Tencent Music Entertainment Group (TME) CEO Cussion Pang on Q2 2020 Results – Earnings Call Transcript



Tencent Music Entertainment Group (NYSE:TME) Q2 2020 Earnings Conference Call August 10, 2020 8:00 PM ET

Company Participants

Millicent T. – Vice General Manager

Tony Yip – Chief Strategy Officer & Head of Ultimate Music

Cussion Pang – CEO & Director

Shirley Hu – CFO

Conference Call Participants

Eddie Leung – Bank of America Merrill Lynch

John Egbert – Stifel, Nicolaus & Company

Binnie Wong – HSBC

Alex Poon – Morgan Stanley

Alicia Yap – Citigroup

Wendy Chen – Goldman Sachs Group

Thomas Chong – Jefferies

Robert Sanderson – Loop Capital Markets

Zhijing Liu – UBS Investment Bank

Alex Liu – China Renaissance Securities


Ladies and gentlemen, good evening and good morning, and thank you for standing by. Welcome to the Tencent Music Entertainment Group 2020 Second Quarter Earnings Conference Call.

Today, you will hear discussions from the management team of Tencent Music Entertainment Group, followed by a question-and-answer session. Please be advised that this conference is being recorded today.

Now I will hand the conference over to your speaker host today, Ms. Millicent T. Please go ahead, ma’am.

Millicent T.

Thank you, operator. Hello, everyone, and thank you all for joining us on today’s call. Tencent Music announced its quarterly financial results today after the market close. An earnings release is now available on our IR website at ir.tencentmusic.com as well as via Newswire services.

Today, you’ll hear from Mr. Cussion Pang, our CEO, who will start the call with an overview of our recent achievements and our growth strategies. He will be followed by Mr. Tony Yip, our CSO, who will offer more details on our operations and business developments. Lastly, Ms. Shirley Hu, our CFO, will address our financial results before we open the call for questions.

Before we proceed, please note that this call may contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management’s current expectations and observations that involve known and unknown risks, uncertainties and other factors not under the company’s control, which may cause actual results, performance or achievements of the company to be materially different from the results, performance or expectations implied by these forward-looking statements.

All forward-looking statements are expressly qualified in their entirety in the cautionary statements, risk factors and details of the company’s filings with the SEC. The company does not assume any obligation to revise or update any forward-looking statements as a result of new information, future events, changes in market conditions or otherwise, except as required by law.

Please also note that the company will discuss non-IFRS measures today, which are more thoroughly explained and reconciled to the most comparable measures reported under the international financial reporting standard in the company’s earnings release and filings with the SEC. You are reminded that such non-IFRS measures should not be viewed in isolation or as an alternative to the equivalent IFRS measure, and other non-IFRS measures are not uniformly defined by all companies, including those in the same industry.

With that, I’m now very pleased to turn over the call to Cussion, CEO of Tencent Music. Cussion?

Cussion Pang

Thank you, Millicent. Hello, everyone, and thank you for joining our call today. As the industry leader of China’s online music market, we continue to shape the development and foresting of the music industry by continuous promotion of the pay-for-streaming model, deeper cultivation of indie musicians, further expansion of our capabilities to promote digital albums and our innovative online concept, TME Live.

For the second quarter, we are pleased to report a stronger-than-first quarter performance. Our online music revenues increased 42% year-over-year, accelerating from a 27% growth rate in the first quarter. Most notably, online music subscription revenues continued their rapid growth, increasing nearly 65% year-over-year in the second quarter driven by improving user retention, effective payroll strategy execution and expanding personalized recommendation capabilities.

Online music paying ratio rose significantly to 7.2%, up from 4.8% in the same quarter of last year, allowing us to maintain our leading position in monetization amongst domestic online music platforms.

As the early applicator and now the absolute leader in China’s digital music industry, our digital album sales also achieved a strong performance in the second quarter. Our successes not only included outstanding achievements of global superstars but also extended to a new-generation artist, such as Sean Xiao, whose new single, Spotlight: Guang Dian, set a new record of digital music sales on a single platform.

Moving on to content. We continue to strengthen our content leadership by forming new strategic partnerships with a broad range of music labels, including those in the top, mid-level and long-tail categories, as well as adding various forms of content, including trendy and original music from indie musicians in order to provide the most comprehensive content offering to our users. This ultimately further solidified our content leadership and improved our core competitive strengths.

We recently completed a contract renewal with Universal Music Group, successfully signing a multiyear contract with them. In addition, we will form a jointly owned music label with UMG to deepen our collaboration. The new partnership, apart from creating mutually beneficial, long-term potentials for both parties, will also enable us to improve efficiencies and profitability through our economy of scale, while unlocking market monetization opportunities for many years to come.

Based on our extensive user insights and in-depth knowledge on content, we are proactively adding new verticals in emerging, long-tail and popular genres to provide an even better content offering to our users. Particularly in response to younger users’ demands, we continue investing in more popular content, such as more ACG genres. In the second quarter, we also added new music — we also added music copyright for trend-setting variety shows such as the Chuang 2020; Youth With You 2, Qingchun You Ni 2; and Sisters Who Make Waves, Cheng Feng Po Lang De Jie Jie. In the first half of 2020, we covered over 80% of music content for variety shows aired in China. Our focus on new hit songs also began to yield positive results.

