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Rating Action: Moody's assigns first-time A2 ratings to Tencent Music; outlook stable
Global Credit Research - 24 Aug 2020
Hong Kong, August 24, 2020 -- Moody's Investors Service has assigned an A2 issuer rating to Tencent Music Entertainment Group.
At the same time, Moody's has assigned an A2 senior unsecured rating to the proposed notes to be issued by Tencent Music.
The ratings outlook is stable.
Tencent Music will use the proceeds from the proposed issuance for general corporate purposes.
RATINGS RATIONALE
The A2 issuer rating incorporates Tencent Music's underlying credit strength and a two-notch uplift, reflecting the high likelihood of the company receiving strong support from its parent, Tencent Holdings Limited (A1 stable), in times of need.
"Tencent Music's underlying credit strength reflects its dominant market position with established operations, proven monetization ability and consistent free cash flow generation," says Ying Wang, a Moody's Vice President and Senior Analyst.
"Its strong financial profile and net cash position provide financial flexibility and serve as a buffer for growing industry competition, potential regulatory risks and future investment needs," adds Wang, who is also the Lead Analyst for Tencent Music.
Tencent Music is China's largest online music service provider, accounting for about 70% of the country's fast-growing digital music market revenues in 2019, based on the company's reported financials and market revenue estimates from iResearch, an independent internet consultancy.
The company has a large user base, with its monthly active users exceeding 800 million at the end of 2019. It also owns the rights to a comprehensive music content library that caters to a wide range of users. The large number of highly interactive users attracts premium music production companies, which in turn drives user growth on Tencent Music platforms. This self-reinforcing cycle results in significant barriers to entry for other players.
Tencent Music also benefits from operational synergies with Tencent Holdings. Supported by the parent company's large active user bases, Tencent Music can acquire and retain users at lower costs. These synergies also enhance Tencent Music's ability to cross-sell and innovate new services and products.
Tencent Music's revenue, which primarily comprises of online music and social entertainment segments, grew 34% in 2019.
Moody's forecasts Tencent Music's revenue will grow 10%-20% in the next two years to USD4 billion-USD5 billion in the 2020-2021 from USD3.7 billion in 2019. This growth will be driven primarily by increases in the number of users who are willing to pay more for premium content and new services Tencent Music offers.
Moody's expects Tencent Music's adjusted EBITDA margin to gradually stabilize around 16%-18% in the next two years, from an average of 20% during 2017-2019. Moody's believes the company will continue to invest to maintain its market leadership in both content and user stickiness.
Moody's expects Tencent Music will maintain a solid financial profile with a net cash position and excellent liquidity in the next two years, supported by its strong operational competence and prudent financial policies. After incorporating the proposed note issuance, Moody's expects Tencent Music's leverage -- as measured by debt/EBITDA -- to stay below 2.0x, a level appropriate for its underlying credit strength.
The assessment of Tencent Music's underlying credit strength also considers rising industry competition in China's online music industry and potential regulatory risks.
The company faces intense competition from its industry peers and emerging forms of entertainment platforms that compete for its users' screen time and wallet share. The competitive pressure is partially mitigated by Tencent Music's dominant market position and established operations.
As the competitive landscape evolves, the regulatory environment also poses risks such as content management and consumer data protection. Given its dominant market position, Tencent Music is under the supervision of industry regulators, including the State Administration of Market Regulation.
However, Moody's believes that China's regulatory policies are aimed at promoting the long-term sustainable growth of the industry. The risk is also partially mitigated by Tencent Music's track record of adhering to regulatory requirements without significant business disruptions.
The two-notch parental uplift reflects Moody's expectation that Tencent Music will likely receive support from Tencent Holdings in a distress scenario.
Tencent Music is Tencent Holdings' sole platform to develop music business in the long run. Tencent Holdings' 55.6% stake and 78.7% voting right points to Tencent Music's high strategic importance to the parent. As such, Tencent Holdings exercises close management and financial control over the company, as reflected in the parent group's direct appointment of key senior management at Tencent Music.
And the sharing of brand names and operating licenses between Tencent Music and its parent means that Tencent Holdings has low tolerance for reputational risks that could arise, should Tencent Music becomes financially distressed.
Tencent Music's issuer rating takes into consideration the following environmental, social and governance (ESG) factors.
In terms of social risk, Moody's has considered the operational and financial risks associated with any failure to comply with regulations regarding copyright and the potential sharing of illegal content by users. This risk is partially mitigated by the presence of a legal team at Tencent Music and its proprietary technology infrastructure to detect illegal or sensitive content on its platforms. In addition, the company has established relationships with large and reputable music labels globally.
In terms of governance risk, we have considered the high concentration of ownership and voting rights in the company's majority shareholder, Tencent Holdings. This risk is partially mitigated by Tencent Holdings' long track record as a listed and regulated entity, and its adherence to prudent financial policies.
Tencent Music's issuer rating is not affected by subordination to claims at the operating company level, because the holding company benefits from contractual upstream cash flow from its operating companies. In addition, despite the issuer's status as a holding company, Moody's expects that support from Tencent Holdings to Tencent Music will flow through the holding company rather than flowing directly to its main operating companies; thereby mitigating any differences in expected losses that could result from structural subordination.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
The stable rating outlook reflects Moody's expectation that Tencent Music will maintain its strong position in China's online music market and will prudently pursue growth while maintaining a solid financial profile.
Moody's could upgrade the ratings if Tencent Holdings' ability to support strengthens, which would be illustrated by an upgrade of Tencent Holdings' rating; and if the company's underlying credit strength improves.
Tencent Music's underlying credit strength could improve if it maintains its dominant market position and further expands its business scale and scope significantly, while keeping a pristine financial profile featuring a low debt leverage, positive free cash flow and a net cash position.
Downward rating pressure could arise if the company (1) fails to fend off competition and experiences substantial reduction in revenue and cash flow generation on a sustained basis; (2) deviates from its prudent financial policy and grows its user base, business scope or content library at the expense of its strong financial profile; or (3) engages in aggressive acquisitions that strain its balance sheet liquidity or weaken its overall risk profile.
Specifically, the issuer rating could be downgraded if (1) Tencent Music's debt/EBITDA rises above 2.0x-2.5x, or (2) the company records a sustained and enlarging net debt position.
Moody's will also monitor for any sustained declines in the company's retained cash flow coverage of debt, which has been above 100% in the last few years.
Furthermore, adverse developments in China's regulatory regime, which could affect Tencent Music's operations or business model, would be negative for the ratings. Evidence of weaker credit linkage with Tencent Holdings or support assessment could also pressure the rating.
The principal methodology used in these ratings was Business and Consumer Service Industry published in October 2016 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1037985. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
Tencent Music is a leading online music service provider in China. The company's business operations originated from Tencent's online music services tracing back to 2003. Tencent Music is the result of a merger between Tencent Holdings' online music operations in China and China Music Group in 2016. Tencent Music was listed in the New York Stock Exchange in December 2018.
REGULATORY DISCLOSURES
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Moody's considers a rated entity or its agent(s) to be participating when it maintains an overall relationship with Moody's. Unless noted in the Regulatory Disclosures as a Non-Participating Entity, the rated entity is participating and the rated entity or its agent(s) generally provides Moody's with information for the purposes of its ratings process. Please refer to www.moodys.com for the Regulatory Disclosures for each credit rating action under the ratings tab on the issuer/entity page and for details of Moody's Policy for Designating Non-Participating Rated Entities.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.
The first name below is the lead rating analyst for this Credit Rating and the last name below is the person primarily responsible for approving this Credit Rating.
Ying Wang Vice President - Senior Analyst Corporate Finance Group Moody's Investors Service Hong Kong Ltd. 24/F One Pacific Place 88 Queensway Hong Kong China (Hong Kong S.A.R.) JOURNALISTS: 852 3758 1350 Client Service: 852 3551 3077 Clement Cheuk Yiu Wong Associate Managing Director Corporate Finance Group JOURNALISTS: 852 3758 1350 Client Service: 852 3551 3077 Releasing Office: Moody's Investors Service Hong Kong Ltd. 24/F One Pacific Place 88 Queensway Hong Kong China (Hong Kong S.A.R.) JOURNALISTS: 852 3758 1350 Client Service: 852 3551 3077
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