Is it “profit” time for Tencent Music Entertainment (TME)?

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Polen Capital Management, an investment management firm, has released its Q2 2021 Investor Letter “Polen Global Emerging Markets Growth Fund” – a copy of which can be downloaded here. The Polen Global Emerging Markets Composite Growth Portfolio (the “Portfolio”) remained broadly stable during the quarter, returning 0.17% gross of fees. This return is lower than that of the MSCI Emerging Markets Index (the “Index”) by 2.29%. You can take a look at the fund’s top 5 holdings to get an idea of ​​their best bets for 2021.

In Polen Capital Management’s Q2 2021 letter to investors, the fund mentioned Tencent Music Entertainment Group (NYSE:TME) ​​and discussed its position on the company. Tencent Music Entertainment Group is a music company based in Nanshan, Shenzhen, with a market capitalization of $11.6 billion. TME has returned -63.67% year-to-date, while its 12-month returns are down -52.02%. The stock closed at $7.13 per share on October 1, 2021.

Here is what Polen Capital Management has to say about Tencent Music Entertainment Group in its Q2 2021 Investor Letter:

“One position that experienced significant stock price dislocation was Tencent Music, which performed well for most of the quarter, before being overtaken by the highly publicized forced deleveraging of a major shareholder in late March. In just three days, Tencent Music’s stock price plummeted 50%. As far as we can tell, no fundamental news flow was associated with this drop. We believe its sale was driven by the same aggressive selling pressure that caused similar stock price declines of companies such as Baidu, Vipshop, Discovery Communications and Viacom.

Our underlying view of the company’s outlook remains unchanged. With the valuation halved, we viewed this unfundamentally motivated sell-off as an opportunity to buy more of a great asset at an attractive price and, as a result, we added to our position. We were pleased to observe that Tencent Music’s management likely came to a similar conclusion, as they quickly responded with a US$1 billion buyout program.

Tencent Music can be considered the Spotify of China with some differences. The main difference is the dynamics of bargaining power. Tencent Music is the dominant audio streaming platform in China with over 600 million monthly users and around 80% market share in terms of listeners. In the West, three major record labels – Warner Music, Sony Music and Universal Music – control almost all recording artists. In China, the market is much more fragmented with a few large-scale Chinese artist labels, and the share of Warner, Sony and Universal in China remains small. For us, this means that Tencent Music is an essential partner for any record company (or artist) who wants to reach music fans in China. Apparently this is a value chain that promotes Tencent Music in China in a way that we think is materially more attractive than it is for Spotify/Apple Music/Amazon Music businesses in other parts of the world. Tencent Music is very profitable with net margins of around 14% compared to Spotify, which has been loss-making since 2015.”

Based on our calculations, Tencent Music Entertainment Group (NYSE:TME) ​​was unable to land a spot on our list of the 30 most popular stocks among hedge funds. TME was in 35 hedge fund portfolios at the end of the first half of 2021, compared to 63 funds in the previous quarter. Tencent Music Entertainment Group (NYSE:TME) ​​returned -54.56% in the last 3 months.

The reputation of hedge funds as savvy investors has been tarnished over the past decade because their hedged returns could not keep up with the unhedged returns of stock indices. Our research showed that hedge fund small-cap stock selection managed to beat the market by double digits every year between 1999 and 2016, but the margin of outperformance has shrunk in recent years. Nevertheless, we were still able to identify in advance a select group of hedge funds that have outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see details here). We were also able to identify in advance a select group of hedge funds that underperformed the market by 10 percentage points per year between 2006 and 2017. Interestingly, the underperformance margin for these stocks has increased in recent years. Investors who are long in the market and short in these stocks would have returned more than 27% per year between 2015 and 2017. We have been following and sharing the list of these stocks since February 2017 in our quarterly newsletter.

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Disclosure: none. This article originally appeared on Insider Monkey.

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