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Podcast #80: Evan Tindell sees value in $TME
Evan Tindell, CIO of Bireme Capital, discusses the value he sees in Tencent Music (TME).
You can find my Twitter thread on TME here, and please follow the podcast on Spotify, iTunes, or most other podcast players, as well as on YouTube if you prefer video! And please be sure to rate / review the podcast if you enjoy it, or subscribe to this Substack (it’s free!) to get all new podcasts and transcripts delivered right to your inbox!
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Transcript begins below.
Andrew Walker: All right. Hello and welcome to Yet Another Value podcast. I'm your host, Andrew Walker. With me today, I'm excited to have Evan Tindell. Evan is the CIO of Bir...
Evan Tindell: Bireme.
Andrew You told me before and I forgot it. Bireme Capital. Evan, how's it going?
Evan: I'm doing well. How are you?
Andrew Hey, I'm doing great. Thanks so much for coming on. We decided to have you on. Let me start this podcast the way I do every podcast. First, a quick disclaimer. Nothing on here is investing advice. Do you really want to take investing advice from a guy who can't even pronounce his guest's firm name? But just remember, nothing is investment advice.
Then, second, a pitch for you, my guest. I think you're easily one of Finchwit's[?] top 100 former poker players turned professional investors. But we've swapped notes and thoughts over the year. I find you to be a really thoughtful guy. You bring that poker player, hey, I'm looking for an edge, I'm looking to think rationally, I'm looking to think logically, I think to markets. I think that's going to shine through in this podcast. Excited for a discussion.
That out of the way, let's turn to the stock that we're going to talk about.
Andrew It's a little bit of a different stock than I think you've generally looked for. But there are all the makings of what you look for here. The stock is Tencent Music. The ticker is TME, and I'll just flip it over to you. Why are we so interested in TME?
Evan: Sure. This is actually the first time I've ever gone long on a stock with the business in China. We didn't talk about this before but I spent a whole year pretty much spending most of my time figuring out which of the Chinese reverse mergers do shorts.
Andrew Which did you end up shorting?
Evan: So many. Yes, so many. [inaudible]
Andrew Let me sidetrack this for a second and ask questions.
Andrew Chinese reverse mergers, a lot of people made a lot of money on them. I don't use that word lightly, a lot of these were just out-and-out frauds, right? But a lot of people made a lot of money on it. I look back on that and I wonder, if that happens in today's market, how many professional investors would have gotten carried out in a body bag because I think of the meme trading, especially in January and February, and I think of these Chinese reverse merger stocks, as soon as the short interest went up, I feel like you would have seen retail traders just trying to send shorts in a body bag and you even saw this with Tala Education and a couple of other things that got squeezed in 2020.
All of them ended up being pretty much... I won't use that word there but they were very shady. People got carried out in body bags because people were just gamma squeezing into the moon. Have you thought about that?
Evan: Yeah. Muddy Waters is the research firm focused mostly on shorting. Originally, it was just Chinese stocks. Now, they do a little more stuff in Europe, although it's still kind of Asia-focused. They were putting out a lot of the research back in the day that kind of is showing how fraudulent some of the companies were. We followed them and a lot of their research is what got us interested in the space.
The perfect example is they're short of GSX. If you pull up a chart, I mean, it went from... I actually talked about this in some of our letters. Well, it's the tickers go-to now.
Evan: I think they started calling it a fraud in the summer of 2020-ish.
Evan: It went from 30 to 130. My firm, we short things and we put on 2% positions. You end up having to cut your losses at some point because it gets too large and you just can't be having 8% short positions in one stock. At least that's not how I operate.
Evan: Yeah, you can get crushed, for sure.
Evan: But who knows? I mean, it's a perfect example of exactly the craziness that can go on in today's market. Things that didn't quite happen like that back in 2012.
Andrew Yeah. No, I agree with you. It's just something that I've been percolating as I think through shorts because I very rarely am short anymore. This is one of the reasons. The go-to example you gave is perfect. I remember, I bought some puts on it and some of them paid off, some didn't, but I remember just seeing that this is an obvious fraud and it's tripled on me. I don't see why I'm even playing the fraud game at this point. Anyway, let's go back to TME.
Evan: Sure. I always had a little bit of a distaste for anything related to China because of my experience with the Chinese reverse mergers. I'm sort of mostly a guy that focuses on statistically cheap stocks. I like to fish in ponds where the whole pond is likely to outperform over time, with the primary example of that being statistically cheap stocks, although just buying statistically cheap stocks, obviously, has done terribly over the past ten years. But that's kind of how I think.
Being invested in Chinese stocks historically, it's kind of been the opposite of that. It's just fishing in a pond where there are land mines and fraud. I never touched it from the long side. But with the sell-off in all of these names in 2021, I started thinking maybe it's time. Maybe it's time to take a deeper dive into some of these companies. I started looking at some of the ones that were down the most and that were the most interesting to me in terms of the business models.
I was familiar with Tencent Music because we've owned Bollore for a long time. Their largest asset these days is a stake in UMG, which they got spun off from Vivendi, which I know you're well aware of that story. We can get into the reason why Tencent is so advantaged but I was just aware of Tencent Music because of that relationship and I think they net own like 2% of UMG actually, Tencent Music...
Andrew I think that's right. They own a little bit of Spotify. Spotify and Tencent Music did a little share spot which, for a while, when Tencent Music was a rocket ship and Spotify was flat, Spotify would always be like, "This is why we're not buying back our stock. Look at the investments we made in Tencent Music." Now, Tencent Music's down and Spotify's up and they're buying that stock. It's kind of funny.
Evan: It's funny you mentioned that because if we talk about margins, I think Tencent Music should be able to do at least as well as Spotify over the long term. I was reading a letter from a Spotify Bowl, who's made a ton of money on Spotify. In one of his letters in 2019, he wrote, "And with our Spotify investment, we get a 9..." I think it was at the time 9%. I forget what percentage it was. Yeah, it was a 9% position in Tencent Music, which is worth $2 billion today and we think it's going to be worth a lot more. Fast forward to now and Tencent Music is down 50% despite the business hadn't grown.
That's actually why I think it's so interesting. When it first started trading, March of 2019, it was worth almost $20 per share. Today, it's trading at 8 something. Actually, yesterday, it was training at 8. Today, it's like 8.70. I'm going to give you all the credit therein bumping up... Actually, no. The credit's to me because people knew that I was going to talk about the stock. Then they got interested in buying.