Also, in the first quarter of 2020, 9 out of the top 10 most popular songs according to Baidu Index could be found in our music library, of which 7 were exclusive to us. All of these ethos have led to further penetration into the younger demographic.

In July, we celebrated the three year anniversary of our Tencent Musician platform. We are proud to say we have made strong achievements on several fronts. First, we have committed significant resources in nurturing indie musicians, which has lead to impressive growth in income for indie musicians. Second, we have experienced exponential growth and scale over the past few years. By the end of the second quarter, both the number of indie musicians and original songs uploaded to our platform achieved a triple-digit year-over-year growth rate, while exclusive indie musicians increased by nearly 10x year-over-year.

Third, we have emerged as the leading and preferred platform for indie musicians, attracting the largest number of new indie musicians over the past several consecutive months. Finally, by leveraging our strong promotional capabilities and well-rounded content knowledge as well as in-depth user insights, we have helped indie musicians’ original content to reach a broader audience.

For example, Meet Him Later, Hou Lai Yu Jian Ta, a song by Hu 66 released in March this year, achieved over 1 billion playbacks and inspired over 5 billion short-form videos on the Internet by the end of the second quarter. As the absolute industry leader in China with the largest music user base, we are actively accumulating a wider and deeper understanding of our users in terms of their evolving demands. We are then integrating this information into our product design and upgrades to provide holistic music experience that is increasingly interactive, social-driven and visually stimulating.

One great example is within QQ Music, the recent introduction of Putong Community. Putong is actually — which means happy in Chinese. It is a dynamic community and platform connecting idols and fans as well as users sharing similar preferences. The platform attracted many artists to join and generated unique and interesting interactions between celebrities and their fans. Through this new feature, total song reviews grew by year grew by over 1 million during the quarter, and we are pleased to see its DAU penetration rate increasing steadily since launch.

Another example is that we are making music streaming more visualized through video enrichment in our apps, which bring brand-new multimedia music experience to our users. In the release of QQ Music 10.0 and the upgrade of Kugou Music, we seamlessly added high-quality music-centric video for users to enjoy while listening to music. We also incorporated video tap recommendations to distribute more personalized video content as well as encourage user-generated video content, which grew triple digits from the first quarter on Kugou Music.

Lastly, with our strong financial position, we continue to invest in China’s fast-growing but underpenetrated long-form audio market. In the second quarter, we rapidly ramped up our long-form audio services. On the content side, we quickly added more iconic audio content, further enriching our long-form audio offering, which was illustrated by a 300% year-over-year increase in the number of licensed titles. Particularly, the catalogs for literature, audio drama and talk show showed an even more rapid growth. We are also pleased to see an increasing number of users streaming more long-form audio content with this MAU penetration increased to 9.4%, significantly up from 4.6% for the same quarter of last year.

In terms of commercialization, we introduced a high-value, standalone, long-form audio subscription plan. This is in addition to our cross-sales package with our music subscription plan, which offers pricing advantages. We expect long-form audio to become a new growth engine for revenue diversification, given the strong synergies that can be achieved with our online music services.

This concludes my prepared remarks. Now Tony will discuss other important area of focus for our businesses. Tony, please go ahead.

Tony Yip

Thank you, Cussion. Hello, everyone. Apart from the key developments discussed by Cussion just now, I would like to add that our overall promotional capabilities have been expanded, and our enhanced, personalized recommendation analytics continue to contribute to improved user experience.

In the second quarter, the DAU penetration ratio of personalized recommendation further increased sequentially, and personalized recommendation accounted for an increasing proportion of streaming volume on our platform. Furthermore, as a pioneering product in creating a whole new experience to live concerts by bringing them online, our TME Live has gained tremendous recognition, making significant social impact and propelling the industry to flourish.

In the second quarter, we successfully organized 9 influential Ultra Live performances for well-known global artists, such as Mayday, Wu Yuè Tian; and Hanazawa Kana, Hua Zé Xiangnài, which have earned TME Live a strong brand name. In July, we went one step further by introducing extended reality technology to online live performances, the first in the industry to do so, which truly demonstrate our commitment to embracing technology and innovation.

As we continue to build our TME Live pipeline, we are exploring different service models for users to enjoy our high-quality live shows, including VIP package, virtual gifting and others, taking another step to unlock the massive value and market potential for online live performances.

Turning to our social entertainment services. Overall, we remained very focused in building and sharpening our long-term competitiveness amidst increasing competition on user time spent. During second quarter, as the COVID-19 situation continued to improve in China, we are pleased to see some recovery, demonstrated by double-digit sequential ARPPU expansion in the second quarter.

To continue to effectively differentiate our live streaming services from other platforms, one of our key focuses has always been on attracting and retaining quality music-centric live streaming performers and then working with them to closely build, expand and commercialize the unique idol/fan-based economy. In fact, through concerted efforts, we successfully grew the number of performers on Kugou Live by nearly 50% in the second quarter comparing with a year ago. Particularly, the number of exclusive performers could triple year-over-year. In addition, the retention rate of live streaming performance improved sequentially as well.

In summary, the growing number and the quality of talents have enriched the content offering on our platform, resulting in improving retention rate and consumption patterns among our user cohorts.

