Tencent Music: Open-source cost-saving, profit margin will increase next year (3Q22 conference call minutes)

The following is the minutes of the Tencent Music.US 2022 Q3 earnings conference call. For the financial report analysis, please refer to "Tencent Music: Pure users, squeeze out profits, looking at "money".

1

Management Report

1. Jay Chou's digital album "The Greatest Work" sold nearly 7 million copies at the end of Q3.
2. In Q3, over 350,000 independent musicians were helped to create and distribute music content. In the Long Audio section, an all-in-one audio creation assistant called Shengbo was launched.
3. TME Live held 32 performances, including those by Han Hong and Emil Chau, in Q3. In collaboration with Pepsi Cola and virtual idol group TEAM PEPSI, TMELAND held a virtual 3D live performance that saw over 4 million fans join in.
4. Future growth drivers include developing long audio, going global, and virtual products. In Q3, Long Audio revenue saw double-digit growth, reaching an all-time high in absolute value.

2

Analyst Q&A

Q1: What is the gross profit margin and net profit margin of Tencent Music's online music business in Q3? Considering many factors such as advertising revenue, ARPPU, music content costs, etc., how do you view the speed of expansion of gross profit margin and net profit margin of online music business in the future?

A: This quarter, the gross profit margin of our online music business continued to grow, and the operating profit also increased. This is mainly due to:

(1) First, we optimized content costs by modifying agreements with some record companies and attempting to convert the MG (Minimum Guarantee) model to a revenue-sharing model.

(2) Second, our subscription revenue grew, especially with ARPPU continuing to increase, which had a positive impact on gross profit margin.

(3) Third, the recovery of advertising revenue and the increase in sales of digital albums also had a positive impact on gross profit margin. Therefore, this quarter, our online music section had a strong gross profit margin performance.

We expect the gross profit margin of the online music section will continue to grow in the next quarter, as advertising revenue and subscription revenue continue to increase steadily. At the same time, we will continue to control content costs, drive overall gross profit margin and profit margin improvement.

Q2: ARPPU and the number of subscribers have increased compared to last quarter. What is the growth trend of both in the future?

A: We are very satisfied with the growth of our subscription user base this quarter. As for the growth of our subscription users, our annual growth rate continues to be in the double digits, and we expect this trend to continue in the short term.

In about a year, our goal is to reach about 100 million subscription users, and we currently have around 80 million, which is a very achievable goal for us.

Currently, the payment rate is around 15%. In the long run, compared with other vertical industries (such as China's online video industry, which has a payment rate of 20-25%), we are confident that we can achieve a payment rate of over 20%. In Q3, the APPPU for our online music business was 8.8 yuan, up from 8.5 yuan in Q2, marking two consecutive quarters of growth. This is due to increased promotion and content management as well as optimized pricing strategies.

Moving forward, we will continue to focus on high-quality growth in overall subscription revenue while reducing promotional activities and further strengthening content management.

On the other hand, we will aim to provide super VIP services with higher ARPPU and more privileges for our users. We hope to gradually increase our ARPPU while maintaining healthy growth in paying users.

We expect our ARPPU to continue to increase in the next quarter.

Q3: Our advertising business saw growth this quarter, reversing the downward trend in the first half of the year. What were the driving factors, particularly in new forms of advertising such as TME Live, and what are our expectations for Q4?

A: In terms of advertising revenue, we saw the return of YoY growth this quarter, reversing the trend of YoY negative growth last quarter. In the earlier part of the year, splash screens generated the majority of our advertising revenue. However, we are pleased to discover that due to our investment in new forms of advertising and innovative ad products, splash screen revenue now accounts for less than half of our overall advertising revenue.

This is the second consecutive quarter of QoQ growth in advertising revenue. As such, if the macroeconomic conditions continue to improve as they are now, we expect this trend to continue into the next quarter and beyond.

We hold an optimistic view of the prospects for our advertising business. The driving factors include:

1. Firstly, as we host and organize more events, we see continued healthy growth in advertising sponsorship revenue. These events include TME Live events, as well as other sponsorships. In addition, "ad-supported free listening" revenue is growing strongly and now represents about 10% of our online music advertising revenue.

2. Coupled with improvements in macroeconomic conditions, we are optimistic about our prospects. We will continue to work with the WeChat team to provide high-quality TME Live to our users, which will help us attract more advertising sponsorship and partners.

In Q3, we successfully launched more than 30 TME Live events. Therefore, we expect advertising sponsorship revenue to continue to grow, driving overall advertising business revenue growth.

Q4: Should we expect a positive impact from economic rebound on social and entertainment business in the future? How do we view the competitive pressure in this business?

A: Due to the challenging macro environment and increasing competition from other entertainment platforms, social and entertainment revenue saw YoY negative growth this quarter and in the earlier quarters. We expect this area to face pressure and challenges.

