Cloud Music achieved revenue of 7.87 billion yuan in 2023, yoy -13%; comprehensive gross profit margin of 26.7%, yoy+12.3pct; non-IFRS net profit of 820 million yuan (-115 million in '22), reversing year-on-year losses. Revenue was basically the same as Bloomberg's agreed forecast; the consolidated gross margin was slightly higher than the agreed estimate of 0.6 pct; non-IFRS net profit to mother was better than the agreed estimate of 630 million yuan, mainly due to the continued healthy growth of online music and significant optimization of content costs.

Online music revenue has accelerated, and the number of paying users is still growing rapidly, returning to the essence of music content in 24 years. According to financial reports, the company's overall online music revenue in 2012 was $4.4 billion, yoy +18%. MAU steadily increased to 206 million in 23, and the number of paying users increased 15% year over year to 44.12 million, corresponding to a payment rate of 21.4% (yoy+1.2pct), which is the core driver of online music growth. The year 23 includes the return of key copyrights such as Mayday, Soda Green, Li Yuchun, and Legend of the Phoenix, as well as competitive categories such as rap and folk songs. In terms of independent musicians, the number of independent musicians registered on the platform reached 684,000 by the end of '23 (vs. 611,000 at the end of '22), and the company continues to consolidate the original music ecosystem in terms of incentives and sharing, creative tools, and music distribution. Furthermore, the company's in-house studio successfully launched hit songs such as “To the Clouds” and “Jingwei” in '23, and “To the Clouds” appeared on the CCTV Spring Festival Gala stage in '24. In '24, the main Cloud Music app was overhauled. Through subtraction, it re-focused on “discovering good music” to strengthen the two long-term barriers of personalized recommendations and community atmosphere. We expect online music revenue to continue growing at double digits in '24.

The social entertainment strategy focuses on adjustments. Social entertainment achieved revenue of 3.44 billion in 2023, yoy -34%. In '23, the company began focusing on the core music ecosystem and making strategic adjustments in the social entertainment sector, such as reducing the share of live streaming, strengthening internal control, and adjusting gameplay, etc., to focus on long-term profitability. However, the company continues to explore more innovative interactive scenarios based on music (such as “MUS”) to broaden potential monetization paths for social entertainment. Considering that the '24 revision further focused on online music, we expect social entertainment to remain under downward pressure in '24, but the decline will narrow.

Gross margin increased dramatically, and profitability improved significantly. The 2023 composite gross profit margin was 26.7%, of which 2H23 gross profit margin was 28.7% (vs. 2H22 gross profit margin 16.0%). The improvement in gross margin was mainly due to the decline in live streaming reward sharing and the scale effect brought about by the growth of online music. Considering that content costs still have room for optimization, we expect the upward trend in gross margin to continue in '24.

Adjust profit forecasts and maintain buying ratings. Due to the long period of time since the previous forecast, there have been major changes in the company's strategy. Considering the contraction of the social entertainment strategy but continued improvement in profitability, we lowered our 24-25 revenue forecast to 81/90 billion yuan (the original forecast was 129/142 billion), adding a 26-year forecast of 9.9 billion yuan; raised the 24-25 non-IFRS net profit forecast to 94/1.14 billion (the original forecast was 57/79 million), and added a 26-year forecast of 1.36 billion yuan. Refer to comparable audio-visual content and community companies (Tencent Music and Spotify for music; Bilibili, Kuaishou, Netflix, Mango Supermedia; community-based Zhihu) to comprehensively consider single user value, PE, and PS levels. The target price was HK$111, based on 22% room for growth, and the purchase rating was maintained.

Risk warning: the growth of paid users falls short of expectations; risk of changes in third-party licensing; changes in industry policy regulations; risk of impact on emerging forms of internet entertainment.