Why Did Tencent Invest in Universal Music Group?

In March, Tencent Holdings Ltd (SEHK: 700) announced the closing of its investment into Universal Music Group (UMG), the American global music company.

Apart from the hefty valuation this transaction ascribes to UMG, investors must wonder what kind of rationale Tencent is looking at or what kind of synergies there are here.

In this article, I’ll try to find these out and assess whether the transaction makes sense.

Deal terms

Before we jump into the implications, let’s take a good look at the deal terms.

It was announced in December last year that Vivendi, the parent company of UMG, would sell a 10% stake to a consortium of investors that were led by Tencent. It valued UMG at €30 billion (US$32.8 billion).

Besides, Tencent and its consortium partners would have the right to buy an additional 10% stake (i.e., total stake to increase to 20%) until January 2021, based on the same company valuation. After three months of due diligence, the transaction was closed in March.

Interestingly, after the closing, it was further reported that both parties have already started discussing the possibility of having Tencent’s music business subsidiary – Tencent Music Entertainment (NYSE: TME), also known as TME – become a minority shareholder in UMG China.

What is Tencent?

The implication of this transaction boils down to a very fundamental question we should ask ourselves – what is Tencent?

Is it just an online communications company that once developed the sensational QQ and WeChat in China? Is it just a gaming company that dominates the global gaming market? Or is it merely an Internet company that tries to do everything?

To me, the current-day Tencent is an IP company, just like Disney (NYSE: DIS) in the US. Current-day Disney is not a mere amusement park operator but an IP company that monetises the IPs of its cartoon characters.

For Tencent, from businesses such as online gaming to China Literature Ltd (SEHK: 772), Tencent Video, or Tencent Music, it’s all about the IPs and how it can make money out of these.

For example, let’s make a movie or a book out of the popular Tencent game, PUBG, and launch it via Tencent Video or China Literature. Every stage of the production is related to Tencent, and this is how it dominates consumers’ waking hours.

Synergies, synergies and synergies!

Universal Music Group counts Taylor Swift, Lady Gaga, and the Beatles among its catalogue. Imagine all the additional synergies Tencent can get for its other businesses with access to these top-notch stars (and their IPs).

How about casting Taylor Swift in one of the movies based on an online novel written on China Literature and launching it via Tencent Video? Sounds unbelievable? It is very possible now.

In addition, the global music business has been expected to grow significantly thanks to streaming, especially in China, India and Latin America.

Although Tencent is undoubtedly the leader in the business in China, it almost has no exposure to other growth areas such as India and Latin America. This investment, together with its investment in Spotify, can allow Tencent to have a larger piece of that growing pie.

Organically, this deal also allows TME to tap into the overseas artists that are under UMG. It can facilitate TME’s expansion overseas (whose business is now mainly confined to mainland China. That way, it can compete with players such as Apple Music or TikTok.

Foolish takeaway

Looking at the deal, regardless of the high valuation some might argue, the long-term winner in this transaction is very likely Tencent.

It not only cements Tencent’s leading position in the music industry in China, but also gives it a chance to fight against the heavyweight players in the countries where TME is currently considered a lightweight.