However, we will continue to innovate with more products and explore new initiatives such as audio live streaming and virtual interactive products. In the audio live streaming business (confirmed as part of social and entertainment revenue), we have achieved very healthy YoY growth in the mid-double digits, which we are very satisfied with. This can help us offset some of the challenges in traditional video live streaming. In addition, we continue to expand in overseas markets, both through organic growth and suitable M&A, such as the acquisition of Japan's leading Karaoke application.

Q5: Can you share with us the KPIs for the Long Audio business, and how should we expect future investment and profits?

A: Long Audio has been proven to be an effective supplement to our strong music application portfolio. As it continues to convert more and more music users into Long Audio users, and thus drive higher user engagement and activity, we continue to expand and differentiate long-form audio content through licensing and content reproduction.

We also provide useful tools for users and content creators, and build an active podcast and UGC content ecosystem. We will gradually increase monetization through monthly subscriptions, and focus on the ROI of our content investments. Our overall goal is to achieve breakeven on the gross profit margin level for the Long Audio business by the end of next year.

Q6: Regarding profit margins, we have made a lot of efforts this year to improve overall operational efficiency. What is the company's expense plan for next year? Especially around employees and marketing strategies, and how much room for improvement is there in our profit margins next year?

A: We expect gross and net profit margins to improve next year. We will continue to control sales and marketing expenses, but instead of giving fixed guidelines for expenses, we will focus primarily on ROI and strive to improve ROI next year.

Therefore, considering the optimization of marketing expenses, there will be more room for profit margin improvement in the future.

Regarding employees, on the one hand, we need to invest more in new products to find more growth opportunities, so we will continue to invest in this area; on the other hand, we will improve the utilization efficiency of our staff, and require them to achieve breakeven on older products, so we want to improve efficiency in this area.

We expect revenue from online music services to grow steadily; the revenue from social entertainment business may remain stable or slightly decline; gross and net profit margins will increase next year.

This quarter is the second consecutive quarter of revenue growth, but our net profit has achieved consecutive quarter-on-quarter growth for the third quarter, so there is a very clear trend here, that we can improve our profitability through cost optimization and efficiency plans. So even if the revenue for the full year drops compared to last year, we still expect to achieve positive growth in revenue next year, so the profit margin will also increase positively.

This quarter's strong financial results show that we have been doing very well in improving operational efficiency. This also shows that we have tried many methods, not just cost optimization. For example, customer acquisition cost, we also worked hard to make the team more streamlined than before, which also helped us improve overall efficiency.

In the future, we will continue to work hard to control content costs. Therefore, I will try to communicate with all our partners and try to change our revenue model from the minimum guarantee model to the revenue sharing model, which will help us further improve efficiency.

Q7: Regarding the competitive landscape, how do you view future competition with other short video platforms? A: We both cooperate with and compete against short video platforms. We use them as marketing tools to promote our music and brand events, which has proven to be quite successful. However, on the other hand, there are also rumors about Douyin entering the music market. So we are closely monitoring the competition dynamics. Currently, their user base is still small, and their content provider services still have a long way to go compared to ours.

Q8: How do you view the gross margin trend of online music and long audio business?

A: The music gross margin continues to improve, driven by steady growth in subscription revenue through ARPPU growth and subscription user growth, as well as sustained and steady growth in advertising, as well as our good cost control in content costs, have led to a healthy and sustainable improvement in music gross margin. The loss margin rate in the long audio sector is also continuing to improve. We expect the total gross margin rate for long audio to reach breakeven by the end of next year.

Q9: Regarding the cooperation between Tencent Music and Tencent Video, what exploration will there be in long-term cooperation? How do you cooperate to get more users and gain more commercial value?

A: We will continue to deepen our cooperation, especially with Video Number, to enhance our focus on music cooperation and promotional capabilities. This is an important way to enrich the music and video content on our platform and WeChat platform, as well as an important way for us to use WeChat to expand our promotional channels for artists, especially independent musicians.

QQ Music and Kugou Music have official accounts on WeChat Video Number, where they use refined operation to continually evaluate user preferences, and the recommended music content is very popular among users, ranking among the top in the music category or within the WeChat Video Number and WeChat Video Number services. It is an important channel for music lovers to discover music, and then users often return to the TME platform to continue exploring and enjoying their favorite music.

In terms of concerts, TME Live and Video Number have already held many live performances, such as the recent concerts of Zhou Huajian and Han Hong. In the future, we will work more closely together to present more and better performances to users and explore more innovative and expanded profit paths.

The cooperation between Tencent Video and our TME side will be based on each of our projects, and it will serve as a distribution platform. If the schedules allow, we can also discuss cooperation in streaming programs. If both sides have a reasonable schedule, we will broadcast together. At the same time, we will also have a revenue-sharing model, but this is based on Tencent's close product cooperation model.

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