Andrew Yeah. I want none of that credit. I never try to pump stocks. I've never done [inaudible]. So you take all the...
You actually touched on just about every point I wanted to touch on this podcast, but I want to dive deeper. Let me start with the first question. I was aware of Tencent Music because I follow Spotify very closely. It's one of my favorite companies to think about. I always debate how big my position should be there and stuff because I just think that the company is a pillar, they [inaudible] is cool, and everything. I was aware of Tencent Music because of that.
My first thought was, oh, Tencent Music, Spotify of China, easy, done, that's how I mentally model. When I was prepping for this podcast, I was really surprised. They have social revenue out of the Wazoo, karaoke app, they've got lots of... in China, the little gifting and many transactions are very popular. They make tons of money on that, which was very surprising for me, much different than Spotify. If I just said to you, "Hey, Evan, Tencent, Spotify of China," How would you respond that the business is different and similar and everything?
Evan: Okay. Well, the first thing is, Tencent is a different company. This is Tencent Music.
Andrew Sorry, I meant Tencent Music. Yes. That is a very [inaudible].
Evan: Well, yes. They have two businesses. Today, 70% of the revenue comes from essentially virtual gifting in the online streaming and karaoke business. That business has grown a lot over the years. It's a $3 billion US revenue business and it's a pretty substantial margin business. It's probably like high teens or 20% EBITDA margin. They have to pay the creators a decent cut. But at the end of the day, it's a pretty good business.
However, it's in increasing competition from Douyin, which is the TikTok, which is a bite dancers TikTok-like app in China. As well as Kuaishou. I'm sure I'm pronouncing that wrong but just like a bunch of other streaming platforms now in China that have those two, both have 400, 500, 600 million MAUs in China and are sort of putting some competitive pressure on the social entertainment business.
That business is not like Spotify at all. It's more like Twitch. I mean, it's more like TikTok live, if you ever watch... I don't know if you use TikTok.
Andrew I can get very addicted to the phone apps so I generally try not to install any of them on my phone.
Evan: Right. Yeah, it's interesting. I watch a little bit of TikTok. I mean, I look at TikTok a lot. A couple of TikTok live... people I look at. Yeah, they're getting gifts all the time. Rocket ships are flying across the screen, which is like a certain amount of TikTok tokens. TikTok is a big competitor for them.
But what's interesting about TME is it is actually the Spotify-like business. I think that that business alone probably supports the market, the whole enterprise value of the company, which is like on the order of $9 billion US today after you know where the stock is, and that's netting out the cash. This business today is 600 million users, which is basically flat because it's such a high percentage of just the internet market in China, right?
Evan: The reason why no one paid is that, historically... I mean, go back ten years... China is a few years behind us in terms of willingness to pay for music.
You go back ten years and people didn't believe that people would pay for access to music. You could stream anything for free basically. On Spotify, if you're on the free version, there's a lot of ads. You can't just like an unlimited skip.
It's basically all these things where they're trying to get you to pay. But TME's app, QQ Music, and the other ones didn't have these features. Basically, the only reason why you had to pay was if you wanted to download all your music. That was what you had to pay for. The number of paying users was 3% or 4%.
But in Q1 of 2019, they started putting some songs behind a paywall, so they're premium only. Right now, that's at 25% or 30% of listening hours of music that is premium behind a paywall. I mean, they saw the number of subscribers Apple Music has. They're like, "Oh, this whole thing is behind a paywall. We can just do this and people will pay for it."
Andrew I saw the thing where they put music behind a paywall to try to get people signed up for premium. I was just curious. I don't know. How did they decide what music to put behind a paywall? Do they have data that says it? Does it have to be Tencent-owned music?
Evan: That's actually a great question. I have no idea.
Andrew Okay, no worries.
Evan: Yeah. I have no idea how they decide what goes behind a paywall. But regardless, it's driven by the number of paid users from 3% of the user base to over 10% of the user base.
Andrew Within 3 years, right?
Evan: Yeah. I'm looking at numbers. In Q1 2019 and Q4 2018, it was 24 million paid users. Today, it's 71 million paid users. Literally, every quarter they're adding 5 million paid users like clockwork, every quarter. I mean, first, they have a weird calendar thing where it looks like it falls in Q4. But on average, they're just adding 5 million paid users every quarter, and the subscription revenue there has gone from like 400 million to a billion.
I mean, I don't see why as an increase, the friction and what's behind the paywall, I don't see why that doesn't go up to 30%, 40%, 50% over time like to up where Spotify is. I mean, yes, it's in China versus Western Europe mostly, so the price per subscription is going to be lower. But right now, the average price is 9 RMB. It's like you're talking about $1.50. It's basically on a GDP-adjusted basis. I think it's cheaper than a Spotify subscription for the average Chinese consumer. I don't see why the paying ratio won't be comparable to Spotify's overtime.
If that happens, you're talking about a $4 or $5 billion subscription business in a $9 billion enterprise value right now, saying nothing about the social entertainment business, which will continue to throw off cash. I just don't see how that can be the right price if they end up getting there.
The frequency, just the consistency of the growth in paying users in the online music business. If you just look at a chart, it's just really impressive and I just don't see how that can be the right price if they grow to that size. Meanwhile, the social entertainment business is going to continue throwing off hundreds of millions of dollars in profits in the meantime.
Andrew Perfect. Good.
Evan: One other thing. Besides this clear arc of growth with the paying ratio that's just going up and up and up every quarter, they have some interesting advantages over Spotify in terms of the structure of the Chinese market.
One interesting thing about Universal Music is the labels have a lot of power over Spotify because 70% or whatever of listening hours are of the label's contents. Spotify, in a lot of countries, in the US and Western Europe, they have some pretty formidable competitors with YouTube Music, Apple Music, Amazon Music.
The labels can pretty credibly say... I mean, they're not really going to cut off Spotify but they can say to Spotify, "You have to have our contents and we can go to Apple Music if you were to die tomorrow, that would suck for a bit. But if you were to die tomorrow, we can go to Apple Music." It's legitimate, it's a threat that will probably never be realized but it's legitimate enough that they get a pretty big chunk of Spotify's revenue. Whereas in China, Tencent Music has 70% or 80% of the paid users. The top five label's content according to the annual report is 20% of listening hours in China.
