New CEO Kyncl Should Drive Emerging Platform Growth at Warner Music Group; Maintaining $36 FVE 

Senior Equity Analyst

Neil Macker

Warner Music Group is the third largest of the three major global record labels, with Vivendi’s Universal Music in first and Sony Music in second. Like its larger peers, Warner increasingly depends on streaming. Streaming services delivered 54% of total recording segment revenue in fiscal 2020, up from 30% in fiscal 2016. This percentage actually understates the overall impact of streaming, as Warner Music does not break out the streaming portion of publishing revenue separately.

We project that overall streaming revenue for the recorded music industry will grow 22% annually from 2019 until 2025, driven by a number of factors, including our forecast that the number of paid streaming music subscribers will double to over 800 million. The increase will be powered by the continued adoption of mobile data plans, smartphones, and slightly increased penetration against the growing base of LTE/5G subscribers. Other drivers include price increases for streaming services, growing ad revenue as advertisers continue to shift their ad spending toward digital, and revenue growth at ad-supported services in emerging markets based on both the number of impressions but also pricing per impression as listener density increases.

While Warner will benefit from the growth of streaming, we think that revenue from both digital downloads and physical media will continue to decline, albeit at a slower pace for physical. We think the growing adoption of streaming will continue to hit digital downloads harder than physical sales, where a core, though shrinking, base of loyal listeners remains. We believe that streaming will continue to replace the purchase of digital singles for most consumers, as the newest songs can be listened to on the major streaming services at the same time or even before they’re available for download.

Despite strong projected growth in overall recorded music, we expect that A&R, or artists and repertoire, will only decline slightly as a percentage of revenue. A&R cost will to continue to grow in absolute terms as Warner will continue to invest in finding and developing new artists even as it sees more competition from its larger peers.

Business Strategy & Outlook

We assign Warner Music a narrow moat rating derived from intangible assets. The firm is the third largest and only pure play of the three major global record labels. Modern music generally contains two copyrights: The first covers the sound recording itself (known as the master), and the second covers the underlying composition, which includes the lyrics and the musical composition. At Warner, the recorded music segment deals with the sound recording, and the publishing arm monetizes the composition and lyrics copyrights. 

The music industry has been massively affected by the increasingly ubiquitous reach of the internet over the past 25 years. Recorded music was one of the first industries to be hit by the growth in internet penetration and the almost concurrent rise of digital piracy. As a result, the industry shrank from revenue of $23.4 billion in 2001 to $14.8 billion in 2010, according to the International Federation of the Phonographic Industry, as the slow growth in digital download sales was nowhere close to enough to offset the rapid drop in physical media sales. The industry continued to decline over the next four years, bottoming at $14 billion of revenue in 2014.

Thanks to consumers of all ages adopting streaming via both general media sites like YouTube and music-specific platforms like Spotify, the music recording industry has enjoyed five years of growth since 2014, with global revenue crossing the $20 billion mark in 2019, a level last seen in 2004, according to the IFPI. While the internet has also democratized the ability to directly record, distribute, and market music for artists, most of the money in the recorded music ecosystem still flows through record labels. The three major labels still take most of the revenue, with a 68% share of $21.5 billion generated in 2019, according to Midia Research. 

The growth of streaming platforms like Spotify benefits the major labels like Warner Music for both its recorded music and publishing segments. In the U.S., Spotify and its peers pay royalties for both the recording (master) and the composition (digital performance when not selected and mechanical when user selected) unlike terrestrial radio, which only pays a performance royalty to the composition copyright-holder. This means the recording artist, songwriter, composer, and of course, the holders of the master (record label) and composition (publisher) all share in the royalty revenue from one song. While the actual royalty calculations for streaming revenue are complicated, the major labels generally have global payout rates with the largest music-specific platforms of 60% of 70% of revenue. The split is done on a market share basis between labels and then by individual songs to determine the royalty split at the master/composition level. 

Given this variable nature of streaming-related revenue, major labels like Warner are well positioned to benefit from increased streaming penetration and revenue from increased ad and subscription pricing. While the deals between the labels and streaming platforms are relatively short at three years on average, the most recent round of deals between Warner, Spotify, and Apple Music in 2020 didn’t see any changes to royalty rates. The growth of nonmusic listening, like podcasts, could decrease the importance of music and thus payout ratio, but we believe that most users will listen to both podcast and music, much like time has always been split between music, news, and talk radio historically. Additionally, if Spotify could increase stickiness via podcasts, the firm would also likely be able to increase subscription costs, which offset some or most of the market share/mindshare losses on Spotify.

