Company Reports

Cloud Music is the second largest music streaming platform in China, with over 180 million monthly active users, about one third that of Tencent Music Entertainment’s, or Tencent Music. As exclusive licensing practices have been prohibited by China’s antitrust laws, we believe Cloud Music should now grow its content through direct licensing from music labels at costs lower than sublicensing from Tencent Music. This could allow it to grow subscribers rapidly and gain market share in the music streaming industry.

Cloud Music’s second-half 2023 earnings beat our expectations, and we are raising our fair value estimate by 18% to HKD 153. The bulk of our upward revision comes from the assumption that Cloud Music can maintain current cost discipline, while the duopoly structure of China's music streaming market won’t ignite a price war that could erode profitability. The company turned profitable for the first time in 2023, and Cloud Music is on a better footing to deliver consistent shareholder returns. We think the company’s shares are deeply undervalued, trading at a 30% discount to our fair value estimate.

Cloud Music is the second largest music streaming platform in China, with over 180 million monthly active users, about one third that of Tencent Music Entertainment’s, or Tencent Music. As exclusive licensing practices have been prohibited by China’s antitrust laws, we believe Cloud Music should now grow its content through direct licensing from music labels at costs lower than sublicensing from Tencent Music. This could allow it to grow subscribers rapidly and gain market share in the music streaming industry.

We fine-tuned our NetEase and Cloud Music estimates but maintained our fair value estimates. Both companies are significantly undervalued and contrary to concerns over a negative macroeconomic climate, we believe their earnings possess a degree of resilience to further economic downturns. Our top pick in the interactive media space remains NetEase. We like that its videogame business should continue to benefit from this year’s launches of a slate of open-world titles and a growing number of government-issued game licenses. Meanwhile, NetEase’s separately listed subsidiary, Cloud Music, could benefit as consumers favor affordable streaming over more costly leisure activities, especially during economic downturns. The ease of access can lead to increased usage as people spend more time at home, and the habitual nature of these subscriptions means they will be the last discretionary expenses consumers choose to cut.

No-moat Cloud Music’s first-half 2023 results exceeded our expectations. We lowered our 2023 revenue forecast on continued livestreaming weakness but upped our margin assumptions considering better-than-expected cost controls. Our longer-term earnings estimates remain largely unchanged. Overall, we are maintaining our HKD 130 fair value estimate, and we continue to believe the shares are undervalued. With $1.2 billion of net cash on its balance sheet as of the end of June 2023, Cloud Music is trading at an enterprise value/2023 sales ratio of just 0.5 times, significantly below the roughly 2 times EV/sales ratios of its peers Tencent Music and Spotify. We believe investors are underestimating the size of its long-term subscriber base and margin upside opportunities as the top line grows.

We maintain our fair value estimate of HKD 130 for no-moat-rated Cloud Music following its parent company NetEase releasing earnings with limited financial information on Cloud Music. To us, the biggest surprise was Cloud’s latest change in strategy which led to a double-digit decline in its live-streaming revenue during the first quarter. We view this as part of the company’s pivot to focus more on profitability than revenue size. Gross margin in the first quarter improved to 22.4% versus 17.8% in fourth quarter 2022, and we attribute part of this margin improvement to Cloud’s lowering of revenue sharing with live streamers.

No-moat Cloud Music closed 2022 with robust revenue growth and significantly improved profitability on the back of subscriber addition and better cost control. While full-year revenue of CNY 9 billion is in line with what we expected, gross profit margin of 14.4% came in above our previous prediction of 12%, thanks to more rationalized music content cost. We are also impressed that Cloud Music managed to cut net losses by CNY 1.8 billion, a larger magnitude than our expectation, given increasing cost initiatives. Looking forward, we believe Cloud Music will retain high mindshare among the young generation of music listeners, and maintain our fair value estimate of HKD 130. Despite the recent run-up in valuation, we still view shares as undervalued, as the persisting subscriber growth and margin uplift have not been fully appreciated by the market.

Cloud Music is the second largest music streaming platform in China, with over 180 million monthly active users, about one third that of Tencent Music Entertainment’s, or Tencent Music. As exclusive licensing practices have been prohibited by China’s antitrust laws, we believe Cloud Music should now grow its content through direct licensing from music labels at costs lower than sublicensing from Tencent Music. This could allow it to grow subscribers rapidly and gain market share in the music streaming industry.

No-moat Cloud Music’s second-quarter results showed impressive improvement in profitability, with gross profit margin up significantly thanks to continuing content cost leverage. With a narrowing of adjusted net losses, the company demonstrated a much clearer path to generating profits in the future. As such, we moved forward our anticipated year of operating breakeven by one year to 2025. For operational metrics, both music streaming and social entertainment segments saw robust paying user additions versus the same period last year, but sequential growth slowed amid weak consumer sentiment and lifted prices. We retain our fair value estimate of HKD 130 and view shares as very underpriced, as the upside of top-line growth and margin expansion are not fully appreciated by the market.

