It’s Too Early to Tell Whether Tencent Music Is a Winner or Loser

Tencent Music IPO - It’s Too Early to Tell Whether Tencent Music Is a Winner or Loser

Source: Shutterstock

It took a while, and there were a lot of twists and turns, but Tencent Music (NYSE:TME) has finally made its debut on Wall Street. Often heralded as China’s Spotify (NYSE:SPOT), Tencent Music stock was forced to go public at $13 per share (the bottom end of its $13 to $15 expected range) due to escalating concerns regarding an economic slowdown in China. But, the Tencent Music IPO has been a sizable success thus far. As of this writing, TME stock is trading north of $14.

Will the successful Tencent Music IPO translate into long-term gains for TME stock? Or does a prolonged and troubled IPO process foreshadow dark days ahead?

At this point in time, it’s too early to tell. Tencent Music stock has huge long term potential if certain winds shift in the company’s favor. Namely, if China’s paid streaming music market finally starts to gain mainstream traction, the Tencent Music IPO could be the start of TME stock roaring to the moon.

But, China’s paid streaming market isn’t gaining that much traction, and right now, this is a company mostly supported by virtual gift revenues. Those revenues don’t seem all that sustainable in the long term. Thus, if China’s paid streaming market doesn’t gain traction ever, Tencent Music stock will have a tough time defending its $20 billion-plus valuation.

Overall, it’s just too early to tell whether or not the Tencent Music IPO will turn into something big, or not. When it’s too early to tell, that means there’s too much uncertainty. And when there’s too much uncertainty, there’s too much volatility. As such, the sidelines seems like the best place to hangout for Tencent Music stock in the near term.

Why There’s So Much Uncertainty Surrounding Tencent Music

The uncertainty surrounding the Tencent Music IPO boils down to one thing: although this company has the potential to be the Spotify of China, it isn’t the Spotify of China today, and the valuation doesn’t really reflect this disconnect.

The core problem here is that paid streaming services are relatively new in China, and aren’t widely adopted. While Tencent Music has a whopping 655 million online music monthly active users, only 25 million of those users are paying subscribers. Thus, Tencent Music is converting less than 4% of its users into paying subs.

Meanwhile, over at Spotify, there’s just 191 million MAUs. But, 87 million of them are paying subs. Thus, Spotify is converting nearly 50% of its users into paying subs, and as such, has more than three times as many paying subs as Tencent. Despite this discrepancy, the Tencent Music IPO valued the company at over $20 billion, which is right around where Spotify’s current market cap sits.

Why? Because Tencent Music makes a bunch of money from non-paying subs through virtual gifts. About 70% of the company’s revenue today comes from virtual gifts.

Unfortunately, this isn’t all that sustainable. The virtual gift phenomena is huge in China. But, the sustainability of this phenomena is highly questionable, and if this market falls through without the paid streaming market gaining traction, Tencent Music will lose a significant portion of its revenue and profits.

Why the Tencent Music IPO Could Be the Start of Something Huge

Having said all that, there are signs out there that the $20 billion valuation for the Tencent Music IPO may prove to be conservative in the long run.

Specifically, as paid streaming markets mature, adoption rates tend to go up. Back in 2011, Spotify was converting just 20% of its user into paying subs. By 2015, that number jumped to 30%. Today, it stands just shy of 50%. Thus, as ad-free streaming aged, it became the norm. And as it became the norm, everyone paid up for ad-free Spotify.

The same could happen in China. Paid streaming in China is a relatively new thing. It may take a few years for it to catch on. Trends in the U.S. and Europe imply that as paid streaming in China ages, it will become the norm. And, once it becomes the norm, Tencent Music’s paying ratio could go from below 5% to 50% in a hurry.

Let’s extrapolate that out. In five years, Tencent could easily have 800 million online music MAUs. If Tencent converts just 25% of those users to paying subs, that would imply 200 million paying subs. That is more than twice as many as Spotify, which has a $20 billion valuation today. Thus, a $40 billion-plus valuation for Tencent Music stock in five years doesn’t seem unreasonable, if the right things fall into place.

Bottom Line on the Tencent Music IPO

Don’t read too much into the Tencent Music IPO being somewhat successful. In the big picture, it is far too early to tell whether or not Tencent Music stock is a long-term winner, or a long-term loser. Until more clarity arises as to how the paid streaming market is developing in China, TME stock is simply one to watch from the sidelines.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

Article printed from InvestorPlace Media,

©2021 InvestorPlace Media, LLC