2021-04-08 16:00PART I ITEM 3. KEY INFORMATION This section outlines the principal risks faced by the company, categorized into business and industry risks, relationship with Tencent, corporate structure (VIE), doing business in China, and risks related to its American Depositary Shares (ADSs) Risk Factors The company identifies significant risks across its operations, including dependence on third-party content licenses, potential copyright infringement, uncertainties in monetization, and structural risks from its VIE setup, alongside reliance on Tencent and evolving Chinese regulations - The company's business is highly dependent on licenses from third-party content providers; adverse changes, loss of relationships, or failure to renew these licenses on favorable terms could materially harm the business152528 - A significant risk arises from the company's corporate structure, which relies on contractual arrangements with Variable Interest Entities (VIEs) to operate in China; if the PRC government finds these arrangements non-compliant, the company could face severe penalties18145 - Tencent, as the controlling shareholder, holds 90.6% of the total voting power, giving it effective control over shareholder actions, which may lead to conflicts of interest not resolved favorably for other shareholders17138142 - The company faces regulatory risks in China, including uncertainties in the legal system and evolving online content regulations; the HFCAA could also lead to the delisting of the company's ADSs if the PCAOB is unable to inspect its auditor for three consecutive years21222224 ITEM 4. INFORMATION ON THE COMPANY This section details the company's history, business overview, organizational structure, and physical assets, outlining the development of its key products and strategic transactions History and Development of the Company The company's history includes the launch of core products like QQ Music, Kugou, and Kuwo, its 2016 combination with Tencent's music business, 2018 NYSE IPO, and recent strategic moves including a US$800 million notes offering and stake acquisitions in UMG and Lazy Audio - In July 2016, Tencent acquired control of CMC and injected its online music businesses (QQ Music, WeSing), making TME a consolidated subsidiary of Tencent272 - The company completed its Initial Public Offering (IPO) in December 2018, with ADSs trading on the NYSE under the symbol "TME"274 - In 2020 and 2021, TME engaged in significant strategic investments, including acquiring a stake in Universal Music Group (UMG) via a Tencent-led consortium and acquiring 100% of Lazy Audio to expand into the long-form audio market276277 Business Overview Tencent Music Entertainment is China's largest online music entertainment platform, operating key apps like QQ Music, Kugou Music, Kuwo Music, and WeSing, with a comprehensive social entertainment ecosystem, vast content library, and multi-faceted monetization models - The company operates China's largest online music entertainment platform, with 644 million online music mobile MAUs and 240 million social entertainment mobile MAUs in 2020285290 - TME's content library is the largest in China, featuring over 60 million music tracks as of December 31, 2020, supplemented by a wide range of long-form audio content like audiobooks and podcasts291 - Monetization is driven by online music services (subscriptions, digital sales, advertising) and social entertainment services (virtual gifts, premium memberships); in 2020, online music paying users reached 49.4 million (7.7% paying ratio), and social entertainment paying users were 11.7 million (4.9% paying ratio)291 - The company is subject to extensive PRC regulations governing the internet, value-added telecommunications, online content, and foreign investment, which necessitates its VIE structure for certain operations366367 Organizational Structure As a Cayman Islands holding company, TME conducts its business in China through wholly-owned PRC subsidiaries and Variable Interest Entities (VIEs) to comply with PRC laws restricting foreign ownership in certain sectors, exerting control over VIEs via contractual arrangements - The company uses a VIE structure to operate in sectors with foreign ownership restrictions in China, such as value-added telecommunication and internet audio-video services489 - Control over the VIEs is established through a series of contractual arrangements, including Equity Interest Pledge Agreements, Exclusive Option Agreements, Exclusive Technical Service Agreements, and Voting Trust Agreements491493497 OPERATING AND FINANCIAL REVIEW AND PROSPECTS This section provides a detailed analysis of the company's financial performance and condition, discussing key factors affecting results, year-over-year comparisons of revenues, costs, and profitability, and details on liquidity, capital resources, and cash flows Operating Results In 2020, total revenues increased 14.6% to RMB 29.15 billion, driven by 30.7% growth in online music services revenue to RMB 9.35 billion, while gross margin decreased to 31.9% due to higher revenue sharing fees and content investments, and