Our expansion into new content categories in live streaming such as gaming and ACG has further diversified the content on our live streaming platform as well as enhanced our user acquisition capabilities. Further to the strategic cooperation announced in the first quarter between Kugou Live and Tencent Games, we attracted thousands of gaming live streaming performers in the second quarter, and our ACG category had a double-digit sequential increase in the number of active performers and total user time spent.

In June, as scheduled, we launched Fanlive, our new live streaming brand for QQ Music. Although small and at an early stage, we recorded good progress in terms of talent recruitment and interaction between users and performers. Leveraging our massive user base from QQ Music, Fanlive offers a differentiated music live streaming experience to music fans on QQ Music, and we plan to introduce more interactive features and tools to achieve further growth in the future.

When it comes to online karaoke services, we are the biggest online singing platform in China and are committed to providing seamless, interactive, visual and sociable singing experiences for our users. Recently, we launched WeSing 7.0, and our key areas of focus have been to introduce more tools that can stimulate video content generation and consumption, which then lead to more sharing and boost the platform’s social attributes.

We are pleased to say that through upgraded singing experience in the second quarter, the number of users publishing videos increased almost 70% compared to the first quarter. Through KOL incentive system incorporating with external platforms, we recorded an almost 300% sequential increase of KOLs, which is critical to boost content creation and build a closer user community on our platform.

Social attributes continue to be strengthened as we launch interactive features to boost the popularity of online singing rooms, which enjoy unique social connections among friends. We will remain focused on sharpening such key areas over the next few quarters. And by doing so, it will enable us to continue to build a self-reinforcing virtuous ecosystem, which starts the journey with online singing, then goes on to content generation, sharing and socializing. As we build on our long-term competitiveness, it will open up tremendous opportunities for monetization, including advertising in different forms and settings.

Lastly, let me quickly discuss Kugou Changchang, an online karaoke product we designed to better serve Kugou Music users through integrated online music streaming and online singing. We introduced interactive features to encourage sing-offs, successfully attracting users from upper-tier cities as well as younger demographics who are no stranger to the sharing of their online singing experience. For the second quarter, we are pleased to see that Kugou Changchang achieved rapid year-over-year growth in MAU and paying user, providing a strong complement to WeSing in our karaoke services product mix.

With that, I would like to turn it over to our CFO, Shirley Hu, for a closer review of our financials.

Shirley Hu

Thank you, Tony. Hello, everyone. Next, I’ll discuss our results from a financial perspective. Overall, I’m very pleased with our second quarter financial results. We achieved strong growth in online music services, particularly in music subscription revenues as well as healthy growth in social entertainment business. Our total revenues were RMB6.9 billion, up 17% — 17.5% year-over-year. Online music revenues were RMB2.2 billion, up 42% year-over-year driven by music subscription revenues, digital album sales and advertising revenues, despite a decrease in sublicense revenues. In particular, our music subscription revenue were RMB1.3 billion, up 65% from same period last year.

On a year-over-year basis, paying users and ARPPU grew 52% and 8%, respectively, resulted from user retention improvements and effective paywall strategy exception, as Cussion discussed earlier. Additionally, we saw strong growth in both advertising revenues and digital album sales. Advertising revenues continue to be an important growth driver for us. We are optimistic about the growth potentials in this area and are proactively taking procedures to grow advertising business effectively.

Growth in digital album sales in this quarter was driven by new digital platform releases of few very popular artists. Social entertainment services and other revenues were RMB4.7 billion, up 9% year-over-year driven by growth in online karaoke and live streaming services. Paying user grew 12% year-over-year. ARPPU decreased 3% year-over-year while increased 13% quarter-over-quarter as we continue to recover from COVID-19 situation.

Our gross margin was 31.3% in Q2 2020 and decreased 1.6% from 32.9% in the same period of last year. The gross margin decrease was mainly resulted from investments in new products such as long-form audio as well as a higher revenue sharing fees in social entertainment to strengthen our platform’s competitiveness.

Online music services had a positive impact on overall margin in Q2 2020, and this trend is expected to continue as our subscription revenues continue to grow, while license content costs are gradually regionalizing as our music industry evolves.

Now moving on to operating expenses. Total operating expenses for Q2 2020 were RMB1.3 billion and was 18.8% as a percentage of total revenues, representing an increase of 1% compared to same period in 2019, with promotion expenses and R&D employee-related costs being the largest drivers. During the quarter, we incurred expenses to promote new products such as long-form audio, Kugou Changchang and the TME Live that are still ramping up in terms of revenue generation. But we are investing for their long-term growth potential.

We also increased the promotional spending for existing products to strengthen our products competitively. Additionally, we continue to invest in R&D for product investment and technology innovation, leading to higher employee-related costs in R&D. Our net profit attributable to equity holders of the company was RMB0.9 billion, non-IFRS net profit attributable to equity holders of the company was RMB1.15 billion, and the non-IFRS net profit margin was 16.7%. As of June 30, 2020, our combined balance of cash, cash equivalents and term deposits were RMB22.3 billion, representing an increase of RMB0.4 billion from Q1, which was primarily driven by cash flow generated from operations of RMB1.44 billion and the cash paid for investments.

In conclusion, we continue to be optimistic about the future of the broad music industry and are confident in the overall ecosystem and the product pipelines that we are building in the long run. We will continue to focus on enhancing and expanding our product and service offering such as long-form audio, Fanlive and the TME Live while maintaining core company investments.

