Why to Be Optimistic About the Tencent Music IPO, and Maybe Stitch Fix, Too

MarketsMotley Fool

In this segment from the Motley Fool Money podcast, host Chris Hill and Fool senior analysts Aaron Bush, Ron Gross, and Matt Argersinger cover a pair of interesting online-focused businesses. First they reflect on the latest news from the world of streaming music, where domestic users will be more familiar with Spotify (NYSE: SPOT). But head to China, and it's a whole different song.

Tencent Music Entertainment has filed to go public, and its 800 million monthly active users put the U.S. major players to shame. The Fools consider the business model, which is not quite the same as the streamers we're more familiar with, and speculate about how strong a performer the company could be.

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Then, it's over to Stitch Fix (NASDAQ: SFIX), an online styling service whose customers can either set up recurring shipments or go with an "on-demand" option. Looks like plenty of people are buying its clothes -- quarterly revenues were up 23% year over year. But Wall Street wanted a lot more, and the shares got pummeled.

The Fools try to separate the underlying business from the hype cycle and look at the changes the business has undergone as it has matured.

A full transcript follows the video.

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This video was recorded on Oct. 5, 2018.

Chris Hill: Spotify has 180 million monthly active users. If you think that's impressive, you're going to be interested in the upcoming IPO for Tencent Music Entertainment. The company filed to go public in the United States, with one of the key data points, Aaron, being that Tencent Music has 800 million monthly active users in China.

Aaron Bush: Not bad at all. Tencent Music is essentially a holding company for four of China's largest music services of various types. Yeah, 800 million monthly active users is crazy, and it's still growing pretty quickly. This is in China and also in the greater Asian area anyways. So, yeah, it should be a pretty massive IPO.

What's interesting about the company to me, besides its obvious dominance and the fact that it's growing quickly, is how it makes money. Instead of relying solely on subscriptions and advertisements like a Spotify, Tencent Music actually makes most of its money from virtual gifts sent through live streaming. Live streaming has been a big trend in China lately. It seems like Tencent Music is in on it, too. Also, online karaoke is a big revenue driver, and song sales. So, this is a very different type of music company than we see here domestically.

They're also more profitable, too. The gross margin is higher than what we would see in a Spotify here, too. It'll be really interesting to see how this company does once it's public.

Hill: Tough week for Stitch Fix. Fourth quarter revenue for the online apparel company came in 23% higher than a year ago, but Wall Street was looking for more. Shares if Stitch Fix down 40% this week. Matty, is that an overreaction? Because on the surface, it kind of looks like one.

Matt Argersinger: It does look like an overreaction to me. But you have to go back to the previous quarter, where revenue was up 29%, active clients grew 30%. That got investors excited. The stock was up 40% from that quarterly announcement. So, going into this one, and then certainly, as you mentioned, revenue was just up 23%, active clients were up 25%. That's quite a sharp deceleration. I think a company like Stitch Fix, which obviously, like a lot of growth companies, was given a pretty high valuation going in.

At the same time, I look at the stock now, after the drubbing it's gotten this week, and you have a business that's still growing about 20%, maybe 20-25%, trading for a little over 2X sales. And it's profitable. This is a business that, I know for one, David Gardner's really excited about, and Tom is excited about, as well. It's an interesting disrupter in the apparel business. It's one I'm interested now that, of course, it's down 30% from its high.

Aaron Bush: I think the concept of what they're doing is fascinating. They're essentially a data company that happens to sell and deliver clothes. But I think they're finding that it's not that easy to keep the momentum going. For years, Stitch Fix pretty much relied on word of mouth marketing in order to grow its brand, grow its revenue. Now, even though it is the top dog, there's more competition than there's ever been. They're having to pay up more for customer acquisition than they've ever had to do before. I think we're starting to see some of those issues appear in the financials. Retention isn't awesome, either. They do have issues to work with, even though it's still a really interesting idea.

Aaron Bush has no position in any of the stocks mentioned. Chris Hill has no position in any of the stocks mentioned. Matthew Argersinger owns shares of Stitch Fix. Ron Gross has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Stitch Fix. The Motley Fool has a disclosure policy.