The performance guidance is not problematic, only that the expectations are overly sufficient. (Minutes of Tencent Music's 4Q22 earnings conference call)

Highlights from Tencent Music's 4Q22 Performance Conference Call Minutes, financial report analysis is available in review of Tencent Music: No more growth, but can a "thrift" strategy support the music dream?

I. Core Metrics vs Market Expectations

1. Revenue: Quarterly revenue of RMB 7.425 billion, YoY -2.4%, exceeding market expectations by 1.10%.

2. Gross Margin: Quarterly gross margin of 33%, YoY+4.2pct, basically in line with market expectations with a 0.1pct match.

3. Guidance:

• In 2023, revenue growth is expected to be in the mid-single digits (market consensus of 4%) and net profit growth is expected to be in the low double digits (market consensus of 11.5%).

• In 2023, quarterly online music service revenue is expected to surpass that of social entertainment services, with online music expected to grow more than 20% YoY (market consensus YoY growth of 17.3%). Tencent Music hopes to achieve gross margins of around 28%-30% in its online music business, on par with Spotify's member subscription business.

• Traditional live streaming in social entertainment continues to face competitive pressures, but steady growth in audio streaming and international business can partially offset this trend. Social entertainment is expected to experience relatively mild decline (market consensus decline of 6.6%).

• In 2023, overall gross margins are expected to grow YoY, with a long-term goal of gross margins reaching 35%.

• In 2023, net profit margins are expected to improve (market consensus for IFRS net profit margins is 17.32%, a 3.5pct increase from 2022).

II. Management Statement

1. Review of 2022 and Outlook for 2023

In the rapidly changing macro environment of 2022, Tencent Music continued to innovate and implemented effective cost optimization measures, resulting in strong growth in profitability for the full year and steady growth in online music subscription revenue. The commercialization model continued to evolve, with good progress in incentivized advertising, long-form audio content, and audio streaming and international businesses. Another noteworthy achievement is Tencent Music's sustained development of the "music + public welfare" model, which innovatively integrates the emotional expression and influence of music, creating more possibilities and value for social progress. In addition, based on the company's solid confidence in its long-term development, it completed the $1 billion share repurchasing program approved by the board of directors in 2021.

Looking forward to 2023, Tencent Music will seize development opportunities and is expected to surpass social entertainment services in quarterly online music service revenue this year. With continued growth strategy, Tencent Music is confident that it can achieve YoY growth in total revenue and profit levels, with continued enhancement of user quality, and contribute to the industry's prosperity and win-win cooperation. 2. 2022 Results

(1) Deepen cooperation with top artists, record companies and industry partners at home and abroad to provide diverse rights and benefits to users and artists

The company has reached a renewal agreement with JVR Music Co., Ltd., and the two parties will continue to develop close strategic cooperation. The company will continue to provide users with high-quality works under JVR through its platform and provide more unique music experiences.

In the fourth quarter, the company also deepened its strategic cooperation with top record companies such as Believe Music and provided works by well-known artists such as Mayday to users. Through extensive cooperation with Billboard, the company independently achieved record high visitor numbers for the "2022 Music Journey Report" released on its QQ Music platform.

In addition, the company supported music talents such as Pan Yunqi to quickly grow into high-quality rising stars. In the fourth quarter, it collaborated with Coca-Cola to create a music party and promoted it to the world through Billboard's global network. With the platform's assistance, Pan Yunqi won third place in the "2022 China Voice of China" and became one of Billboard's cover persons in December.

Recently, the English version of the "Tencent Music You List" officially debuted on the Billboard Global website, becoming the only Chinese-language music chart from mainland China. It invited well-known producers to create the first personal mini digital album (EP) for the company's strategic cooperative artist Chen Zhuoxuan, and the song "Skylight" topped QQ Music's new song chart and continued to top multiple music charts.

(2) Continuously enhance original content production support capability through innovative intelligent tools and end-to-end rich resources and perfect service system

The company launched its first hyper-realistic virtual idol, Lu Xiaoxi LUCY, as well as three other virtual idols, Xiaoqin, Shanbao, and Anke, who have original works, unique voices, and dance moves.

