"The Hills are Alive with the Value of Music"
Updated: Nov 15, 2022
WARNER MUSIC GROUP (WMG) - $37.45/sh - 7/9/21
Warner Music (“WMG”) is one of the largest music labels in the world. Since its founding in 1958, WMG has built an irreplaceable and valuable library of intellectual property that includes recordings and song compositions from Prince, Led Zeppelin, Bruno Mars, Madonna, Fleetwood Mac, Aretha Franklin, Ray Charles and the Grateful Dead, among many others. Some of the greatest recording artists of the last several decades have composed and recorded music for WMG.
WMG also develops, markets, and distributes new musical acts. While the business of artist development and distribution has evolved from Radio to CDs to the Internet, the role of the music label in helping artists produce and sell commercially viable music remains vital. Warner’s decades of experience, industry knowledge and long-standing relationships enable the business to remain a key partner to musicians and songwriters around the world.
We were attracted to WMG for two primary reasons: 1) the global growth of streaming music is driving increasing demand for WMG’s music catalog and 2) the shift to digital distribution of music is dramatically improving WMG’s margins and long-term earnings power.
WMG’s recorded music catalog is in high demand as consumers around the world adopt music streaming services as the preferred means of accessing and listening to music. By providing consumers with simple, personalized, and easy-to-use services, companies such as Spotify and Apple have driven a global boom in the music business by encouraging consumers to pay for digital music subscriptions. Large companies, such as Amazon, Google (YouTube) and Facebook, have all made music an increasingly essential component of their product offerings. Each of these large, global companies are licensing WMG’s music catalog across the world.
Music streaming services are not the only platforms with a growing demand for music. Social platforms, such as Tik-Tok and Snapchat, connected fitness companies such as Peloton, and new gaming platforms such as Roblox all want music to be a core part of their product experience. Ten years ago, these platforms did not exist. Today, they represent some of WMG’s largest customers. It is likely that over the coming years, new platforms will emerge with similar demand for music. The proliferation of digital platforms with a need for music should provide a strong and sustainable tailwind for WMG’s music catalog licensing business for many years.
WMG’s growing music licensing business is driving a sustainable and meaningful increase in profit margins. Unlike vinyl, record-cassettes, or CDs, which require physical investment in packaging and distribution, digital music licensing has a low variable cost. Because the music has already been recorded, sometimes decades ago, WMG does not need to spend money to produce or distribute the music recording. Consequently, WMG operating margins have expanded from 13% in 2017 to an estimated 20% in 2021; operating earnings have grown from $473mm in 2017 to an estimated $1B in 2021, nearly 110% growth.
WMG’s management team, led by CEO, Stephen Cooper, and CFO Eric Levin, are embracing the digital transformation of the music industry by forging innovative partnerships with new digital platforms and expanding the role of services that label provides to the artists. Often incumbent businesses are reluctant, unable or unwilling to adapt to change because they see it a threat to their legacy business. WMG has faced radical change head-on by hiring new talent and investing in innovative partnerships that expand the distribution of its valuable catalog and artist roster.
We believe WMG has a long runway to grow its revenue, earnings, and stock price. Goldman Sachs estimates that the streaming music market will grow from $25B in 2021 to $75B in 2030, a compound growth rate of 15%. As one of the leading global suppliers of music to the streaming market, WMG should be able to grow revenue roughly in-line with the growth of streaming, or 10-15% annualized. Given the higher margins associated with digital licensing, WMG’s earnings could grow faster than revenue. By 2025, we estimate WMG could earn $1.7B in operating profit, maintain its 20x EBITDA multiple, and be valued at $58/share, nearly 70% upside or a 14% annualized return. WMG’s music licensing business should prove to be a stable, recession-resistant business as the demand for music remains constant throughout market and economic cycles. To steal a phrase from the title track of one of WMG’s most famous acts, Led Zeppelin, in “Good times, Bad times,” people will still listen to music.
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