Tencent Music's IPO Filing Reveals Its Greatest Strengths -- And Competitors -- On The Global Streaming Stage

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The logo of the music streaming platform Tencent Music Entertainment (TME) is displayed on the screen of an iPhone on June 12, 2018. 

When Spotify and Chinese music-tech company Tencent Music bought equity stakes in each other in Dec. 2017, industry onlookers saw the move as a landmark collaboration between what would otherwise be two aggressive competitors in the global streaming landscape.

But Tencent Music’s filing to go public with the U.S. Securities and Exchange Commission on Tuesday (Oct. 2) reveals a much different story: the Chinese company arguably isn’t competing with Spotify at all.

Instead, the former has grander, more lucrative ambitions in shaping the future of entertainment and tech -- encompassing more flexible digital revenue streams beyond monthly subscriptions, more direct-to-fan opportunities for creators and tighter integration with existing social media platforms.

Housed under tech conglomerate Tencent Holdings -- which owns social mobile application WeChat, instant messaging service QQ and League of Legends developer Riot Games -- Tencent Music currently runs the four top mobile music apps in China by monthly active users, namely QQ Music, Kugou Music, Kuwo Music and WeSing. Combined, the four services have over 800 million monthly active users, according to the parent company’s F-1 filing.

In the first half of 2018, Tencent Music made over $1.3 billion in revenue and $294 million in profits before taxes. That’s a stark contrast to how no single Western pure-play music streaming service has turned a profit yet: Spotify reported net losses of $461.4 million in Q2 2018, while Pandora, which is now housed under SiriusXM, lost $92 million over the same time period.

Across all of its services, Tencent Music houses around 20 million tracks, trailing behind Spotify, Apple Music and other global market leaders, but has long-term exclusive licensing deals with all three majors as well as a non-exclusive deal with Merlin. The IPO filing reveals that Warner Music Group and Sony Music Entertainment have also purchased a total of 68,131,015 ordinary shares in Tencent Music, worth approximately $200 million; Universal Music Group is curiously nowhere to be found the mix.

Despite drastically lower conversion rates to paid subscriptions -- and over 900 pending lawsuits alleging copyright infringement -- Tencent Music’s profitability is nonetheless a signal of power and leadership to major rights holders abroad, in an emerging music market that many industry execs are still trying to understand.

Below are the biggest takeaways from Tencent Music’s F-1 filing, and what the document reveals about the potential future of the global music business:

Tencent Music’s conversion rate from free users to paying subscribers for streaming is alarmingly low -- but the company sees the low numbers as a potentially lucrative opportunity for early investors.

According to its F-1 filing, Tencent Music has 644 million monthly active users across its mobile music streaming applications, namely QQ Music, Kugou Music and Kuwo Music.

But only 23.3 million of those users -- a mere 3.6 percent of the total base -- actually paid for streaming in Q2 2018. Moreover, the monthly average revenue per paying user (ARPPU) across Tencent Music’s three streaming services was only 8.7 RMB (~US$1.27), and total quarterly subscription revenue clocked in at just 605 million RMB (~US$88 million).

In comparison, Spotify reported 83 million paying subscribers and an average revenue per user of around $5.70 in Q2 2018 -- eclipsing Tencent Music by 3.6x and 4.5x, respectively, even with non-paying users in the latter equation.

Nonetheless, Tencent Music’s paid subscriber base grew by over 40 percent year-over-year in Q2, and the company indicates in its filing that its low paid-to-free user ratio indicates “significant growth potential.” Interestingly, the company is also banking its growth on sweeping macroeconomic shifts its home country of China, whose per capita spending on recorded music is expected to more than quadruple by 2023, according to iResearch analysis cited in the IPO filing.

Tencent Music makes the majority of its revenue not from paid subscriptions or advertising, but rather from "music-centric social entertainment services" like tipping and virtual gifts.

While Tencent Music is indeed set on widening its paid streaming user base, revenue from “online music services” overall -- which includes paid music streaming and downloads, advertising and content sublicensing -- accounted for just 29.6 percent of total revenue in the first half of 2018.

The remaining 70.4 percent of Tencent Music’s revenue comes from a unique ecosystem that no Western music streaming platform has effectively tapped into yet: a suite of value-added, monetizable interactions with music and its creators that Tencent calls “social entertainment services.”

The primary vehicle for Tencent Music's "social entertainment" is WeSing, a karaoke and live-streaming app that counts 228 million monthly active users as of Q2 2018, according to the F-1 filing. Similar to Vine and Musical.ly, WeSing has helped a handful of lucky creators with millions of followers launch their own careers as independent artists.