Based on the Qinyin Engine of the company's Tianqin Laboratory, Lu Xiaoxi LUCY has a disc-level voiceprint that is automatically generated. After its debut in the fourth quarter, it has appeared on multiple cooperative stages and received widespread attention from global business customers.

As of the fourth quarter, the independent musicians on the company's Tencent Musicians platform have created more than 2.3 million music works together. At the same time, it pays more attention to the development of the music industry ecology, and launches more functions and intelligent tools for independent musicians. In addition to accelerating song creation and release, it also helps them obtain additional income from audience appreciation on the basis of album sales revenue.

Nearly 1,000 popular original works created by songs produced and launched by the company have exceeded one billion plays in 2022.

In the fourth quarter, the popular song "Grant Me" topped various music charts with nearly 500 million plays. Another popular song "Turn Into Fireworks and Fall for You" was widely used as music background on social media, receiving over 5 billion social media topic views. Deepening cooperation with Tencent's ecology, the company jointly produced and launched 111 game and animation songs in 2022. Among them, the song "Forest Love Song" produced for "Peace Elite" successfully reached the final of the "13th Hollywood Media Music Awards Best Hand Game Song".

• Continuous Enhancement of Product Features, Providing Users with Comprehensive Music Companion -

We continue to layout and develop breakthrough AIGC innovative tools, relying on technological power to continuously enable the creation and production efficiency of music-related content. For example, the launch of the Muse engine achieves automated and scaled music poster generation based on song melody and lyrics.

In the field of long audio, the company has expanded the use of its self-developed Lingyin engine and launched long audio content for synthetic voice reading.

In addition, QQ Music, a subsidiary of the company, has launched the VR New Year Card function. Users who receive the card can enter the virtual gift space generated automatically and receive blessings in the form of virtual images. We have comprehensively improved the sound quality and sound effects and brought users more vivid listening experiences through the introduction of a brand new Zhenpin series sound quality and flexible customizations such as pitch and speed adjustments.

In the fourth quarter, the personalized recommendation play count and average play time per recommender of the company's products continued to grow. We comprehensively expanded our ecological cooperation with WeChat Video Accounts, enriching users' visual experience and exploring new models of audio and video content distribution.

TME Live deepened cooperation with WeChat Video Accounts, attracting a wider range of users to participate in paid and free music performances, and providing users with innovative online and offline integrated interactive gameplay. The guests of its fourth quarter performances included Ryuichi Sakamoto, Andy Lau, and Hacken Lee.

In addition, the company's song recognition function can automatically identify the background music of videos in WeChat Video Accounts, allowing users to jump to QQ Music to listen, set WeChat ringtones, or use the same music in their video content for publishing.

• Social Responsibility -

The company is committed to practicing social responsibilities. In the fourth quarter, the company launched the "China Rhythm · Guangxi Wind" theme event, inviting singers Hu Xia and Liu Yuxin to promote traditional culture in the form of digital music. Many music works from the company's previously released "China Rhythm 2020" public welfare album were also officially included in the first batch of network digital version collections of the Chinese National Versions Museum in December 2022, using digital form to assist in recording and inheriting Chinese civilization.

• Platform Progress in 2022 -

In 2022, we continue to firmly promote the "One Body, Two Wings" strategy of content and platform, launching a series of innovative intelligent tools, and relying on end-to-end content service systems and promotion resources to help partners realize more content value. At the same time, we continue to innovate in each of the four music entertainment pillars of "Listen, Watch, Sing, and Play" to provide all music lovers with fascinating and unique experiences. With a new mission vision of "Creating Unlimited Music Possibilities with Technology," we launched multiple product upgrades in the fourth quarter and achieved groundbreaking progress in virtual idols, sound quality, visual effects, social functions, and virtual entertainment experiences. We have also further expanded our extensive cooperation with WeChat Video Accounts under Tencent's eco-system, and carried out more innovative exploration in audio and video content distribution. In addition, we are continuing to layout and develop breakthrough AIGC innovative tools and have launched engines such as Qinyin, Muse, Lingyin, etc., relying on technological power to continuously enable the creation and production efficiency of music-related content. In the future, we will continue to explore the widespread application of large language models (LLMs) in various forms such as text, images, videos, as well as music recommendation and search to meet the huge demand for music-related content. We will continue to innovate in content and platform development, and fulfill our responsibility as a leading platform in the music industry to assist in upgrading the industry.

