We downgrade our rating to "Accumulate" and revise our target price upwards to HK$46.06. While maintaining our previous valuation level of 24x PE for 2024, the target price has been adjusted upward due to the increase in forecasted EPS.
TME's operational income for 1H2024 was basically in line with market expectations, and the Company is anticipated to further optimize its net profit margin in the second half of the year. TME's financial report for 2Q2024 shows total revenue of RMB7.16 bn, a YoY decrease of 1.7%. Online music subscription revenue reached RMB3.74 bn, marking a 29.4% increase YoY. The number of online music paying users grew to 117 mn, up 17.7% YoY, with a sequential increase of 3.5 mn. Net profit amounted to RMB1.79 bn, reflecting 33.1% YoY growth, while net profit attributable to equity holders was RMB1.68 bn, up 29.6% YoY. Notably, the gross margin improved from 34.3% in the same period last year to 42.0% in 2Q2024. The Company has consistently optimized and improved its gross and net margins over the past nine quarters. We anticipate that in the second half of 2024, TME will deliver unexpected profitability through effective cost reduction and efficiency enhancements.
We raise our revenue forecasts for subscription and other online music services, while significantly lowering our forecast for social entertainment revenue. Consequently, the better-than-expected performance in music-related revenue is partially offset by the underperformance in social entertainment. For the music business, we revise up our subscription revenue forecasts for 2024-2025 by 4.5% and 4.3%, respectively, and increase our forecasts for other online music services revenue by 11.2% and 10.9% for the same periods. Conversely, we reduce our social entertainment revenue forecasts for 2024-2025 by 7.9% in each year. Based on our revised model, we project total revenue growth of 4.6%, 12.1%, and 11.4% for 2024-2026, respectively. We also significantly raise our gross margin forecasts for 2024-2025 by 4.2 percentage points in each year, reaching 41.6% and 42.5%, respectively, and updated 2026 to 43.2%. Ultimately, we forecast net profit attributable to shareholders to grow by 25.3%, 16.9%, and 13.1% YoY for 2024-2026.
In the short term, TME might face valuation adjustments related to the AIGC industry; however, the increasing Matthew effect in the technology sector and TME's deep penetration into the content industry suggest that its long-term growth and valuation levels remain robust. Online music embodies dual characteristics of the content and internet industries, relying both on music content that users love and the platform's user experience. In terms of content services, TME offers digital album products with unique artist-fan interaction rights, greatly enhancing emotional connections between fans and artists and boosting digital album sales. Through deep user engagement and integration into the industry value chain with artists, TME supports growth in the music industry and the incremental market for digital albums. We believe this model can be likened to Spotify, the leading streaming music platform listed in the U.S. market. Currently, TME holds greater growth potential than Spotify, and therefore, we believe that in the future, TME's valuation will be more on par with Spotify's valuation levels.