This concludes our prepared remarks. Operator, we are ready to open the call for questions.

Question-and-Answer Session


[Operator Instructions]. Your first question today comes from Eddie Leung with Bank of America Merrill Lynch.

Eddie Leung

Just wondering if you could share a bit of color of the MAU trends happening into the summer. We probably understand that the decline year-on-year in the same quarter partly because of the people getting back to work. So just wondering how is the trend going when we hit summer. And then just a quick follow-up. Wondering if you could address some investors’ questions on any measures to mitigate the risk of a — delisting of ADL from U.S.

Tony Yip

Thank you, Eddie. Your first MAU question, I suppose it relates to music. Actually, in the second quarter, we saw a very mild year-over-year drop of 0.0% year-over-year basis for music MAU, and that’s actually not because of people getting back to work. Because as you know, when people get back to work, during the commute, they can actually tend to listen to more music. So that’s actually a positive factor for us. The offsetting factor is more a result of the younger demographic going back to school. And when the younger demographics are locked down at home, they spend more time on music and on karaoke as well, whereas when they go back to school, they actually spend less time. And that’s actually the main reason we saw a small decline in the music MAU. And also, that’s a key reason for the decline in the social MAU as well.

Just on the social MAU, and just to finish up on the music MAU, we do expect the MAU in Q3 to see some growth. But again, I think given the sheer size of the music MAU at around 650 million, our focus is very much on growing the paying penetration and monetization and engagement as opposed to growing that base — user base much further.

And then in terms of social MAU, I think just to recap, we saw a very sizable increase in the first quarter on social MAU. Because of COVID, more users have more time to spend on karaoke at home and live streaming at home. And so in the second quarter, when the lockdown ended, in particular, as the younger users go back to school, the second quarter MAU decreased. And that’s the first factor.

The second factor that’s impacting our social entertainment MAU is continued competition with short video apps for user time, in particular, WeSing. And while we do expect that competition to continue and we will see a slightly lower MAU in Q3 than in Q2, we do expect it to bottom out in Q3 and then stabilize from there. Because we’re starting to see improvements in some of the core metrics as we roll out a number of the product enhancements that we talked about in WeSing relating to reducing the usage barrier, increasing the video features as well as social elements.

Cussion Pang

He also talked about delisting.

Tony Yip

And then in terms of the second question about delisting, well, first of all, I think just to take a step back, the executive order that was provided — or actually, it’s not an executive order. The recommendation by the President’s Working Group is a recommendation. The President’s and the White House actually have not come out with an official executive order as of yet as to what to do with that recommendation. So we do think it is premature to speculate on how that would evolve.

Secondly, I want to stress that delisting is not the only option because if you look at the recommendation paper submitted by the President’s Working Group, it does outline alternative options, for example, co-audit between a U.S. auditor and a Chinese-based auditor. So that is also a potential option. So we are evaluating all options and ensure that when there are further policy comes out, we will be acting in the best interest of our shareholders to protect long-term value.


Your next question comes from John Egbert with Stifel.

John Egbert

Great news about the UMG deal. Aside from the obvious change that this is a license for TME services only, can you talk about some of the primary objectives you’re most excited about accomplishing in the new deal? And perhaps, something — is there anything related to TME’s promotional capabilities, given Universal’s adoption of marketplace services as part of its new deal with Spotify?

Cussion Pang

Okay. Thank you so much, John, for your questions. We are so excited to enter a new deal with UMG Group. As I always mentioned, this relationship is not just starting today, but actually, we have a very good history of working with UMG and also other very leading music label over the world for many, many years already. We are trying our very best to protect the IP rights, which we have did a really good job and has been fully appreciated by them. And also in the past few years, we have laid a really good foundation in — we are promoting the music industry together. And we are also helping them to promote their artists and their songs through our big data analysis. So all of this has been — lay a good foundation for us and help us to — can even work closer together in the coming years.

And this time, when we are going to recontract with Universal, we are pleased that the outcome is a new multiyear agreement, which is we believe that is a truly win-win situation. And unlike the last agreement, which was effectively more like a fixed cost contract in respect to — of the revenue generated, the new one has a reasonably fair MT level that both parties are incentivized to work together to exhibit and see the revenue sharing can kick in. So I think that the new deal is really aligned both on the parties’ interest and motivate us to cooperate closely to better serve each other.

And the other really good news is Universal also selected us, okay. We are going to form a new joint venture music label in China, which will be basically focusing on nurturing some of the new younger-led generation artists. I think it’s another truly win-win situation because Universal Group has been really good in doing the — for example, like ANR and also the music production really well. And TME is serving a really huge base of domestic users in China, and we understand the user preferences, and also we understand how to distribute the content right. So this is very important for us to join together, and I really look forward to this joint music label that we are going to set up in China.


Your next question comes from Binnie Wong with HSBC.

Binnie Wong

It’s Binnie here. And my question here is a — two quick question here is on the user engagement strategy. Saw that like you have various new innovative features, right? You have TME Live, long-form video. And also in QQ Music, we also observed there’s a new user features called the Putong Community, right? Is it more like kind of like a Weibo style that we are basically promoting more interaction with like the singer or the streamers with like users? So any metrics on how these users are converted into subscriber will be helpful. And what is our plan for monetization on these new features?

