TME(TME) - 2019 Q4 - Annual Report

Part I Key Information This section provides selected consolidated financial data and an extensive list of risk factors for Tencent Music Entertainment Group from 2016 to 2019 Selected Financial Data Total revenues grew from RMB 10,981 million in 2017 to RMB 25,434 million in 2019, with profit for the year reaching RMB 3,977 million Selected Consolidated Statement of Operations Data (RMB millions) | Indicator | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | | Total revenues | 10,981 | 18,985 | 25,434 | | Online music services | 3,149 | 5,536 | 7,152 | | Social entertainment services and others | 7,832 | 13,449 | 18,282 | | Gross profit | 3,810 | 7,277 | 8,673 | | Operating profit | 1,593 | 2,039 | 4,622 | | Profit for the year | 1,319 | 1,832 | 3,977 | | Adjusted profit for the year | 1,904 | 4,174 | 4,903 | | Basic Earnings per Share (RMB) | 0.51 | 0.60 | 1.22 | | Diluted Earnings per Share (RMB) | 0.50 | 0.58 | 1.19 | Selected Consolidated Balance Sheet Data (RMB millions) | Indicator | As of Dec 31, 2018 | As of Dec 31, 2019 | | :--- | :--- | :--- | | Total assets | 44,605 | 52,678 | | Total current assets | 20,778 | 26,914 | | Non-current assets | 23,827 | 25,764 | | Total liabilities | 6,833 | 9,000 | | Total current liabilities | 6,238 | 8,490 | | Non-current liabilities | 595 | 510 | | Total equity | 37,772 | 43,678 | Selected Consolidated Cash Flow Data (RMB millions) | Indicator | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | | Net cash generated from operating activities | 2,500 | 5,632 | 6,200 | | Net cash used in investing activities | (483) | (1,190) | (8,102) | | Net cash generated from/(used in) financing activities | 99 | 7,741 | (31) | | Net increase/(decrease) in cash and cash equivalents | 2,116 | 12,183 | (1,933) | | Cash and cash equivalents at end of the year | 5,174 | 17,356 | 15,426 | Risk Factors This section details risks related to business operations, content licensing, the VIE structure, Tencent's control, PRC regulations, and ADS price volatility - The company's ability to attract and retain users is highly dependent on offering attractive content that caters to evolving user preferences, with failure potentially adversely affecting user traffic and engagement[31][32] - A significant portion of the music library is licensed from third parties, and the loss of these licenses or renewal on unfavorable terms could materially harm the business[34][35][36] - The company faces risks from its VIE structure, used to comply with PRC foreign investment restrictions, and could face severe penalties if these arrangements are found non-compliant by the PRC government[188][189][191] - As a controlling shareholder, Tencent has effective control over shareholder actions, and its interests may not always align with other shareholders, leading to potential conflicts of interest[177][178][180] - The company faces risks from potential PRC government censorship of content, which could lead to penalties, loss of licenses, and reputational harm[109][112][113] Information on the Company This section outlines the company's history, business operations, organizational structure, and property, including its platform ecosystem and VIE structure History and Development of the Company This section traces the company's evolution from individual music platforms to Tencent Music Entertainment Group, including its IPO and proposed UMG investment - In July 2016, Tencent acquired control of China Music Corporation (CMC) and injected its online music businesses, with CMC later renamed Tencent Music Entertainment Group[329] - The company completed its initial public offering in December 2018, with its ADSs trading on the New York Stock Exchange[331] - In December 2019, TME proposed to acquire a 10% equity stake in Universal Music Group (UMG) at an enterprise value of EUR30 billion, with an option for an additional 10%[331] Business Overview The company operates China's largest online music entertainment platform, with 653 million online music mobile MAUs and a vast content library, generating revenue from music and social entertainment services - The company operates the top four music mobile apps in China, with 653 million online music mobile MAUs and 232 million social entertainment mobile MAUs in 2019[337][342] - The platform has China's largest music content library with over 40 million tracks as of December 31, 2019, sourced from domestic and international music labels[344] Key User Metrics (2018-2019) | Metric | 2018 | 2019 | | :--- | :--- | :--- | | Online Music Paying Users (millions) | 24.4 | 33.7 | | Online Music Paying Ratio (%) | 3.8% | 5.2% | | Social Entertainment Paying Users (millions) | 9.8 | 11.6 | | Social Entertainment Paying Ratio (%) | 4.3% | 5.0% | | Online Music Monthly ARPPU (RMB) | 8.5 | 8.8 | | Social Entertainment Monthly ARPPU (RMB) | 114.4 | 131.3 | - Revenue is generated through two primary segments: Online Music Services (28.1% of 2019 revenue) and Social Entertainment Services and Others (71.9% of 2019 revenue)[420][424] Organizational