Andrew If it's only 20%, who is the rest? Because as you said, those stats are pretty much flipped elsewhere. Is the rest just unlicensed content where people are going and...
Evan: I'm actually not sure. I think it's a lot of smaller Asia-focused labels. Some of it is probably unlicensed. I mean, I know that Tencent Music has its own kind of 'we'll be your label thing', I believe.
Andrew They do. Yeah. They push that really hard in their earnings calls.
Evan: Yeah, so they have that over there. Interestingly, that actually can get us into some of the regulatory stuff. Originally, Tencent Music was the sole exclusive master licensor for all the labels content in China. Actually, that relationship got dismantled by the government during the recent crackdown, which is kind of interesting. My interpretation of what was going on there was the labels basically saying, "We don't necessarily want to have to sue people in China. Let's just let Tencent worry about... We'll license to Tencent, they'll pay extra because they're going to license it back out. If some app pops up and is using pirated content, we'll let Tencent sue them because they're going to be able to navigate the legal system better than we are." That's my interpretation of what was going on there.
Andrew We talked about a lot of things and I'm going to circle back to a lot of it.
Andrew One thing I thought was interesting, you mentioned Tencent has their own label. Spotify has been very careful not to encroach into labels for a lot of the reasons you mentioned. Spotify might have a third of the US market, but that's only a third. Tencent's got 80%. In the US, Spotify is a third and the label's control is 80% of music listening or something, right? In China, Tencent Music has 80% and the labels only control 20%. When you get that big difference, Spotify can't have a label because if they did the labels, it would go ballistic. Tencent can and I just thought that was one really interesting thing that shows how power dynamics can flip where if you control enough of the market, you can go and just disintermediate their suppliers. Whereas, if you don't control enough... That was one thing that was interesting to me. I just wanted to harp on for one second. But let me back up and I'm going to ask lots of questions on everything you just covered in there.
Andrew The first thing I just want to start with... We've alluded to it a couple of times. Tencent Music stock is down a lot, 50, 60%. A big part of that is from the Chinese... I'll just call it the Chinese crackdown... the CCP crackdown. They've made noise about eliminating the VIE structure, which we're probably going to talk about in a bit. They pulled the Ant Financial IPO, Jack ma, is he here? Is he not? All this crazy stuff is happening over China.
I just want to zoom out for a second. We can talk about all those risks but why did you choose TME as your choice? I mean, we talked about a little bit of Spotify, but Alibaba, Charlie Munger backs it. That is a great business that's available at a price that makes no sense if you look at the growth rates and stuff. That Tencent, which controls Tencent Music, has some great game business. They're historically very good investors if you look at the game. Just why was TME your pick here?
Evan: Yes, for a few reasons. One is, I think it's probably easier to talk about relative to Alibaba.
Evan: First of all, it's actually down, but significantly more. If you look back to early 2019, I think Alibaba was actually up 20% and Tencent Music is down 40%. If you just look sort of purely on what's down more and what could go up 3, 4 times, it's a lot easier to see how TME can go up... can be a 4, 5, 6 bagger. You don't have to think, you don't have to...
Andrew Stretch the numbers too harder.
Evan: ...stretch the numbers too much just to see how they could go up that much. The other thing that I think is interesting is, relative to a lot of operators in China, I actually trust Tencent as a controlling shareholder.
Evan: I don't think I trust Jack Ma.
Andrew Can I pause here?
Andrew You trust Tencent as a controlling shareholder and I just want to know what's the difference. We're talking about TME Tencent Music?
Andrew Tencent is a different company, maybe one of the biggest companies in the world. They are the controlling shareholder of TME. When you say you trust Tencent, you mean you trust them as a controlling shareholder of TME?
Evan: Right. I trust Tencent Inc. the original parent company of Tencent Music more than I trust the board of Alibaba.
Andrew I think that's fair. If you look at Alibaba's history, I mean, they stole Ant Financial from Alibaba. Yeah, I think that's a hundred...
Evan: Completely. I remember looking at Yahoo! over the years when the vast majority of its value was in Alibaba. I just never got comfortable with partnering with Jack Ma implicitly.
The other thing that I think is really interesting about having Tencent as your controlling shareholder is Tencent Inc. I think it's called Tencent Inc. or whatever. Tencent Hold Co. owns a hundred billion or more of minority investments in publicly traded companies across Hong Kong, the US, ADRs, VIEs. Their investment in Tencent Music right now is a 5 billion market cap or something.
The idea that they would try something shady at Tencent Music... First of all, it's kind of out of character with the way they've operated their business for a long period. For example, Tencent itself has paid a dividend for a really long time. They weren't one of these companies that immediately came to the US, Tencent, to try to arbitrage the idiocy that US investors were allowing with some of these Chinese reverse mergers. They were always listed in Hong Kong, which had sort of tighter controls historically.
But they own a hundred billion dollars worth of minority investments. The last thing they want to do is give anyone ideas about how to screw over VIE minorities. There's just no chance that they're going to start giving anyone ideas about how to be a poor steward as the majority shareholder. They just have too much riding on it in my opinion.
Andrew That is an interesting thought. I do agree with you on the point that Tencent, historically, has treated minority shareholders. I think they've treated them pretty well, to be honest with you, versus especially if you compare them to Alibaba or just a lot of other companies for minority shareholders. I don't disagree with you that I don't think they're going to start pulling stuff on TME, which is a rounding error to them, but I always come back to... Are you familiar with Brookfield Management?
Evan: Yeah, BM.
Andrew BM, I've invested in some of their minority subs and every time I do, I just remember one of my friends when I was looking, he was like, "Look, BM is a take under artist. If you go invest in something that they've got a control or semi-controlled stake, when things get rocky, they're going to tank the share price and then they're going to buy out the whole thing, and 3 years later, they're going to IPO it for 5 times what they paid, and you're going to look there and you're going to have said, 'oh, but BAM's controlling shareholder. They've got a reputation to protect. They're going to be fine,' and they're going to murder you on it and you're going to be sad."
Andrew Every time he's actually proven correct and I don't think Tencent's like that but I'm just saying that always comes to my head when somebody says they're not going to screw the minorities.
Evan: Yeah, I mean, but I think it's a little bit to me Brookfield I think tends to be the controlling operator of most of their stuff. Even their listed stuff, they usually have control over it. Most of Tencent's investment, they don't have control over.
Andrew They do have control over this one though, right?
