Summary
- UMG is the unquestionable leader of the music industry. With 37.5% market share, 1 in every 3 songs you listen to earns the company money.
- After many years of drought during the "piracy era", record labels are riding the streaming wave to become wonderful fast-growing profitable businesses once again.
- The stock is 11% below its IPO price, but 45% above its October 2022 lows.
- The stock lacks institutional coverage as a European stock, and this provides patient investors with a unique value opportunity.
- With revenues projected to grow high single digits in the mid-term, and EBITDA margins projected to increase significantly, UMG is a Strong Buy ahead of earnings.
Universal Music Group (UMGNF) provides investors with the opportunity to benefit from the success of the best artists worldwide. As a European stock, the lack of institutional coverage provides individual investors a unique option to invest in the leader of a very fast growing industry below its fair value. I find UMG's shares to be trading at a discount of 22%, based on a DCF valuation and multiple analysis. I believe the music industry's hyper growth mode isn't going to slow in the foreseeable future. For these reasons, UMG is a Strong Buy.
Company Overview
Universal Music Group is a world leader in music entertainment. The company has local presence in 60 geographies and covers more than 200 markets. Universal is the largest music company in the world with more than 3 million recordings and 4 million publishing titles under its belt. Some of its famous record labels include Abbey Road, EMI, Decca, Geffen, and Virgin. UMG represents the world's most renowned artists like Rihanna, The Beatles, Taylor Swift, Drake, Queen, Kendrick Lamar, Guns N' Roses, Justin Bieber, Aerosmith, BTS, The Weekend, Ariana Grande and the list goes on and on. In 2021, UMG had 4 of the top 5 artists on Spotify ( SPOT ), it represented Apple Music's ( AAPL ) artist of the year and songwriter of the year, and it had 8 of the top 10 artists in the U.S Billboard charts. Overall, no other company comes close to UMG's presence in the music industry.
Business Model
It's important to understand the legal framework of the music business in order to understand the difference between the company's business segments, which are similar to those of Warner Music Group ( WMG ) and Sony Music ( SONY ), the other two main players in the industry. Generally, a song is made of two separate sets of rights. The first is publishing rights, which are protecting the composition and the lyrics. The second is recording rights, which are protecting the master mix as it was recorded. In some cases, both sets of rights belong to the same entity, for example when the songwriter and compositor is also the recording artist. In other cases, those rights are split. UMG and its artists divide the ownership of those rights between them through contracts. Famous artists like Drake and Taylor Swift logically receive better terms and more ownership, while beginning artists and younger up and comers will get less. Much like investing in the stock market, when UMG deals with already successful artists like Eminem and ABBA, the return on investment would be lower in percentages but probably higher in absolute numbers. However, when UMG discover and develop a young artist from scratch, the ROI could be very high (or non-existent).
UMG operates under three business segments - Recorded Music, Music Publishing, and Merchandising. The Recorded Music segment is dedicated to discovering and developing recording artists and marketing, promoting, distributing, selling, and licensing the music they create. The Music Publishing Segment is committed to acquiring and administering rights to musical compositions and licensing them for use in multiple formats. The Merchandising Segment ('Bravado') represents the merchandising rights of artists and entertainment brands and properties. Providing an end-to-end merchandising ecosystem, Bravado offers services including sales, licensing, branding, marketing, eCommerce and creative resources for its clients and innovative experiences for fans worldwide.
As a European company, UMG discloses full financial reports on a semi-annual basis. Below is a segment breakdown of revenues and EBITDA for H1-22:
Revenue Streams
Often times investors who are very bullish on a company can't actually explain what makes the company money. Due to some complexity, I think it's important to shed some light on what actually makes UMG money.
In the Recorded Music Segment, UMG derives revenues from digital and physical consumption of its music, and from licensing agreements. Digital consumption includes listening to music via streaming services like Apple Music, Spotify and Deezer. UMG gets paid for each stream, whether the listener is a premium subscriber of the service or using an ad-supported version. In addition, digital consumption includes the downloading of an album or a song on a pay-to-listen service (like the old iTunes), and when its music is used on social media, like Instagram Reels or TikTok. Physical consumption is the old-school CD or Vinyl sales. Licensing includes the use of UMG's music in TV shows, movies, video games and advertisements.
In the Music Publishing segment, revenue streams are essentially the same. The only difference is that they come from the use of the publishing rights, instead of the recording rights. Unique to the publishing segment is revenues from live performance, which includes concerts and broadcasts (radio or TV).
The Merchandising segment needs no explanation. UMG makes money from selling merchandise related to its artists.
Market Outlook & Growth Drivers
The global recorded music industry generated revenues $25.9B in 2021, representing 18.5% growth from prior year. More than 71% came from digital consumption, either through streaming, downloads, or synchronization. This is materially different from how the industry looked at its 90's peak, when 100% of revenues came from physical consumption of music. Between 1999-2014, the music industry experienced a sharp decline, mainly as a result of piracy. 2015 marked a significant change in consumer behavior. It wasn't a result of efficient war against piracy. Actually, people were finally willing to pay for their music consumption because of the high quality and convenience services like Spotify and iTunes provided. Today, people listen to 20.1 hours of music a week. It is estimated that there are more than 616 million music streaming subscribers worldwide. The industry is experiencing significant growth, even though 30% of music listeners are still using unlicensed or illegal ways to obtain music.
