With Universal Music Group on the brink of launching one of the biggest initial public offerings to date, it’s worth noting how much the music industry has changed — and hasn’t — since analysts placed the business on the critical list 20 years ago.
By the mid-oughts, the music industry had lost half of its peak value, but the advent of streaming and a rising awareness of the value of intellectual property — not to mention the multi-billion dollar, albeit pandemic-hobbled touring business — have risen it to a new, more diverse peak that does not depend overwhelmingly on the sales of an overpriced slab of plastic. Now UMG is poised for a valuation of as much as $48 billion after the curtain actually rises, unleashing a wild ride and a big splash when its long-planned spinoff from parent Vivendi takes place Tuesday on the Amsterdam Euronext exchange. As much as 60% of the company’s new stock issue will be up for grabs, when Vivendi’s stake in UMG reduces from 70% to 10%.
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As the world’s largest label group, not to mention the second largest music publisher (according to Music & Copyright), UMG’s assets are more than impressive. The company recently spent hundreds of millions of dollars investing in talent — most notably in its eye-popping $300 million acquisition of Bob Dylan’s publishing catalog — a move that turned out to be prescient. In fact, a JP Morgan report says, “We would be worried if UMG were not investing ahead of a decade of double-digit industry growth.”
While the stage for the IPO was set with industry rumblings in 2018 and continued with Chinese media giant Tencent’s acquisition of 20% of the company (and billionaire Bill Ackman’s acquisition of 10% last month), the company’s spinoff from parent Vivendi could not have asked for a more inviting welcome mat than this week’s robust mid-year report from the Recording Industry Assn. of America, which reported 27% improvement over revenue in the first six months of 2021 — a year-over-year number strongly influenced by the pandemic — which essentially promises a seventh straight year of global growth.
“Many had left the industry for dead a decade ago, especially with piracy and a lot of the issues facing the music industry,” says Daniel Ives, managing director of equity research at Wedbush Securities. “Now they come out smelling like roses. When you look at Universal, Warner Music and overall streaming with Apple Music and Spotify, it’s been a massive turnaround that very few predicted would happen.”
Last year, the U.S. trade’s $12.2 billion accounted for more than half of the $21.6 billion global revenue reported by the International Federation of the Phonographic Industry, so the RIAA report sets the stage nicely for the world’s largest music company to step out from Vivendi, its parent since 2001, a move that allows investors a pure-play opportunity to capitalize on music’s momentum.
“It is 100% the right time [for such a move], with spectacular results for H1 in the U.S. coming out from the RIAA,” says Mark Mulligan, managing director of UK media analysis firm MIDiA Research. “Universal Music has managed to divest significant chunks of its business [via the Tencent and Ackman deals] at very strong valuations and it’s referenced those valuations in its supporting materials, I really expect that to have an influence on how that stock trades.”
“This valuation was already teed up with Tencent round one,” says Gigi Johnson, president of tech consultancy Marmel Institute, who recently wrapped an 11-year tenure on the music industry faculty at UCLA Herb Alpert School of Music. “This wasn’t something to make [UMG] look cute and sexy in the last 18 months. This goes back a few years to the pledge to be taking shares to the public.”
As the music industry’s value reached an unprecedented peak in 2000, the downfall was already in motion with the fast-rising popularity of file-sharing service Napster, which, for millions, made piracy a primary format for recorded music. But after 15 dismal years, streaming, led by Spotify, saved the day. Now analysts sing UMG’s praises, with glowing pre-IPO reports fielded by the London offices of Barclays, Exane BNP Paribas and JP Morgan.
It was JP Morgan, in fact, that first declared the possibility of at least a $30 billion valuation for a stand-alone UMG, when the Tencent group’s first investment of 10% approached the finish line in late 2019. Last December, the Tencent consortium announced its intention to double its stake to 20% of UMG, exercising a call option from the first investment, again citing the valuation of $30 billion, a deal that closed in late January.
Hedge fund billionaire Bill Ackman was next on UMG’s dance card, when reports in early June suggested his special purpose acquisition company Pershing Square would take a 10% stake for $4 billion at a valuation of $42 billion. Headlines on June 19 reported that Pershing was retreating from the deal, but a day later, it announced its intention to see it through. Pershing acquired 7.1% of UMG in August, then late that month announced it would round its holding up to 10% with an additional deal for a 2.9% stake at $1.149 billion. That set the table for next week’s launch.