Evan: No, they do have control in this one. I'm just saying there are other people that have control over 90% or whatever, 70%, 80%, 90% of their investment portfolio and they're in the minority position in the vast majority of those investments.
Andrew Got you.
Evan: I think that is likely. I mean, granted, they could just try to steal Tencent Music and just figure, hey, we're going to do this to our minorities but probably no one would know, that doesn't mean that someone else is going to do it to us. But I just feel like that will put them in a dip. I just feel like they have a different mindset to that like they're not structuring everything as they want to be in control [crosstalk].
Andrew I misunderstood for some that make total sense, especially because a lot of times they'll do a startup business and then they'll merge it with the competitor business, and as you said, they won't take full control. They probably don't want people starting to think, hey, if you control this thing, screw your minority shareholders up because as you're saying, in a lot of cases, their end game is a minority stake in a combined business.
Evan: Right, and they have $100 billion on the line with trusting those sort of relationships and almost in most of those involved VIEs also.
Evan: I think that that gives me some comfort besides and the other thing that's interesting is Tencent itself, the company is not a controlled entity.
Evan: Pony Ma owns 8% of the shares, Naspers owns 30% but I think there's some type of non-voting agreement with their shares. I forgot. But regardless, it's not a controlled entity where there's one person that can just say, hey, I'm going to do this to benefit myself. If Pony Ma has said, hey, we're going to steal Tencent Music, okay, 8% of that value accrues to him. Do you know what I mean? 8% of whatever they steal accrues to him, and I just don't see the incentives being there. Then there's some Tencent Music employees are going to own more Tencent Music stock than they own Tencent. I just don't see the incentives with being there for them to not sort of treat the minorities well.
Andrew That's perfect. Let me ask a related question. This is just a general China question, the VIE question.
Andrew All Chinese stocks that are traded in the US domestically, as I call it, their structure as a VIE because China says, hey, if you're an external investor, basically you can't own stock in Chinese companies, right?
Andrew All these do these complicated VIEs structures, every Chinese listed stock in the US with, I don't think with any exceptions is a VIE structure, and that's always terrifying, right? Because as many short sellers have pointed out, one day China decides, there were some rumors over the summer that China was going to side with VIE structure was illegal and basically, every share you own, every China stock would go to zero or one day, a company decides they don't want to honor the VIE and they can basically zero the shares out. I just wanted to ask on the VIE structure, how are you looking at that risk?
Evan: Yes, so I think with regards to the company sort of trying to use the VIE structure to let them steal it, I think my comments about Tencent would apply there as well because everything they own, the majority of what they own is VIE anyway.
Andrew That's perfect. So let's just talk to general VIE [crosstalk]. Yeah.
Evan: My thoughts about what the government is likely to do, first of all, I don't think that the incentives are really there for the government to do away with the VIE structure in a way that zeroes out existing shareholders. I know there was talk about changes to the VIE rules and making them stricter and to not letting VIE companies IPO in the US and whatnot. I don't know that it follows that the changes would have zeroed out shareholders.
I believe, my opinion is that, if there are ever any changes to the VIE structure, it will be from the standpoint of, yes, let's rip up these VIE structures and let's provide a bridge to just changing it into normal ownership. Because, after all, these rules about foreign ownership aren't mattering anyway. No one cares if it's not negatively affecting the ability of the Chinese government to regulate these companies, they're regulating the shit out of them. It doesn't matter that X percent of Tencent Music is owned by US investors clearly, that doesn't affect their ability to regulate these companies.
Andrew Yeah, I don't disagree. I always did wonder if, at some point, if the trade war between US and China had gotten bad, right? If China would have just said, hey, all VIEs are completely illegal and there's no going back from this. All VIEs are instantly canceled and international investors, screw you. I've always wondered if that was a risk?
Evan: The other interesting thing is, the VIEs have been actually accepted by the Hong Kong Stock Exchange for a long time. If you're an investor in mainland China like you've been able to invest in those companies via the Shanghai-Hong Kong stock connect for a while, for years.
Evan: There's a ton of money of the mainland Chinese people invested in VIE structures via Hong Kong that I don't really think the CCP has an incentive to just transfer to the already billionaire owners because that's essentially what you're talking about in most of these cases.
Evan: VIE contracts are ripped up like Pony Ma and other 4 guys who are the VIE owners would just be splitting some insanely huge windfall. Politically, I don't really know if that's actually the best thing. It's interesting because it kind of flies in the face of the thesis that a lot of people have with regards to the regulations where they say, well, they're just trying to tear down the rich billionaires in China and make them less powerful, like Jack Ma or whatever. But, I mean, ripping up the VIE structures will make them more wealthy.
Andrew Again, I think you're right though. You could always rip up the VIE structure and then the Chinese government comes to you and says, nice little business you've got there, be a shame if we shut it down unless you give us all of those VIE proceeds or something. You could always run into that, but I do agree with you. I do.
Evan: The other thing besides just acceptance by the Hong Kong Stock Exchange, the other thing is, if you look at the regulations that the Hong Kong Stock Exchange has on VIE is one of the things they require, they like a long list of requirements with how the contracts have to be done. One of the things they require is a plan for when the VIE contracts are no longer needed. The reason that they have that is because that the number of industries that the Chinese government regulates with respect to foreign ownership, has been shrinking over time. In 2017, one count of the size of the negative list was 63 different Industries. Today, it's 33. Actually, if you look at the Chinese government PR releases, for the 2020 rules, they were like China liberalizes foreign ownership again, they're like promoting it as a positive thing that they're doing.
Evan: They removed the rules against foreign ownership of investment firms and insurance firms. I believe, you can just go in and buy an investment firm in China and it's completely kosher. I think, one day we're going to wake up and the Chinese government's going to say, yeah, the VIEs are, the ban on foreign ownership in this industry just no longer applies. They've already done that to tons of industries.
Andrew That's interesting because, at the height of the Chinese pessimism, I did hear from a couple of friends who are kind of China experts, they were like, hey, the market's freaking out but they might be giving you this wrong, it's not that China is trying to tear up the VIEs there, they actually might be trying to liberalize. Again, I don't know, but that is consistent with what my friend presented. [crosstalk]
Evan: One other quick comment.
