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Updated: Everything you need to know about the NetEase Cloud Music IPO

​LINYI, CHINA - MARCH 3, 2021 - A mobile phone shows app Netease cloud music interface, Linyi City, Shandong Province, China, March 3, 2021.- PHOTOGRAPH BY Costfoto / Barcroft Studios / Future Publishing

Update, Aug 9, 2021: NetEase has shelved its Hong Kong IPO, multiple sources report, due to what a Nikkei Asia report calls "tepid feedback" from investors concerned about further regulatory crackdowns on China's Big Tech sphere.

NetEase, a heavyweight Chinese tech company, had planned to spin off its music arm, officially called Cloud Village, and filed a prospectus to list on the Hong Kong Stock Exchange. Here's everything you need to know about the music platform, which was valued at $5.3 billion back in 2019, according to Nikkei Asia.

What does NetEase Cloud Music do?

Ever since NetEase decided to join China's music streaming competition in 2013, it has maintained one clear position: It's a platform not just for listening to music, but also talking about music and giving recommendations.

NetEase Cloud Music's flagship feature is the comments section below each song, where users share emotional reactions or personal stories inspired by the song. (The company says 48% of listeners have browsed the comments sections.) The app also promotes individual playlists generated by users, capitalizing on their unique music tastes. The prospectus even has an unconventional section comparing the app to a physical neighborhood, with playlists being "the carousel" and comment sections "the central square."

Today, with 181 million active users and 16 million paying subscribers, it's one of the most popular music streaming platforms in China, although the top spot is firmly taken by Tencent Music. But NetEase boasts a younger user base. It's the platform with the highest proportion of users born after 1990 and also this user group's favourite platform, according to a report by China Insights Consultancy commissioned by NetEase.

The prospectus repeatedly mentions AI, which NetEast Cloud Music uses to improve its recommendation system. By December 2020, of every 10 music streams consumed on the platform, 2.8 came through the recommendation algorithm. The engine is powered by a strong research team accounting for over half of the company's headcount. But the prospectus also mentions that advanced technology is used in monitoring sensitive content during livestreams, meaning a livestream session can be automatically cut off if any content deemed inappropriate is detected by the machine.

NetEase Cloud Music's financials

NetEase Cloud Music's annual revenue has grown steadily, from $171 million in 2018 to $357 million in 2019 and then to $761 million in 2020. In 2020, about half of all revenue has come from music streaming subscriptions, and half from livestreaming services.

The latter, which started only in late 2018, has proven to be a cash cow: It generates roughly the same portion of revenue as the former, but with 98% fewer paying members. On average, a music subscriber pays slightly over a dollar every month, while a livestreaming audience member pays $89 in the same period. The number is high, but not particularly surprising given the overspending culture across all livestream platforms. The 1% of extremely generous patrons may have also skewed the average.

But the costs are growing larger too, and NetEase Cloud Music has never turned a net profit. The unadjusted net loss increased from $311 million in 2018 to $313 million in 2019 and then to $458 million in 2020. The vast majority of spending goes toward purchasing music streaming rights, while R&D and marketing also incur significant costs.

What's next for NetEase Cloud Music

The company vows to continue investing in advanced technologies like AI and machine learning to improve its personal recommendation algorithms. It's planning on developing AI-powered tools to help creators produce music too. The prospectus also mentions the possibility of using augmented reality and virtual reality technologies to produce music-inspired content.

NetEase Cloud Music is not satisfied with just being a streaming platform. Instead, it's also exploring all fronts of audio-plus-social. It has a Karaoke app, a Clubhouse-like chat room app (which actually predates Clubhouse's popularity in China) and even a music-based dating app. None of these have become a big hit yet, but it shows the company's interest in expanding its footprint.

What could go wrong

The biggest problem for NetEase Cloud Music, ever since its inception, has always been music licensing. Until recently, Chinese streaming platforms held exclusive streaming rights to most songs, which means users have had to go to a specific platform to listen to their favorite artists, and Tencent Music has been the winner of this licensing turf war. But that has changed as China's copyright regulators have called out monopoly behaviors and demanded Tencent and NetEase share over 99% of their exclusive songs. Still, compared to Tencent, NetEase has been less successful at purchasing music streaming rights from major record labels, and its limited music availability continues to haunt it.

NetEase's answer to the problem is to scout its own emerging artists. Since 2016, the platform has started several projects to incentivize and nurture independent musicians. The prospectus claims that by last December, the platform had served over 230,000 independent musicians, whose music now accounts for 45% of all streaming on NetEase Cloud Music.

The popularity of NetEase Cloud Music's comment sections can also backfire. Last year, a wordplay of the app's name that basically translates to "Net Depression Cloud Music" trended on social media because users were seeing more and more depressing comments on the app. Some were even suicidal. It's great for an app to be able to inspire deep connections, but it's not always easy to moderate the content it engenders.

Who gets rich

NetEase Cloud Music is a spin-off from NetEase, and is 62.46% owned by its parent company. Since Ding Lei, NetEase's founder, owns 42.3% of NetEase, he will be the biggest beneficiary.

Alibaba and Baidu, the two Chinese tech giants and Tencent rivals, respectively own 10.81% and 4.26% of NetEase Cloud Music through earlier rounds of investment.

Institutional investors Yunfeng Capital (co-founded by Jack Ma), Boyu Capital, General Atlantic and CMC Capital Partners respectively own 5.41%, 3.47%, 3.47% and 2.99% of the company.

What people are saying

"In the current scenario, there's little chance that [NetEase] can challenge Tencent Music's lead … Most users choose a platform based on whether there are enough songs available. And on that score, with the financial support of Tencent, Tencent Music has an absolute advantage. It's not something NetEase Cloud Music can change immediately by poaching a few record labels when their contracts with Tencent expire." — Tech industry commentator Zhang Shule, in Beijing-based finance publication China Times

"NetEase Cloud Music doesn't have a music library as large as Tencent Music. But in terms of maintaining user stickiness, it is doing so very efficiently … Is obtaining licensing rights a valuable battlefield? It is, but it is also gradually losing its significance." — Zhang Zhaoyi, chief strategist at music licensing platform HIFIVE, in digital outlet PingWest

"While music licensing in China is cheaper than in the U.S., none of Tencent's competitors reported profits. Similar to Apple Music or YouTube Music, most Chinese music platforms have resource-rich parent companies ...The subscription fees for Chinese music platforms are incredibly low, causing platforms to be more creative in how they monetize." Market analysis by Daxue Consulting