As a newly-minted public company in the U.S., Tencent Music Entertainment could offer a rather different, and potentially more attractive, offering to investors compared to similar music-streaming stocks like Spotify and Pandora — but not without its challenges and industry criticism.
After a two-month delay, Tencent Music finally launched its initial public offering on the New York Stock Exchange Wednesday (Dec. 12), closing the day up 9.2 percent at $14.19 per share. A subsidiary of Chinese tech and entertainment conglomerate Tencent Holdings, Tencent Music had initially planned to go public in October, but delayed the launch in part due to global market turmoil and U.S.-China trade disputes. The company raised a total of $1.1 billion ahead of its public debut, selling 82 million shares at $13 each for an implied market value of $21.3 billion.
For investors, Tencent Music has a fundamentally different product offering and business model from the major Western streaming services. The Chinese company currently owns four music apps — streaming platforms QQ Music, Kugou and Kuwo, plus karaoke app WeSing — and made over 70 percent of its revenue in Q2 2018 not from paid subscriptions or advertising, but rather from in-app tipping, virtual gifts and other “social entertainment services,” according to the company’s F-1 filing.
Overall, Tencent Music reported post-tax profit of $263 million in the first half of 2018, a 341 percent increase year-over-year. In contrast, with the exception of Napster, no Western music streaming service has turned a profit — and shareholders seem to be responding accordingly.
At market close yesterday, Spotify’s stock price was $128.40 per share — a 5 percent decrease from its opening price of $132.00 in April, and a 35 percent drop from its peak of $196.28 on July 26. Warner Music Group and Merlin both sold their entire stakes in Spotify this year, while Sony cashed in half of its Spotify shares in July, around the streaming company’s peak. Warner and Sony subsequently purchased a collective $200 million in shares in Tencent Music in October. (Spotify and Tencent Music also own minority stakes in each other, having signed a landmark equity-swap agreement in Dec. 2017.)
Will Tencent Music make investors more bullish on the future of global music streaming? The answer isn’t so clear-cut, in part because of ongoing licensing and revenue tensions with international rights holders.
While Tencent Music is profitable, labels and publishers are seeing nearly none of the upside from the “virtual gift” money that accounts for the lion’s share of the company’s revenue. Moreover, a complex web of sub-licensing and “copyright transfer” agreements among streaming rivals in China — i.e. Tencent Music sub-licensing its “exclusive” catalog to NetEase Cloud Music and Alibaba’s Ali Music Group, alongside NetEase striking its own cross-licensing agreements with Ali Music Group and Xiaomi Music — has led to frustration around lack of data transparency for artists and labels.
Understanding Tencent Music’s viability as a public company also necessitates a wider investigation into the health and maturity of the Chinese music industry as a whole, and how the market is slowly but surely recovering from a fraught history with piracy.
Below are four important trends underlying Tencent Music’s launch as a publicly traded company, and their implications both for their success and for global music streaming as a whole.
Tencent Music’s early stock price perhaps reflects ongoing skepticism about the overall health of China’s recorded-music market.
Despite its profitability and rapid growth, Tencent Music’s starting valuation of $21.3 billion somewhat undercut Spotify’s opening valuation of $26.6 billion in April.
That price gap may reflect ongoing hesitation from international investors regarding the maturity of China’s music industry, given the country’s ongoing struggle to combat piracy. Sources say that China was still a 99-percent pirated music market as recently as 2011, even though Tencent’s QQ Music, Kugou and Kuwo had all been in operation since around 2005.
The music revenue picture has improved somewhat since then, in part thanks to government-led crackdowns on copyright infringement. According to the IFPI, annual recorded-music revenues in China grew by 35.3 percent to $292.3 million in 2017. Streaming revenue also increased by 26.5 percent year-over-year to $204.5 million, accounting for 70 percent of the overall pie.
But China also still ranks among the lowest in the world when it comes to music revenue per capita — clocking in at just $0.21 in 2017, compared to around $15 to $20 in more mature music markets like the U.S. and the U.K.
What’s more, rights holders aren’t always getting the fairest deals from Chinese music services. Sources say that China’s market standard for streaming revenue splits have the tech platforms setting aside anywhere from 20 to 40 percent of their revenue for “channel costs” off the top (Spotify keeps around 30 percent of its revenue for this purpose). Out of the remaining revenue, the platforms keep 50 percent, then pays out 42 percent to labels and only 8 percent to publishers.
