TME - Tencent Music: Post-Earnings Stock Price Outperformance Isn't Sustainable

2023-08-18 08:50:45 ET

Summary

• Tencent Music Entertainment Group's Q2 2023 revenue and user metrics for its online music services business were better than what the market expected.
• But Tencent Music's Q3 2023 outlook is unfavorable, taking into account regulatory headwinds for its social entertainment services business.
• The market reacted positively to Tencent Music's second quarter results, but I think its positive share price momentum won't be sustained, and this explains my Hold rating for TME stock.

Elevator Pitch

My Hold investment rating for Tencent Music Entertainment Group (TME) [1698:HK] shares remains unchanged. TME's shares have run ahead of fundamentals after its recent post-earnings stock price outperformance. While the company's online music services business has done well in the recent quarter, the prospects for its social entertainment business remain unfavorable. In view of these factors, I have made the decision to maintain my current Hold rating for TME.

Market Reacted Positively To TME's Second Quarter Results Announcement

I previously wrote about Tencent Music Entertainment in an earlier article published on June 12, 2023, reviewing TME's Q1 2023 financial performance. As per Seeking Alpha price data, Tencent Music Entertainment's shares fell by -13% following my prior June 2023 write-up, as compared to a +1% gain for the S&P 500 (SP500) in the same time frame.

But TME's stock price had gone up by a significant +10% in the past three trading days, from $6.15 as of August 14 to $6.77 as of August 17. The company released its second quarter results on August 15, before trading hours.

Tencent Music Entertainment's headline numbers for the second quarter of this year were largely in line with the sell-side analysts' expectations. Based on data sourced from S&P Capital IQ , TME's actual Q2 2023 top line of RMB7,286 million was marginally, or -0.1%, lower than the market's consensus revenue forecast of RMB7,293 million. Also, the company's actual second quarter normalized net income attributable to shareholders amounting to RMB1,529 million was pretty close to the sell-side's consensus bottom line projection of approximately RMB1.5 billion. An August 15, 2023, Seeking Alpha News article also referred to TME's Q2 2023 financial performance as "mixed."

Nevertheless, Tencent Music Entertainment's shares outperformed following its Q2 earnings announcement, because investors chose to focus on the positives relating to TME's strategic pivot.

The company has been working hard to reduce its reliance on its social entertainment services business and focus more on growing its online music services business. A prior September 21, 2022, Fitch Ratings report highlighted that TME's social entertainment services business focused on live-streaming is expected to "face sustained pressure due to tightened regulations." Q2 2023 marks the first quarter that the company's online music services revenue has surpassed the top line contributed by its social entertainment services business.

There are other metrics which indicate that the company's online music services business' performance in the recent quarter has surpassed expectations by a wide margin.

Despite a challenging economic environment, the Monthly Active Users, or MAUs, for TME's online music services unit only declined by -4.7% YoY (versus a -18.1% YoY drop for social entertainment services arm) to 594 million, and this beat the analysts' consensus music services MAU estimate by +2% (source: S&P Capital IQ ). Separately, Tencent Music Entertainment's music entertainment subscription fees rose by +37% YoY to RMB2.89 billion in Q2 2023, which was +4% above the market's consensus forecast by +4%.

This explains why Tencent Music Entertainment stock has done pretty well in the past few days, since it revealed its second quarter financial numbers.

Tencent Music Entertainment's Near-Term Outlook Is Weak

I am of the opinion that TME's positive share price momentum is unsustainable, taking into account the company's near-term prospects. Also, it is worthy of note that Tencent Music Entertainment's consensus forward next twelve months' price-to-sales multiple has hit a new two-month peak of 3.14 times (source: S&P Capital IQ ) following its recent share price run.

In its Q2 2023 earnings press release , Tencent Music Entertainment disclosed the company's guidance of "a low-to-mid teens percent decrease year-over-year" in its revenue for the third quarter. This implies that TME expects to record a top line in the RMB6.3-6.5 billion range in Q3 2023. In contrast, the consensus third quarter sales projection for TME prior to its Q2 results release was much higher at RMB7.3 billion as per S&P Capital IQ data.

As per TME's Q3 2023 management guidance, it is clear that the top line growth for the company's online music services business can't sufficiently offset the revenue contraction for its social entertainment services business.

Tencent Music Entertainment highlighted at the company's Q2 2023 results briefing on August 15 that it had "implemented several service enhancement and risk control measures" for its social entertainment services business, which "are expected to put pressure on (social entertainment services) revenues" for 2H 2023.

It isn't a surprise that TME had to make adjustments to its social entertainment services (or live-streaming) business, considering the tightening regulatory environment for the Chinese live-streaming industry and technology sector. An August 2, 2023, Seeking Alpha News article noted that the regulatory authorities in China came up with new rules "aimed at curbing internet addiction" such as restricting the number of hours that minors in the country can be online.

Closing Thoughts

Tencent Music Entertainment Group shares continue to be rated as a Hold. I think that the market has become too optimistic about TME's outlook due to its online music services business' good performance in Q2 2023. But investors shouldn't ignore the regulatory headwinds that the company's social entertainment services business has to deal with. I continue to have a Neutral view of Tencent Music Entertainment Group stock, which translates into a Hold rating, as I think that TME's good share price run is likely to come to an end pretty soon.

For further details see: