Tencent Music Entertainment Group (NYSE: TME) is the largest music streaming company in China. The company’s shares have been a bright spot for investors in the country over the past 52 weeks, providing a total return of 84%. Meanwhile, the SPDR S&P China ETF (NYSEARCA: GXC) has returned -8%.

Tencent Music Entertainment: Dominating Music Streaming in China

Tencent operates as one reportable segment. However, it breaks down its revenue into two divisions: online music services and social entertainment services.

The company has three music and audio streaming platforms in China: Kuguo Music, QQ Music, and Kuwo Player. At the end of 2023, the company had 589 million monthly active music users, giving it about 60% of the country’s streaming market share.

The social entertainment segment includes live streaming and an online karaoke platform called WeSing. The company generated 62% of total revenue from the music division and 38% from the social entertainment division. Interestingly, those percentages were flipped in 2021.

TME Earnings: Declining Social Entertainment Revenue Disappoints

The company beat estimates on both earnings per American Depositary Share (ADS) and revenue. An ADS represents shares of a foreign company traded on an American exchange. The company posted earnings per ADS of $0.15, just above the $0.14 estimate and an increase of 30% from the previous year.

Revenue was $985 million, just slightly above estimates and a decrease of 1.7%. The company’s revenue streams performed wildly disparately. Social entertainment revenues dropped 43%, while music revenues grew 27%.

Tencent lost total users in both divisions, yet it increased the number of users paying for a subscription rather than the free version of its apps. The average revenue per paying user (ARPPU) increased by 10% in music, but it declined by 46% in social entertainment.

Tencent's Growth Strategy: Focus on Increasing ARPPU

So, how does Tencent Music grow from here? First, let's look at the potential size of the Chinese market. Examining the number of smartphone users in China can gauge this as users install Tencent's applications on mobile devices. Additionally, the company has no meaningful plans to expand to other countries.

The number of people in China with cell phones is approximately 1 billion. If Tencent’s 589 million users at the end of 2023 are 60% of the market, then the total size of the market is around 980 million. With these assumptions, 98% of the people in China who have cell phones have a music streaming service. In this case, the potential market is already very saturated.

The number of cell phone users is expected to increase, but not at a particularly fast rate. Tencent, knowing this, has two main avenues to pursue growth.

First, it could steal market share from competitors; however, right now, it is trending in the wrong direction. Its biggest competitor, NetEase Cloud Music (NASDAQ: NTES), increased its music users by 25 million in 2023, which is similar to the number of users Tencent lost.

Another avenue is to consolidate around the firm’s most loyal users and continue to increase ARPPU. This feels like a better plan, and it has momentum.

The company’s report has a silver lining: It still beat earnings and revenue estimates, just in a much different way than expected. The higher ARPPU in music boosted the company's operating margin by 160 basis points from last quarter and nearly 900 basis points from a year ago. This led to Tencent beating earnings estimates despite the drop in total users.

However, the drop in users does cap the company’s growth potential. That's likely why five Wall Street analysts cut their price target for the stock after the release. Among those analysts, the price target for the firm sits at $14.60, implying an upside of 31%.

Tencent's Premium Strategy: A Strong Bet on Future Growth

Tencent believes its Super VIP subscription will boost ARPPU in music. It has not released numbers on the new tier but may do so in the next earnings release. It costs five times more than the company’s regular tier, so if successful, it could truly be a game changer.

Success in the Super VIP tier should boost Tencent's shares and signal the firm's strong long-term prospects.