2Q26 results: Navigating competition headwinds

2Q26results:Navigating competitionheadwinds Target PriceUS$15.00(Previous TPUS$17.50)Up/Downside72.0%Current PriceUS$8.72 TME reported2Q26results: total revenuegrewby6% YoY to RMB8.93bn, andnon-IFRS net profit was up by 4% YoY to RMB2.69bn, 2% and 6% ahead of VAconsensus estimates respectively,mainlydueto the consolidation of Ximalaya,whichcontributedrevenue of RMB407mn in 2Q26.To cope with competitionheadwindsand reaccelerate revenue growth,the company continued tostrengthencopyright protection, deepen cooperation withtheWeixin ecosystem(e.g. Weixin Video Accounts and Weixin Pay), and expand freemium access.Looking into 3Q26E, weforecast total revenue to increase by 9% YoY toRMB9.18bn. Welowerour FY26-28Eearnings forecastsby 6-9%, mainly toreflect the increased expensesrelatedto Ximalaya’s integration and competitionheadwinds.Wetrimour DCF-derived TP to US$15.0(previous: US$17.5basedon DCF).TME’s current valuation (10x FY26E non-IFRS PE) and attractiveshareholderreturn offer ample protection in our view, while it is pendingfundamentalrecovery. Maintain BUY. China Internet Saiyi HE, CFA(852) 3916 1739hesaiyi@cmbi.com.hk Wentao LU, CFAluwentao@cmbi.com.hk Ye TAO, CFA(852) 3850 5226franktao@cmbi.com.hk Resilient music-related businessgrowth.Music-related servicerevenueincreased by 11%YoY to RMB7.61bnin 2Q26: 1) Membership servicesrevenue grew by 8% YoY to RMB4.79bn (54% of total revenue), mainly dueto the consolidation of Ximalaya and expansion of SVIP program; 2)Revenues from marketing and consumption serviceswereup by 16% YoYto RMB2.81bn (31% of total revenue), fuelled by the robust growth ofrevenue from offline performances, but partially offset by the adbusinessheadwind.Social entertainment and others revenuedeclinedby16% YoYtoRMB1.33bn(15% oftotalrevenue) in 2Q26.For 3Q26E, we forecast totalrevenue to grow by 9% YoY to RMB9.18bn, with revenue from membershipservices/marketing&consumption services up by 9%/20%YoYrespectively. Shuyin GUO(852) 3916 3716guoshuyin@cmbi.com.hk Product innovation to cope with competition.The company continuedto revamp its products to expand user reach and cope with competition. Ithas1) introducedvertical swipe-based discoveryandvideo feeds to drivehigherusertime spent,2)strengthened music content distribution throughWeixin Video Accounts,3)deepenedcooperation withWeixin Pay to drivetraffic toitslightweight apps, such as Bodian Music and Kugou Concept,4)integrated with Weixin XiaoWeito tap into Weixin's user base, and 5)upgraded AI agents to help users createpersonalizedplaylists. Stepping up shareholder return.OverallGPMdropped by 0.2ppt YoY to44.2%in 2Q26,mainly due to the increased costs related to offlineperformances and audio content. Non-IFRS net margin was down by 0.4pptYoY to 30.1% in 2Q26. Lookingaheadin 2H26E,managementexpectedGPM/non-IFRS margin to decline slightly YoY, primarily attributable torevenue mix shift and increased opex. The company acceleratedthepaceof shareholder return,and repurchased a total of 43.5mn ADSs withc.US$400mn cash (c.3% of current market cap) in 2Q26. Source: FactSet Businessforecasts updateand valuation DCF valuation Our target priceofUS$15.0isbased on the DCF valuationmethodology(unchangedWACC of9.6% and terminal growth of3.0%). Risks Intensifying competition;macro headwinds impact ad businessgrowth; increasedinvestment innew initiatives dragsprofitmargin. Disclosures& Disclaimers Analyst CertificationThe research analystwho is primary responsible for the content of this research report, in whole or in part, certifies that with respect to the securities or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personalviews about the subject securities or issuer; and (2)no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific views expressed by that analyst in this report.Besides, the analyst confirms that neither the analyst nor his/her associates (as defined in the code of conduct issued by The Hong Kong Securities and Futures Commission) (1) have dealt in or traded in the stock(s) covered in this research report within 30 calendar days prior to thedate of issue of this report; (2) willdeal in or trade in the stock(s) covered in this research report 3 business days after the date of issue of this report; (3)serve as an officer of any of the HongKong listed companies covered in this report; and (4) have any financialinterests in the Hong Kong listed companies covered in this report. CMBIGM RatingsBUY : Stock with potential return of over 15% over next 12 monthsHOLD: Stock with potential return of +15% to-10% over next 12 monthsSELL: Stock withpotential loss of over 10% over next 12 monthsNOT RATED: Stock is not rated byCMBIGM :Industry expected to outperform the relevant broad market benchmark over next 12 months:Industry expectedto perform in-line with the relevant broad market benchmark over next 12 months:Indus