Evan: The other interesting thing is that there is actually at least one VIE that trades on a mainland China Stock Exchange. I don't know if you've heard of the company Ninebots, but they actually are the owner of the Segway brand in the US and they also have a similar electric scooter-like business that's not Segway. But they IPO'ed, I think in late 2020 or maybe as early as 2021 on the Shanghai Stock Exchange, and they operate VIEs. VIEs historically have never been allowed in China, but this is the first one. I feel like, my guess is that that was not done lightly and that it's just another move towards sort of liberalizing that structure.
Andrew Perfect. Let me ask you a little bit about the history of this business. This business, Tencent Music, was originally part of Tencent. I believe they merged it with a competitor, kind of spun it off, all that type of stuff.
Andrew You mentioned they were 4 times bigger than their competitor. I believe, for a while, Alibaba had a music streaming competitor and Alibaba ended up shutting that music streaming competitor down, which kind of left the field open for Tencent Music.
Andrew I just wanted to go through a little bit of the history in how they came to be so much bigger and so dominant because I do think it's a little bit instructive. I believe they launched the paywall service about a year after Alibaba shut down their music streaming. Clearly they were looking at the competitive landscape before they put the paywall on.
Evan: Yeah, I think they launched the paywall in Q1 of 2019. But yeah, I mean, they actually got, they bought, I forget the name of the other competitor that they merged, QQ Music. I think it's CMC Music or something, or it's [crosstalk].
Andrew It sounds about right. Yeah.
Evan: China Music Corporation, CMC. But, yeah, I mean, through acquisitions, they came to own all of this. They have one app that is dominant.
Evan: They have 3 of the top 4 online music apps, QQ, I think it's Cogoo, and Cool Music. Actually, the regulator gave them a slap on the wrist fine for the acquisition of, I think, of the other competitor that was, I think what the regular has said was that they should have like filed it with the competitions or whatever. But they didn't and got fined a couple of million dollars or something.
Andrew Could you imagine in the US if Spotify and Apple Music merged, didn't notify regulators. Then a couple of months later, the US Regulators like, hey, that's going to be $2 million, Mr. Apple and Mr. Daniel Ek at Spotify. You should have let someone know.
Evan: Yeah, I mean obviously, they don't care about a couple of million dollars. It's a little bit ridiculous. They're just trying to make a point.
Evan: I'm sure Tencent probably was like, well, you guys didn't even care about this type of thing so we didn't even know we were supposed to notify you. I don't know if we have that. I don't know what that decision was like back in the day. But yeah, it's pretty clear that they have a, it's not quite a monopoly. I mean, NetEase Cloud Music has been growing and cutting into their subscribers a little bit like the MAUs. But yeah, it's a pretty dominant market position that I don't think would be allowed in Western Europe or the US.
Andrew Yeah. Balance sheet here, right? The company, I tweeted this out, I'll put my links to the tweets and the show notes and everything, all my tweets, which we've covered almost all the questions at this point. But one of the things that jump out to me is the balance sheet. It's basically $3 billion of cash on their balance sheet, plus there's a Spotify investment as well and maybe 1 or 2 other investments buried in here versus the total liabilities for the company. Not the debt, the total liabilities which includes accounts payable we pay our employees is less than $2.5 billion, right? This is a massive cash balance sheet.
Andrew They're starting to address that with share buyback. I think they had $200 million in Q3, which is reasonably aggressive for a company of this size.
Evan: Yeah, I mean ,they have like a one-billion-dollar authorization, which is a little less than 10% in the market production.
Andrew Which is great, especially at this price, it's nice to see a company down 60% buying back shares. But the balance sheet is still, it's not crazy out of line with Chinese companies. But when you see a company with this much cash on the balance sheet, your first thought is what the heck is going on? How do you look at the balance sheet? How do you look at what they're going to do with shareholder returns with the price this low?
Evan: Yeah. I mean, I think they bought 13 million shares in Q1 and 25 million shares in Q2, or maybe that was Q2 and Q3. I forgot.
Evan: Yeah, I think that was Q2 and Q3. They're putting some capital to work there. I mean, the problem is, when you have $3 or 4 billion dollars of cash, you kind of need to do or you kind of can do more than $250 million of buybacks per quarter. I mean, it's just weird when the cash balance is such a large percentage of the market cap.
Evan: I mean, if it was me, I would love to see them just do a tender for 10% for $1 billion or $2 billion. Of course, companies never do that. I mean, I don't know why I would expect them to.
Andrew Can I just jump in here? I just want to explain, for listeners it's weird for a company to have this much cash on the balance sheet. But I think one of the things that would stick in both Evan and I's head because we've got familiarity with Chinese companies is, one of the old things with Chinese companies when there was a lot of reverse merger fraud going on was, they'd have massive cash balances. Either the cash balance didn't exist or the reason they had massive cash balance is they were raising lots of cash from investors on their fake business numbers and everything. They were just raising cash, raising cash, raising cash, and then eventually, they take the cash or they'd say, oh, we're a fraud and people try to go recover and it was inside of China so external investors couldn't get access. I just want to drive home, when I said, yes, it is inefficient for them to have this much cash. But I think lingering in the back of my mind and probably the back of your mind too, is that risk in that thought process just drive that.
Evan: Yes, certainly. I mean, you've seen a lot of the Chinese, especially the Chinese reverse mergers back in the day, the cash just weren't there, right?
Evan: I mean, the business wasn't there either. I mean, that also happens with Wirecard in Germany. But that's actually one thing I like about the way they're handling it. Okay, the buyback isn't quite as big as I'd like, it obviously could be bigger. But, at the end of the day, I mean, most of the frauds over the years, where there was fake cash, they have not instituted substantial buybacks.
Evan: Mostly, they just would make a big stink about how the fraud allegations were unfounded, and then they would slink off into the night.
Andrew Then 6 months later, nobody could find the CEO anywhere.
Andrew You said it's not a big buyback, but just to maybe push back on your point a little, I mean, as we speak it's under $9 per share. This is an under $15 billion market cap, and I think they bought back $350 or $400 million in shares so far this year, which Tencent's not selling and Tencent owns about 10% or 15% of the stock or something. $400 million on a $15 billion market cap, even smaller free float, it's not the biggest buyback we've ever seen but it's certainly not small and by Chinese standards, it's pretty impressive.
