Is Netease Cloud Music worth buying when it goes public？ Over $5 billion in valuation is at a low level？

Wen | Hong Kong Stock Research Society

On November 23rd, Netease Cloud Music announced the launch of the initial public offering in Hong Kong. The co-sponsors of the listing are Bank of America Securities, CICC and Credit Suisse.

According to the announcement, Netease Cloud Music will publicly issue 16 million common shares worldwide, with the offering price range of HK$ 19-220 per share, and plans to raise HK$ 3.04-3.52 billion (about RMB 2.49-2.89 billion), with an over-allotment right of no more than 15%. It is estimated that the valuation of Netease Cloud Music will be between 39.47 billion and 45.71 billion Hong Kong dollars (about 32.37 billion to 37.48 billion yuan) after listing.

According to the prospectus, Netease Cloud Music introduced Netease, Sony Music Entertainment and Orbis Investment Management Co., Ltd. as cornerstone investors, with a total subscription of 350 million US dollars (about 2.73 billion Hong Kong dollars). According to the plan, Netease Cloud Music will be officially listed on December 2nd with the code "9899.HK".

What is the valuation level of Netease Cloud Music with a stock price of HK$ 190-220?

According to the calculation of the prospectus, assuming that the over-allotment option has not been exercised, the shares raised by Netease Cloud Music in public account for 7.7% of the total issued shares. Based on the calculation of HK$ 19-220 per share, its valuation is between US$ 5.065 billion and US$ 5.87 billion when converted by exchange rate.

Netease Cloud Music reached 184 million monthly users in the first three quarters; The number of online music paying users was 27.52 million, an increase of over 93% year-on-year; The online music payment rate reached 14.9%.

In December 2018, Tencent Music landed on the New York Stock Exchange with a valuation of US$ 21.3 billion. The current market value is about US$ 12.9 billion, and the valuation of Netease Cloud Music is about 40% of Tencent Music. Judging from the number of users and financial situation; The cumulative MAU of Netease cloud music online music service and social entertainment is a quarter to a fifth of TME; And compared with TME, the revenue is about one fifth. However, compared with the market value of TME, the current valuation of Netease Cloud Music is obviously higher than its equivalent value. It shows that the capital market recognizes and values its content community.

This optimism should mainly come from Netease Cloud Music’s unique community route, original music advantages and highly sticky young users; It is optimistic about its long-term development. Recently, Xiaohongshu completed a new round of $500 million financing, with a market value of $20 billion after the investment. Community concept stocks are still promising investment targets in the capital market.

As far as community products are concerned, compared with the market value of bilibili and other content communities, the valuation of Netease Cloud Music is still in the low range. Bilibili’s monthly income in the third quarter of this year was 267 million, and its market value exceeded HK$ 200 billion. In contrast, Netease Cloud Music had a monthly income of 184 million in the first three quarters, and the highest valuation was only HK$ 45.7 billion, which was obviously underestimated.

Recently, Zhihu released its third quarter financial report, with an average monthly active users of 101.2 million and an average monthly paid members of 5.5 million. At present, the market value of Zhihu is about $4.6 billion. Netease Cloud Music’s monthly activity is about 1.8 times that of Zhihu in the same period, but its valuation is similar, which shows that its community valuation has not been fully reflected.

Due to the recent correction of China Stock Exchange, Internet community enterprises are at a low market value. When bilibili was first listed in the US in 2018, its market value was only $3.2 billion, and its share price really broke through more than two years after listing. In the long run, the valuation of Netease Cloud Music is seriously underestimated, and there is still much room for growth in the future.

Is the "first share of the music community" valuable after the copyright is not independent?

According to the prospectus, Netease Cloud Music’s revenue from 2018 to 2020 was 1.1 billion yuan, 2.3 billion yuan and 4.9 billion yuan respectively. In the first three quarters of 2021, the total revenue was 5.1 billion yuan, a year-on-year increase of 52%; Among them, online music revenue increased from 1.85 billion yuan in the same period of 2020 to 2.44 billion yuan, social entertainment and other sectors revenue increased from 1.52 billion yuan in the same period of last year to 2.67 billion yuan, online music service revenue accounted for 47.7%, social entertainment services and other income accounted for 52.3%.

From the cost side, the proportion of Netease Cloud Music content service cost to revenue has gradually decreased, and the gross loss has continued to narrow. At present, the gross profit margin has turned positive. In terms of revenue growth rate, Netease Cloud Music also far exceeds the overall level of the industry, reaching over 100% in 2019 and 2020, and still reaching 60.0% in the first half of 2021, about twice the growth rate of the industry. In the first half of 2021, the adjusted net loss of Netease Cloud Music narrowed to 500 million yuan year-on-year, and the gross profit margin increased significantly and turned positive to 0.4%.

It is worth noting that at present, most of Netease Cloud Music’s losses are caused by changes in the fair value of convertible redeemable preferred shares. After listing, this part of the loss will disappear with the completion of the share conversion (the latest one will expire on October 23, 2023) and will not lead to the outflow of cash flow.

In July this year, the exclusive copyright of music was banned. For the online music market, this means that the industry has returned to a level playing field. Affected by this, Netease Cloud Music has recently reached copyright cooperation with Modern Sky, Hong Kong Emperor Entertainment and China Record Group. Many famous artists, bands and musicians, such as Nicholas Tse, Joey Yung, Twins, New Pants, Tong Yang and Wu Tiao, have returned. According to the analysis of Western Securities, under the premise of gradually eliminating copyright monopoly in the music industry, the core competition of online music platform will focus more on ecological construction and user operation experience, and Netease Cloud Music has advantages in these aspects.

Hong Kong stock policy is favorable and frequent attention is paid to high-growth technology Internet enterprises.

This year, the global capital market continued to fluctuate, and many Internet companies decided to suspend the IPO process. Recently, however, with the stabilization of the market, the HKEx has also released a number of positive signals, including optimizing and broadening the secondary listing mechanism, and including technology Internet stocks such as Netease, JD.COM and Xinao Energy in the Hang Seng Index, so as to attract more enterprises to come to Hong Kong and return to Hong Kong for listing. Netease Cloud Music, as the first Internet company to officially launch IPO, also shows the strong endogenous motivation and development potential of the music community.

Compared with bilibili’s market value of more than 20 billion US dollars, and Xiaohongshu’s valuation of 20 billion US dollars; If Netease Cloud Music operates properly and the fundamentals continue to improve, there should be more room for growth.

After the reform of the listing system of the Stock Exchange in April 2018, attracting more relevant funds and enterprises to IPO in Hong Kong became the focus of work, and more and more Chinese stocks "returned" to Hong Kong for secondary listing. The relevant planning of the Stock Exchange shows that it will continue to develop Hong Kong into a large global and regional enterprise for major listing or secondary listing; andraise fundsTo attract global investors interested in investing in companies in the Asia-Pacific region and mainland investors seeking international investment opportunities.

Recently, Weibo also passed the hearing of Hong Kong stocks. Netease Cloud Music officially launched the IPO, and the recovery of Internet stocks in the Hong Kong stock market may have gradually occurred.