But there’s one crucial difference: unlike Vine and Musical.ly (both of which are now defunct), WeSing has found a lucrative monetization model beyond advertising. Using real money, WeSing users can buy "virtual gifts" to show appreciation for their favorite artists and broadcasters, who can then cash out said gifts back into real currency. The model is similar to "digital tip jar" experiences that startups like Huzza and TipCow (both also defunct) have tried to build in the past.

While these social music features account for the majority of Tencent Music's income, only around 9.5 million users -- or 4.1 percent of the total "social entertainment" user base -- shelled out money for such features in Q2 2018. Looking at the wider company, this means that 70 percent of Tencent Music’s total revenue in Q2 2018 came from just one percent of its user base.

Moreover, the ARPPU for Tencent Music’s social entertainment in Q2 2018 was 111.8 RMB (~US$16.30) -- nearly 13x that of the company’s online streaming business, and 2.9x that of Spotify's overall business.

This highly skewed distribution of revenue towards power users sounds more similar to free-to-play games (e.g. League of Legends, or even Candy Crush Saga) than to your standard music subscription service. For instance, a 2016 study found that the top 10 percent of spenders were responsible for 70 percent of revenue for the average mobile gaming app. Hence, Tencent Music’s rise arguably points to how game mechanics could help music streaming services around the world find a sustainable business model.

Everything that is still considered relatively niche, emerging or cutting-edge for music streaming in the West -- from direct artist distribution and user-generated content, to hi-res audio, dynamic fitness playlists and owned-and-operated hardware -- is old news for Tencent .

Throughout the F-1 filing, Tencent Music outlined many differentiating features across its music apps that Western platforms have been fighting to build for years.

Perhaps the most interesting feature is the “Tencent Musician Program,” which the company launched in 2017 as ”an online service for selected aspiring artists to upload original music content to our platform that can be streamed and downloaded by [our] users.” This sounds exactly the same as Spotify’s new direct-distribution initiative, which allows a select number of indie artists to bypass distributors, upload their music directly to Spotify free of charge and keep all of their royalties.

Another interesting vertical where Tencent Music has already been venturing for years is hardware. Spotify was hiring for a handful of hardware production roles back in Feb. 2018 -- purportedly to diversify its revenue streams and reduce its reliance on the likes of Apple, Google and Amazon for hardware integrations -- but a physical product has yet to see the light of day. Meanwhile, Tencent Music already has many proprietary hardware products available for sale, including but not limited to wireless bluetooth headphones, branded karaoke microphones and, yes, a forthcoming set of smart speakers (through a rumored joint venture with Samsung).

Hi-res audio is another example of a feature that is not yet available on most mainstream music services in the West (with the exception of Deezer and Tidal), but is already offered across Tencent Music’s portfolio of music apps, under the names QQ Music SuperSound, Kugou Viper and WeSing Super Voice, according to the company's F-1 filing.

Tencent Music has also made waves in concert live-streaming, selling hundreds of thousands of virtual tickets on its platforms Kugou Live and Kuwo Live. For original content, the company co-produces music talent shows with the separate subsidiary Tencent Video, while Western music streaming services are still struggling to nail down a viable video strategy.

Tencent Music’s biggest global rival arguably isn’t Spotify: it’s Facebook.

All of the aforementioned points, particularly the role of “social entertainment,” suggest that Tencent Music envisions the future of music consumption thriving first and foremost on a social network, rather than on a individualized user interface driven by personal recommendations.

According to its IPO filing, Tencent Music touts its “unique access to Tencent’s massive user base, representing China’s largest online social community” as one of the its greatest strengths and growth opportunities. As of Q2 2018, WeChat and QQ have over one billion monthly and 800 million monthly active users, respectively -- providing fertile ground for organic marketing of Tencent’s music offerings.

For example, "WeSing users can enjoy the recorded performances of their [WeChat] and QQ friends and interact with them on our platform," reads Tencent Music's filing. "In return, our users and their content enrich Tencent’s content ecosystem."

No other Western streaming service benefits from direct ownership of such a sprawling and influential social network -- except for the possible future version of Facebook.

Facebook, which reported 2.5 billion monthly active users across all of its apps in Q2 2018,  has secured licensing deals with most of the biggest labels, publishers and collecting societies, and has already been developing several native music applications -- including its own karaoke-like app, Lip Sync Live. Similarly to Tencent, the Silicon Valley behemoth is betting on the future rise of music consumption behavior that is more tightly integrated into existing social frameworks.

In July 2018, Facebook gained historic approval to build a subsidiary in China, after being blocked from the country for nearly a decade. Navigating China’s complex, siloed tech ecosystem is a staggering battle for any foreign company -- and music will undoubtedly become a crucial tool.