In normal times, Tencent Music Entertainment would be prized by investors for leading China’s fledgling recorded music business, now the 6th largest in the world, away from decades of rampant piracy into a lucrative market with hundreds of millions of online subscriptions.
Parent company Tencent, one of China’s largest tech conglomerates, spun off TME on the New York Stock Exchange in December 2018. By early 2021, TME shares had risen 148% above the IPO price, briefly valuing TME at nearly $52 billion, almost on par with Spotify, the world’s largest music-streaming company.
But 2021 and early 2022 have been far from normal. And lately, a string of global and domestic events has led U.S. investors to flee Chinese stocks.
China’s friendship with Russia has investors concerned it could face retaliation by the U.S. and other Western countries over the war in Ukraine. And on Monday (March 25), 26 million residents in Shanghai were put under lockdown as part of China’s “zero-COVID” strategy.
On the business front, in 2021 the Chinese government launched a series of regulatory crackdowns aimed at improving competition, protecting corporate data security and remedying the consumerism of young internet users. At the same time, Chinese companies listed on U.S. exchanges came under scrutiny by regulators in both countries, leading to speculation that some companies would exit the U.S. for exchanges in China.
The result has been disastrous for the once high-flying TME. On March 14, TME’s share price stood at $3.12, 90.3% lower than its all-time high of $32.25 on March 23, 2021.
It’s not alone. Dozens of Chinese tech stocks listed on U.S. exchanges have been regular fodder for financial press headlines. In one notable case in April 2021, Chinese antitrust regulators fined e-commerce giant Alibaba $2.8 billion for abusing its dominant competitive position. In June, Chinese authorities shocked the financial world by launching a cybersecurity review of Didi, a Chinese ride-hailing app like Uber, and pulled it from app stores mere days after it raised $4.4 billion through a New York Stock Exchange initial public offering.
Tencent, TME’s parent company, has been affected by new Chinese government rules limiting the number of hours children and teenagers can play online video games, which hurts the online advertising its games generate. Last week, Tencent said it may shift its mobile payments business, WeChat Pay, to a holding company to appease regulators’ concerns about stability in online banking. The regulatory scrutiny has damaged one of China’s most valuable companies: Tencent’s revenue grew just 8% on an annual basis in the fourth quarter, the slowest rate since the company went public in 2004.
For its part, TME has also suffered from ongoing concerns that Chinese companies may be delisted from U.S exchanges. In December, President Biden signed into law the Holding Foreign Companies Accountable Act (HFCAA), requiring Chinese companies that list on U.S. exchanges and retain accounting firms in foreign jurisdictions to comply with U.S. accounting inspectors.
“Most companies cannot agree to that given China’s own data protection laws,” says Charles Chai, analyst at 86Research Ltd. That’s because Chinese law prohibits foreign securities regulators from inspecting domestic companies’ books without government permission.
A Trump-era law with bipartisan support, the HFCAA stemmed from concerns about the lack of transparency in Chinese companies’ accounting practices. On March 11, the Securities and Exchange Commission placed five Chinese companies on a provisional list of companies identified under the HFCAA as having an accounting firm identified by the Public Company Accounting Oversight Board. Chinese and U.S. regulators have recently had productive talks in efforts to solve the audit dispute and Chinese regulators are supposedly close to making concessions, Chinese state media reported.
But since the HFCAA was passed, China has pushed back by making it more difficult for its companies to list overseas. A new law passed in February requires any Internet platform with more than one million users to receive government approval before conducting a new listing on a foreign exchange.
Concerns that TME could delist from the New York Stock Exchange became heightened on March 23 when the company quietly revealed it would seek a dual listing on the Hong Kong Stock Exchange — through an “introduction” rather than an issuance of new shares — in order “to provide greater liquidity and protection amid an evolving regulatory environment.” (TME representatives declined to comment.)
Audits and accounting issues aren’t the only challenges TME is facing. More than a dozen Chinese ministries launched “Operation Cyber Sword” in October 2020, which resulted in new rules for everything from livestream e-commerce (which impacts TME’s social entertainment business) to ethical use of algorithms. Other regulations center on the theme of “common prosperity,” which president Xi Jinping described in an August speech as an essential requirement of socialism and necessary to limit financial risk while safeguarding the country’s growth.
In July, Chinese regulators passed down rules for on-screen advertising “which to a certain extent imposed constraints on Tencent Music’s advertising space and unit prices,” Huatai Securities analysts wrote in a Jan. 28 note to investors. Then in August, the Cyberspace Administration of China tightened governance on “fan circles” — groups of fans on Chinese social media platforms — to eliminate “idol worship” by underage consumers.
“It is clearly required that fans should not buy charts, and artists should not induce fans to consume,” wrote the Huatai Securities analysts. Gone are rankings — charts, effectively — of top celebrities, while rankings for music, drama and film are still allowed but governed by new rules. Fans cannot be encouraged to purchase items to help their favorite idols up the rankings — such as buying multiple copies of the same track or albums by a favorite musician, which has reduced the amount of music downloads TME has sold. Fan clubs and forums that violate the rules will be dissolved.
While TME cannot promote celebrity culture or offer exclusive content, regulators aren’t stopping the company from helping to develop careers and build a catalog of long-tail music. To that end, “independent musicians and self-produced content can still help platforms to build content advantages,” CITIC Securities analysts wrote in a Jan. 24 note, “and we expect the head music platforms to strengthen the ecological cultivation of independent musicians.”
TME has poured resources into building what it calls “a hotbed for hit songs”: Tencent Musician Platform, a suite of career-boosting tools to help independent musicians release and promote music on the platform. TME grew from 260,000 independent artists to 300,000 in the fourth quarter of 2021. That helped TME grow its revenues 7% to $4.9 billion in 2021, while music subscriptions improved 36% to 76.2 million, a counterweight to its sagging social entertainment segment.
China’s leaders “do not seem to be dazzled by improvements to e-commerce platforms, video games, or food delivery services,” wrote Ryan Hass, a senior fellow at the Brookings Institute. Instead, China’s leadership is focused on key, strategic sectors such as green tech, high-end manufacturing and electric vehicles.
For TME investors, the situation is still uncertain. “It remains too early to tell where this regulatory crackdown will end,” says Hass. But Xiaomeng Lu, director of Eurasia Group’s geopolitical practice, tells Billboard there will be “sustained pressure in 2022 rather than record-making cases like the Alibaba antitrust probe or [the] unprecedented cybersecurity review of Didi.”