Cloud Music is the second largest music streaming platform in China, with over 180 million monthly active users, about one third that of Tencent Music Entertainment’s, or Tencent Music. As exclusive licensing practices have been prohibited by China’s antitrust laws, we believe Cloud Music should now grow its content through direct licensing from music labels at costs lower than sublicensing from Tencent Music. This could allow it to grow subscribers rapidly and gain market share in the music streaming industry.

Narrow-moat Tencent Music posted second-quarter 2022 results that were ahead of our and Pitchbook's consensus expectations. Strong cost control measures led the firm’s gross margin to expand by almost 200 basis points compared with the previous quarter, reaching 30% in the second quarter of 2022. In addition, music streaming subscription revenue was also better than expected thanks to strong subscription pricing and growth in paying users. We fine-tuned our near-term forecasts, but maintain our fair value estimate at USD 8 per share. With its shares closing at USD 4.70 as of market close on Aug. 14, we view the firm as significantly undervalued. We think investors are underestimating its long-term subscriber base and the potential for more operating leverage as it grows the business.

On June 22, China’s National Radio and Television Administration and Ministry of Culture and Tourism released new regulations governing livestreaming, with guidelines that amount to a code of conduct for online livestreamers covering matters such as the qualifications required to livestream certain professional topics, for example medical and livestreamers’ tax liabilities. We believe there will be more specific responsibilities for internet audiovisual platforms, which could increase compliance costs. However, the regulations do not contain specific penalties if platforms are found to be negligent by the government, and we think performers face much greater risk. Article 15 and 16 of the regulations indicate the government will strengthen supervision and inspection as well as enforcement of rules for internet audiovisual platforms, agencies, and livestreaming hosts. If content and livestreamers violate these rules, platforms will need to deal with violations properly and quickly. Article 17 stipulates that internet performance, platforms, and agencies need to strictly adhere to statutory duties and obligations, enhance training and education, daily management, and guidance of standards for livestreamers. For example, internet hosts who commit serious or repetitive misconduct should be stopped and not allowed to conduct internet performance on another platform or use another account. We think that further regulations will be created if misconduct continues. At this stage, we expect the regulations will have an immaterial impact on the Chinese internet companies under our coverage. We maintain our fair value estimate, earnings estimates, moat and uncertainty ratings for Tencent Music, NetEase Cloud Music, Bilibili, Alibaba Health, JD Health, Alibaba, JD.com, and Pinduoduo.

No-moat Cloud Music reported strong revenue and earnings in the first quarter of 2022. Revenue growth of 39% year over year beat our full year estimate, and gross margin came in above our expectation. Despite robust quarterly results, we think the recent macroeconomic downturn and regulatory clampdown on live streaming will pressurize near-term top-line growth, but the longer-term impact on revenue is limited. We maintain our fair value estimate at HKD 130, as well as our upbeat outlook on the expansion of music streaming subscribers and live streaming paying users in the next few years. We continue to believe that the market is overlooking the upside potential in Cloud Music's major business lines, and view shares as undervalued.

Cloud Music is the second largest music streaming platform in China, with over 180 million monthly active users, about one third that of Tencent Music Entertainment’s, or Tencent Music. As exclusive licensing practices have been prohibited by China’s antitrust laws, we believe Cloud Music should now grow its content through direct licensing from music labels at costs lower than sublicensing from Tencent Music, This could allow it to grow subscribers rapidly and gain share in the music streaming industry.

We initiate coverage of the Chinese music streaming sector with a favorable long-term view. We assign Tencent Music Entertainment, or TME, a narrow moat rating and a fair value estimate of USD 8.60; and assign Cloud Music a no-moat rating and fair value estimate of HKD 130. Both firms look undervalued to us, and of the two, we prefer TME for its strong network effect and proven track record of profitability. We think the share prices of TME and Cloud Music are overshadowed by the recent selloff of Chinese internet firms listed overseas, but the outlook on the fundamentals of both firms is intact. Also, we believe the near-term decline in TME's live streaming revenue and Cloud Music's sharp downturn for average spending per user have been priced in, but the upside of music streaming revenue is not fully reflected in current prices. In our view, the current prices of TME and Cloud present good opportunities to tap into the long-term growth in music streaming in China.

Cloud Music is the second largest music streaming platform in China, with over 180 million monthly active users, about one third that of Tencent Music’s. As exclusive licensing practices have been prohibited by China’s antitrust laws, we believe Cloud Music should now grow its content through direct licensing from music labels at costs lower than sublicensing from TME, This could allow it to grow subscribers rapidly and gain share in the music streaming industry.