Evan: Yeah. I mean, that's a good point. It's actually one of the things that makes me a little more comfortable with how they're operating things and the confidence that we're going to be treated well as minority shareholders are when you see, okay, the stock is down 60%, what are they doing? Okay, they announced a $1 billion buyback at pretty low prices, then you say, okay. Two quarters later, what have they done? Okay, they've done 300 million or 400 million of it, let's go, it looks like this is a real thing. It's not all, it's not just smoke and mirrors. Yeah, they could do more, but it definitely makes me feel good to have at least something substantial going on in that department.
Andrew Let's talk valuation because I think we've done a couple of shorthands for valuation, right?
Andrew Earlier you said, hey, this was at 20 a couple of years ago, and now, it's at 8, the stocks been hammered. You said, hey, I think the Spotify-like business alone could be worth the entire market cap, which would imply you're getting the karaoke business, which might not be the fastest-growing business or sorry, I say karaoke, the social business might not be the fastest-growing business, might be losing a share to TikTok. But guess what? Social businesses with that many users and that much revenue spit off an insane amount of cash. There's a lot of value there.
Andrew Let's just try to quantify it.
Andrew How do you look at the valuation for Tencent Music right now?
Evan: I think it trades at roughly high teens, multiple of EBITDA right now. Obviously, the 2 questions are, where's EBITDA going? Where are profits going?
Andrew Always a good question.
Evan: Always a good question. Where are profits going? Okay, let's see. Boomer has it 24 times PE right now.
Evan: I mean, I think even if the subscription business or sorry, even if the social entertainment business is flats and then it declined a little bit in the most recent quarter, even if that business is flat, I think the growth of the online music business probably goes from, I'm just looking at this in my notes, RMB 5.6 billion to I have it at RMB 40 billion in 2027, which is a combination of paying user growth, a little bit of [inaudible]growth, and the question then becomes what type of margins is that going to generate? I mean, historically, the social entertainment business did a high teens, the overall business did a high teens EBITDA margin. There's a little more competition these days in the social entertainment business.
They increase the payouts to some of their creators on that end to try to retain them competitively. The online music business because it's so small, is actually not profitable right now. That's been also a little bit of drag on margins as they're been a little bit of a mix shift. There's also a separate story about how they're investing in long-form audio.
Evan: They have 140 million...
Andrew Longform audio is podcasting. I guess, maybe audiobooks [crosstalk] podcasting just so people can understand.
Evan: Yeah, podcasting and audiobooks. They have 140 million users of that business with 5 million paying users already. Actually, they bought a company for $500 million last earlier in the year. They're investing in that. All these things have been a little bit of a drag on the margins in the short term. The real question in my mind is, what is the margin of the subscription business going to be in the long term?
Evan: I think given the dominance that they have in China in terms of their control of the market, as well as the lower share that the labels have in China, I don't see how they don't do substantially higher margins than Spotify over time in that business just because of the change in negotiating leverage with the labels. Therefore, I mean, I don't see how it's less than a mid-teens EBITDA margin business once those revenues go from $1 billion US to $4 or $5 billion. That basically means, so if they end up doing $5 billion of revenue in the subscription business and 20% EBITDA margins, that's a billion of EBITDA right there for an enterprise value of less than $10 billion today.
When you combine that with whatever they're doing in the social business these days, 700 or 800 million, which gets knocked down in the consolidated level because of the unprofitability of the other stuff, you're basically going to have $1.5 to $2 billion EBITDA business in the long term, in my view, with really good economics and sort of stranglehold on their core market and tons of good reasons why that should generate a pretty substantial multiple, I think.
I think you end up with something that is in the range of, I think, if it's 10 times EBITDA, then that's 15 billion to 20 billion of enterprise value, which would mean the stock would need to go with double or triple to get there. But it could be more, right? Because, if you look at where Spotify trades, it's a 45, I think billion-dollar market cap or enterprise value right now roughly, is that right?
Andrew Spotify? I think it's a little over 50 right now.
Evan: Is it a little or 50? Okay. Yeah, so it's 50 billion. I mean, I feel like investors there are probably thinking of, I mean, you're a Spotify investor so tell me what if I'm wrong but 2 billion to 3 billion of EBITDA with a 20 times multiple in the longer term.
Andrew It's tough because these are online businesses. The three most interesting tech companies to me right now, US tech companies, are Peloton, Twitter, and Spotify. All of them are just, I think they've got huge potential. Let's just focus on Spotify. Sorry. I shouldn't have even mentioned it.
Evan: Yeah, that's fine.
Andrew For Spotify, I just look at it and I say, all right, they've got over 200 million monthly active users, right? How many businesses in the world have over 200 million monthly active users of whom over 100 million them, they have credit card data, people listen to them for multiple hours on end, all of this type of stuff. How many businesses like that are there out there and how many businesses are there that are less...
Evan: Tencent Music is one of them.
Andrew Yeah, so Tencent, we're going to talk about the [crosstalk].
Evan: Yeah. No, go ahead.
Andrew But for Spotify just think about all the optionality they have, which I've mentioned a thousand times but as they're moving into podcasting to get podcast advertising, to get owners' economics on the podcast, and where I was going with Peloton and Twitter saying, I just think there's this massive right tail because they have so many users. They are by far the best product and the thing that they are playing with Twitter is a little bit weird in that, but they've got so many users. For Spotify, they play a little bit on hard mode because the people they compete with are Amazon Music, basically giving it away for free as part of the Amazon Prime bundle. Apple Music, Apple doesn't pay the Apple tax whereas Spotify pays the Apple tax if you're an iPhone user.
They're competing on hard mode and they're still winning. They're making sure they're growing all this sort of stuff. If they're winning on hard mode and they've got all this optionality, you can just start dreaming up all these scenarios where Spotify, they don't compete on hard mode anymore, right? The Apple tax goes away and they compete on a level playing field or they continue growing and all of the sudden, they've got the most users, and I just see all of these optionalities for Spotify that at 50 billion, again, the argument for Spotify has always been Netflix 2.0. Netflix is a $300 billion company at this point, right?
Andrew If Spotify's even half that, triple from here, and I think Daniel Ek is just one of the best people out there, but probably neither here nor there for Tencent right now.
Evan: Yeah, I mean, I think a lot of those optionalities exist for Tencent Music because of constraints to the China market, which I think is very interesting.
Andrew Agree. On Spotify, they've got some optionality from all the social stuff that Tencent Music does. I was really impressed and they've got those optionalities. But Tencent, guess what? Tencent Music owns 80% of the market so they've probably got options that Spotify can't even dream of because they're so dominant.
