In episode 33 of TechBuzz China, co-hosts Ying-Ying Lu and Rui Ma talk about Tencent Music (TME), which finally completed its $1.2 billion IPO after a two-month delay due to market volatility. The company rose 9 percent on its first day, but has traded below the initial offering price ever since. This episode covers the business model of TME, its market potential, and our co-hosts’ thoughts on its future outlook. Though often compared to Spotify, to what extent are these two companies truly similar?
Rui and Ying-Ying begin today’s story by reviewing Tencent Music’s corporate history. The entity is comprised of four apps: QQ Music, Kugou Music, Kuwo Music, and WeSing, which today account for a combined 70 percent of China’s music market. However, once upon a time these were disparate products that sometimes competed; in fact, they only came together together through an entity known as China Music Corporation (CMC), which was formed in 2012 by Xie Guomin. CMC acquired Kuwo in 2013 and Kugou a few months later; Tencent turned its minority stake in the entity into a majority position when it injected the QQ Music and WeSing assets for over 60 percent ownership at a valuation of $2.7 billion. At this point, the company was renamed to Tencent Music Entertainment.
From here, Rui and Ying-Ying contrast the strategies of China- and US-based music player apps. They delve into the reasons for these divergent paths, including China’s unique business environment, its domestic user behavior and cash-giving habits, the impact of new categories such as mobile livestreaming… and even Chinese people’s deep love for karaoke. Notably, the legally-trained and opportunistic Xie Guomin was first spurred to found CMC to capitalize on the government’s changing policies around copyright and intellectual property. Listen to find out: How has this “race to own copyrights” affected the industry and its major players? How do Alibaba and Baidu fit into the picture– or not? Why is it that paying for music is a behavior TME still needs to cultivate in its users? What does all of this mean in today’s competitive landscape, and what does betting for or against TME really entail?
As always, you can find these stories and more at pandaily.com. Let us know what you think of the show by leaving us an iTunes review, liking our Facebook page, and tweeting at us at @techbuzzchina to win some swag! Finally, we would like to welcome our new listeners over at our partner, dealstreetasia.com.
Our co-hosts will be on a two-week break for the holidays but we look forward to releasing a new episode the second week of January. Happy Holidays!!
(Y: Ying-Ying Lu; R: Rui Ma;)
[00:00] R: Last Wednesday, on December 12, Tencent Music finally completed its $1.2Bn dollar IPO after a tortuous road to the public markets. It rose 9% on the first day, but has traded below IPO price ever since.
Y: Tencent Music has been compared to Spotify, and they are both broadly speaking, digital services based on people’s enjoyment of music.
R: But that’s where the similarity ends. Spotify is primarily a music streaming service, with some artist management tools sure, but basically, listening to music from the cloud.
Y: Whereas Tencent Music, to quote from its prospectus, is “pioneering the way people enjoy online music and music-centric social entertainment services. We have demonstrated that users will pay for personalized, engaging and interactive music experiences.”
[00:49] R: For those of you who have never used anything outside of Spotify for your music needs, you might be mystified by what that means — what the heck is music-centric social entertainment services? And yet that mouthful? That’s actually what Tencent Music is, because music-centric social entertainment services accounted for 70% of total revenues in the first half of this year.
Y: On today’s episode, we are going to talk about Tencent Music, and how it shows a completely different way that Chinese people consume, enjoy and interact with music and our hypotheses on why that might be.
R: We’ll go into the business model of the company, the market potential, and our thoughts on the future outlook. So stay a while, and listen.
[1: 58] R: Hi everyone! We are TechBuzz China by Pandaily, powered by the Sinica Podcast Network!
Y: We are a weekly podcast focused on giving you a peek into what’s buzzing within the tech community in China.
R: We uncover and contextualize unique insights, perspectives and takeaways on headline tech news that don’t always make it into English language coverage. So you can be smarter about the world of China tech.
Y: TechBuzz China is a part of Pandaily.com, an English language site that tells you “everything about China’s innovation.” I’m one of your two co-hosts, Ying-Ying Lu.
R: And I’m your other co-host, Rui Ma. We’d like to acknowledge our partners DealStreetAsia and SupChina, creator of the Sinica Podcast Network! In addition to Techbuzz, you can also find the Sinica podcast, a weekly discussion of current affairs on China.