Average royalty payouts through a typical ad-supported tier in China amount to just 0.001 RMB ($0.00015) per stream — 3 percent of the low end of Spotify’s reported payout rate of 0.005 per stream, sources say. Conversion from free to paid subscribers also remains low: Tencent Music’s F-1 filing revealed that only 3.6 percent of its streaming users paid for access to content in Q2 2018.
Wall Street investors and music-industry stakeholders alike are hoping that Tencent will serve as a role model for the rest of China when it comes to converting more free streaming users to paying subscribers, and generally to bringing more legitimacy to copyright protection in the country.
Tech and telecom giants will likely play a more dominant role in developing China’s music market compared to pure-play services like Spotify and Deezer.
Over the past few years, artist advocacy organizations in Western markets have spoken out about misaligned incentives between rights holders and the tech companies that control their revenue, marketing and distribution. That issue may be even more exacerbated in the Chinese music market, the vast majority of which is funded and owned by tech conglomerates, including but not limited to Tencent.
By some reports, Tencent Music’s three streaming companies (QQ Music, Kugou and Kuwo) currently account for at least 70 percent of the entire Chinese music streaming market. This is in part due to the sizable capital and cross-vertical marketing prowess of its parent company Tencent Holdings, which also happens to own China’s biggest messaging app (WeChat) and the world’s biggest gaming company (Tencent Games).
Most of the remaining 30 percent of China’s music market is also controlled by larger tech companies. Alibaba, an e-commerce giant whose market cap sat at $392.7 billion at market close yesterday, owns music streaming service Xiami. NetEase Cloud Music, which is influential for marketing international music in China, is also owned by one of the world’s biggest game developers. Chinese telco giant Huawei, which reported nearly $93 billion in sales last year, recently shared that its music streaming platform Huawei Music has 100 million monthly active users (although industry sources dispute this claim).
In fact, despite the dominance of Spotify, the landscape actually doesn’t look that different in the States. Thanks to its parent company’s sprawling device ecosystem, Apple Music has proven to be one of the fastest-growing streaming services in the world, reportedly outnumbering Spotify in paid U.S. subscribers in July. Likewise, Amazon and Google not only have similar cross-vertical capabilities for marketing Amazon Music and YouTube, respectively, but can also afford to take on music streaming as a loss leader given their more lucrative investments in hardware, cloud services, e-commerce and other sectors.
Whether or not this tech-driven dominance helps or hurts artists and labels, the reality in China is that music is considered just one pillar in a wider entertainment business ecosystem that spans gaming, video and social media — a stark contrast to the likes of Spotify, Deezer and Tidal, which take pride in being “pure-play” music and audio services even if their bottom lines are underperforming.
“We tend to talk about Spotify all the time, because they’re one of the first to market, and are currently the global market leader,” Jordan Bromley, entertainment & media partner at Manatt, Phelps & Phillips LLP, tells Billboard. “But I think their model will be the exception rather than the rule for global streaming success, based on how things are shaping up.”
Tencent Music has more or less monopolized the Chinese music market when it comes to licensing and data, leading to tensions both with streaming competitors and with music rights holders.
As mentioned, Tencent Music is involved in a tangle of sub-licensing and “copyright-swap” agreements with several rival services, including NetEase Cloud Music, Ali Music Group and Xiaomi Music — a trend that became more popular once the Chinese government began cracking down on unlicensed digital music in 2015.
Such deals allow these services to access selections from each other’s otherwise “exclusive” catalogs, partially for the purpose of preventing expensive copyright infringement lawsuits. The major labels’ “exclusive” deals with Tencent Music are not actually exclusive from the vantage point of access, because their content also benefits from distribution and exposure on other streaming platforms in the country.
This kind of “copyright-swap” behavior seems backwards in Western markets — the equivalent would be Spotify sub-licensing its catalog to Apple Music, and setting the price for them — and its origins lie in quasi-monopolistic ambitions on behalf of Tencent.
