Kuke Music Holding (NYSE: KUKE) Full Year Earnings Review and Analysis

The fourth quarter and full-year financial results of 2020 (4Q20 and FY20, ended December 31, 2020) for Kuke Music Holding Ltd – ADR (NYSE:KUKE) came out on Thursday, April 15, 2021. Following the release of the results, the company's Founder, Chairman and the Chief Executive Officer (CEO), Mr. Yu He along with Public Relations (PR) and Investor Relations (IR) Director, Ms. Claire Choi, and Mr. Tony Chen, the CFO of the company held an Earnings Call to dive deeper into the financial results and provide a forward-looking outlook as well.

We will have a rundown on the earnings results and call, whether the company is on the right track to penetrate the smart music education industry in China and what to expect from the Beijing-based company in the future.

Profit & Loss Performance

Revenue

Kuke Music Holding Limited ("Kuke" or the "Company") (NYSE: KUKE), revenue in the fourth quarter increased by 21.7% to 128.0 million from 105.2 million. For the last three months, the company's top line increased from the same period last year due to the inclusion of BMF's revenue into Kuke’s financials and also on the back of improvement in the revenue from the Smart Education segment. Kuke Music had acquired BMF in February 2020.

Kuke Music is currently involved in providing smart music education to the kindergarten segment and has a presence in 1,672 kindergartens as opposed to only 448 kindergartens at the end of 2019. This reflects the aggressive expansion plan for the company. Through these 1,672 kindergartens across 172 cities, the company is catering to 30,000 students. The company works with these kindergartens through a distributor network.

This means that Kuke Music has penetrated only 0.6% of the total kindergarten universe of 280,000 kindergartens and only 0.06% of the total student population of 47 million kindergarten students in China. These numbers provide an insight into the potential market that Kuke Music can further tap into. There is huge potential for higher penetration due to the absence of competent music teachers along with exuberant tuition fees for music education. Despite both these shortcomings, more than 60% of China’s students of 160 million are enrolled in music education courses. The closest extra-curricular activity that students opt for is sport competitions, which is opted by nearly 40% of students only. The company aims to have a significant chunk of the market through a gradual and continuous increase in a few years.

Kuke Music might receive an impetus in its push in the smart education segment as the Chinese Ministry of Education (MOE) has announced recently that it will increase the focus on arts education, physical education, and music education. It is expected that music education will be included in high school entrance exams by 2022. This would make it necessary for students to be proficient in music.

It would be interesting to note that the smart education segment of the business faces the impact of seasonality and it may not be surprising that the sales from this segment may decline significantly in the first quarter of 2021 (1Q21) results. This is because the Chinese school calendar runs in two terms. The first term is between September and December and the second term is from March to June. During the first quarter, the school remains closed due to the winter and Chinese New Year holidays. Meanwhile, during the third quarter, the schools remain closed due to the long summer holidays.

It should be highlighted that the company is not only involved in the smart music education segment but also in the music licensing and subscription segment as well with a leading collection of Chinese classical music content. The company is sifting through the collection to find content that is relevant to its smart education segment and use it there.

Cost of Sales

The increase in the cost of sales by nearly 37% was due to higher capital expenditure (Capex) as a result of installing Kuke smart pianos in all the new kindergartens added to the Kuke smart education network. The company installs Kuke smart pianos at kindergartens free of charge. The the kindergartens deliver Kukey music courses to their students through the Kuke smart pianos.  Parents pay the tuition fees directly to Kuke. Going forward, this should not be a sign of concern as the company would increase its presence in kindergartens by partnering with them, and thus more Capex would be done.

In regards to the production of the smart piano, the company is also working in improving the designs of its pianos and making them cost-effective and thus increasing its profit margins in the process. This will counter some of the increase in Capex going forward. Furthermore, the company anticipates economies of scale and higher bargaining power to come into play in countering the impact of a higher cost of sales. All this will be done in addition to adding more features into its product.

Gross Profit

Gross profit (GP) increased in monetary terms but the overall GP margin contracted by 2.2 percentage points (ppts) due to an increase in the cost of sales.

Selling & Distribution and Administrative Expenses

Meanwhile, the spike in administrative expenses was a one-time event due to professional fees incurred for the initial public offering (IPO) on the New York Stock Exchange (NYSE) along with the consolidation of BMF into Kuke Music’s financial statement. As a result, the company's operating profit shrunk due to significantly higher administrative expenses.

Conclusion

The company has all the tools to penetrate the smart music education industry. If Kuke courses penetrate even 1% of total kindergarten students market for a complete school year, the company can see its revenue increase to 423 million yuan. This represents a threefold increase in revenue from the current level. To achieve this, the company is taking all the current measures. It is adding more distributors, lowering its cost to improve its margin, and incurring more Capex to place Kuke smart pianos to more kindergartens.