Y: You can also find NuVoices, a podcast on women, as well as the new business-oriented ChinaEconTalk, and of course the Caixin-Sinica Business Brief from China’s leading business magazine. Be sure to check these out! And oh yeah, if you enjoy listening to us, please take the time to leave us a rating or review on iTunes, Facebook or wherever you get your podcast!
[3:10] R: What is Tencent Music? We’ll save you the time of reading through the prospectus and give you a quick review of its corporate history. Its stock ticker on the NYSE is TME, and it’s composed of the following apps – QQ Music, Kugou Music, Kuwo Music, and WeSing.
Y: QQ Music, Kugou and Kuwo were founded between 2003 and 2005, and they were independent entities with completely different teams competing against each other. Of course, QQ Music was part of Tencent from the beginning, but the other two were both startups.
R: Kugou launched in 2003 as a comprehensive music platform integrating music search, playback, downloading, management, and sharing. Its chief innovation was the playback of lyrics that was comparable to karaoke, and subsequently imitated by QQ music.
Y: Kuwo was founded by Baidu’s former Chief Architect Lei Ming and Stanford MBA Huai Qi. As compared with other music platforms, Kuwo Music could claim technological advantages. For example, users could hum melodies and the platform would automatically recognize the song they were singing. Additionally, there were more than 10 million songs in their music libraries. At one point, the number of users exceeded 300 million.
[4:30] R: Nowadays, both Kugou and Kuwo have Live functions which allow for livestreaming as well. Unfortunately, we couldn’t test these products because of the regional restrictions on music copyright. You probably noticed that if you were trying to access songs people share on their WeChat moments through these services, you’ll get an error.
Y: Rounding out the four apps is WeSing. Founded in 2014, it’s also another Tencent product. It’s a karaoke app that allows you to sing with your friends, or celebrities, much like a US-based app called Smule. It’s nicely integrated with Tencent products such as WeChat, which of course can boost traffic quite quickly with its 1Bn users.
R: Another benefit of being so tightly connected to Tencent, by the way, is in the ability for Tencent Music to co-produce music talent shows, such as Produce 101, a show which created an entirely new crop of popstars and set some viewing records.
Y: Yeah that was actually really innovative and really cemented brand recognition at the same time. But it’s arguable that Alibaba, which also owns significant assets in online video and has its own entertainment and production arm, can pretty easily do the same thing.
[5:42] R: Either way, I’m kind of sad no one has asked me to sing a duet with them on WeSing yet, as most of the connections are supposedly made through WeChat. Hey guys, invite me! I love karaoke!
Y: Alright, we’ll get into Rui’s love for karaoke later, but before that, let us tell you the way these disparate and actually competing apps came together. It was through an entity known as CMC.
R: China Music Corporation, or CMC, was formed in 2012. Xie Guomin, the founder, had a legal background and saw the opportunity in acquiring copyrights as the music industry was becoming more professionalized in China and the Chinese government was also getting more serious about intellectual property.
Y: Staying low-key, he managed to “hoard” a large amount of music copyrights by signing agreements with nearly 100 copyright companies and reaching long-term deals with 40 agencies, of which more than 20 were exclusive. In total, these represented 20 million songs. This was significant because the biggest spender up until that point, QQ Music, only had about 15 million songs to its name.
[6:48] R: CMC acquired Kuwo in 2013 and Kugou a few months later. Xie Guomin convinced the founder of Kugou to be co-President with him while the Kuwo founder became CTO.
Y: Tencent already owned a minority stake in CMC, but turned that into a majority position when it injected the QQ Music and WeSing assets into the entity for a total stake of over 60% at a valuation of $2.7Bn. And that’s when the company was renamed to Tencent Music Entertainment.
R: When this happened at the end of 2016, of these three platforms, Kugou was the largest, followed by QQ Music, and then Kuwo. Together they accounted for 56% of the market. Today, it’s even higher than that, some say as high as 70%.
Y: Rumors of the pending IPO began a while ago, but it wasn’t until September that the news hit the wires. The prospectus was filed on October 2nd, the the IPO was delayed for two months due to market volatility.
[7:52] R: And when it finally IPOed we know how that ended. Below IPO price, as many have predicted. But is that because the markets are just terrible these days, or something about the business? Let’s see …To talk about that, the first thing we have to talk about, whenever we talk about China music, is the importance of copyrights.
Y: When Kuwo Music was acquired for nearly $100 million ten years after its founding, 雷鸣 Lei Ming, the tech founder, said: “Now music has completely become a “race to own copyrights”. I am an engineer, and have decided to gradually withdraw from management.”