While companies like Spotify see the growth only in their top line, companies like UMG and WMG see their profits soaring. Between 2018-2021, UMG and WMG grew EBITDA at a CAGR of 19.86% and 19.15%, respectively. This demonstrates the balance of power in the industry. Services like Spotify are struggling to generate profit, mainly because of intense competition from the likes of Apple Music, Amazon Music ( AMZN ) or Google's ( GOOG ) YouTube Music. The real beneficiaries of this competition are the record labels, who are excited to see their industry surpassing its 1999 peak:
There is no signs of slowdown either. YouTube has recently announced it has surpassed 80 million music and premium subscribers globally and Spotify is projecting 11 million net new MAUs for Q1-2023, and 2 million net new premium subscribers. Not only subscribers are projected to continue to grow for all the streaming services, but prices are also increasing. This will directly result in higher revenues for the music labels. In addition, new revenue streams that are only at the development stage, like TikTok and Instagram Reels, will be another growth engine.
Overall, the music industry is in a hyper-growth stage, and no company other than UMG is better positioned to benefit from this trend.
Competitors & Multiple Analysis
The record label industry is dominated by an oligopoly of 3 companies which own a combined 83% of market share. UMG has 37.54% of the market, compared to Sony's 26.87% and WMG's 19.05%. Since Sony Music is only a segment in the huge Sony enterprise, the only comparable peer is WMG. Let's take a look at the numbers:
Company | Market Cap | Adj. P/E (2022) | EV/EBITDA (2022) | 4Yr Revenue Growth | EBITDA Margin (2022) |
Warner Music Group | $17.12B | 32.2 | 19.63 | 9.8% | 18.02% |
Universal Music Group* | €41.36B | 25.7 | 20.6 | 12.2% | 20.01% |
*P/E & EV/EBITDA are estimated. Data as of February 19th, 2023.
Even though UMG is a larger company in terms of sales, it's still able to grow faster than WMG. For the first 9 months of 2022, UMG generated €7.4B in revenues, which equal to a 23.6% increase YoY, whereas WMG generated sales of $4.3B, an 8.5% increase YoY. Overall, I find UMG's results to be superior. This is a showcase to the quality of UMG's current artist portfolio and its new-artist discovery and development capabilities.
Valuation & Near Term Expectations
I used a discounted cash flow methodology to evaluate UMG's fair value. I assume UMG will see revenues grow at a CAGR of 10.6% between 2022-2027, which is slightly higher than the company's long-term guidance of high single digit growth. I believe revenues will grow at this pace due to price increases of streaming services, an increase in total global subscribers, and the improvement of monetization in social media. I project EBITDA margins to increase incrementally up to 23.6% in 2027. While this is a 3-point increase compared to its 2022 margins, it is below the management's guidance of mid-twenties. I believe margins will improve due to better mix between physical and digital consumption, as well as a lower percentage of merchandising revenues.
Taking a WACC of 7.81%, I find UMG's fair value to equal €50.3B, which represents a 22% upside compared to its market value at the day of writing.
To check the reasonability of my result, I assign today's forward P/E multiple (25.7) to my 2024 EPS projection of €1.09. This results in a fair price per share of €28.0, which represents 20% upside compared to the current market price.
Regarding the H2-23 earnings release, which is due in the beginning of March, I expect UMG to report revenues of €5.7B and EBITDA of €1.1B, representing a 23.6% and 33.6% YoY increases, respectively. I am not forecasting EPS because of hard-to-predict volatility in UMG's equity portfolio, which could materially affect GAAP earnings. As of June 30th, 2022, UMG's equity portfolio had a carrying value of €636M and consisted of a 3.3% ownership stake in Spotify, and a 0.75% stake in Tencent Music Entertainment ( TME ).
Risks
On the macro-economic side, many investors are worried about less discretionary expenses from customers. I wouldn't worry too much about the influence of deteriorating economic conditions on the music industry:
Music has been proven to be extremely resilient in economic downturns. I've been through about 4 of them in terms of global headwinds on the macroeconomic side. And that excludes the piracy and file-sharing crisis. This team that we have here have managed those headwinds several times in the past. Music is a low-cost form of entertainment with what we consider incredible consumer value and we are monetizing content from more sources than ever before.
--- Lucian Graine, UMG's CEO, Q3-23 Earnings Call
In recent years, financial players, mainly private equities, have entered the music industry with some major headlining deals. While these do affect UMG's ability to purchase catalogs, those financial players are usually partnering with one of the major music companies in order to manage the catalog. As the leader of the industry, UMG is usually very aware of every potential deal, but the company's strategy is to be very selective regarding catalog acquisitions:
Now with regard to catalog acquisition, I mean, we have seen and we are likely to continue to see IP assets coming up for sale. But we're very, very selective in what we look at. We're only interested in the best of the best. We're only interested in those assets where we can control. And what I mean by that is that we are actually able to increase the monetization of those assets. I think we're smart and strategic in how we approach them.
--- Lucian Graine, UMG's CEO, Q3-23 Earnings Call
I would also point out that the value of those deals is actually a representation to the value of catalogs owned by UMG.
The last risk I would address is the growing strength of the artist. It could be argued that today, with social media, artists are able to monetize their music without the backing of a major music label. While that is true regarding small-market artists, in order to become a worldwide phenomenon, a music label backing is a must. The fact is social media, currently, is a major net positive for the music labels.
Conclusion
Universal Music Group is the leader of the music industry. It represents the best artists in the world, and owns the most renowned record labels. Music's share of people's time is constantly growing, and is now standing at 20.1 hours per week. Music as an industry is in a hyper-growth mode, and no company other than UMG is better positioned to capture the value of this trend. I find UMG to be trading 22% below its fair value, and project the March earning report will be excellent. For these reasons, I rate UMG as a Strong Buy.
For further details see:
Universal Music Group: Buy The Leader Of The Music Industry Ahead Of Earnings