Cloud Music announced FY23 financial results: total revenue dropped by 13% YoY to RMB7.87bn in FY23, in line with our/consensus estimate. 2H23 total revenue was down by 16% YoY to RMB3.96bn, mainly due to the adjustment of social entertainment business (-42% YoY). Cloud music recorded adjusted net income of RMB819mn in FY23, beating our/consensus estimate of RMB686/629mn, thanks to the solid GPM improvement (+12.3ppt YoY). We expect social entertainment business to remain under pressure, and thus lower FY24-25E revenue forecast by 6-8%. However, we are positive on the core music business growth and GPM expansion, supported by the growing paid user base. We raise FY24-25E adjusted net income forecast by 1-2%, and lift our DCF-derived target price to HK$106.5 (previous: HK$99.5). Maintain BUY.
　　Positive on core music business outlook. Online music revenue was up by 22% YoY to RMB2.3bn and accounted for 59% of total revenue in 2H23 (1H23: +13% YoY), driven by solid growth of subscription business (+24% YoY) and strengthened ad monetization capabilities. Average monthly paying users grew by 15% YoY to 44.1mn in 2023, with paying ratio rising by 1.2ppt YoY to 21.4% in 2023. For 2024, we expect online music revenue to grow by 17% YoY, driven by 16% YoY growth in monthly paying users. Social entertainment business was under pressure, with revenue down 42% YoY to RMB1.6bn in 2H23, due to operating strategy adjustment. In 1Q24, Cloud Music launched a comprehensive product upgrade to focus more on its core music business, which however may impact live streaming user traffic and revenue in FY24. We forecast social entertainment revenue to decline by 18% YoY in 2024E.
　　Driving quality development of music ecosystem. Average MAUs recorded steady growth of 9% YoY to 205.9mn in 2023, with DAU/MAU consistently above 30%. Cloud music leverages AI capability to further enhance users’ music discovery and consumption experience in 2023, with an increasing percentage of music streams from the platform’s recommendation. The company continues to expand its content library, with no. of music tracks up by 28% YoY to 149mn as of 2023-end. In addition, Cloud Music enriched the long-form audio offerings on its platform, with total listening time of audio content up by 71% YoY in 2023.
　　Solid margin expansion ahead. Overall GPM expanded by 12.8ppt YoY to 28.7% in 2H23, due to the improved music monetization, optimized content cost and revenue sharing ratio. We forecast GPM will rise to 31.0/33.7/35.5% over FY24-26E. We are upbeat on Cloud Music earnings growth outlook supported by its solid core music business and economies of scale. We forecast adjusted net income to grow at a CAGR of 28% over FY24-26E, and view its current valuation of 18x FY24E PE attractive.