R: What did he mean? Well, industry sources estimate that until 2011, 99% of music in China was pirated. But it was also around then that the government got much more serious about intellectual property and there was a flurry of purchases for IP in every sector that touched content.
Y: And in China, where everyone tries to be a monopoly with few consequences, that turned into deals for exclusive copyrights. Which meant price wars. Let us give you an example. Last year, Universal had put out a bid for new copyright partners in China. While the initial global licensing fee was only $30-40mm, after several rounds of negotiations, Tencent Music supposedly ended up offering $350mm in cash plus a $100mm equity stake, which illustrates the depths to which it is willing to go to secure inventory.
R: A few months later, Tencent reached a historic agreement with Alibaba to share, or sub-license, the exclusive copyrights it owned for Universal, Warner, Sony and etc. Of course, in return, Alibaba had to agree to share its own exclusive rights for many Asian labels. Together, for Tencent Music, this amounts to something like a staggering 90% of the copyright for China.
Y: Increased profit from shared costs, but also the government’s guidance, probably contributed to this agreement, as policy explicitly discouraged exclusive copyrights as well as price wars.
[10:00] R: Do you find all this exclusive licensing and subsequent sub-licensing confusing? Don’t worry, industry insiders do as well. The agreements are very different from streaming services in the US, who tend to differentiate on curation, product and marketing. But in China, it’s a volume game, and so having the most inventory, the most selection, has always been Tencent’s strategy, and others have had to follow suit because of Tencent’s aggressive tactics.
Y: But where is the rest of the BAT? Aside from going after some copyrights and making two acquisitions in the space, Alibaba has hired some titans of the music industry, including a famous composer 高晓松 Gao Xiaosong. But making good music doesn’t translate into making good money in music, and so in terms of music streaming, Alibaba’s services are only number 5, with the top 3 occupied by Tencent.
[10:51] R: The one thing Alibaba does have going for it though, is its focus on new and independent musicians, not tied to existing copyright. Since it can’t compete with Tencent on pure copyright, it’s been focusing on growing organic original content, but whether that strategy will bear fruit is still a question mark.
Y: But if you’re listening carefully, you’ll note that we haven’t announced the 4th place player. That’s because it’s not BAT. China’s 4th place music streaming service is NetEase, a rather unexpected choice since NetEase Cloud Music did not exist until 2013.
R: NetEase Founder William Ding is supposed to be a music fan, and the story is that he didn’t find any of the existing music players to be to his liking, and so decided to launch his own version, which is known for its recommendation engine as well as active user comments. Many users swear by this service, and it is indeed impressive that for such a late starter, it’s managed to do really well.
Y: As for Baidu? It made a small acquisition years ago, but has not made any new moves since then, except for renaming the service several times. It’s not in the top 5. Why are we not surprised?
R: Even though the content is now all licensed or sub-licensed though, the labels aren’t very happy with the way business is done in China. You see, all the sub-licensing obscures where the real traffic is coming from, so Universal, for example, just gets one lump number from Tencent, and not any more detail than that. And also, the contracts prevent differential pricing, which means that the sublicensors cannot undercut the licensor, so users are not getting the benefits of competition.
Y: But for the labels, at least there is some revenue now where there used to be none. Only $0.21 per capita, to be exact, which is far less than the $15-$20 in developed countries. And while global recorded music was a $17.3Bn market last year, with year-on-year growth of just 8%, streaming services had a growth of 41%.
[12:51] R: So now you understand the copyright situation. But Tencent Music’s model is so different from the economics that prop up a company like Spotify. Spotify went public back in April at a market capitalization of just under $30Bn. Spotify and Tencent, by the way, own a small minority stake in each other. In 2017, Spotify’s revenues were about $4.6Bn USD, triple Tencent Music’s revenue for the same period.
Y: Spotify was a high flying IPO when it came out, but its stock is down about 20% for the year. Its Q3 earnings report shows that it had 87 million premium subscribers, and another 109mm ad-supported users, which is in total less than a third of Tencent Music’s.
R: So last year TME had roughly triple the users at only one-third the revenue of Spotify. And although it is growing faster, nearly doubling from last year, in the first half of this year at about half the revenue of Spotify.
Y: It’s really an apples-to-oranges comparison though, because Spotify has only music streaming as its revenue source, whether it be in the form of subscriptions or advertising supported AKA free membership, whereas if you’ll remember, music streaming is less one-third of Tencent Music’s revenue.
