net profit margin.

Q: My question is about macroeconomic adverse factors. Given the recent macroeconomic uncertainties we have seen, how should we consider the impact on our different business segments (subscription, advertising, and social entertainment)? The second question is about competition. Have we really seen changes in the competitive landscape?

A: I will answer the first question about the macro environment. The downturn in the macro environment will certainly bring some challenges to different aspects of the business. However, I believe that for TME's online music business, frankly speaking, it is truly valuable and relatively low-cost entertainment that all users can afford.

Therefore, you can see that in our subscription business, the online music business has not been greatly affected by the macro environment. In terms of advertising, we have also performed well in these two quarters. Although the advertising expenses of some advertisers may be affected to some extent, we see that we are still doing well, especially in some areas related to tourism and activities related to our sponsorship of offline music events Therefore, I believe that besides sponsorship, we are also exploring new forms of advertising, which can help us further develop our advertising business with great momentum. Thus, I think the overall macro environment has little impact on TME. Moreover, we remain confident in our long-term business health goals.

Regarding your second question about online music, especially the competitive landscape, I believe it is clear to everyone. We still have competitive players, or these players will remain in this market for the long term. This year marks our eighth anniversary, and our focus remains on doing well in our business. We will continue to follow a strategy of balancing content and platform. We firmly believe that as long as we continue to improve our content, enhance our competitiveness, and further refine and optimize the user experience, we will maintain our position in this market. At the same time, by further improving and optimizing the user experience, we will continue to maintain our position in this market.

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