Q&A Session

1. Profitability

Q: Expected growth rates for online music service revenue, subscription user numbers and ARPPU, and social entertainment service revenue in 2023?

A: In general, it is currently expected that 2023 will be a year of positive growth with revenue growth expected to be in the mid-single-digit percentage and net profit growth expected to be in the low-double-digit percentage.

1) Online Music Services: At some point this year, quarterly revenue from online music services is expected to surpass that from social entertainment services, becoming the main source of revenue. This is driven by policies that support growth at the macro level in China, as well as the company's continued investment in strengthening its operations in online music.

Subscription revenue is expected to continue achieving healthy year-on-year growth of over 20%, driven by the growth in paying users and ARPPU. In addition, advertising, long audio, and Internet of Things (IoT) services are expected to make meaningful contributions to growth.

2) Social Entertainment Services: Although traditional video livestreaming continues to face competition pressure, TME's audio livestreaming and international business can partially compensate by providing healthy growth, resulting in an expected moderate decline in social entertainment business compared to last year.

3) Overall: Based on all the above circumstances, and with the company's continued focus on cost management to improve efficiency, net profit margin is currently expected to continue improving in 2023.

Q: In 2022, due to the faster growth of online music services compared to social entertainment services, gross profit margin continued to expand. Can this trend continue in 2023 or even 2024? Currently, the gross profit margin for online music services is still lower than that of social entertainment services, and its growth rate is faster than that of social entertainment services. What is the expected gross profit margin in the next 1-2 years?

A: (1) 4Q22

TME's gross profit margin is 33% in 4Q22, with a YoY increase of 4.2pct and a QoQ increase of 0.4pct. The main influencing factors are as follows:

• Positive factors:

1. Net increase in monthly subscription users, and long-term user revenue growth from subscription digital albums, artist-related merchandise, long audio, etc. had a positive impact on gross profit margin.

2. Reduced promotional activities, improved content quality, and a decrease in the percentage of revenue sharing from live streaming.

3. Increased RC (Revenue Contribution) requirements for content costs to optimize the RC model, and restrictions on certain music companies' terms to shift from MG model (minimum guarantee copyright fee) to revenue sharing model. This adjustment has received positive feedback and generated more reasonable income.

4. Technological and operational strategies related to bandwidth and storage capacity improved the utilization rate of services and equipment, and operating costs were lower than the previous year and previous quarter.

• Negative factors:

The decrease in social entertainment revenue and the change in social entertainment revenue structure had a negative impact on gross profit margin. （2）Expected for 2023

Looking ahead to 2023, all positive and negative factors will continue. The company will continue to use tools such as incentive advertising, artist-related merchandise, and super VIP membership to promote monetization expansion, and it is expected that online music revenue will continue to grow. In addition, we will continue to focus on reducing costs and increasing efficiency.

Overall, it is expected that the gross profit margin will increase year-on-year in 2023.

Q: Mid-term gross profit margin target, and the impact of investing in LLMs

A: The online music gross profit margin hopes to reach the level of Spotify.

In 2023, the overall gross profit margin is expected to increase year-on-year; the long-term gross profit margin target is 35%.

Q: Brand cooperation plan, and its impact on gross profit margin

A: TME is the preferred partner for domestic and foreign brands and artists, and insists on doing this IP to promote the healthy development of the Chinese music industry. Currently, TME provides Chinese users with the most comprehensive music library.

In terms of long-term cooperation, we will continue to work with brands to produce content, promote music better through leading music and advanced technology. In addition, with the relaxation of the epidemic, there will be many opportunities for live events, so we are also paying attention to live events. In 2022, TME Live launched many high-quality music events, most of which were online; in 2023, we will jointly launch more offline events with brands, such as top artist concerts, music festivals, etc.

Currently, we have established good long-term cooperative relationships with most of the brands around the world, proving that TME is a trustworthy partner, and we expect more cooperation in the future.

