Music streaming is now a US$10 billion-a-year industry made possible by the advent of high-speed mobile internet and smartphones. These subscription-based services have breathed new life into a once-declining music industry, with revenues six times larger than the amount spent on physical music albums.
It’s already given rise to Spotify (Exchange: New York; ticker: SPOT), which has more than 83 million paying users around the world.
The company is now worth US$25 billion – making it more valuable than United Airlines (the second-largest U.S. airline) or Hyundai Motors (the world’s third-largest car maker).
Spotify also has a big rival, in China – one that’s about to become a public company on December 12.
Much more than China’s Spotify
Tencent Music Entertainment Group is the online music-streaming arm of Tencent Holdings (Exchange: Hong Kong; ticker: 700), China’s largest internet services and entertainment company with a US$383 billion market cap.
Tencent Music hopes to raise US$1.2 billion, offering 82 million shares at a price somewhere between US$13 and US$15 a share. That would give the company a market cap between US$21 billion and US$24 billion.
Tencent Music generated US$1.66 billion in revenues last year, compared with US$1.13 billion for Spotify. It also made an operating profit of US$229 million last year, while Spotify lost US$340 million.
But Tencent Music generates just 30 percent of its revenues from streaming music services like Spotify’s. The bulk of its revenue (US$1.16 billion) last year came from social entertainment services that are unique to China’s enormous active online community.
Virtual gifts are big money
These social entertainment activities involve live-streaming a user’s vocal performance via a karaoke-like app, called WeSing, to friends and random viewers. Users are also able to send virtual gifts as reward to others for good performances.
One unusual feature about Tencent Music’s social entertainment service is that users get a percentage of the cash value of the gifts they receive.
Other similar social video streaming services even allow users to convert virtual gifts into cash (at 50 percent of the original value). And there have been cases where some users have received gifts of upwards of US$90,000.
The company states that it had almost 10 million paying users for its social entertainment business as of end-June 2018. That would indicate an average revenue per user of US$16.09, which is 12 times higher than its music streaming business.
Has Tencent Music stumbled on a much more profitable business model than the world’s online streaming music pioneer? Perhaps.
It still pays to wait
It’s easy to get excited about an IPO, especially one that bears a lot of similarity to a successful company that people are already familiar with.
Spotify listed its shares in April 2018 at US$132 each. It opened its first day 25.6 percent higher, and went as high as US$199 a share by July. But since then, it’s gone back down to US$139.
So if you’d bought Spotify’s IPO, at worst you would be up 5 percent in eight months. And if you were lucky (and smart) enough to sell at the high, you could have made 50 percent in just three months.
Given the relatively encouraging performance of Spotify since its IPO, Tencent Music is likely to attract a lot of investor attention.
But buying the hype is almost always a recipe for incurring unnecessary losses.
It often pays to wait for the company to go through at least two rounds of earnings after its IPO. This gives you the chance to see whether the company is on track to meet its optimistic goals set out during the initial offering.
It also gives you time to find the answers to some of the lingering questions about its business that may not have been addressed when it first listed shares.
Recent IPOs have performed well
While past performance is never an indication of future performance, especially in the stock market, it’s also worth looking at how recent Chinese IPOs have done in the U.S. market. After all, if people are doing well from past IPOs, there’s a higher likelihood they will be eager to buy the next one.
Looking at the five largest IPOs of Chinese companies in New York so far this year, investors have reason to be optimistic.
So the largest Chinese IPOs have done well this year.As you can see in the table above, three of the five posted gains on their first day of trading, with two (Pinduoduo and NIO) rising by 40 percent and 75 percent, respectively. And as of today, four of them are showing gains from their IPO prices.
This doesn’t mean Tencent Music’s IPO will be a winner right out of the gate.
It’s also important to consider how the general markets are doing. When the stock markets are rising, IPOs have the wind to their backs and tend to do better. But when the markets are falling, as they have been lately, poor sentiment can hurt an IPO’s performance.
In these situations, sometimes the best thing to do is nothing at all. While waiting might cause you to miss out on some gains at the onset, it helps you avoid potentially large losses in the event the company fails to deliver on expectations.
Editor, Stansberry Pacific Research