R: For Spotify, paying users accounted almost half, for about 46% of active users. Compare that to Tencent Music streaming, which has a paying ratio over 12 times lower, at just 3.6%. The average revenue per user (ARPU) per quarter themselves are not as different, over $5 for Spotify, and just less than $4 for Tencent Music.
Y: Yet, it is Tencent that is profitable, and not Spotify. Well, of course. That’s because most of Tencent’s revenues, 70%, remember, is from paying users for “music-centric social entertainment services.” The ARPU per social entertainment services user is close to $50 for the quarter, more than ten times what music streamers are paying.
[14:54] R: But before you get too excited about that number, note that the percentage of paying users for this segment is just a wee bit higher than that for streaming, at 4.2%. And both of these ARPUs, by the way, don’t have a clear trend of up and to the right, and are largely the same as they are two years ago, with the entertainment services business much more volatile than that.
Y: So what can we do with this information? If you take the glass half full view, then you can say, as Tencent did in its prospectus, that the room for growth for both revenue streams are enormous since the percentage of paying users is so low.
R: Right. In an adjacent vertical, we see that paid memberships for video services in China is approaching 30% this year after having exceeded 20% last year. A huge part of the Tencent Music growth story is the expectation that a similar trajectory can be expected for music streaming, and that it will expand from the current 4% or so to nearly 30% within 5 years.
Y: I could believe that, even though it does sound optimistic. But Gen Z is much more open about consuming online. However, the much bigger and more profitable entertainment AKA livestreaming business will have to keep up as well, and is that going to grow commensurately?
R: Well, even though looking backward, China mobile livestreaming as a category had a 200% CAGR in the last 5 years. I’m personally not as bullish on this front. First of all, those of you who listened to our livestreaming episode know that a good portion of the webcam talents on platforms such as YY sing for entertainment value. So there is a lot of competition for this kind of talent in content.
Y: And not just from other livestreaming platforms either, sentiments are against livestreaming as more and more user minutes are taken up by short videos such as Douyin AKA Tik Tok. Although it’s been argued that Douyin also drives traffic to the music platforms as the short videos popularize certain songs set to them as soundtrack.
[16:54] R: But still, YY, the livestreaming leader, experienced 36% growth this past quarter. If we do some quick math, we see that the percentage of paying users on mobile, which accounts for the majority of its revenues, is less than 7%. Inke, another livestreaming darling, fares a little better at 7.5% as of June 2018, but that’s actually down significantly from over 12% a year earlier.
Y: Profitability wise, the companies are doing well. They take fairly healthy cuts — we are talking about 60% or more — of virtual gifts on the platform. Inke, for example, had an adjusted net profit margin of 18% for the first six months of this year, showing similar profitability as Tencent Music.
R: You really have to wonder why the model in the West, with Twitch’s gaming livestreaming as a prime example, is still a mixture of advertising and subscription, although there is increasingly virtual currency and gifting added in.
https://overcast.fm/+M_6isE2Ws/14:22 Well, if it helps, culturally there is just less of a cash-giving habit in the rest of the world compared to Asia, especially China. Remember, WeChat’s payments exploded as a result of the digital red packet 红包 feature. There’s always red packets flying around in group chats, and people are always showing off the red packets they get from their significant others on WeChat Moments.
[18:11] R: In China, it’s just a totally acceptable thing to give cold, hard cash, or cold, hard cash disguised as virtual roses and airplanes, whereas in the West we prefer to either be subscribers or to support our favorite celebrities by sitting through advertisements, and it feels less like a transaction because it’s one layer removed.
Y: OK, that explains the virtual gifts, but why are singing livestreams and karaoke so popular in China? I mean, for comparison, an article from early 2014 talks about the rise of karaoke in the US, but if you click through to the 3 top apps they mention, only one of them, Starmaker, is still around, and it doesn’t look like it’s a hit by any means.
R: Even Smule, which we mentioned earlier is similar to WeSing in terms of features, and is perhaps the largest karaoke-style app in the West, has a lot of Asian users, especially in Southeast Asian countries like Indonesia and the Philippines, who sometimes become Youtube stars from their work.
Y: Yeah. In Indonesia, Smule’s brand recognition is 80%, versus just 15% in the US. It knows its largest market opportunity is not here, but in emerging countries, including Brazil, India and of course China, which makes sense why Tencent led a $54mm round into the company in 2017. Who knows, that could become Tencent Music’s next acquisition if it ever wants to expand abroad.