Q: Sales & Marketing Expenses Plan for 2023

A: In 4Q22, we will strictly control sales and marketing expenses, YoY-65%. At the same time, we balance MAU and monetization, that is, we pay more attention to user engagement, user retention rate, and paying users when evaluating the health of our business. We will further monitor the ROI of each promotion channel, more effectively manage internal and external resources, and improve sales and marketing efficiency.

In 2023, sales and marketing expenses will be maintained at a low level and achieve a year-on-year decrease (but the decrease is limited). In 2023, we will invest in content promotion, which is a new way to increase MAU.

2. Segment Business

Q: Status and Outlook of Advertising Business

A: (1) Advertising Revenue

After the epidemic is released, advertising revenue continues to recover.

1. Splash screen ads continue to recover at a healthy rate.

2. The proportion of incentive advertising continues to increase, currently accounting for about 15% of advertising revenue.

3. Although sponsored advertising in 4Q22 has temporarily weakened due to the epidemic, there will be more live events as the epidemic is released, which will bring more opportunities for sponsored advertising.

In summary, it is expected that 2023 will be a strong recovery year, and the advertising business will grow actively.

(2) Vertical Fields

In 4Q22, given the seasonality of e-commerce, the vertical field of e-commerce shows meaningful growth. General Internet services, food and beverages, consumer electronics, and local services are vertical fields where advertisers demand increases. Q: AI Strategic Planning and Relevant Potential Investments or Cost Impacts

A: We have been investing in AI-related fields all along. Recently, the emergence of LLMs models will change some TME applications. TME mainly focuses on upper-layer applications and will maintain cooperation with Tencent Group while using relatively advanced engines to drive applications. Applications include conversational song recommendations, playlist creation, and image, video and voice generation. Currently, the applications of music player, app icons, lyrics posters, and music greeting cards have been well implemented.

In the future, we will continue to invest heavily in self-developed LLMs to drive the added value of conversational, graphic and video, and music fields closely related to music. Currently, more and more large models are used to generate music, lowering the threshold for music creation.

In general, LLMs do not have a significant impact on creativity. The core logic of using LLMs is to lower the threshold of many links and improve efficiency, so that AI-generated content can be fully applied in practical operations.

Q: Reasons for the growth of online music ARPPU and outlook for 2023

A: We hope to continue to promote ARPPU growth through improving the quality of member services and the comprehensiveness of member benefits, more extensive platform internal and external sales channels, and more effective promotional activities.

Q: Does the improvement in sales and marketing expenses and profits imply a decrease in competitive pressure from videos and a more stable competitive landscape (unanswered); Long-term outlook for the revenue proportion of online music and social entertainment

A: In the long run, we hope that the revenue from online music services exceeds that of social entertainment, and online music services become the main source of revenue.

In 4Q22, the growth rate of online music subscription revenue just exceeded 20%, while non-subscription revenue grew faster due to the low base in 2021. Looking at 2023, the situation will be slightly different: subscription revenue will grow by more than 20% YoY; with regard to non-subscription revenue, advertising, long audio and IoT services will achieve good growth, but will be offset to some extent by the fluctuations of digital albums and licenses. In addition, benefiting from unique platform and content strategies, as well as sponsored advertising for content production, content licensing, and live events, TME has begun to monetize. At the same time, the sales revenue of artist-related merchandise has started to emerge, which helps to further explore e-commerce opportunities for TME. All of the above are expected to become new sources of revenue in the future.

Q: Trends in paid subscription user growth and views on increasing offline entertainment activities

A: Excluding the impact of the pandemic, user growth has always followed a long-term trend. We are more concerned with the overall subscription revenue driven by the growth of paying users and ARPPU.

Increasing offline activities are conducive to advertising monetization- TME has organized a large number of offline music events, thereby generating good sponsorship advertising revenue. This part of the business was temporarily affected by the epidemic in 4Q22, and it is expected that with the increase of offline activities after the epidemic is lifted, it will push for an increase in sponsorship advertising revenue as the second growth driver outside of online music subscription revenue. This article's risk disclosure and statement: Dolphin Research's Disclaimer and General Disclosure