3 Reasons Tencent Music's Earnings Failed to Impress

Tencent Music Entertainment (NYSE: TME) hit a fresh all-time high on Tuesday, only to cough the gains back out after posting disappointing financial results. China's leading streaming music service came through with the kind of numbers its peers would love to be generating, but it just wasn't enough.

Revenue rose 50.5% to hit $785 million, well ahead of global bellwether Spotify (NYSE: SPOT), which pushed out a 30% top-line increase during the same three months. A share-based accounting charge turned a reported profit into a deficit, but on an adjusted basis Tencent Music Entertainment saw its earnings rise 37% to $133 million, or $0.08 a share. Tencent Music Entertainment has been consistently profitable given its high-margin revenue mix, which has never been the case with Spotify, which just scored its first-ever quarter with an operating profit.

Tencent Music Entertainment's report seems solid on the surface, but the stock initially moved lower after Tuesday afternoon's release. Let's see why the market isn't impressed.

1. Decelerating growth can be problematic

There was plenty of gas in the tank when Tencent Music Entertainment went public late last year. Revenue skyrocketed 84% through the first nine months of 2018, and net income more than tripled. The explosive growth has come from social entertainment services, accounting for 72% of the revenue, as Tencent Music Entertainment cashes in on online karaoke and live streaming services. While online music services account for the lion's share of Spotify's top-line results, the revenue Tencent Music Entertainment receives from user subscriptions, music sub-licensing, and the sale of digital music adds up to just 28% of the business.

It's easy to see why nearly 51% growth in the fourth quarter would be a disappointment for a dot-com speedster growing at an 84% clip through the first nine months of the year. It's an even harder pill to swallow that adjusted earnings failed to keep pace with the slowing revenue growth.

2. Meeting expectations isn't enough

This was Tencent Music Entertainment's first quarterly release as a public company. Analysts nailed the adjusted profit at $0.08 a share, but they aimed a bit high with the consensus estimate calling for $786.4 million in revenue.

You can't blame Tencent Music Entertainment that Wall Street got too eager with its prognostications, but the top-line miss is problematic. Tencent Music Entertainment will now have to conservatively manage expectations. It will be hard to regain the faith of investors if it falls short again next time out.

3. Rallying into earnings can be a problem

Tencent Music Entertainment has had a volatile stock since going public at $13 in mid-December. It didn't generate a lot of initial buzz, and it closed as a broken IPO by its third day of trading. The stock began to rally when investor sentiment for Chinese growth stocks improved, soaring 69% from its mid-December low through Tuesday morning's all-time high.

Momentum is great, but it also heightens expectations. If the stock was still trading in the pre-teens and came within spitting distance of Wall Street forecasts, as it did, the stock could've moved higher with a sigh of relief. Knocking on the door of $20 on Tuesday made a ho-hum report a failure.

Tencent Music Entertainment remains a dynamic, fast-growing Chinese dot-com, with more than 800 million active users across its four popular platforms. It controls roughly 75% of China's music streaming market. It's generating niche-defying chunky margins, given the popularity of virtual gifting and other premium social goodies. This is one to watch despite the disappointing earnings report.

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Rick Munarriz owns shares of Tencent Music Entertainment Group. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.