profit for the year rose to RMB 4.18 billion Key Financial Performance (2018-2020) | Financial Metric | 2018 (RMB million) | 2019 (RMB million) | 2020 (RMB million) | 2020 (US$ million) | | :--- | :--- | :--- | :--- | :--- | | Total Revenues | 18,985 | 25,434 | 29,153 | 4,468 | | Online music services | 5,536 | 7,152 | 9,349 | 1,433 | | Social entertainment services and others | 13,449 | 18,282 | 19,804 | 3,035 | | Gross Profit | 7,277 | 8,673 | 9,302 | 1,426 | | Gross Margin | 38.3% | 34.1% | 31.9% | 31.9% | | Operating Profit | 2,039 | 4,622 | 4,710 | 722 | | Profit for the year | 1,832 | 3,977 | 4,176 | 640 | Key Operating Metrics (2018-2020) | Operating Metric | 2018 | 2019 | 2020 | | :--- | :--- | :--- | :--- | | Online Music Mobile MAUs (millions) | 642 | 653 | 644 | | Social Entertainment Mobile MAUs (millions) | 226 | 240 | 240 | | Online Music Paying Users (millions) | 24.4 | 33.7 | 49.4 | | Online Music Paying Ratio | 3.8% | 5.2% | 7.7% | | Online Music Monthly ARPPU (RMB) | 8.5 | 8.8 | 9.4 | | Social Entertainment Paying Users (millions) | 9.8 | 11.6 | 11.7 | | Social Entertainment Paying Ratio | 4.3% | 4.8% | 4.9% | | Social Entertainment Monthly ARPPU (RMB) | 114.4 | 131.3 | 141.1 | - Revenue from online music services grew 30.7% in 2020, primarily due to a 56.0% increase in music subscription revenue, driven by a significant rise in paying users and a higher monthly ARPPU579 - Cost of revenues increased by 18.4% in 2020, mainly due to higher revenue sharing fees for platform competitiveness and increased content costs for new products like long-form audio and TME Live581 Liquidity and Capital Resources The company's primary sources of liquidity are cash from operations and financing activities, with RMB 11.13 billion in cash and cash equivalents as of December 31, 2020, and sufficient cash flow for the next 12 months, despite significant cash used in investing activities for term deposits and UMG investments Consolidated Cash Flow Data (2018-2020) | Cash Flow Item (RMB million) | 2018 | 2019 | 2020 | | :--- | :--- | :--- | :--- | | Net cash generated from operating activities | 5,632 | 6,200 | 4,885 | | Net cash used in investing activities | (1,190) | (8,102) | (14,206) | | Net cash generated from/(used in) financing activities | 7,741 | (31) | 5,292 | | Net increase/(decrease) in cash and cash equivalents | 12,183 | (1,933) | (4,029) | | Cash and cash equivalents at end of the year | 17,356 | 15,426 | 11,128 | - As of December 31, 2020, the company held RMB 11.13 billion (US$1.71 billion) in cash and cash equivalents613 - The company has two share repurchase programs: a US$400 million program announced in December 2019 and a US$1 billion program announced in March 2021614 DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES This section provides information on the company's leadership, compensation practices, board structure, and employee base, including key directors, executive compensation, share incentive plans, and employee headcount by function - As of April 2, 2021, the board of directors consists of nine members, including Tong Tao Sang as Chairman and Cussion Kar Shun Pang as CEO643 - In 2020, the aggregate cash compensation paid to directors and executive officers was approximately RMB 62.1 million (US$9.5 million)659 - The company has three main share incentive plans: the 2014 Share Incentive Plan, the 2017 Option Plan, and the 2017 Restricted Share Scheme, to attract and retain talent663670677 Employee Headcount by Function (as of Dec 31, 2020) | Function | Number of employees | | :--- | :--- | | Research and development | 2,821 | | Content management and operation | 879 | | Sales and marketing | 440 | | Management and administration | 629 | | Total | 4,769 | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS This section details the company's major shareholders and significant transactions with related parties, highlighting Tencent as the controlling shareholder with 90.6% of voting power and Spotify as another major shareholder, alongside various business cooperation and co-investment activities with Tencent and its affiliates Major Shareholders (as of April 2, 2021) | Shareholder | Class A Shares (%) | Class B Shares (%) | Total Ordinary Shares (%) | Aggregate Voting Power (%) | | :--- | :--- | :--- | :--- | :--- | | Tencent | 13.5% | 95.6% | 55.1% | 90.6% | | Spotify | 16.9% | — | 8.4% | — | - The company has a master business cooperation agreement with Tencent, covering various operational aspects712 - TME and Tencent have co-invested in Spotify and Universal Music Group (UMG), highlighting a strategic alignment in the global music industry713715 Significant Related Party Transactions with Tencent Group (2020) | Transaction Type | Amount (RMB million) | | :--- | :--- | | Revenues from Tencent Group | | | Online music services | 277 | | Social entertainment & others | 213 | | Expenses to Tencent Group | | | Operation expenses recharged | 1,082 | | Advertising agency cost | 440 | | Content royalties | 306 | FINANCIAL INFORMATION This section covers consolidated financial statements, legal proceedings, and dividend