And then do you see that there’s a need, right, basically to monetize beyond our core subscription and live streaming? So do you think advertising would be something that we will be introducing soon more or maybe doing more? So that is my questions here.

And then lastly, just want to see in terms of — on the margin side, do you see 2 half — second half remains an investment year, given the margins we saw in the first half? Do you think these kind of trends should extend in the second half just on the trend-wise?

Tony Yip

Yes. I’ll address the first part of the question about — around engagement and monetization, and then I’ll let Shirley take the margin question. It’s — I think we’re actually very pleased. I mean this quarter, as we mentioned, we announced quite a few product enhancements that are very much focused on increasing user engagement. You saw TME Live, you saw our Putong Community, the increasing video enrichments across pretty much all of our apps in QQ Music, Kugou Music and WeSing. In WeSing 7.0, you saw more interactive features around community, increasing adoption of online singing rooms, promoting more, publishing activities by our KOLs as well as our ordinary users. I think all of these are very much focused on building a long-term, sustainable and healthy platform, which — from which, obviously, there will be a plan to monetize.

We are seeing very good metrics. So for example, for Putong Community that you mentioned, the DAU penetration is increasing, and the total number of songs reviewed that are coming on the back of the Putong Community exceeded over 1 million, right, in a very short span of time.

In terms of the video enrichment within, for example, QQ Music or Kugou Music, we’re seeing increasing video content, DAU consumption penetration, right, increasing sequentially. I quoted some metrics around online karaoke in terms of the video publishing activities, which are seeing very exciting growth. So I think all of these are very healthy for the overall sustainability and long-term growth of the platform.

And in terms of monetization, you’re actually right. We do see advertising as an other — third major revenue source behind subscription and live streaming. In fact, we have said in the last quarter that we are actively hiring to increase our team as well as increase our advertising product and technology behind that. You will see us do more as we proceed into the second half, and advertising revenue will ramp up substantially next year.

Shirley Hu

Okay. About gross margin, in second half of this year, we expect that gross margin will be stable compared to the first year and maybe a little increase. The first — in the first half of this year, the revenue sharing fees give us some pressure on gross margin. We will monitor these costs in the second half of this year and improve this part of this margin.

And second — the online music revenues will have positive impact on our gross margin because our online music revenue grows very rapid. And the cost structure of the online music will be regional in the next quarter and in next — in some years. And second, we will also need to invest to our new product such as long audio form — long-form audio and Kugou Changchang the TME Live. So this part of cost will be increased.

In sum, the overall — the gross margin will be stable in the second half compared to the first half of this year.

Cussion Pang

Yes. I just want to add a little bit more color on the advertising business that you also mentioned during your questions. I think that during the pandemic situation, our advertising business was actually impacted a little bit, especially when you’re seeing the data in Q1. But I think that we are definitely on the path of recovery. And in Q2, our advertising revenue, actually, a record 52% year-to-year growth. And we are thinking that we are doing really good in this area. And there’s a number of ways. First of all, we will be — continue to improving our user experience, okay, by — even though adding some more advertising, but we can also let the user to have more chance to reach to our payer content.

The other part is for the advertising business, we can also — using this in different use cases and scenario. For example, like the IoT business that we are working in, the in-car music services that we provide, we think also is a good scenario for us to implant audio forms of advertising aspect in it.

We also, as mentioned before, we are heavily investing in doing the long-form audio business, which is also — create another very natural way for us to not just doing the subscription plan, but also, we can do our advertising model in it. So we are seeing that the advertising business, we are building the foundation for it, and we are expecting that is going to be another stream of revenue for us in the years to come.


Your next question comes from Alex Poon with Morgan Stanley.

Alex Poon

Congratulations on good results. My first question is related to the new agreements with UMG. Is there anything you can share from this agreement that has an impact on your gross margin of music services? And if you can also comment on the music gross margin in second quarter and also in second half, the trend. And my second question is regarding how do you see the competition with NetEase in the longer term as they also signed an UMG agreement today. The user base of both companies are very big, but paying ratio is low. So everybody is still growing very nicely. So how will competition play out in the longer term? And what are you doing in reaction to this?

Tony Yip

With respect to the UMG contract renewal, as Cussion mentioned, we are very pleased with the outcome. In particular, I think the structure of the economics in the contract, we see it as a win-win situation in that it’s a — there’s a reasonably fair minimum guarantee level, which is, in striking distance, where both parties are incentivized to work together to exceed it. And we do foresee we should be able to exceed it based on the current trajectory of our subscription growth.

And I guess another point to note is that as part of the agreement with UMG, we do intend to add the UMG content behind our pay-for-streaming paywall. And in fact, you may have already seen some of the UMG content being behind the paywall already, yes? So that’s a very positive element that would help drive the revenue for paid subscription that are coming from this UMG partnership.

And then in terms of the competition with respect to our peers, we won’t sort of comment directly as to what they do. I think you can talk to them, but we are very pleased to see that the industry is moving in lockstep and in a fairly aligned fashion towards supporting paid music. Because ultimately, it’s important for users to appreciate the value of music, and all players in the industry are moving towards the pay-for-streaming direction, right, and — which is actually a very good thing for the industry overall. We see that within online video. There are over 300 million paying subscribers, whereas within music, ourselves, we are still only at around 50 million, plus or minus. And so there’s a lot more room for the music subscriber market to grow.

