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Tencent Music Entertainment Brings the Noise in Q2, HUYA Q2 Exceeds Expectations, Tencent Rebounds

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Key News

Asian equities were largely higher as Japan returned from a three-day weekend in good spirits and South Korea and Hong Kong were outliers to the upside. Hong Kong’s outperformance was driven by news that quarantine rules for visiting Macau would be lifted. Macau gaming stocks Galaxy Entertainment and Sands China gained +5.47% and +9.83%, respectively, on the news. Meanwhile, bargain hunters lifted Tencent following yesterday’s decline. Hong Kong volume leaders were Tencent +2.29%, Meituan Dianping -2.06%, Next Digital, which is the media company owned by Jimmy Lai, +331%, Alibaba HK +0.66%, HK Exchanges +0%, and Semiconductor Manufacturing (SMIC) -0.36%.

The PBOC released July credit data overnight:

Takeaway: The release occurred after the Mainland close and demonstrated that the credit expansion slowed modestly in July. China has been trying to direct credit to private small medium enterprises post-coronavirus though it isn’t willing to repeat the debt-fueled stimulus post the Global Financial Crisis. Liquidity is a key driver of equities with Exhibit A being the US equity market. I don’t see the PBOC pulling liquidity at this juncture though keeping an eye on debt levels is important.

Tech was off due to lingering concerns around US China political rhetoric as several click bait articles speculated that Tencent’s WeChat could be removed from iPhones in China. Hasn’t anyone seen the photos of Tim Cook at the White House? Duh! The White House action on WeChat removal specifically mentioned US jurisdiction. Mainland China was having a decent day until a late day swing left indices down for the day. One broker speculated that the cause was a broker denying a merger with a rival. The decline was despite strong July auto sales.

Car sales rose +7.7% year over year in July to 1.6mm vehicles according to a WSJ article that quoted data from the China Passenger Car Association. Electric vehicle sales grew +19.3% to 98,000. Tech and communications were weak today on lingering concerns of US China relations while recent outperformers such as brokers and materials were off. Alcohol stocks Kweichow Moutai and Wuliangye Yibin were up +0.52% and +1.49%, respectively. It is worth noting that foreign investors bought nearly $600mm of Mainland stocks today. Hopefully they placed market on close orders.

NPR is reporting that TikTok will sue the White House in the US District Court for the Southern District of California over its proposed ban and forced sale. According to the article, a source at the company called the move “unconstitutional”. Yesterday we articulated our “Kabuki theater” thesis of US-China political rhetoric: all bark but no bite. We know that bashing China polls well but US-China economic relations are very strong, much stronger than most would realize. If you think about it, TikTok should have moved its non-China business servers outside of the country, which may have negated this move. Out of  WeChat’s 1 billion users it is estimated that around 100mm to 200mm are outside of China. Putting servers outside of China makes sense to me though it might not be economically viable or even a palatable solution for the US government.

Tencent is engineering the merger of online gaming streamers HUYA and peer DOYU as it owns large stakes in both. The combined company should be a competitor for Bilibili (BILI US), in which Alibaba owns a 3.85% stake. While pure speculation on my part, Alibaba raising its stake in BILI makes sense to me in order to compete with its rival Tencent. The same might be true for NetEase (NTES), which announced a licensing agreement with Universal Music Group to distribute UMG’s recording artists in China via its NetEase Cloud Music paid subscription platform. UMG also inked a deal with Tencent Music Entertainment, which is discussed below. Alibaba was light on games within its ecosystem though this is pure speculation on my part.

New Orient Education & Technology Group (ticker EDU) has reportedly chosen Bank of America, Credit Suisse, and UBS to lead a Hong Kong relisting IPO. Details are minimal at this point though broker chatter was that the company could raise $1B in the listing. According to Bloomberg and broker chatter, iQiyi, Baozun, Yum China, 21Viatnet and GDS are considering relisting as well.

Considering the need for US tech executives to testify before Congress on their monopolistic success, what if the same standard was applied to other industries such as US asset management? Ever wonder how companies can charge such low or even non-existent fees? By themselves, the individual funds would not be sustainable if they weren’t part of a much bigger entity. Regardless of the election outcome, big government is here to stay. Is a larger government inflationary or deflationary? On the one hand, big government and increased debt means more rules and bureaucracy that can slow growth. On the other hand, tariffs raise prices for consumers, which is inflationary. Is the dreaded stagflation on the horizon? I had the opportunity to catch up with a friend of mine who is the CIO of a very large investment firm yesterday. He mentioned the difficulty presented by having US investors accept non-US holdings. The market does what is least expected so non-US outperforming after a decade of US outperformance makes sense to me.

Tencent Music Entertainment (TME US) reported strong results that were above analyst expectations for Q2. The results were released after the US close yesterday along with an announcement of a joint venture partnership with Universal Music Group. TME will distribute UMG’s recording stars’ hits through its digital music platform which will include Drake, Justin Beiber, Kayne West, Ariana Grande, Taylor Swift, Maroon 5, Marvin Gaye, Elton John, Billie Eilish, Imagine Dragons, Post Malone, Demi Lovato, Bon Jovi, Carrie Underwood, The Weekend, Katy Perry, Luke Bryan, Sam Smith, Chris Stapleton, Selena Gomez, Jonas Brothers, and Lady Gaga, among others (my wife and kids love pop music so don’t feel bad if you don’t recognize some of these stars). The partnership has a wealth of potential not only for TME’s music subscription model but also for its ability to sell virtual concerts and generate advertising revenue. With over 130 cities with populations over 1mm, imagine the concerts that could be held in China alone. TME’s Q2 beat analyst expectations while the company’s efforts to drive paying users to online music and entertainment platforms bore fruit. Percentage numbers below are year over year for Q2 2020 versus Q2 2019.