Evan: Right. Of course, it's mostly restricted to China. I mean, the WeSing app is live in a few other countries and they cite that as one mode of expansion for the karaoke for the live streaming business. But it's mostly China-centric, which is limiting in some ways. But I think if you get past the China regulatory issues and the VIE issues and the Tencent majority ownership issues, which admittedly took me 10 years to get over.
Andrew Small issues to get over.
Evan: Then you just see a business that, I mean, yeah, it's easy to just look at it and focus on. I mean, one thing that Spotify doesn't, their investors aren't super concerned about next year's EBITDA, obviously and Tencent Music because they're posting significant EBITDA and you can make an EBITDA multiple, their investor base is a little bit less focused on the right tail optionality.
Andrew The classic thing you would hear among already public companies that had profits, especially a couple of months ago, they'd see the valuations people were going with SPAC mergers and stuff and they'd say, wait, we're bigger, we're profitable, they're smaller, and they're unprofitable, and they're going for 5 times the rate, I wish we were unprofitable so people would slap a revenue multiple instead of an EBITDA multiples on us or something.
Evan: Right. Exactly. Yeah. I mean, Spotify trades for almost 5 times sales and TME trades for on enterprise value basis 2.5 times sales or something.
Evan: But seriously, they have all the optionality that Spotify has and they have optionality within the core subscription business. Well, it's beside the optionality, it's just like the chart that goes up into the right and you just have to know that it's going to continue.
Andrew Clear penetration. We've talked about a lot of risks here, right? Most of the risks we talked about are more because they're so dominant, the risk we've talked about is more on the corporate governance and regulatory side. Are there any risks either operationally or corporate governance regulatory-wise that we haven't addressed that you think we should have talked about?
Evan: I don't think so. I mean, actually what seems to me right now, given that I've got kind of mentally gotten past and accepted, I guess, the VIE risk and the Chinese regulatory risk, it seems to be the biggest risk is actually competitive for them. I mean, yes, they're dominant now, but if you look at app store rankings, NetEase Cloud Music is number one in the app rankings last time I checked.
Andrew Really? Okay.
Evan: I mean, it's number one in recent downloads, I believe, in terms of music.
Andrew They've got 600 million users out of a billion people in China. The issue could just be everybody's already downloaded Tencent.
Evan: Right. Exactly. Yeah, so maybe that's an issue, but, of course, I mean, I feel like you still see Facebook and Instagram in the top-down list, right? Who knows? But yeah, so competitively, I think there's a lot for smaller competitors to shoot at. I mean, granted, it seems like NetEase Cloud Music is the only one that has a chance to, especially with Alibaba and some other ones shutting down their apps, that's the only one that has a chance to compete. But there is a big thing for them to shoot at. Separately, they have lost some users in the karaoke and live streaming business, right? TikTok or Douyin and Quest Show are really booming and it looks like they might be taking away some users from WeSing.
Evan: Therefore, that's their main source of profitability in the short term. I mean, yeah, I can make a good argument about why I think the online music business has high profitability in the long term, but for tomorrow, their profits are going down a little bit because of the competitive issues in the social entertainment business. I think those two things seem to me the biggest risks.
Andrew We've talked about a lot of risks here. Now we've talked operational risks, we've talked the social side risks, we've talked regulatory risks, ownership risk, all the sort of stuff. Of all the risks we've talked about with Tencent Music, which one is the one that personally kind of keeps you up the most at night?
Evan: It's what is the profitability of the online music business in the long term. I tell this a big story. I tell the story about why they should theoretically have more negotiating power over the labels than a Spotify would have. But at the end of the day, even 30% or 40% of listening hours gives the labels a pretty good negotiating leverage in terms of being able to say maybe you can't really have a music app in China without the label's content. They could just say hey, NetEase is growing share every quarter, why don't we just we can threaten to cut you out and NetEase will be happy to take this deal, and then you're done. I do worry long term if my story about the negotiating power translates to double-digit EBITDA margins, which I think are likely, but would be a [crosstalk].
Andrew I would say having done a lot of work on Spotify in the labels, I think they have so much share that the labels are going to be really over a barrel given this year's discrepancy between them and the smaller competitors and how little the labels own. I do think that's interesting though because I will tell you, you saw the Twitter thread I tagged you on it, people send DMs, the big risk I hear is the same with every Chinese stock, corporate governance and VIE cracked on all that sort of stuff. It's just interesting to me, you obviously have a very divergent view because you're big risk is the long-term economics of this business, and the big risk that most people think about are these other things. Let me ask you a more general question real quick.
Andrew Tencent Music, I know you're also invested in, we mentioned Bollore, which is a French conglomerate controlled by Vincent Bollore. Some people think he's the Carl Icahn of France or Europe or whatever. Then you and I have also talked about Cogeco, which is a controlled Canadian cable company that I'm happy to talk offline or maybe we'll do a second podcast on this or something. But that's 3 companies where I think most people, if they looked at them for 5 minutes would say, oh, yes, those companies are undervalued but they are controlled companies and to some extent, we have varying degrees of control of how much shareholders will really benefit versus kind of the control shareholders, or if they're going to do the rational thing, although such a risk.
You've got three of those companies, I just want to take a second test. Is that the type of thing you normally look for or did you just find 3 unique companies here? How do you look at that risk?
Evan: Yeah, I think these three are out of 10 to 12 stocks that we own or probably the only three where this issue exists. I think the rest of the companies we own are not controlled entities in this way, but I think a lot of times the stories about worries about control and how minorities are going to be treated. In certain cases, they flow more from people, I think what happens is people get negative on the stock after it's been underperforming for a while and then [crosstalk]
Andrew Then they use the control issue to create a story. Yeah.
Evan: They use the control thing so kind of tell a story about why they don't want to own it.
Andrew Let me push back on that because Cogeco, right? Cogeco had an offer from Altice and Rogers, which I think the offer was too low, but they could have negotiated, right? I think Altice and Rogers were both very clear, hey, come to the table, and we'll give you a good deal more than this, and Cogeco just flat-out refused.
Andrew Bollore, I think probably not there though. I do think Vincent Bollore hasn't exactly been super shareholder-friendly over his lifetime. But I do hear you on that, but there is some evidence that these guys have not exactly done the best most profitable things for shareholders overall at all times.
