Tencent Music Entertainment (NYSE: TME) released an uninspiring set of results earlier this week. Yet, the stock price is only down 3.5% for the week, despite the lukewarm results and Wednesday’s market rout. Without a new growth catalyst, there will be downside ahead.

TME’s second-quarter results were ahead of Wall Street’s expectations but digging deeper into the numbers points to tepid earnings growth going forward. Non-GAAP EPS of $0.10 were $0.02 higher than estimates while GAAP EPS of $0.08 were a cent ahead of estimates. Revenue of $859 million was $18.07 million ahead of expectations and 31% higher year-on-year.

 

Music Business Already Slowing

The music business clearly has little pricing power, and competition is rising. It’s hard to see significant earnings growth coming from this part of the business in the next few years.

TME’s online music business is seeing little growth in new users. While non-paying users are steadily being converted to paying subscribers, the total number is still low and the revenue from each user remains very low.

Total MAUs (monthly active users) were flat at 652 million. Of that 31 million are now paying users, up 9% for the quarter and 33% for the year. ARPPU (average monthly revenue per paid user) is just $1.22 and only grew 4% during the quarter while falling from a year ago. This is well below competitors like Spotify which earns over $5 per premium user.

The problem is that the music business clearly has little pricing power, and competition is rising. It’s hard to see significant earnings growth coming from this part of the business in the next few years.

 

Social Entertainment Has a High Base to Beat

The bulk of TME’s revenue (74%) comes from the social entertainment business. This segment managed to grow both the number of paid users and the revenue per user by 17% each from a year ago.

The monthly average revenue per user for the social platform is now $18.45, which is impressive, but growth has slowed dramatically in the last few quarters. This metric has been the main growth driver for the entire business. Further growth from this high base will be difficult to achieve as is already becoming evident.

 

The Valuation is at Risk

In March it was rising costs that alarmed the market. This time around, investors need to question the sort of revenue growth TME is really likely to see going forward.

TME has delivered impressive growth to date. But it is now in a position where revenue growth is likely to slow, costs are rising, margins are under pressure, and it has little pricing power in a very competitive environment.

The price multiple of 80 is expected to unwind to 26 in the next year, based on analyst estimates of 38% growth in EPS. However, the risks for earnings growth appear to be to the downside.

Without a new growth catalyst, the probability of disappointing results in the next year is high. Strong results from Alibaba and Netease, and the delay of new tariffs boosted the Chinese internet companies this week. TME’s stock price appears to have benefited from that sentiment but will be vulnerable going forward.