Tencent Music Entertainment Begins US IPO Effort

Quick Take

Tencent Music Entertainment (TME) intends to raise gross proceeds of at least $1 billion from a U.S. IPO, according to an F-1 registration statement.

The firm operates an all-in-one digital music entertainment platform in China.

TME has enviable financial and operational metrics, but valuation at IPO will be critical.

Company Technology

Shenzhen, China-based Tencent Music, previously known as China Music Corporation, was founded to enable people to create, enjoy, share and interact with music on an online music entertainment platform.

Management is headed by Director and CEO Cussion Kar Shun Pang, who has been with the firm since 2014 and was previously Corporate Vice President at parent firm Tencent (OTCPK:TCEHY).

Tencent Music has developed a digital music entertainment platform that allows users to seamlessly engage with music in many ways, including discovering, listening, singing, watching, performing and socializing.

Social interactions such as sharing, liking, commenting, following and virtual gifting, are integrated into its products, enhancing our user experience, engagement, and retention.

Below is a brief explainer video for Tencent Music:

(Source: UDtech)

Customer Acquisition

Tencent Music is part of Tencent’s larger internet ecosystem.

Tencent, the company’s controlling shareholder, is a leading provider of internet value-added services in China, offering a broad range of internet services.

Sales and marketing expenses as a percentage of revenue have been essentially flat, per the table below:

(Source: Company Prospectus and IPO Edge)

Market Competition

According to a market research report by Statista, the total digital music market in China has been growing at a CAGR of 6.7% during the period between 2013 and 2018, starting from $6.42 billion in 2013 to $8.91 billion in 2018.

Major competitors that provide digital music services in China include:

  • Ali Music Group (BABA)
  • NetEase Music (NTES)
  • Baidu Music (BIDU)

The company also faces competition from online offerings of other forms of content, including live streaming, karaoke, radio services, literature, long- and short-form videos provided by other online service providers, and games.

The social integration between Tencent’s social graph and Tencent Music’s platform gives the company an advantage over its competitors due to low cost and wide distribution and machine-learning data processing to optimize marketing placement for maximum consumer adoption.

Financial Performance

TME’s recent financial results can be summarized as follows:

  • Strong topline revenue growth, but at a decelerating rate
  • A sharp increase in gross profit
  • Continued growth in gross margin
  • Strong growth in cash flow from operations

Below are the company’s financial results for the past two and ½ years (Audited PCAOB for full years):

(Source: TME F-1)

Total Revenue

  • Through Q2 2018: $1.3 billion, 89% increase vs. prior
  • 2017: $1.66 billion, 147% increase vs. prior
  • 2016: $671 million

Gross Profit

  • Through Q2 2018: $526 million
  • 2017: $576 million
  • 2016: $189.5 million

Gross Margin

  • Through Q2 2018: 40.4%
  • 2017: 34.7%
  • 2016: 28.2%

Cash Flow from Operations

  • Through Q2 2018: $311 million
  • 2017: $378 million
  • 2016: $139.7 million

As of June 30, 2018, the company had $1.47 billion in cash and $740 million in total liabilities. (Unaudited, interim)

Free cash flow during the six months ended June 30, 2018, was $330 million.

IPO Details

TME intends to raise at least $1 billion in gross proceeds from an IPO of its IPO, although the final amount may be significantly different.

The firm is selling ADSs representing underlying Class A ordinary shares.

Class A shareholders will be entitled to one vote per share and Class B shareholders, which include parent firm Tencent, will be entitled to fifteen (15) votes per share.

Multiple classes of stock are a way for existing management or controlling shareholders to retain voting control of the company even after selling economic control to other shareholders.

The SP 500 Index no longer admits firms with multiple classes of stock into its index.

Management says it will use the net proceeds from the IPO as follows:

approximately 40% for investment to enhance our music content offerings to improve the variety, quality and quantity of content on our platform;

approximately 30% for product and service development to expand and enhance our current product and service offerings, as well as to develop new products and services to further enhance user engagement;

approximately 15% for selling and marketing, including marketing and promotions to strengthen our brand and grow our paying user base; and

approximately 15% for potential strategic investments and acquisitions and general corporate purposes.

Management’s presentation of the company roadshow is not yet available.

Listed underwriters of the IPO are BofA Merrill Lynch, Deutsche Bank Securities, Goldman Sachs [Asia], J.P. Morgan, Allen Company, BOCI, CICC, China Renaissance, Credit Suisse, HSBC, KeyBanc Capital Markets, and Stifel.

Expected IPO Pricing Date: Not yet on the calendar.

An enhanced version of this article on my Seeking Alpha Marketplace research service IPO Edge includes my initial commentary and underwriter performance for the IPO.

Members of IPO Edge get the latest IPO research, news, market trends and industry analysis. Get started with a free trial.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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