So you thought that Tencent Music Entertainment (TME), the Spotify (SPOT) of China, going public at $13 a share on the New York Stock exchange would mean the music streaming giant would potentially tyrannize the Western music streaming market.

Relax, it will never happen, China’s personal data laws are analogous to Facebook’s (FB) lax data guidelines multiplied by a factor of 10.

There is no possible scenario in which a Chinese content service constructed at the magnitude of Tencent Music Entertainment Group would ever get the thumbs up from American regulators. 

The ongoing trade war has effectively barred any Chinese capital’s ability to snap up key American technological firms, as well as stymieing any Chinese tech unicorns dishing out streaming content in participating in a monetary relationship with the American consumer.

In August, the Department of the Treasury which chairs the Committee on Foreign Investment in the United States (CFIUS) rolled out an expansionary pilot program widening CFIUS’ jurisdiction to review foreign non-controlling, non-passive investments in companies that produce, design, test, manufacture, fabricate, or develop “critical technologies” within certain industries deemed paramount to national security.

Even though the amendment does not specify China, it means China.

If you had a hunch that Tencent would take over the music streaming world, then the better question is to ask yourself if Tencent Entertainment is equipped to take over the Chinese streaming world and monetize the product efficiently.

What really is (TME)?

(TME) is the Tsar of Chinese music streaming with apps that allow users to stream music, sing karaoke, and watch musicians perform live. (TME) dominates this sphere of Chinese tech with a combined 800 million monthly active users.

(TME) is a concoction of services including QQ Music, Kugou, Kuwo, and karaoke app WeSing making up over 70% of the music streaming industry in China.

Its daily active users (DAUs) spend over 70 minutes per day on the platform and have inked exclusive deals with elite Western artists.

Tencent Music's revenue nearly doubled YOY to $2 billion during the first nine months of 2018, and its net income more than tripled to $394 million.

The social entertainment services aspect has been a massive revenue driver for them including income from virtual gifts on WeSing, a platform where fans gift virtual items to favorite singers, and sign up for premium memberships giving users access to exclusive concerts.

This collection of clever services mixed with social media has been successful, and the reason why it comprises 70% of total revenue.

Paid membership has grown 24% YOY to 9.9 million while paid users only make up 4.4% in China. This is a huge change in the tech climate from the past when Chinese netizens would never pay for internet content. This has allowed the average revenue per user (ARPU) to creep up to $17.22 per paid user.

The other 30% of revenue can be attributed to its ad-less music service which is not ad-less for free users.

So, in fact, the 30% of the business that mirrors Spotify is its Achilles heels echoing the painstaking task of monetizing pure music content.

No company has ever shown that a pure music streaming internet model can be profitable, the music streaming graveyard is littered with the failed attempts of companies from the past.

The unit registered a mere $1.24 in average revenue per paid user during the third quarter, paltry compared to (TME)’s social media products.

(TME)’s combination of social media and music entertainment weighted towards virtual gifts’ income is a weak business model in the west and would not extrapolate in the western world.

It is a supremely China model only unique to China and other Asian countries.

Therefore, I would point out that even if this arm of Tencent could migrate to America, management knows better than to put square pegs in round holes.

That being said, its potential in China is its long runway and most Chinese content companies haven’t been able to crack the western market.

The only types of Chinese companies that have had any remnant of success in the west are hardware companies and look what happened to telecommunication equipment companies Huawei and ZTE recently – taken out by the western regulatory sledgehammer.

It’s crystal clear that the Chinese understanding of personal data and IP regulation simply don’t marry up with western standards, and that is why I suggested that these two massive tech worlds are in for a hard splintering dividing these two competing models.

There has been some intense jawboning going on behind the scenes as Huawei, who is in the lead to develop 5G technology, still needs Qualcomm’s radio access technology to make 5G a reality.

The scenario of a hard fork between western and Chinese 5G becomes more real each passing day.

Part of Tencent Music’s ability to perform revolves around its swanky position installed in the center of the most popular chat app in China called WeChat.

Using this position as a fulcrum, Tencent Music plans to invest 40% of the capital raised from its IPO on expanding its music library, 30% on product development, 15% on marketing, and the last 15% on M&A.

For right now, there is an elevated emphasis on growing the number of paid users and converting its free users to premium subscriptions.

Ironically enough, Spotify has a 9% stake in Tencent Music and Tencent has a 7.5% holding in Spotify. Just by having stakes in each other is enough reason to avoid migrating into the same competitive markets with each other.

If you read between the lines, the stakes seem more a pledge of trading expertise in developing each other’s business as you see traces of each other in both unicorns.

Would I invest in Tencent Music?

One word – No.

There are almost 1,000 pending lawsuits alleging copyright infringement, not a huge surprise here.

Tencent concedes around 20% of the music content is not licensed.

Pouring fuel on the fire, a Tencent Music executive is also being sued by a seed investor claiming he was bullied into selling his stake ahead of its IPO.

There are question marks surrounding this company and that might have been part of the justification of tapping up the American public markets to prepare for this next stage of uncertainty.

As it is, Spotify cannot make money because of the elevated royalty costs eroding its business model, (TME) probably can if it steals most of its music, but that is a suicide mission waiting to happen.

Fortunately, Tencent is a hybrid mix of not only pure music streaming but of social media fused with music apps through gift giving gimmicks and karaoke-themed services.

These higher margin drivers are the reason why Tencent is profitable and Spotify is not, plus the giant scale of servicing 800 million Chinese users that give credence to the freemium model.

However, it’s entirely feasible that Tencent Music could use a good portion of the $1.1 billion from the IPO to battle the slew of pending lawsuits waiting around the corner.

Would you want to invest in a company that went public just to fund their legal defense?

Definitely not.

Look at its streaming cousin iQIYI (IQ), shares peaked over $40 in June after its IPO and have swan-dived ever since going down in a straight line and is trading around $17 today.

In general, most Chinese tech stocks have been collateral damage of a wider trade war pitting the maestros of crude geopolitical strategies against each other.

This year has not been kind to Chinese tech shares, and considering most of Tencent’s music library has been stolen, investors would be crazy to invest in this company.

I am surprised this company held up as well as it did on IPO day because the timing of the IPO couldn’t have been worse in a segment of tech that is awfully difficult to become profitable in a country whose economy is softening by the day in an insanely volatile stock market.

And to be honest, I would have stopped listening about this company after knowing they face pending lawsuits of up to 1000.

As for Spotify, yes, they are the industry leader in music streaming but investors need concrete proof they can become profitable. I like the direction of increasing operating margins, but that all goes to naught if it’s in a perpetual loss-making enterprise. I would sit out on both these stocks with a much negative bias towards its ticking time bomb Chinese music version.

Regulation and the trade war have taken a huge swath of tech off the gravy trade such as semiconductors, Google, social media, hardware, American tech who possess supply chains in China and I would smush in Chinese tech ADR’s on that list too.

Stay away like the plague.