TME reported in-line 2Q23 total revenue (up 6% YoY to RMB7.3bn) and adj. NPM (21.0%) but with more divergent performance of music and social. Both historical high paying ratio and monthly ARPPU supported 37% YoY music subs and outperforming ad mainly contributed to 77% YoY music non-subs. Social plummeted by -25% YoY mainly on 1- month streaming adjustments. GPM of 34.3% was above consensus.We significantly cut our 2023-25 social revenue forecasts as Co. is determined to reset their social business by proactively, comprehensively and gradually executing stringent streaming adjustments since June. But we believe their solid music growth momentum with multiple visible catalysts will offset social impact along the road. Margin expansion trajectory remains solid mainly on music GPM expansion and improved cost efficiency. Maintain BUY but cut our TP to US$8.30/ HK$33.00 on 16.0x 2023E Non-GAAP EPADS.
　　Key Factors for Rating
　　Reset for social business once and for all. Co. has proactively executed comprehensive and strict streaming function adjustments and risk control measures gradually for their social entertainment business since June 2023 amid tightened industry-wide regulatory environment and guides their 3Q23 total revenue to drop by low-to-mid teens % and 2023 total revenue to drop by low- to-mid single digit % mainly due to these adjustments. This is worse than our previous expectations and we believe Co. has determined to reset their social business once and for all amid weak macro and intense competition for L-T sustainable growth. We expect monthly social revenue will bottom out and stabilise in 4Q23 after all related adjustments have been implemented. Thus, we cut our 2H23 social entertainment revenue forecast significantly by -51%.
　　Solid music partially offset N-T social impact. We remain optimistic on their clear music growth momentum along the road with multi-catalysts supporting both their music subs and non-subs revenue. Co. states that their music paying users reach 100m in June 2023. We believe both paying users and music monthly ARPPU will continue to reach record high to contribute music subs growth in the following quarters supported by their content, paywall strategy, privileges, packages, consumption scenarios, partnerships, operational strategies (scale back promotions) and AIGC application. Ad, merchandise sales and LFA will be the main music non-subs contributors. Moreover, enhanced monetisation of big addressable iOT market, especially in-car use cases, will further provide growth engine for music business. We believe Co. will accelerate their music monetisation to offset some negative impact brought by social. Thus, we raise our 2023-25 total music revenue estimations by 7-17% by both uplifting our music subs and non subs revenue forecasts. In summary, we cut our 2023E/ 24E/25E total revenue by 9%/15%/11% respectively.
　　Margin expansion trajectory remains. We expect increased music GPM brought by Op leverage on strong growth, revenue mix (more revenue contribution of original music content with higher margin), optimised label structure and improved cost efficiency will fully offset social GPM declines mainly due to Op deleverage on adjustments. We also cut our opex estimations mainly in 2024-25 to reflect disciplined cost control especially headcount efficiency.
　　Thus, our 2023-25 margin forecasts remain on upward trajectory though we cut our adj. net profit absolute amount forecasts by low-to-mid-single digit %.
　　2Q23 results: In-line results with more profound divergence between music and social. Total revenue of RMB7.3bn (up 6% YoY) was in line with consensus but -2% below BOCIe. Music revenue delivered 48% YoY, 7% beat BOCIe. Both music subs and non-subs revenue reached historical record high, continuing to accelerate at 37%/77% YoY to RMB2.9bn/RMB1.4bn respectively.
　　Both historical record high paying ratio of 16.7% and monthly ARPPU of RMB9.7 contributed to strong music subs growth. Ad and merchandise sales led to music non-subs growth momentum with outperforming ad-supported mode and strong ad verticals, including eC, game and travel. However, social revenue plummeted by -25% YoY to RMB3.0bn mainly due to industry-wide streaming function adjustments, -11% miss BOCIe. GPM increased by 4.4ppts YoY to 34.3% mainly due to revenue mix, Op leverage and improved cost efficiency, above consensus of 33.5%. Adj. NPM further expanded to 21.0%, in line with consensus/ BOCIe.
　　Key Risks for Rating
　　Downside risks: 1) traditional social streaming competition; 2) regulation; 3) ineffective monetisation; 4) ADR delisting; 5) destructive M&A.
　　Valuation
　　We maintain our BUY rating but cut our P/E based TP to US$8.30/ HK$33.00 on 16.0x blended 2023E Non-GAAP PER (in line with 2022-25E Non-GAAP EPADS CAGR) by assuming equally net profit contribution from music and social in 2023 and US$0.52 2023E Non-GAAP EPADS (drop from US$0.55 previously).