Among the financials revealed in UMG’s prospectus are €7.43 billion ($8.7 billion) in revenue for fiscal year 2020, up 3.8% over 2019, and a half-year comparison for the start of 2021, when €3.8 billion ($4.45 billion) marked a healthy 10.75% gain over the first half of fiscal 2020.
“The best time to do IPO is when you are very near the peak, because you are going to get people to invest while the market is accelerating, so you’re maximizing your value there, but you’re not missing out on too much future valuation,” says Mulligan. “Put all those things together, Universal is selling at a really good time — perfect timing, you might say. I wouldn’t say that there’s any sign the market is going to slow down anytime soon.”
Ives adds, “We’re at a stage where we’re really hitting the next wave of growth on streaming and overall royalties, and Universal is obviously in a clear position of strength. They’re striking when the iron is hot in terms of the broader market opportunity.”
The aforementioned reports from JP Morgan, Barclays and Exane laud the company, too, with the first two rating the stock as “overweight,” a term you’d much rather hear in the investment world than at the doctor’s office. Morgan describes UMG as an “an extraordinary asset with exceptional leadership,” Barclays raised its estimation of UMG’s market value from €38.5 to €41.4 billion ($48.4 billion),” while Exane’s forecast says, “We think UMG is set to prosper in an industry where scale will increasingly matter, especially as relationships with digital partners become increasingly important.”
It should be noted that Exane BNP Paribas are among the investors advising the IPO, as are Crédit Agricole, CIB, Morgan Stanley, Natixis and Société Générale. Ten other institutions, Bank of America among them, are listed in the prospectus as “financial co-advisors,” while Bank of China and Goldman Sachs Bank Europe SE are credited as “other financial advisors.”
This broad flank of support is in stark contrast to 2018, when Spotify had to list itself on the New York Stock exchange without assistance from a single investment house. Then again, the global music business was only three years into its comeback, and the prospects of a tech startup that had not yet seen a profitable quarter don’t compare to the potential of a large, proven player with an established business model.
As strong a showing as Warner Music had when its IPO brought a valuation of $12.75 billion last year, Mulligan thinks the climate might be even better now. “Something in the region of about a couple of billion dollars of streaming in 2020 came from outside the DSPs, through the likes of Peloton, Instagram, TikTok and the rest,” he says. “These are what they are betting on to deliver good, continued strong growth.”
The listing on one of the European markets reflects that corporate headquarters for the company now called Universal Music Group BV is stationed in Hilversum in the Netherlands, although its chairman and CEO Lucian Grainge is expected to continue working out of UMG’s Santa Monica quarters, now referred to as its “operational headquarters.”
One source suggests that like other companies, tax considerations enticed UMG to plant its flag in the Netherlands, but this isn’t the first time a major label has been based there. PolyGram was headquartered there until 1998, when it was bought by Seagram, then the parent company of both Universal Music and Universal Studios, an acquisition that immediately made UMG the world’s market leader.
At press time, there was no firm word on how star-studded Universal Music might strike the gong (the Dutch equivalent of the New York Stock Exchange’s bell) when trading opens on Amsterdam’s exchange. It might be a virtual ceremony, given the travel considerations of COVID, not to mention sprawling time zones, with 9 a.m. in central Europe translating to 3 a.m. in New York and midnight at the Grainge homestead.
A combination of European market factors and the structure of UMG’s spin off from Vivendi means the early days of trading will likely look more volatile than one is accustomed to seeing during New York launches. Shareholders of Vivendi will automatically start the day with stock from the new company, and some will be tempted to quickly offer them up, a factor that might drag average share values down before they settle at the price where UMG will ultimately be valued.
Wedbush’s Ives is optimistic about where it lands. “I think their growth is more than investors had been anticipating,” he says. “There was a view that they were maybe growing mid to high single digits; double-digit growth is impressive. After hitting some rough patches, along with the broader industry, it really feels like they have a lot of momentum going into coming years.”
One eye-popping detail, on page 129 of UMG’s 306-page prospectus, might startle those who are not acclimated in the ways of IPOs: a bonus for Grainge of $150 million, plus 1% for the difference above $30 billion U.S. where UMG is ultimately valued. However, such bonuses are not unusual, according to Ives and Maremel’s Johnson — and needless to say, Grainge’s serious battle with COVID-19 last year, which saw him on a respirator and sidelined for several weeks before recovering, placed his importance to the company in drastic relief.
“He’s one of the assets of the company, and I’m not surprised at all at a compensation clause,” says Johnson. “Most of the time there will be some kind of success metric and some kind of retention metric. This would have had to be approved by the Vivendi compensation committee. It might have been arranged before the first Tencent deal.”