On the recorded music side, labels discover, develop, and market artists and their music, which generally includes marketing, distributing, licensing, and selling the recordings created by the signed artists. Many recording artists fail to gain traction in a competitive marketplace with or without the help of a major label. This high level of failure and the required upfront investment by labels means that artists generally get a low percentage of royalties, 10%-15%, with more-established artists garnering high rates in their later contracts. 

Record contracts with artists can take on many different forms, but the two of the most common are the standard record deal and the 360 deal. The standard record deal was most common before the rise of digital music and was structured based on a number of albums, generally five, with only the first one guaranteed for new artists. The label provides advances on royalties and a production and promotion budget. 

With the rise of digital downloads and streaming, 360 deals are now signed more often. In a 360 deal, the label can receive a percentage of multiple revenue sources, including digital, physical media, artist rights like touring, sponsorships, ticketing, and merchandising, and licensing of music. The majors view these new sources like artist rights and licensing as growth drivers to offset the ongoing decline in physical media. At Warner, for example, artist rights more than doubled to $629 million in 2019 from $301 million in 2015, while physical media dropped to $559 million from $767 million over the same period.

The three majors are better capitalized than independent labels and thus can invest more resources into the scouting and development of A&R. Part of this advantage is the financial ability to take more risks on new talent. But other resources, like development teams and coaches, production facilities, other talent with cross-promotion potential, and marketing teams are stronger at the labels than elsewhere. Amplification of an artist and her works is an important piece of standing out in the massive flood of content that is put on the market daily. In the current always-on world, the ability to have a large number people and resources devoted to a wide range of artists helps the major labels attract new talent. 

The majors also benefit from a diversified portfolio of artists versus minor labels, which not only have much smaller rosters but also tend to focus on a genre or subgenre of music. In contrast, the three majors have talent from across the world and can relatively easily pivot into a new genre when it becomes popular or even beforehand.

While independent labels have beaten the majors to finding and developing high-profile artists over the last 30 years, many of the most famous labels have either closed shop or been subsumed by the majors, like Sub Pop (Nirvana) by Warner or Def Jam (Run-DMC) by Universal. Additionally, the long track record of the majors in helping to develop and maintain massive superstars is highly appealing to many artists at the beginning of their careers. This intangible asset also helps the majors sign artists away from healthy independent labels even if the artist is on the cusp of stardom or already there. 

The internet, along with cheap and widely available digital tools, has made it much easier for artists to directly record/produce, distribute, and market music to consumers. However, this benefit has produced a deluge of songs, making it more difficult for any single artist to stand out. While minor labels could help these artists, the majors provide amplification along with larger budgets, access to other talent, and development tools. Even some of the independent artists who made it out of the morass via a massive viral hit have signed with major labels, including Lil Nas X of “Old Country Road” fame, who signed with Columbia Records (Sony), and Danny Ocean, the singer-songwriter behind “Me Rehuso,” who joined Atlantic Record (Warner).

The publishing arm focuses on the underlying compositions instead of the artists. For example, Warner Chappell, one of the largest music publishers, does not necessarily hold the rights to every composition recorded and released by Warner Music. However, the publishing arm owns the rights to numerous songs and entire catalogs written and composed by artists on other labels. Warner Chappell generates revenue via royalties paid for five usage categories: performance of live or broadcast versions of a song; digital for streaming or downloads; mechanical for physical media; synchronization for use in filmed media, video games, or merchandising; and other for sheet music and other publishing. Given the smaller investment in scouting and development, and lower overall risk, music publishers generally take a much smaller cut of the royalties than their recorded music siblings, spanning from as high as 50% for newer songwriters to 25% for major established ones to 5% for simple copyright registration and administration.

Music copyrights have generally been upheld and even strengthened by regulatory and judiciary bodies in most of the largest music markets, including the U.S., Japan, and Europe. In the U.S., the Copyright Royalty Board in 2018 significantly raised the royalty rates paid to publishers through 2022. The European Union passed a directive in 2019 that safeguards the right of copyright-holders and artists to be fairly compensated for the use of their recording and compositions when uploaded to user-generated content sites like YouTube. Given the relative unpopularity of large technology firms like Google and Apple, we expect that copyright law with respect to music will continue to rule in favor rightsholders and artists.