[19:37] R: For now though, Tencent Music is pretty heads down focused on China, even though there had been speculations that they would go abroad, given that Warner and Sony are also shareholders. And WeSing is driving a lot of the growth for the entertainment services portion of the revenue, according to the prospectus. WeSing’s virtual rooms and premium memberships, in particular, are named as key drivers. I really wish this app was available in the US!
Y: Guys, if you haven’t ever visited China, you may not understand the Chinese obsession with karaoke or KTV. But much more than sports or dancing, it’s the go-to activity for both youth and adults. Research apparently shows that singing music together is a better way of bonding than many other activities. I definitely went at least monthly when I was in China, because it was the most affordable and fun activity of choice that everyone could enjoy.
R: Don’t forget, they serve food and alcohol and are often open all night! And there’s just so many of them, everywhere. Even in the middle of malls now, where you can jump into a private mini booth to belt your heart out for a few minutes, or hours. So yeah … the demand for karaoke is definitely there, it’s just whether or not WeSing is going to be the most popular platform, given how obvious the opportunity is and how many competitors there are.
[20:54] Y: WeSing is thriving though. Despite being later to market, it has taken over the lead in karaoke apps due to its tight integration with Tencent’s social networking assets, especially WeChat. But that’s not to say there isn’t an opportunity for disruption here. Currently, the labels actually don’t get paid anything for karaoke versions of music where the vocals are stripped out, so karaoke apps are not as expensive to run as you would think.
R: Yeah there is lots of competition. So how about we summarize what we learned today Ying-ying?
Y: Well, we learned that Tencent Music got its real start when an astute businessman with a legal background saw the opportunity to buy up music copyrights in China as the government was becoming more serious about intellectual property. He really cornered the market on those and then used an entity called China Music Corporation to acquire two of the leading streaming services at the time, Kuwo, which means cool me, and Kugou, which means cool dogs.
R: Tencent, which owned QQ Music, a streaming service, and had just founded WeSing, a karaoke app, was compelled to inject these two assets into the company in exchange for a majority stake, upon which the company was renamed to Tencent Music Entertainment, and spun off for an IPO listing that completed just last week at a valuation of just over $20Bn, far less than the rumored $30Bn from two months ago.
Y: We also learned that although the headlines like to compare the company to Spotify, only 30% of TME’s revenues come from music streaming, with the remainder coming from entertainment services such as livestreaming and premium memberships for the karaoke app. But as mentioned numerous times in its prospectus, paying for music is a behavior that TME will need to cultivate in its users.
R: Another key difference, depending on if you’re a bull or a bear, is that only about 4% of users are paying users. For livestreaming, the industry looks to be in the high single digits, but for music streaming, some analysts are optimistic it will exceed 20% in a few years in China, perhaps at one point catching up to the impressive 46% commanded by Spotify.
Y: For both of those segments, there’s plenty of competition. But it’s the integration with the Tencent Wechat ecosystem that’s been crucial to its growth. And so if you’re betting against TME, then you’re betting either that paying habits won’t increase quickly, livestreaming and other entertainment services are either a fad or highly volatile, or that Tencent and Wechat aren’t as impregnable as they appear. Which, by the way, is not an unpopular opinion these days.
R: I think it’s more likely that the first two will happen, which means, that TME will not grow as fast as expected and livestreaming will slow, and paying users won’t grow that fast. But that it will still benefit significantly from WeChat so others will still have a hard time catching up.
Y: Before we close out for today, we’d like to thank Jacky Wong, journalist at the Wall Street Journal, who wrote a piece titled “Tencent Music: Tune In, But Don’t Turn On Yet” last week that inspired us to do this episode. We were supposed to have Jacky on but didn’t make it in time for recording. Thanks Jacky!
[24:15] R: OK, that’s all for this week folks! Thanks for listening. We’re by the way taking the next two weeks off, so we’ll see you again in 2019. We really enjoyed putting this together, and we are always open to any comments or suggestions. You can find us on twitter at thepandaily, at techbuzzchina, and my personal Twitter account is RUIMA.
Y: And my Twitter is spelled GINYGINY.
TechBuzz China by Pandaily is powered by the Sinica Podcast Network. Pandaily.com is an English language site that tells you “everything about China’s innovation.” Our producers are Shaw Wan and Kaiser Kuo.