The Tencent deal played no small role in the company’s current value, Ives notes. “It speaks to some of the inherent risks in the industry and the broader business model that every other competitor is facing, especially when it comes to doing business in China, with Tencent and others,” he says. “That first Tencent deal is really one of the linchpins of their success, so even though [the bonus is] a big number that sticks out — and some investors could question — I think it speaks to just how important that deal was in the broader growth story.”
While Ives and Mulligan applaud UMG’s timing, Johnson, a former banker, says, “I might have come out sooner. They’ve kind of proven that the pandemic recession was not going to be long-term damage.”
Mulligan has remarked more than once how the predictable revenue that streaming delivers enhances music as an “asset class” investment, a notion that would have been unthinkable even 10 years ago, and Johnson agrees. In short, streaming has made the industry less specifically hit-dependent: People are paying for a monthly subscription to millions of songs, rather than being lured to plunk down $17 for a CD as many times per year as the industry could manage. “There used to be a timing issue of when something is released and when the revenue comes in,” Johnson says. “This business has gotten a lot sexier to investors because it’s much more predictable cash flow.
“If you look at old numbers from labels, you would see a lot of whipsaws based around major releases,” she continues. “But now, like the software business, it’s now based on subscription models and we’ve all been trained into paying by the month. There’s no lumpiness anymore.”
Universal’s vast catalog, which reaches back to the advent of recorded music and sprawls from the Beatles and Louis Armstrong to Billie Eilish and the Weeknd, is the wellspring of that more-predictable cash flow. Its prospectus points out that its current top 50 artists account for just 23% of its recorded music revenue — a statistic that would have been unthinkable during the decades when the business was based on hits and sales. But, with streaming shifting the industry from ownership to access, the economics of the business are driven by consumer’s listening preferences, rather than purchases.
“Even if terrible things happen, someone will want this catalog,” says Johnson.
As is customary, UMG’s prospectus lays out an array of risks that it faces, including competition, how it manages new business models, regulatory challenges and the like. But future growth, and how it plays out with ARPU (average revenue per unit, or user) is the potential warning light that Mulligan and Johnson see on the horizon.
“The growth of streaming in emerging markets is going to look a lot better if you are a streaming service measuring subscribers than if you’re a major label measuring revenues,” says Mulligan. “Quite simply, in emerging markets [such as Asia, Africa and Latin America], the ARPU is lower because the subscription rates are lower, so that means that subscriber growth will out-accelerate revenue growth. In some ways, the major labels have made a rock for their own back because they made ARPU a really big industry issue. They really wanted Spotify in particular to push ARPU, so they just kept telling journalists about how ARPU’s going down and it’s devaluing music.
“That’s when they were focusing on a Western industry, but they’ve got an alert in the investor community that ARPU decline is a bad thing. So, I think that is a risk.”
Asks, Johnson, “Other than maybe China — where you’re getting your music services through your phone— where does growth come from to keep this healthy still-in-single-digit revenue growth that we’ve seen?”
Mulligan also warns that the appetite for local music in territories outside Western countries represents another potential challenge. “Now that streaming is driving huge amounts of consumption, often with indigenous music services in the Middle East, China and India, with hundreds of millions of people streaming for free, listening to local music, that is generating a cycle of internal investment in those markets.”
He says this dynamic will prompt Western labels to invest in indigenous artists and repertoire. “Obviously, Universal’s doing some smart things on account of that. It’s got some JVs like the recent label announced in China, but that’s signing new artists and we know that even according to Universal’s own stats, that new frontline music is a minority of listening. So, you’re competing for a minority of listening and you don’t have the benefit of all the catalog. It’s a slow start in terms of turning back that tide.”
While UMG and Warner Music offer pure plays — the ability to take stakes in a music major — Johnson notes there’s no shortage of investment opportunities. “There’s a lot of money going into other areas of music right now in terms of new investment, so if you’re actually going to invest in music, Universal is almost a grand dame that may or may not have a lot of growth to it. There are people who are investing heavily into the creator-economy tools: With 60,000 tracks being produced a day, what do those people need? That’s where a lot of new money is coming in for new investments in music tech, in new dimensions of music publishing.”
But, while there’s no shortage of investment opportunities, she notes that UMG’s market-leading status keeps it at the hub of that activity. “There’s a real hunger for figuring out next solutions in this industry,” Johnson says. “All of them have to work with Universal.”
Additional reporting by Jem Aswad.
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