Tencent Music Earnings: Margin Expansion Should Drive Earnings Growth in the Near Future

Narrow-moat Tencent Music’s TME first-quarter results slightly exceeded Refinitiv consensus expectations, and management is optimistic about margin expansion for the rest of 2023. Overall, we maintain our USD 12.50 fair value estimate, and we continue to view shares as undervalued. We think investors underestimate the size of Tencent Music’s long-term subscriber base and overlook margin expansion opportunities as revenue grows.

During the first quarter, total revenue finally rebounded (up 5% year over year) after five quarters of consecutive decline. Growth was led by a 30% increase in music subscription revenue, but was partially offset by a 13% decline in social entertainment revenue, that is, livestreaming. Despite an 11% increase in the average subscription price, paid subscribers grew 16% year on year, underscoring the enduring value of the firm’s network. With the average monthly subscription cost standing at just CNY 9.20 (USD 1.30), we see significant room for Tencent Music to hike subscription prices—a key driver of long-term revenue growth.

Profitability was another highlight in the first quarter, with gross margin coming in at 33.1%, an improvement of more than 500 basis points compared with the same period last year. Management attributes the improvement to sales leverage and various cost-control initiatives, and expect sequential improvement to continue in the second quarter of 2023.

We modestly lifted our earnings forecast for 2023 by 18% to account for stronger margins going into the rest of this year. We continue to like Tencent Music’s ability to convert freemium users to paid subscribers. With streaming subscriber/user ratio standing at just 16%, we remain confident that there remains significant room for subscription revenue growth. We also expect the firm to record higher profitability in the future as growing revenue brings more cost leverage. Our fair value estimate of USD 12.50 per share implies a 2023 price/earnings ratio of 28 times.