And in terms of margin, I think, as Shirley mentioned, our gross — we expect the second half gross margin to be largely in line with the second quarter, right? So — and in particular, our online music margin would see some uplift, given the rapid growth in our subscription.

Cussion Pang

And also, in terms of the content, the UMG content, actually, I think that there’s not too much difference in the past because like TME also, our peers, the platform, we all have the UMG content for a couple of years, even that is under the master licensing arrangement. So from a user point of view, from a platform point of view, the content will be much more the same and will not be — have any difference in the past.

But I think the most important point is we really reached a new milestone when going to the — another phase of cooperation with UMG. As I mentioned before, we are not just doing as the content distribution partner right now, we are also doing business together with them in music label. This is a really step — big step forward and also, once again, demonstrating how good the relationship of UMG and also the trust that — UMG on TME. I think that we are their preferred partner. And what we are focusing on is we will continue to do our best and extract the best value and create the best music for our users. This is what we are — we’ll be 100% focusing on in the years to come.


Your next question comes from Alicia Yap with Citigroup.

Alicia Yap

My question is related to the social entertainment. So are there any updates in terms of the competition situation and regulatory front that might or could affect the growth outlook on the social revenue line into the second half or even 2021? What is management view on the industry prospect? Will management worry about the industry has saturated? And also, will game broadcasting to become more important user and monetization driver into the future?

Tony Yip

Sure. Well, I mean in terms of the overall outlook, I see — I mean subject to the relevant disclaimer to any forward-looking statement — I mean start from the total company revenue, I think we do expect our second half total revenue, year-over-year growth rate to be similar to first half, around mid-teens level.

Within social — or within — I’ll talk first about the music, and then we can talk about social entertainment. Within music revenue, online music revenues in the second half, we expect the subscription revenue to continue its rapid growth, right, while nonsubscription revenue to decline year-over-year due to sublicensing as well as normal fluctuation in the digital album sales, in particular, after a very strong second quarter.

And then in terms of the social entertainment revenue in the second half, we do expect the revenue growth on a year-over-year basis to be higher than the first half, which is a healthy recovery from the 6% year-over-year growth in the first half, and continue a reasonably good growth trajectory, considering the macroeconomic weakness is likely to have a lingering impact on some of our paying users’ willingness to spend on virtual gift.

In terms of competition, as I mentioned, we do see continued competition with short video platforms for user time spent. That’s sort of one of the 2 major factors that have impacted our social MAU this quarter. However, we have been investing and continue to roll out multiple product enhancements to strengthen the platform, in particular, the WeSing platform. And we are starting to see some of the core metrics improve. And so we are optimistic that the social MAU will bottom out in Q3 and stabilize from that point onwards.

Now within the online karaoke segment, it is a very specific vertical, and we do already have a very commanding lead in that space with over 200 million MAU. So it is already very sizable in terms of the user base, so we don’t foresee there to be — a lot more growth from there from a user base perspective. However, we do see there to be a lot more potential for monetization on that platform because as we roll out more of these product enhancements that we talked about, it will bring additional monetization opportunities for us in terms of online singing rooms, in terms of virtual gifting as well as advertising for us.

Cussion Pang

And also for the future entertainment business that we are working in right now, I think that we have a truly competitive advantage to other live broadcast applications available in the market. It’s — we are truly a music-centric social entertainment platform. This is very important because — which means that we can have a lot of synergies, especially when we mentioned it before, we have the Tencent Musician programs. So all of the new younger generation of musicians, they can also start doing live broadcast, singing out their songs and also started to gather their friends on our platform.

We also mentioned about the TME Live, which is a very, very important project that we start during the pandemic situation. It’s — we are also receiving really good feedback from the artists. A different kind of online concept. The format that we are running right now is more on the top-tier artists, but you can imagine that in the future, we can further extend it — our footprint, not just from the top-tier artists, but we can also extend it to other — different level of artists, and even that we can have a lot of more good results from our users. And we continue receiving really good feedback, not just from our users, but also our business partners as well.

So we are seeing that in the total music ecosystem that we are creating, TME is really in the situation that we can leverage on all these kind of very innovative ideas, and at the end of the day, which will make our social entertainment — the platform is going to be — work together really well and also gather the fans on our platform and let them to interact with each other like the Putong society that we mentioned and also the singing room that we have available in the WeSing platform, which made us to standout and to have the competitive advantage when compared to other pan-entertainment live broadcast application available in the market.

Tony Yip

Yes. And just to add to that, we’ve successfully introduced QQ Music’s live streaming in June, as we talked about in the remarks, our Fanlive service. And we are very pleased to see this initiative gaining traction since launch. It is still in an early stage. We just launched it in the second quarter. It is aimed at providing a differentiated experience with more innovative features that allow our music fans to interact. We do expect revenues to start to gradually scale up in the fourth quarter and in a more meaningful — show a more meaningful contribution to revenue growth in 2021.


Your next question comes from Wendy Chen with Goldman Sachs.

Wendy Chen

So my question is about the process of paywall. So just wondering, can we have a quick update on how is the percentage of songs that we are moving behind the paywall so far? And the renewal with the UMG, to what extent you can expand — drive expansion of the paywall beyond the 20% full year target you mentioned in previous call? And if I may quickly follow up. With the new UMG license renewed, can we have an update on how the management foresee in the second half of paying subscriber on music to grow? Do we see further acceleration from the first half?