policy, noting the company's involvement in copyright infringement lawsuits with RMB 46.9 million in sought damages, shareholder class action lawsuits, and its current policy of retaining earnings for business expansion - As of December 31, 2020, the company was involved in 1,116 pending lawsuits related to alleged copyright infringement, with total damages sought of approximately RMB 46.9 million (US$7.2 million)730 - The company and certain directors/officers were named as defendants in two putative securities class action lawsuits filed in 2019, alleging material misstatements in its IPO Registration Statement and 2018 annual report; the company intends to defend these actions vigorously732 - The company has no current plans to declare or pay dividends, intending to retain earnings to fund business growth and expansion733 ADDITIONAL INFORMATION This section provides details on the company's corporate governance, material contracts, exchange controls, and taxation, including its dual-class share structure, Cayman Islands tax exemption, PRC EIT rates, and the risk of being classified as a Passive Foreign Investment Company (PFIC) for U.S. investors - 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 share745749 - The company is an exempted company in the Cayman Islands and is not subject to income or capital gains tax there768 - In the PRC, the company is subject to a 25% Enterprise Income Tax (EIT), but certain subsidiaries qualify for preferential rates (e.g., 15% for HNTEs) or tax holidays7701055 - For U.S. investors, there is a risk that the company could be classified as a Passive Foreign Investment Company (PFIC) for a given taxable year, which could result in adverse U.S. federal income tax consequences7851468 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company's primary market risks are foreign exchange risk, as revenues are almost entirely in RMB, and to a lesser extent, interest rate and inflation risk, with no current hedging instruments in use and minimal impact from inflation to date - The company's main market risk is foreign exchange risk, as revenues are almost entirely in RMB while it may have US dollar-denominated needs; the company does not currently engage in hedging799 - Interest rate risk is not significant as the company's notes payable carry fixed rates797798 - Inflation in China has not materially impacted the company's results of operations801 PART II MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS This section confirms no material modifications to security holder rights and details the use of proceeds from the company's December 2018 IPO, with all US$509 million net proceeds used as intended for content acquisition, strategic investments, and other operating purposes - The company received net proceeds of approximately US$509 million from its December 2018 IPO810 - As of the date of this report, all net proceeds from the IPO have been used for their intended purposes, including content acquisition and strategic investments812 CONTROLS AND PROCEDURES This section addresses the company's internal controls, with management concluding that disclosure controls and internal control over financial reporting were effective as of December 31, 2020, a conclusion also attested to by the independent registered public accounting firm - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2020814 - Based on the COSO framework, management concluded that the company's internal control over financial reporting was effective as of December 31, 2020816 - The independent registered public accounting firm, PricewaterhouseCoopers Zhong Tian LLP, has audited and confirmed the effectiveness of the company's internal control over financial reporting as of December 31, 2020818 PART III FINANCIAL STATEMENTS This section contains the audited consolidated financial statements for Tencent Music Entertainment Group for fiscal years 2018, 2019, and 2020, prepared in accordance with IFRS, including the independent auditor's unqualified opinion on both the financial statements and internal control over financial reporting Consolidated Income Statement Highlights (RMB million) | Item | 2018 | 2019 | 2020 | | :--- | :--- | :--- | :--- | | Total Revenues | 18,985 | 25,434 | 29,153 | | Gross Profit | 7,277 | 8,673 | 9,302 | | Operating Profit | 2,039 | 4,622 | 4,710 | | Profit for the year | 1,832 | 3,977 | 4,176 | | Basic EPS (RMB) | 0.60 | 1.22 | 1.25 | | Diluted EPS (RMB) | 0.58 | 1.19 | 1.24 | Consolidated Balance Sheet Highlights (RMB million) | Item | Dec 31, 2019 | Dec 31, 2020 | | :--- | :--- | :--- | | Total Assets | 52,678 | 68,273 | | Cash and cash equivalents | 15,426 | 11,128 | | Goodwill | 17,140 | 17,492 | | Total Liabilities | 9,000 | 15,542 | | Notes payable | — | 5,175 | | Total Equity | 43,678 | 52,731 | Consolidated Cash Flow Highlights (RMB million) | Item | 2018 | 2019 | 2020 | | :--- | :--- | :--- | :--- | | Net cash inflow from operating activities | 5,632 | 6,200 | 4,885 | | Net cash outflow from investing activities | (1,190) | (8,102) | (14,206) | | Net cash inflow/(outflow) from financing activities | 7,741 | (31) | 5,292 |