Narrow

Economic Moat

Warner Music Group

Warner Music Group Corp. engages in the publishing and recording of music. It operates through the Recorded Music and Music Publishing segments. The Recorded Music segment is involved in the sale, marketing, distribution, and licensing of recorded music produced by the company's recording artists. The Music Publishing segment acts as a copyright owner and/or administrator of the musical compositions and generates revenues related to the exploitation of musical compositions. The company was founded on November 21, 2003 and is headquartered in New York, NY.

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NEW YORK, May 15, 2023 (GLOBE NEWSWIRE) -- Warner Music Group Corp. (“Warner Music Group” or “WMG”) announced today that Eric Levin, Executive Vice President and Chief Financial Officer, will participate in a question and answer session during the J.P. Morgan 51st Annual Global Technology, Media and Communications Conference on Monday, May 22nd, at 11:20am ET.

Warner Music Group Corp. to Participate in J.P. Morgan Global Technology, Media and Communications Conference

Warner Music Group Corp. (NASDAQ:WMG ) Q2 2023 Earnings Conference Call May 9, 2023 8:30 PM ET Company Participants Kareem Chin - Head of IR Robert Kyncl - CEO Eric Levin - CFO Conference Call Participants Michael Morris - Guggenheim Securities Ben Swinburne - Morgan Stanley Sebastiano Petti - JPMorgan Benjamin Black - Deutsche Bank Rich Greenfield - LightShed Partners Stephen Laszczyk - Goldman Sachs Matthew Thornton - Truist Securities Tim Nollen - Macquarie Operator Welcome to Warner Music Group's Second Quarter Earnings Call for the period ended March 31, 2023. At the request of Warner Music Group, today's call is being recorded for replay purposes.

Warner Music Group Corp. (WMG) Q2 2023 Earnings Call Transcript

NEW YORK, May 12, 2023 (GLOBE NEWSWIRE) -- Warner Music Group Corp. (“Warner Music Group” or “WMG”) today announced that its Board of Directors declared a regular quarterly cash dividend of $0.16 per share on WMG's Class A Common Stock and Class B Common Stock. The dividend is payable on June 1, 2023, to stockholders of record as of the close of business on May 23, 2023.

Warner Music Group Corp. Announces Quarterly Cash Dividend

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Warner Music Group shares were trading downwards on Tuesday morning after its fiscal 2Q earnings came in well below estimates. The firm reported quarterly earnings of $0.06 per share compared to earnings of $0.18 per share a year ago, missing the $0.20 per share figure pegged by Zacks.

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Shares of Warner Music Group Corp. WMG, +3.37% rose 2.0% in premarket trading Tuesday, after the music recorder and publisher reported fiscal second-quarter revenue that rose above expectations, amid strong growth in music publishing streaming revenue. Net income for the quarter to March 31 fell to $34 million, or 6 cents a share, from $92 million, or 18 cents a share, in the year-ago period.

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Financial Highlights Underlying Growth in Recorded Music Streaming Revenue Despite a Challenged Macroeconomic Environment Continued Momentum in Music Publishing Drives Double-Digit Revenue Growth Adjusted OIBDA Growth and Margin Improvement Underpinned by Financial Discipline Cost Savings to be Reinvested in Tech-Focused Initiatives and Expertise to Drive Long-Term Growth For the three months ended March 31, 2023 Total revenue increased 2% or 5% in constant currency Digital revenue increased 1% or 4% in constant currency Net income was $37 million versus $92 million in the prior-year quarter OIBDA decreased 19% to $207 million versus $255 million in the prior-year quarter or 16% in constant currency Adjusted OIBDA increased 4% to $286 million versus $274 million in the prior-year quarter or 8% in constant currency Cash from operating activities decreased 114% to a use of $6 million versus a source of $44 million in the prior-year quarter NEW YORK, May 09, 2023 (GLOBE NEWSWIRE) -- Warner Music Group Corp. today announced its second-quarter financial results for the period ended March 31, 2023. “With continued momentum in music publishing, and a more robust schedule that includes the return of worldwide superstars and new artists breaking globally, we are optimistic about the second half of the year,” said Robert Kyncl, CEO, Warner Music Group.