Tony Yip

Sure. In terms of the paywall, we are on track to get to the 20% by year-end that we previously talked about. In fact, I think we might slightly exceed that. And in the second quarter, in particular, we actually had a very fairly attractive and balanced portfolio of overseas major labels as well as domestic labels that went behind the paywall. If you look at our service, you probably recognize that some of the songs behind each of the big 3, Universal, Warner, et cetera, have already gone behind the paywall, and that process will continue, right? So that would be obviously an important driving force that can help with our strong paying user growth.

We do expect our paying users to continue very strong growth. In fact, in the second quarter, we grew paying users by 52% year-over-year, which is faster than Q1. Actually, in fact, it’s the fastest-ever reported quarter in terms of year-over-year increase in our paying users, adding about 4.4 million paying users this quarter. We do expect to see some fluctuations in the quarterly net adds because not every quarter we have — we are adding the content behind the paywall at the same pace. So it wouldn’t be — it would be totally normal if the net add numbers comes down a little bit in the next quarter. But overall, we do still expect the our paying user to see very rapid growth.


Your next question comes from Thomas Chong with Jefferies.

Thomas Chong

Just two quick questions. The first one is about our outlook in 2021. Given that our online music services remain a very strong momentum, and our social entertainment should come off from a relatively lower base in 2020, together with Q2 live streaming, should we expect our revenue to accelerate and our margin improve on a year-on-year basis next year? And my quick follow-up question is about our long-form audio content. How should we think about the competition on this front?

Tony Yip

Sure. Well, in terms of the 2021 outlook, I think we’ll talk more about it as we approach the year-end, so we won’t be addressing that directly here.

And then in terms of the long-form audio, we are very pleased, actually, with the outcome of the development on our long-form audio service. You saw a very significant growth in our long-form audio user penetration. Our user MAU effectively more than doubled year-over-year — on a year-over-year basis. And our long-form audio content has very rapidly expanded on a Q-over-Q basis by the number of IPs. We’re actively working on securing popular audio production licensing. And we have a lot of in-house adaptation from the top IPs to make them into long-form audio content. We’re actively collaborating with podcasters for — to include some of the premium UGC content.

And there’s a long way — there’s a very long runway for monetization. We started with a cross-selling subscription strategy that has proven to be very successful. So for a music subscriber, all you need to do is add a small amount and you’ll be able to enjoy the long audio subscription, which is attractive to our existing music subscriber and makes our music subscription also more attractive. And we also introduced a stand-alone subscription package for the long-form audio. And in addition to that, there will be potential for us to monetize through advertising as well as we continue to grow our user penetration.


Your next question comes from…

Shirley Hu

And for the margin side — sorry. And for margin side, we think the long-form — the revenue from long-form video will be in — could process in 2021. And we can get revenue from Kugou Live — in Kugou Live streaming in 2021. So the margin — gross margin side, we expect will be recovered and improving than this year.


Your next question comes from Rob Sanderson with Loop Capital Markets.

Robert Sanderson

Perhaps for Cussion or Tony. Just going back to the IPO, your original expectation was that digital music subscriptions would begin to accelerate in 2021 and then in 2022 time frame as you plan to slowly tighten the paywall over time and encourage the behavior changes, et cetera. But we’re accelerating now, and growth is up meaningfully in each of the past 3 half-year periods and that continues to grow. So question is this, what is developing different than your earlier expectation? Are you leaning into more accelerated use of the paywall? Are consumers more responsive maybe than perhaps you had expected? Or do you still see potential for an inflection in the years ahead? That’s part one.

And then along these lines — I mean if you look at the other subscription media markets, there’s many examples, streaming music services around the world or Internet video in China. Which example has pay ratios do you think will be more similar to what you’d expect for your business over the long term?

Cussion Pang

First of all, I think that we are doing really good on the online music services, especially according to the plan that we have laid out during the IPO time. The paying ratio right now is 7.2% this quarter when compared to 4.8% a year ago. And we are seeing that this trend will continue. But as we mentioned before, I think that we need to strike the balance, not just keep — continue pushing for a higher-paying ratio. But at the same time, we need to care about the user experience.

If you remember during the IPO period, we also — always mentioned that in the past, the Chinese music industry actually is a perfect music experience because everything is for free. People do not need to pay for a penny in order to enjoy a song. But we are in the very long run education process. But I think that our hard work is really paying off, and we are also receiving a very pretty good result up to this moment. This is the hard work of the last 4 to 5 years, at least.

So I think that we are not in a rush to — even though we are on target right now and even we are a little bit ahead of target. But we will continue to make sure that we will strike the balance. And as we mentioned before, I think that at the right time, the inflection point will be achieved. And we are seeing that there’s still a lot of room for us to grow the paying ratio, especially when we are comparing to some of the other examples over the world like Spotify or even, as you mentioned, that we can also compare it to the other like — the long-form videos industry as well. We are seeing that, yes, the sky is unlimited, and we’ve still got a lot of room to grow. And we can also use the long-form video industry as a reference for us. But I think that we are a couple of years behind in them, but we will be growing in much more similar fashions. And see whether Tony would like to add anything.