  • Revenues +17.5% to $981mm (RMB 6.93B) versus estimate RMB 6.871B
  • Online music services +42.2% to $314mm (RMB 2.22B)
  • Social entertainment services +8.6% to $667mm (RMB 4.76B)
  • Mobile Monthly Average Users -0.2% to 651mm from 652mm
  • Paying online music users increased 51.9% to 47.1mm from 31mm
  • Paying social entertainment users increased 11.6% to 12.5mm from 11.2mm
  • Gross profit +11.8% to $307mm (RMB 2.17B)
  • Gross margin 31.3%
  • Total operating expenses increased to $184mm (RMB 1.3B) from RMB 1.05B)
  • Operating profit increased slightly to $157mm (RMB 1.11B)
  • Diluted EPS $0.10 (RMB 0.69) versus average estimate RMB 0.649

Online gaming streamer Huya Inc. (HUYA US) reported strong Q2 financial results prior to the US market open. I assume the investors who sold HUYA yesterday after the stock fell -9.83% might regret that decision. Separately, social media company Joyy Inc (YY US) announced the sale of 30mm shares to Tencent for $810mm in cash. Percentage numbers below are year over year for Q2 2020 versus Q2 2019.

  • Revenue +34.2% to $381mm (RMB 2.697B) from RMB 2.010B, which beat average analyst estimates of 2.623B
  • Monthly Average Users (MAUs) of Huya Live +17% to 168mm while mobile MAUs +35% to 75mm
  • Net income +86.2% to $32mm (RMB 226mm) from RMB 121mm
  • Non GAAP net income +106% to $49mmm (RMB 351mm) from RMB 170mm versus analyst estimate of RMB 285mm
  • Total operating expenses increased to RMB 414mm from RMB 299mm
  • Adjusted EPS $0.21 (RMB 1.49) from RMB 0.73 and versus analyst estimates of RMB 1.20

H-Share Update

The Hang Seng opened higher, swung lower in the late afternoon but managed to bounce back to close +2.11%/+513 index points at 24,890. Volume picked up +4% to nearly 1.5X the 1-year average while breadth was strong with 49 advancers and only 1 decliner. The index was led by Tencent +2.29%/+65 index points, AIA +2.54%/+64 index points, and HSBC +3.02%/+63 index points. Hong Kong-domiciled stocks returned +2.15% versus China-domiciled stocks, which returned +1.63% using the HS HK 35 and China Enterprise Indexes as proxies. The 205 Chinese companies listed in Hong Kong within the MSCI China All Shares Index returned +1.14% with communication +2.27%, energy +2.11%, financials +1.31%, real estate +1.22%, staples +0.9%, utilities +0.47%, industrials +0.34%, discretionary +0.3%, tech -0.08%, materials -0.42%, and health care -0.81%.

Southbound Stock Connect volumes were light in mixed trading. Shanghai Connect volume leader Tencent was bought 2 to 1 (the value of buy trades was 2X the value of sell trades), SMIC was sold slightly and CPIC was bought 3 to 2. Mainland investors bought $68mm of Hong Kong-listed stocks today as Southbound Stock Connect trading accounted for 10.2% of Hong Kong turnover.

A-Share Update

Shanghai and Shenzhen were up +0.88% and +0.86, respectively, until a fairly dramatic afternoon sent both indices down -1.15% and -1.49% to close at 3,340 and 2,243, respectively. Volume was off a touch -1.8% while breadth was off with 1,129 advancers and 2,564 decliners. Large cap stocks were declined modestly less than mid and small caps. The 510 Mainland-listed stocks within the MSCI China All Shares Index were off -0.6% with staples +0.87%, utilities +0.37%, energy +0.23%, discretionary -0.17%, real estate -0.42%, industrials -0.74%, financials -0.84%, health care -0.97%, communication -1.26%, tech -1.37%, and materials -1.53%.

Foreign investors were active buyers of Mainland stocks today on moderate volumes. Shanghai Connect volume leaders were Kweichow Moutai, which was bought 5 to 4, Ping An bought 9 to 5, and Jiangsu Hengrui Medicine sold 3 to 2. Shenzhen Connect volume leaders were Luxshare, which was bought modestly, East Money Information, which was bought 4 to 3, and Muyuan Foods, which was bought 2.5X. Foreign investors bought $568mm worth of Mainland stocks today as Northbound Stock Connect trading accounted for 5.4% of mainland China turnover.

Last Night's Exchange Rates & Yields

  • CNY/USD 6.95 versus 6.96 yesterday
  • CNY/EUR 8.18 versus 8.18 yesterday
  • Yield on 1-Day Government Bond 1.43% versus 1.28% yesterday
  • Yield on 10-Year Government Bond 2.95% versus 2.95% yesterday
  • Yield on 10-Year China Development Bank Bond 3.47% versus 3.46% yesterday