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Chinese regulatory risk casts a shadow over Tencent Music

Streaming business presses ahead with IPO without key licences

Tencent Music Entertainment Group, China's largest music-streaming company, is planning to an initial public offering   © AP

HONG KONG -- Tencent Music Entertainment, China's largest music streaming company, has filed for an initial public offering in New York despite having no license to operate a substantial part of its core business.

The company, a spinoff of China's social media giant Tencent Holdings, this week set out potential regulatory risks in its filing for the IPO, which is expected to raise at least $1 billion. These risks include the possibility that Chinese regulators could decide the structure behind the operation of its music services in China is unacceptable.

Cayman Islands-registered Tencent Music Entertainment runs three major streaming apps -- QQ Music, Kugou and Kuwo -- and controls roughly 70% of the Chinese online music market based on industry estimates. However, Beijing has imposed heavy restrictions on foreign ownership of companies in sensitive industries such as telecommunications, media, and technology. Music streaming is considered as one of those prohibited areas.

To overcome the barrier, Tencent Music is using a structure called a variable interest entity. A foreign-invested public company using the VIE structure can obtain the relevant license to operate in restricted Chinese industries through local companies which it controls through a series of contracts.

In Tencent's case, it contracts with a company called Guangzhou Kugo which owns 100% of a company called Tencent Music Shenzhen. TMS operates the QQ Music and WeSing platforms, but has not yet applied to obtain the appropriate license for the business, the company said in its filing posted Tuesday on the U.S. Securities and Exchange Commission website. "We cannot assure you that it can successfully obtain these licenses in a timely manner, or at all," the statement reads.

Outside of the mainland, Tencent Holdings also runs music streaming service Joox, which serves Hong Kong, South Africa and Southeast Asia. This business has not been put under Tencent Music Entertainment.

Tencent is not alone in using VIEs. US-listed Chinese internet companies, including Baidu and Alibaba, use them to run their Chinese businesses. Earlier this week it emerged that Jack Ma, chairman of Alibaba Group Holding, was preparing for his retirement next year by surrendering control of the VIEs holding the licenses for China's most valuable company.

However, the manner in which they are used remains a gray area legally, and is unproven in Chinese courts, said a corporate law expert in Hong Kong who preferred to remain anonymous. "A lot of US-listed Chinese companies operate through VIEs. Their reading is that if Beijing did not say it is illegal, then it is legal. However, Chinese regulators do have the ground to go after them," she said.

Tencent Music acknowledged the risks in its filing. "We rely on contractual arrangements with our VIEs and their respective shareholders for a large portion of our business operations," the company said in its statement. "If the PRC government finds that our contractual arrangements do not comply with its restrictions on foreign investment in the value-added telecommunication services ... it would have broad discretion in dealing with such violations or failures."

The group refused to comment further when asked by Nikkei Asian Review.

The prospectus also revealed the extent to which Tencent Music relies on VIEs to operate its business, and it set out the group's recent financial performance for the first time. Tencent Music reported a $230 million profit on revenue of $1.3 billion for the six months ended June 30 the filing stated. "The revenues contributed by our VIEs and their subsidiaries constituted substantially all of our revenues in 2016 and 2017 and the first half of 2018," the company said.

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