Tony Yip

Yes. I guess the only other thing I’d add is, and we mentioned this before, for comparison with online video, the subscribers there tend to pay for the latest content and the latest show, whereas compared to music, users are willing to pay even for a very, very old song, right, as long as they’re a fan of that artist. So we actually do think there’s more sustainability in the long run for the — for our subscribers in music. And so we’re very, very excited about the prospects in this area.


Your next question comes from Zhijing Liu with UBS.

Zhijing Liu

Congratulations on the great result. I have only one question. How should we think about potential revenue from advertising for music? How will you think about the competitive factors for our advertising strategy?

Tony Yip

Sure. Well, look, I mean there’s a very — there’s a lot of potential in our advertising revenue growth. We are only generating a very small amount at the moment. A very small, low single-digit percentage of our total revenue is in the form of advertising. And at the moment, you see that we have not been aggressive at all in terms of ad loads across our app. And going forward, we do think there’s a lot of potential for us to increase that, starting in 2021. You will, in fact, see us starting to do some of that in the second half.

I mean relates to what Cussion has mentioned before, as part of the complement to the paywall strategy, you may see that we start to offer some users to be able to — in lieu of paying for a subscription, they could actually watch a video ad or listen to an audio ad and — in order to redeem some streaming of certain song behind the paywall, right? And you start to see some of that. To us, that actually opens a lot of opportunity that doesn’t impact our paying user growth because we think that there’s a lot of users out there that are willing to pay for the music subscription. They do see value in music. But on the other hand, it’s a fairly polarized situation. There are certain users that no matter what you do, you will not be able to convert them. And so targeting those users, we would be rolling out an advertising strategy so that they — even though it’s very difficult to convert them because of their behavior and/or their preferences and whatnot, there will still be an opportunity for us to monetize through advertising with this group of users.

Cussion Pang

Yes. And also for the users, they come to our platform, and they’re not just paying for content, but they are also paying for the overall user experience. As I mentioned, always emphasizing, is we really care about our users how they can get the best of our platform, like the personalization recommendations of the things that we can do for them, so that they come to our platform to discover new music. Not just something that like the music library, they come and search a song, but it’s something that really creates value for them.

We are also thinking about — socialization is also very important. So we’re always emphasizing that we are creating the new Putong society, and also even the singing room in the WeSing platform, which allows our users to have a place for them to share what they feel about that music, why they love this song, and then they can also share some of the user-generated content and even the news and pictures of their beloved idols to all their friend. So it’s really a socializing experience.

So when you think about that, if you got — just pay for CNY15 a month, and then you can enjoy all the songs on our platform, which is hassle-free. You can enjoy any time. You can also have a lot of recommendations for you. You can also interact with your friend. You can get a lot of very good, I think, user experience. So this is what we are selling. We are not just selling on content only. It’s a total experience that we always care about.


Your next question comes from Alex Liu with China Renaissance.

Alex Liu

Just one question. How should we think about TME’s value proposition on audio rich — audience reach and content promotion, given recently we know that some nonmusic platform, for example, Crenshaw also invested on the music content and celebrities? Could you help us to understand whether there is any overlap between their content agreement versus ours?

Tony Yip

Sorry, could you clarify your question? Was that about audience reach and promotion?

Alex Liu

Yes. Well, obviously, our value proposition on promotion capability is quite dominant within the music industries. But I was just wondering, given some other short video platforms started also cooperating with musicians and also offer some promotion capabilities, how should we think about their strategies versus our advantages?

Cussion Pang

Yes. Yes, I’ll get it. Yes, thank you for your question. I think that — first of all, I think the TME platform and also the video platform can really work together. Because like the video platform, you mentioned that they are also a good channel for content promotion, like Tencent videos. There’s a lot of singers. They also want to promote themselves or their songs through the video platform. But I’m thinking that we need to look at it as a holistic approach. So what I mean is, okay, for example, if there’s going to be a variety — music variety show on Tencent video platform, and then the artist is going to be appearing on it, and then they can sing out their strong and is very attractive. But when the song is a wonderful one, and then the users always need to go back to the music platform and listen to this song again, and also maybe the full version of the songs, and even some of the other version of this song. Because you always think about in the variety shows, some of the singers will sing out some of the other song by other singers. So there’s a lot of people that also need to share their experience as well. So the users will need to cherish each other. They need to keep taking in a lot of information relating to the song or relating to the artist.

So I think that, that’s a very good way for us to work with the video platform like Tencent video, as I mentioned before. TME has already been involved in coproducing some of the music variety shows together with the user platform, together with the video platform, and we are also doing some of the joint promotions together. And at the same time, we are also seeing that for the younger generation of musicians, they’re also looking for some of the more exposure from different platforms as well. So we also work with Bilibili and launch of — some of the program in nurturing the younger musicians as well. So this is what we are working on.

So we are seeing that the video platform will be a component, and also we will proactively work with them to promote music. But frankly speaking, I don’t think that the video platform can replace a music platform because we do have a different market positioning. But absolutely, I think we can work together.


Thank you. That is all the questions we have time for today. We are now approaching the end of the conference call. I will now turn the call over to your speaker host today, Ms. Millicent T., for closing remarks.

Millicent T.

Thank you, Ashley, and thank you, everyone, for joining us today. This concludes today’s call, and we look forward to speaking with you again next quarter. Thank you and goodbye.


The conference call has now concluded. Thank you for attending today’s presentation. You may now disconnect.


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