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NEW YORK, April 27, 2023 (GLOBE NEWSWIRE) -- Warner Music Group Corp. (Nasdaq: WMG) today announced the election of Val Blavatnik to the company's Board of Directors, as well as his appointment to its Executive Committee. He replaces Alex Blavatnik, who has served as a director of WMG since July 2011, when Access Industries completed its acquisition of the company.

Val Blavatnik Elected to Warner Music Group Board of Directors

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NEW YORK, April 17, 2023 (GLOBE NEWSWIRE) -- Warner Music Group Corp. will release its financial results on Tuesday, May 9, 2023, for the second quarter ended March 31, 2023, and will hold an earnings conference call that morning at 8:30 a.m. ET.

Warner Music Group Corp. To Conduct Earnings Conference Call On Tuesday, May 9, 2023

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Warner Music Group Corp. WMG on Wednesday said it planned to cut about 270 jobs, or around 4% of its overall workforce, with most of them to be completed by the end of the company's next fiscal quarter. Robert Kyncl, the music entertainment giant's chief executive, said in a note to employees that “new business models are constantly emerging,” and that the company was “positioning itself for this new phase of growth at the intersection of creativity and technology.

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Warner Music Group to Cut 4% of Workforce

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NEW YORK, March 01, 2023 (GLOBE NEWSWIRE) -- Warner Music Group Corp. (“Warner Music Group” or “WMG”) announced today that Robert Kyncl, Chief Executive Officer, will participate in a question and answer session during the Morgan Stanley Technology, Media & Telecom Conference on Wednesday, March 8th, at 2:40pm PT.

Warner Music Group Corp. to Participate in Morgan Stanley Technology, Media & Telecom Conference

NEW YORK, Feb. 22, 2023 (GLOBE NEWSWIRE) -- Warner Music Group Corp. (“Warner Music Group” or “WMG”) announced today that Eric Levin, Executive Vice President and Chief Financial Officer, will participate in a question and answer session during the Deutsche Bank 31st Annual Media, Internet & Telecom Conference on Tuesday, February 28th, at 10:30 a.m. ET.

Warner Music Group Corp. to Participate in Deutsche Bank's Media, Internet & Telecom Conference

Celebration Launched At Grammy® House In Los Angeles Partnerships Announced With Dolby, LGND Music, New York Red Bulls, Peloton, And Vinyl Me, Please, With More To Be Introduced In Coming Weeks Watch The Trailer For Hip-Hop Fifty Now Keep Up To Date At Newly Launched HipHopFifty.com Listen To Official Hip-Hop Fifty Playlist Now LOS ANGELES , Feb. 15, 2023 /PRNewswire/ -- Warner Music Group (Nasdaq: WMG) is excited to announce the launch of Hip-Hop Fifty, a yearlong, global celebration of the groundbreaking genre that turned the world on its head during the last half century. The far-reaching Hip-Hop Fifty campaign will bring together the worlds of art, fashion, sports, and more to honor every facet of America's most popular musical genre.

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NEW YORK, Feb. 10, 2023 (GLOBE NEWSWIRE) -- Warner Music Group Corp. (“Warner Music Group” or “WMG”) today announced that its Board of Directors declared a regular quarterly cash dividend of $0.16 per share on WMG's Class A Common Stock and Class B Common Stock. The dividend is payable on March 1, 2023, to stockholders of record as of the close of business on February 21, 2023.

Warner Music Group Corp. Announces Quarterly Cash Dividend

Warner Music Group Corp. (NASDAQ:WMG ) Q1 2023 Earnings Conference Call February 9, 2023 8:30 AM ET Company Participants Kareem Chin - Head of IR Robert Kyncl - CEO Eric Levin - CFO Conference Call Participants Benjamin Black - Deutsche Bank Sebastiano Petti - JPMorgan Benjamin Swinburne - Morgan Stanley Rich Greenfield - LightShed Partners Matthew Thornton - Truist Securities Michael Morris - Guggenheim Partners Kutgun Maral - RBC Capital Markets Stephen Laszczyk - Goldman Sachs Operator Welcome to Warner Music Group's First Quarter Earnings Call for the Period Ended December 31, 2022. At the request of Warner Music Group, today's call is being recorded for replay purposes and if you object, you may disconnect at any time.

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