Why Tencent Music Is Stuck With the Same Old Song

China’s largest online music company will struggle to change its tune.

NYSE-listed Tencent Music’s latest quarterly results, reported Monday, struck a bum note. The number of users paying for its Spotify-like music-streaming service rose by a third year-over-year, but since it made less revenue from each of them, sales growth from online music slowed to just 20%. Its share price slumped 6.6% in after-hours trading.

Instead of music, nearly three-quarters of total revenue comes from selling virtual goods to users of its live-streaming and online-karaoke apps, who then gift these to performers they love. That is a problem in the medium term, since the segment faces increasing competition from other entertainment options, like short-video apps and games streaming.

The backdrop helps explain a potential deal from parent Tencent, which spun off the music arm in December. The Chinese videogames and social media giant is in talks to buy 10% of Universal Music, the world’s biggest label, owner

Vivendi

said last week. That stake could rise to 20% in time.

This tie-up could make music subscriptions more important by helping Tencent Music better compete with its rivals, units of Alibaba and NetEase. The three share the vast majority of their music libraries, partly due to government pressure. Having even a small percentage of exclusive songs could be a key differentiator.

Some analysts think Tencent could also press Universal to take a tougher stance on Bytedance, a valuable Chinese startup that runs the popular short-video apps TikTok and Douyin. These are taking users’ attention away from Tencent games and Tencent Music apps. Theoretically, Universal could withhold licenses or demand higher licensing fees from Bytedance. However, Tencent’s ability to influence Universal’s commercial decisions could be limited.

The more-serious problem is convincing Chinese fans to pay for music. Piracy is rampant and paying users make up less than 5% of Tencent Music’s user base.

Tencent Music’s stock trades at 33 times expected earnings—higher than both its parent and many other Chinese internet companies. With that in mind, now isn’t a good time to tune in.

Write to Jacky Wong at JACKY.WONG@wsj.com

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