Evan: Yeah, I mean, I think the Cogeco angle is very interesting because I don't know, I just like to think with any sort of non-control situation or whether is it... sorry. I mean non-control is every stock I'm invested in as a 50 million AUM investor. I'm not controlling zero percent of the companies that have invested in. But while investing in companies that are controlled by other people, of course, generally see it as a slight negative because the likelihood of there being a major buyout or the risk of things that are adverse to your interests is always present. However, I just like to think of the incentives of the people that are operating in. I think, for example, in the Cogeco scenario, the guy who is the current chairman, Louis Audet, is I believe the son or the grandson of the founder.
Andrew Isn't it Louis Audet the third or fourth? Is my rumor there correct?
Evan: Yeah. Maybe he's the fourth not the third. I'm not sure. Yeah, you mean his name or the...
Andrew I think his name is Louis Audet the fourth or third. I think he's the third or fourth CEO, I can't remember pretty sure.
Evan: I think, yeah, it's something like that. They see it as representing the thing that their family created and so there's some pride in keeping it in the family and all that. But I think a lot of times, those sorts of issues can get overplayed in terms of the impact on the valuation.
A perfect example is, we were invested in Fox back in the day and forever you heard that Murdoch will never sell and he wants to keep it all in the family and his sons are coming up in the business, and he's gotten offers before and blah, blah, blah. Then he woke up one morning and was like, you know what? I'm getting pretty old. Let's sell a huge chunk of this while we can get a good valuation and then my one son can go to that company, and my other son can go off into the woods or whatever. He ended up selling and it's despite the fact that... Yeah, go ahead.
Andrew No, we could have the Fox discussion another day because I don't disagree with you there. Though, if you think back to the Fox case, they would not talk to Comcast, right? Then Comcast came in and threw in a bid that was 50% higher than what Disney's original bid was and then Disney and they got in a mini bidding war, right? I don't disagree with you, though it took much longer and I think he could have done a lot more shareholder-friendly things in the meantime before he sold. Even when he sold, it was really inefficient, right? If you sell, and then an obvious strategic buyer comes and offers you a 50% premium a couple of months later, clearly, you didn't do a nice job or good enough job of shopping.
I think he wanted Disney stock and a semi-control. Hey, neither here nor there we could have that conversation but it's just interesting you chose that case because I'm familiar with it. Dow Jones right now or News Corp right now. he controls that and people are still having the same, hey, is this guy going to... It's just a really interesting case that shows every story, there's 4 different sides to it.
Evan: Right. I think, I mean, honestly, I prefer to own, I like owning things that are undervalued now, and yes, I mean, obviously any stock that you can buy right now has not been sold yet, has not been sold to a competitor yet. It's kind of just part of the equation. But I like owning things that are obviously cheap and where there's obvious bidders for it in the long term. Okay. Yes, the CEO currently is like, no, we're not going to sell. Please don't give us better offers. But in the long term, if the guy's in his 60s or 70s, I forget how old Louis is. I think he's the late 60s. In the long term, I don't think any of his sons are running the business like a bull ride, this is not true a bull ride, but it is true at Cogeco. His sons are not running the business, Rogers continues to own 30% plus of the shares.
Andrew Rogers is another one with the very interesting [crosstalk].
Evan: Yeah, and then Rogers has a whole other story but Rogers has definitely wanted to buy Cogeco one day, right? They've been at this for fucking decades.
Andrew They do, but I think Rogers is buying Shaw and we're probably getting way off track here, but I think Rogers buying Shaw is them throwing the towel in on Cogeco. I think what Rogers does with the Cogeco stake will be interesting because I wouldn't be surprised to see them sell or dispose of it. Could Cogeco try to buy the whole block, which would be a bonanza for shareholders? I know some people are worried they're just going to sell it on the open market and hit the price for 6 months or something, which is probably an opportunity, but that it's an interesting one as well.
Evan: The thing is though, as this combined Rogers-Shaw entity, I don't think the math works on it that being like them throwing in the towel just because the combined entity will have what's like so the EBITDA of Rogers is $5 billion and EBITDA of Shaw is $2 billion. The amount of free cash flow that the company is going to have, it won't really take that, in 5 years, they can easily buy Cogeco.
Andrew I don't think it's a financial capacity situation. I think it's a regulatory situation where they're going to struggle to get the Shaw deal over the finish line. I think it's kind of like Comcast Charter, I think Comcast and Charter should be allowed to merge, and frankly, I think they should merge but talk to either of them and they'll be like, yeah, we don't compete with each other, right?
Our cable systems are in New York, their cable systems are in Philadelphia. But guess what? Regulators aren't going to let us merge because we're just going to be too big and I think they'll run it that. The last two more questions, quick questions, and then I'm going to let you go. Things that are trading undervalue. It strikes me what's always trading undervalue some part of Liberty Media. Are you in any Liberty Media stocks right now?
Evan: I'm not. I've always watched that business unfolds over the years. Why? What sort of most [crosstalk]?
Andrew I'm going to tell Faux Greg Maffei and Faux Greg Maffei is going to be mad at you and you're going to have to deal with the wrath of that guy and I don't want to deal with his wrath. Yeah.
Evan: It's hilarious because if you looked at my Bloomberg right now, I use his alter egos, FA custom sheet on my Bloomberg. It's like you're stuck. I won't reveal the name of the alter ego, but it's every day on my Bloomberg I see his alter ego's name.
Andrew We'll have to talk about that offline and then just podcast listeners, we're doing a Liberty Media Day is a week from today in New York. If you're up here, I don't know if... where are you from? Where are you based?
Evan: I'm in Philly.
Andrew Okay, you're in Philly. When I said Philly, you've got the Comcast. If you want to come with me and a bunch of Liberty investors is meeting up after so that would be a lot of fun and that would be great.
Andrew But the last question, which wraps up nicely, where can people find you if they're looking for a little bit more?
Evan: Yeah, my Twitter is @evantindell and otherwise Bireme Capital. We write stuff on the blog there, biremecapital.com.
Andrew Do you want to spell it out for people just in case they [crosstalk].
Evan: Sure. Yeah. It's B-I-R-E-M-E and I assume that your listeners are smart enough to spell Capital.
Andrew I'm hoping so and I'll have a link to my Twitter account and the website in the show notes. If people want to follow up, you can follow it there. Evan, it was great having you on. We started the Cogeco talk. Maybe we'll just have to do Cogeco or another one, but looking forward to [crosstalk]. Thanks for coming on.
Evan: Yeah. Thanks, Andrew.