With Universal Music Group recently valued at $33 billion — as part of its agreement to sell 10% of itself to a consortium led by Chinese tech giant Tencent — it’s really no surprise that its competitors would test the waters. What is surprising is that Warner Music Group did it so soon, announcing its initial public offering on Feb. 6.
Underwritten by Morgan Stanley, Credit Suisse and Goldman Sachs & Co. LLC, Warner’s move came less than six weeks after UMG closed the Tencent deal, catching many observers, and even many of its senior executives, off guard.
The inspiration for this move is not hard to deduce: Universal, the world’s largest music company, was valued by Goldman Sachs at $23.5 billion in August of 2017 — $10 billion less than its current value, and nearly five times what it was worth in 2013. Although ink on the Universal deal didn’t dry until the end of December, Tencent’s intention to raise $3 billion for a 10% UMG stake had been known since early August, and that news apparently inspired Warner to explore its options.
“There’s no doubt that there’s a lot of growth left in the market but we’re also of the opinion that the rate of growth is going to start slowing,” says Mark Mulligan, managing director and analyst at London-based MIDiA Research. “It’s always good to sell at the peak if you can.”
Mulligan says Vivendi’s play raised the stakes in an environment where the music industry’s upward momentum whetted the appetite of investment bankers, only to find that the inventory of attractive merger and acquisition targets among labels and publishers had already been picked over by larger independents like Concord and BMG.
“Just as Vivendi was able to extract a huge premium in the price that Tencent, along with its fellow investors, paid to take the stake in Universal, because it’s a rare asset in the market, Warner Music is essentially going to be doing exactly the same thing, becoming a rare and successful asset in the growing market of music catalog M&A.”
A senior executive at a major music label says it was inevitable that Len Blavatnik, whose Access Industries took Warner private from an earlier public chapter with a $3 billion investment in 2011, would take Universal’s play as a cue to check the temperature on Warner’s value. “You know, for 15 years, no one wanted to touch music and now it’s hot again,” he says.
Although Warner Music was historically aligned with whichever parent owned Warner Bros. Pictures, the company has been a pure music play since 2004, when investors led by Edgar Bronfman, Jr. bought the label group from Time Warner. Mulligan says Warner Music’s structure made it a more likely player than the other major, Sony Music, to ride the momentum that Universal Music started.
“Sony Music’s too small a part of Sony to provide direct investment in music and up until now, Warner Music wasn’t an option. There’s so much in there; you’ve got Sony Electronics, Sony Pictures and PlayStation. There’s just too much risk associated with taking a stake in Sony for the sake of music. Underperformance in any of those divisions would undermine any music performance that you’d be extracting.”
The investment fever reflects the vigorous growth the industry has realized from streaming’s supercharged rise. After five straight years when the Recording Industry Assn. of America saw business in the U.S. hover around $7 billion (2011 through 2015), RIAA measured an 11.4% uptick in 2016, a 16.5% gain in 2017, and a 12% gain in 2018, when business clocked in at $9.8 billion. The trade group has not yet released its 2019 report, but in its 2019 mid-year report, business was 13.5% ahead of First Half 2018.
Global business actually started to improve a year earlier than the U.S. growth spurt, as the IFPI measured a 3.5% gain in 2015, followed by 5.9% growth in 2016, an 8.1% rise in 2017 and a 9.7% gain in 2018, when it measured the world’s music value at $19.1 billion.
Streaming accounted for 80% of U.S. music revenue in RIAA’s mid-year 2019 report, and nearly half of the global business in IFPI’s 2018 summary.
“If you would have asked me this 10 years ago, I wouldn’t have thought to say this, but right now, to an asset manager, music is a relatively safe and solid performing stock to add to your portfolio,” says MIDiA’s Mulligan “Most of those asset managers and funds who’d be looking to buy into Warner Music would not be expecting an astronomic growth. It’s not the same sort of reason that someone would add Spotify to a portfolio.
“It was about three years ago when we started to get the global investment banks signing up for our music service, and they were essentially saying, ‘We’ve spent the last 10-plus years not even giving the most cursory glance at music, now we find it interesting and we need to understand the market’.”
Unlike a startup or tech play, a well-run label and publishing business operating in a growth market, Mulligan says, “If you’re a pension fund manager, then what you want to know is that the business looks reasonably secure and that the company is one of the leading ones there, that has a good track record and a strong chance of outperforming the market. Warner Music and the recorded music market tick both of those boxes at the moment.”
“There are sufficient advantages with an IPO, if the timing is good and it works well,” says Peter Alhadeff, professor in the Music Business program at Berklee College of Music. “It’s a play for shareholder value.
“The business of old where the record companies finance themselves and the music operation has to pay for itself is long gone. Now you’ve got a number of other players investing into the business,” Alhadeff adds.
One commonality between Tencent’s Universal Music stake and those who buy Warner Music stock: the new investors have no say in determining the company’s course. Just as Vivendi remains in charge of Universal Music’s destiny, Blavatnik’s Access will still steer Warner’s ship.
“Tencent and its supporting investors were taking an unprecedentedly, highly priced investment in a music company for a minority stake with no meaningful input or control over the strategy of the company. You then think about the sort of company who would be interested in that sort of investment, it comes down to asset managers. It’s pension funds, larger institutional investors who want to add a shareholding in the company to go in your portfolio that is a calculated mix of different levels of risk.”
Tencent itself represents an odd bond between Universal and Warner, as the S-1 filing attached to the latter’s IPO reveals that Warner Music is an investor of the Chinese company. Warner’s parent, Access, also holds a controlling stake in Deezer, the French streaming company.
Earlier in the digital evolution of music, Warner established itself as the most tech-friendly of the then five music majors. Its S-1 underlines that reputation, stating, “We were the first major music entertainment company to strike landmark deals with important companies such as Apple, YouTube and Tencent Music Entertainment Group, as well as with pure-play music technology companies such as MixCloud, SoundCloud and Audiomack.”
Although a label or a publisher is a long-established model, such companies represent attractive investment opportunities, especially compared to launching a new streaming play in a market driven by three companies—Spotify, Apple and Amazon—with the last two mentioned capable of running theirs as loss leaders.
“We’ve fundamentally only got one product in the market, the 9.99 streaming subscription and that market is tied up with three dominant players who are increasing their market shares as each quarter goes by, so you’re probably looking at something like a billion dollars to bring a global streaming service to market with little chance of unseating the leading players,” Mulligan says.
“If you’re a small to midsize investor, you’re looking at this and say, I definitely can’t compete at the top end, there’s no place I can compete on the consumer services side so I can invest in some of these B2B services, I can invest in creative tools or there may be a dozen record labels, there may be a dozen good sized music publishers where as a private equity company I can go give them a half a billion dollars to grow their business.”
Among the many details missing from Warner Music’s S-1 filing is what percentage of its business will be represented in the public offering, how many shares will be offered and we’re nowhere near learning the opening price the company hopes to attract, nor do we know the timing of when it will launch.
However, it does point out one caveat to its future value: “a potential loss of catalog if it is determined that recording artists have a right to recapture U.S. rights in their recordings under the U.S. Copyright Act.” That act grants artists the ability to claim the rights to their works 35 years after initial release — a provision some artists, such as the Eagles, Pink Floyd and others, have exercised, while others have quietly worked out deals with their original labels.
Such risks notwithstanding, with three established investment bankers at its side, what we do know is that Warner Music will soon be open for business on Wall Street.