Structure The company operates through a Variable Interest Entity (VIE) structure in the PRC due to foreign ownership restrictions, maintaining control via contractual arrangements and consolidating VIE financial results - Due to PRC laws restricting foreign ownership in value-added telecommunication services, the company operates its core business through a VIE structure[568] - Control over the VIEs is maintained through a series of contractual arrangements, including Equity Interests Pledge Agreements, Exclusive Option Agreements, and Voting Trust Agreements[572][573][580] Revenue and Asset Contribution by Entity Type (2019) | Entity Type | % of Total Revenues | % of Total Assets | | :--- | :--- | :--- | | Consolidated VIEs | 99.8% | 28.7% | | Wholly-owned PRC subsidiaries | 0.2% | 12.3% | | TME Group & offshore subsidiaries | 0.0% | 59.0% | Operating and Financial Review and Prospects This section analyzes the company's financial performance, liquidity, capital resources, and critical accounting policies, detailing revenue, cost, and profit trends Operating Results Revenues grew 34.0% to RMB 25,434 million in 2019, driven by online music and social entertainment services, despite a gross margin decrease due to higher content costs Revenue Breakdown (2017-2019, RMB millions) | Revenue Source | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | | Online music services | 3,149 | 5,536 | 7,152 | | Social entertainment services and others | 7,832 | 13,449 | 18,282 | | Total revenues | 10,981 | 18,985 | 25,434 | - In 2019, revenues increased by 34.0% year-over-year, with online music services growing 29.2% and social entertainment services growing 35.9%[676][678][680] - Gross margin decreased to 34.1% in 2019 from 38.3% in 2018, primarily due to increased content costs and revenue sharing fees[683][685] Key Operating Metrics (2017-2019) | Metric | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | | Online music mobile MAUs (millions) | 606 | 642 | 653 | | Social entertainment mobile MAUs (millions) | 201 | 226 | 232 | | Online music paying users (millions) | 17.4 | 24.4 | 33.7 | | Social entertainment paying users (millions) | 7.4 | 9.8 | 11.6 | | Online music monthly ARPPU (RMB) | 8.8 | 8.5 | 8.8 | | Social entertainment monthly ARPPU (RMB) | 88.2 | 114.4 | 131.3 | Liquidity and Capital Resources The company's liquidity is primarily driven by RMB 6,200 million in operating cash flow, with RMB 15,426 million in cash and cash equivalents as of December 31, 2019 - As of December 31, 2019, the company had RMB 15,426 million (US$2,216 million) in cash and cash equivalents[715] - Net cash generated from operating activities was RMB 6,200 million (US$891 million) in 2019, an increase from RMB 5,632 million in 2018[721][722] - A share repurchase program was announced in December 2019, authorizing the repurchase of up to $400 million of Class A ordinary shares in the form of ADSs[716] - Capital expenditures totaled RMB 286 million (US$41 million) in 2019, up from RMB 144 million in 2018[731] Directors, Senior Management and Employees This section details the company's leadership, compensation, board structure, and employee base, highlighting Tencent's controlling share ownership - The board of directors consists of nine members, including key executives like Chairman Tong Tao Sang and CEO Cussion Kar Shun Pang[748][801] - In 2019, the aggregate cash compensation paid to directors and executive officers was approximately RMB 65.0 million (US$9.0 million)[765] Employee Headcount by Function (as of December 31, 2019) | Function | Number of Employees | | :--- | :--- | | Research and development | 2,021 | | Content management | 641 | | Sales and marketing | 361 | | Management and administration | 587 | | Total | 3,610 | - As of March 25, 2020, Tencent is the principal shareholder, beneficially owning 55.6% of total ordinary shares and controlling 78.7% of the aggregate voting power[818] Major Shareholders and Related Party Transactions This section details major shareholders and significant related party transactions with Tencent Group, including revenues, expenses, and balances - Tencent Group is the company's principal owner and a major related party with which the company conducts significant business transactions[821][828] Significant Related Party Transactions with Tencent Group (2019, RMB millions) | Transaction Type | Amount | | :--- | :--- | | Online music services revenue from Tencent | 355 | | Operation expenses recharged by Tencent | 752 | | Advertising agency cost to Tencent | 231 | Balances with Tencent Group (as of December 31, 2019, RMB millions) | Balance Type | Amount | | :--- | :--- | | Accounts receivable from Tencent Group | 1,653 | | Accounts payable to Tencent Group | 215 | | Other payables and accruals to Tencent Group | 382 | Financial Information This section details legal proceedings, including copyright infringement and securities class action lawsuits, and the company's dividend policy - As of December 31, 2019, the company faced 132 pending lawsuits related to alleged copyright infringement, with total