Sources say that Tencent Music’s early growth strategy involved trying to lock up the majority of music content in China through exclusive deals with major labels, in order to set prices for and squeeze out its competitors. This tactic is in contrast to Western digital-music strategy, which has tended to focus more on editorial curation, product improvements, brand marketing and original content than on pursuing exclusive label licenses, particularly with the majors.
As a result of Tencent’s demands, Ali Music Group lost its direct deal with Universal Music and was never able to sign agreements with Warner or Sony, although Ali Music still has active deals with BMG, Cooking Vinyl and a handful of local labels.
Through its sub-licensing agreement with Tencent Music, NetEase Cloud Music is prohibited from undercutting Tencent’s pricing model for music subscriptions. While disproportionately benefiting the latter company, sources say that this agreement has actually had a positive impact on China’s music ecosystem, in the sense of solidifying and spreading the paid-subscription model for music to a wider user base.
One major frustration that major-label sources currently face with Tencent Music is that due to their deal exclusivity, the labels receive little to no usage data from Tencent’s sub-licensors, leading to a skewed outlook on Chinese music consumption.
If a major label has a new artist whom they think has a bigger opportunity to build a streaming fanbase on NetEase, they still have to go through Tencent for distribution — and most likely won’t receive any substantial report from Tencent about NetEase consumption data, which would be essential information for measuring the success of local marketing campaigns. Sources say that Tencent itself hasn’t given international artists and labels enough promotional interest or real estate to satisfy industry stakeholders and compensate for this information asymmetry.
The problem travels the other way around too, in that labels licensing exclusively to NetEase or Ali Music Group will see little to no usage data from Tencent Music or other sub-licensors of those companies. This is where independent organizations like Merlin — which struck non-exclusive deals with Tencent, NetEase and Ali Music in March — could have a significant competitive advantage over the majors, with respect to receiving data from all of these services directly.
While this behavior seems unconventional for Western markets, sources have pointed to the possibility of Spotify enabling artists to distribute to other platforms through its partnership with DistroKid as a similar threat, with respect to the balance of power in the music industry.
Social video and live-streaming have significant influence on music consumption trends in China — but for Tencent Music and other players, licensing remains the elephant in the room.
In its F-1 filing, Tencent Music claims that it has a significant advantage over competitors through deep integration with its parent company’s suite of media properties, including but not limited to “co-produc[ing] Tencent Video’s music talent shows.”
The partnership reflects the enduring popularity and influence of visual entertainment culture on music consumption trends in China and across Asia — from karaoke experiences like Tencent Music’s WeSing to other live-streaming video apps like TikTok, which is owned by Chinese tech corporation ByteDance and has gained significant traction among international celebrities.
“TikTok seems not to cannibalize streaming revenue from the main streaming platforms in China,” Alex Taggart, general manager, China at music-industry services firm Outdustry, tells Billboard. “It’s a really great promotional mechanism, where consumption on TikTok often drives more streams on services like NetEase and QQ Music.”
The one big catch: the licensing agreements behind the vast majority of karaoke and live-streaming apps in China are weakly monitored, completely unenforced or nonexistent altogether.
Sources say that licensing their catalogs to WeSing was part of many of the exclusive agreements that the majors struck with Tencent Music. But like several other karaoke apps, WeSing allows users to toggle between the original master version of a song and an unofficial “karaoke version” — which automatically strips the vocals from the track, and doesn’t count towards overall play metrics or payouts.
Labels and publishers have also seen no upside from Tencent Music’s “virtual-gift” features, even when their music is played in the background of lucrative streams. Music-industry stakeholders have issued similar complaints against Twitch — which also makes the majority of its revenue from user subscriptions and donations during live-streams, but shares none of that income with the rights holders of music played in the background of those streams.
Such challenges are encouraging label and publishing executives to rethink music copyright legislation on a larger scale, especially given that more social and live digital-music behaviors are deeply ingrained into the Chinese music market.
“To capitalize on this new wave of consumption, artists cannot solely rely on digital music downloads alone anymore — so getting their work onto a leading short video platform has become one of the biggest music promotional opportunities of this generation,” Rebecca Yang, co-founder and chairwoman of Anglo-Chinese entertainment production company IPCN, recently wrote in Music Business Worldwide. “It’s imperative that artists now fully embrace their work being edited, regenerated and re-packaged by consumers.”