Above is an overview of TME’s income statement, which displays figures in $USD million. Net revenues continued to grow during last year, driven by increased statistics related to Online Music Services and Social Entertainment Services.
Total revenues saw a growth of 33.9% between 2018 and 2019 while growing “only” 14.6% between 2019 and last year.
Gross profit margin has been affected by the notable investments into new product and content offering such as long-form audio and TME Live. Moreover, during last year the revenue sharing fees were strengthened to impede market penetration to all the competition at the source. The gross profit margin percentages went from 38.3% in 2018 to 34.1% in 2019 and 31.9% in 2020.
The operating income stayed stable above the 700 million dollars mark, with a margin percentage that went from below 10.7% in 2018 to 18.2% in 2019 and 16.1% in 2020.
The net income remained positive and grew from 9.7% in 2018 to 15.6% in 2019 and 14.3 in 2020.
To understand the characteristics of Tencent Music Entertainment Group’s economies, it is also essential to check out the numbers related to the user base and the paying customers.
From this table, we can immediately spot the growing segments of the platforms.
In synthesis, TME’s management improved (as promised) the figures of paying users by implementing several paywalls.
The already large customer base, then, was prompted to contract a subscription to not miss out on the great content that Tencent has been able to aggregate in years of partnerships and joint ventures with some of the most significant and most relevant labels.
The monthly users of social entertainment services remained the same over the last three years, but the value extracted from them changed.
There has been a solid 14.58% compound annual growth in the average revenue per paying user, really positive data for TME. It means that the current customers are happy to pay more for the exclusive services offered.
The balance sheet shows a healthy expansion, even though the debt to equity ratio went from 0.18 in 2018 to 0.29 in 2020. This increase, however, is a logical response to TME’s position in the market and current growth prospects: it’s positive operative leverage that doesn’t harm the organisation.
A company valuation’s objective is always to understand the intrinsic value, making consistent assumptions that can be relatively safe in the middle term.
In the case of TME, a Discounted Cash Flow is, for sure relevant, since the company gives us enough information to try and estimate its future revenue figures, profitability, and liquidity.
Instead, a comparative analysis is not relevant because TME is the lone leader of the Chinese Market in its industry. Other companies operate in the sector, but not at the same scale and not as a primary business: Alibaba, Xiaomi, and Baidu consider the music business as a lateral one, without further making this part of the business independent.
Let’s start from a DCF Analysis then!
The first step to understanding this company’s future value is forecasting the services’ value for the next five years, up until 2025.
The table below is an overview of the forecasts and the assumptions made for Tencent’s business evolution.
Revenue streams comprehend the already existing segments and also a new one: it is related to the acquisition in January 2021 of “Lazy Audio”, a platform leader in audiobook streaming in Mainland China. This is a significant value to be considered, as TME will enormously benefit from this part of its business in the future.
The audiobook market is growing sensibly, and it is forecasted to continue its expansion in the following years.
Analysts from Deloitte, Statista and other data platforms estimate that the audiobook industry’s market will surge at a 30% year on year pace. At the moment, researchers estimate that the value stands around 8.2 billion yuan.
Since the segment is not even explored in China yet, there’s ample space for TME to gain a considerable market share.
On the other hand, we also have to consider that among the competitors in this market, there’s also Amazon, which has seen great success with e-books.
For this reason, even though TME has good odds of conquering a large portion of the market, we have considered figures that could take into account the presence of competitors.
From the EBIT figures’ assumptions, we went forward to spread the forecasted free cash flow figures.
As shown in the following graph, Tencent Music and Entertainment Group is expected to see a growth in the EBIT and FCF figures.
After a probable stagnation of the EBIT figures in the next two years, the company will benefit from the current intense investment programs and augment its cash positions.
We identified the Debt% as 22.76% and the equity as the remaining 77.24% to calculate the Weighted Average Cost of Capital.
In the calculation of WACC, we employed the values in the following table. In the notes, you can find the sources or comments to that particular data. If not present, it’s a simple calculation or ChineseAlpha’s team estimation.
We used both the perpetual growth method and the EV/EBITDA multiple methods to determine the Terminal Value.
For the perpetual growth method, a yearly increase of 2% was estimated. This can be seen as really high, but considered the inflation and the possible further economies of scale of TME is the most senseful value. It has to be pointed out that the EV/EBITDA multiple is at the moment in an “outlier” level, as the current value is 73x. We consider it in our analysis, but this detail can help us understand the intrinsic value. Keeping the multiple as a factor in the valuation has to do with the fact that for this type of businesses that usually rely on subscription models, the EBITDA figures can be volatile. Consequently, we also observe absurd values of this multiple in the global leader, Spotify.
As can be seen, the EBITDA multiple approach gives an entirely different value of the Terminal Value.
We think that the correct value is in the middle: that’s why we took, for the determination of the Enterprise Value, the average of the results of the two methods.
At this point, we also summed the Present Values (discounted to the WACC) for the years 2021-2025.
We added to the Enterprise Value found to non-operating assets, which equate to cash, subtracted debt and other non-equity claims.
The result is an equity value of $59,539 million. This is divided by the number of ADS diluted shares outstanding as of 31/12/2020 of 1,660 million. The result is an intrinsic price of $35.86/share. The analysis then identifies TME as undervalued by the market, especially after the recent crash on the 24th and 25th of March.
But that’s not all! Continue reading the analysis to understand what are the risks of investing in this stock right now.
First, let’s see how Tencent Music and Entertainment Group can be categorised using Peter Lynch’s framework.
Peter Lynch company category
Following Peter Lynch’s guidelines, we can categorise TME as a Stalwart. The company can continue growing at a moderate to high rate, even if being a large firm.