damages sought of approximately RMB 20.5 million (US$2.9 million)[837] - In late 2019, the company, along with certain directors and officers, was named in two putative securities class action lawsuits alleging material misstatements and omissions in its public filings[839] - The company has no current plans to pay dividends and intends to retain future earnings to operate and expand its business[840] Additional Information This section covers corporate governance, including the dual-class share structure, and taxation in the Cayman Islands, PRC, and U.S. federal income tax implications for ADSs - The company has a dual-class share structure, where each Class A ordinary share has one vote, while each Class B ordinary share has 15 votes and is convertible into one Class A share[851][854] - The company is an exempted company in the Cayman Islands and is not subject to income, corporation, or capital gains tax there[882] - In the PRC, the company is subject to a standard 25% Enterprise Income Tax (EIT), but certain subsidiaries qualify for preferential rates of 15% or lower as High and New Technology Enterprises (HNTE) or Software Enterprises (SE)[1192][1193] - There is a risk that the company could be classified as a Passive Foreign Investment Company (PFIC) for U.S. federal income tax purposes, which could result in adverse tax consequences for U.S. investors[322][901][902] Quantitative and Qualitative Disclosures About Market Risk This section identifies the company's primary market risks as interest rate, foreign exchange (RMB-USD), and inflation, noting no hedging instruments are used - The company's main market risks include interest rate risk on cash deposits, foreign exchange risk due to revenues being in RMB, and inflation risk in China[916][917][920] - Substantially all revenues are denominated in Renminbi (RMB), exposing the company to fluctuations in the RMB-USD exchange rate, and it has not entered into any hedging transactions to mitigate this risk[917][918] Part II Material Modifications to the Rights of Security Holders and Use of Proceeds This section details the net proceeds of approximately US$509 million from the December 2018 IPO, which remained unused as of December 31, 2019 - The company received net proceeds of approximately US$509 million from its December 2018 IPO[926] - As of December 31, 2019, the net proceeds from the IPO had not yet been used, but the company still intends to use them as previously disclosed[928] Controls and Procedures Management and the independent auditor concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2019 - Management concluded that as of December 31, 2019, the company's disclosure controls and procedures were effective[929][930] - Based on the COSO framework, management concluded that the company's internal control over financial reporting was effective as of December 31, 2019[931] - The independent registered public accounting firm, PricewaterhouseCoopers Zhong Tian LLP, issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of December 31, 2019[933] Item 16.A-H This section addresses corporate governance, including the audit committee financial expert, code of conduct, principal accountant fees, and use of home country governance exemptions - The Board of Directors has determined that Ms. Edith Manling Ngan qualifies as an "audit committee financial expert"[935] Principal Accountant Fees (RMB thousands) | Service Type | 2018 | 2019 | | :--- | :--- | :--- | | Audit Fees | 6,000 | 15,000 | | Audit-Related Fees | 13,800 | — | | Tax Fees | 400 | — | | Other Fees | 2,000 | 2,690 | | Total | 22,200 | 17,690 | - As a foreign private issuer, the company follows certain Cayman Islands corporate governance practices in lieu of NYSE standards, such as not having a majority of independent directors on the board[942] Part III Financial Statements This section presents the audited consolidated financial statements for 2017-2019, prepared under IFRS, with an unqualified opinion from PricewaterhouseCoopers Zhong Tian LLP - The independent auditor, PricewaterhouseCoopers Zhong Tian LLP, issued an unqualified opinion on the consolidated financial statements and the effectiveness of internal control over financial reporting as of December 31, 2019[956][957] - Critical Audit Matters identified by the auditor include revenue recognition from the sale of durable virtual gifts in social entertainment services and the impairment assessment of goodwill[964][965][969] Consolidated Income Statement Highlights (RMB millions) | Line Item | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | | Total revenues | 10,981 | 18,985 | 25,434 | | Gross profit | 3,810 | 7,277 | 8,673 | | Operating profit | 1,593 | 2,039 | 4,622 | | Profit for the year | 1,319 | 1,832 | 3,977 | Consolidated Balance Sheet Highlights (RMB millions) | Line Item | As of Dec 31, 2018 | As of Dec 31, 2019 | | :--- | :--- | :--- | | Total Assets | 44,605 | 52,678 | | Goodwill | 17,088 | 17,140 | | Cash and cash equivalents | 17,356 | 15,426 | | Total Liabilities | 6,833 | 9,000 | | Total Equity | 37,772 | 43,678 |