Just Who Would Buy Universal Music?

Vivendi continues to look for a buyer for a portion of Universal Music. Though the process has been running officially since May 2018, the transaction (or transactions) may not close until 2020. In many instances, dragging out a sale could reflect badly, suggesting that the seller is struggling to find suitable buyers. But in the case of UMG it probably helps the case. A seller will always seek to maximise the sale price of a company, which means selling as close to the peak as possible. It is a delicate balance, sell too early and you reduce your potential earnings, sell too late and the price can go down as most buyers want a booming business, not a slowing business. In the case of UMG, with institutional investors looking for a way into the booming recorded music business, UMG is pretty much the only game in town for large scale, global institutional investors.

In this sellers’ market, banks have been falling over themselves to say just how valuable UMG could be, with valuations ranging from $22 billion to $33 billionand Vivendi even suggesting $40 billion. Meanwhile, recorded music revenues continue to grow — up 9.0% in 2017, and up 8.2% in 2018 according to MIDiA’s estimates. 2019 will likely be up a further 6%, all driven by streaming. With UMG’s market share (on a distribution base) relatively stable, the market growth thus increases UMG’s valuation. This in turn increases Vivendi’s perceived value, and that is the crux of the matter.

The role of Bolloré Group

Vivendi board member and major shareholder Vincent Bolloré was Vivendi chairman until April 2018, when he handed power to his son Yannick, one month before he was reportedly taken into police custody for questioning as part of an investigation into allegations of corrupt business practices in Africa. Bolloré senior remains the chairman and CEO of Bolloré Group, which retains major shareholdings in Vivendi. Bolloré Group’s Vivendi holdings will inherently be devalued by a sale of prize asset UMG, which is a key reason why only a portion of the music group is up for sale. But, even selling a portion of UMG will have a negative impact on Vivendi’s valuation and thus also on Bolloré Group’s holdings. So, the sale price needs to be high enough to ensure that Bolloré Group makes enough money from the sale to offset any fall in valuation. Hence, dragging out the sale while the streaming market continues to boom. All this also means the sale is of key benefit to Bolloré Group and other Vivendi investors. It is perhaps as welcome as a hole in the head to UMG. Little wonder that some are suggesting UMG is markedly less enthusiastic about this deal than Vivendi is.

vivendi umg potential buyers

All of which brings us onto which company could buy a share of UMG. These can be grouped into the four key segments shown in the chart above. Normally, higher risk buyers (i.e. those that could negatively impact UMG’s business by damaging relationships with partners etc.) would not be serious contenders but as this is a Vivendi / Bolloré Group driven process rather than a UMG driven one, the appetite for risk will be higher. This is because the primary focus is on near-term revenue generation rather than long-term strategic vision. Both are part of the mix, but the former trumps the latter. Nonetheless, the higher-risk strategic buyers are unlikely to be serious contenders. Allowing a tech major to own a share of UMG would create seismic ripples across the music business, as would a sale to Spotify.

Financial investors

So that leaves us with the lower-risk strategic buyers, and both categories of financial buyers. Let’s look at the financial buyers first. Private equity (PE) is one of the more likely segments. We only need to look back at WMG, which was bought by a group of investors including THL and Providence Equity before selling to Len Blavatnik’s Access Industries in 2011 for $3.3 billion. Private equity companies take many different forms these days, with a wider range of investment theses than was the case a decade ago. But the underlying principle remains selling for multiples of what was paid. Put crudely, buy and then flip. The WMG investors put in around half a billion into the company, but a six-fold increase is less likely for UMG, as the transaction is taking place in a bull market while WMG was bought by Providence and co in a bear market. Where the risk comes in for UMG is to whom the PE company/companies would sell to in the future. At that stage, one of the current high-risk strategic companies could become a potential buyer, which would be a future challenge for UMG. The other complication regarding PE companies is that many would want a controlling stake for an investment that could number in the tens of billions.

Institutional investors such as pension funds are the safest option, as they would be looking for long-term stakes in low-risk, high-yield companies to add to their long-term investment portfolios. This would also enable Vivendi to divide and rule, distributing share ownership across a mix of funds, thus not ceding as much block voting power as it would with PE companies.

Strategic investors

The last group of potential buyers is also the most interesting: lower risk strategic. These are mainly holding companies that are building portfolios of related companies. Liberty Media is one of the key options, with holdings in Live Nation, Saavn, SiriusXM, Pandora, Formula 1 Racing and MLB team Atlanta Braves. Not only would UMG fill a gap in that portfolio, Liberty has gone on record stating it would be interested in buying into UMG.

Access Industries is the one that really catches the eye though. Alongside WMG, the Access portfolio includes Perform, Deezer and First Access Entertainment. On the surface Access might appear to be a problematic buyer as it owns WMG. But compared to many other potential investors, it is clearly committed to music and media, and is likely to have a strategic vision that is more aligned with UMG’s than many other potential suitors.

There is of course the possibility of being blocked by regulators on anti-competitive grounds. However, at year end 2017 WMG had an 18% market share, while UMG had 29.7% (both on a distribution basis). If Access acquired 25% of UMG, respective market shares would change to 25.4% for WMG and UMG for 22.2% (still slightly ahead of Sony on 22.1%). It would mean that the market would actually be less consolidated as the market share of the leading label (WMG) would be smaller than UMG’s current market leading share. While the likes of IMPALA would have a lot to say about such a deal, there is nonetheless a glimmer of regulatory hope for Access. Especially when you consider the continued growth of independents and Artists Direct. All of which point to a market that is becoming less, not more, consolidated.

The time is now

Whatever the final outcome, Bolloré Group and Vivendi are currently in the driving seat, but they should not take too much time. 2019 will likely see a streaming growth slowdown in big developed streaming markets such as the US and UK, and it is not yet clear whether later stage major markets Germany and Japan will grow quick enough to offset that slowdown in 2019. So now is the time to act.

The Three Eras Of Paid Streaming

Streaming has driven such a revenue renaissance within the major record labels that the financial markets are now falling over themselves to work out where they can invest in the market, and indeed whether they should. For large financial institutions, there are not many companies that are big enough to be worth investing in. Vivendi is pretty much it. Some have positions in Sony, but as the music division is a smaller part of Sony’s overall business than it is for Vivendi, a position in Sony is only an indirect position in the music business.

The other bet of course is Spotify. With demand exceeding supply these look like good times to be on the sell side of music stocks, though it is worth noting that some hedge funds are also exploring betting against both Vivendi and Spotify. Nonetheless, the likely outcome is that there will be a flurry of activity around big music company stocks, with streaming as the fuel in the engine. With this in mind it is worth contextualizing where streaming is right now and where it fits within the longer term evolution of the market.

the 3 eras of streaming

The evolution of paid streaming can be segmented into three key phases:

  1. Market Entry: This is when streaming was getting going and desktop is still a big part of the streaming experience. Only a small minority of users paid and those that did were tech savvy, music aficionados. As such they skewed young-ish male and very much towards music super fans. These were people who liked to dive deep into music discovery, investing time and effort to search out cool new music, and whose tastes typically skewed towards indie artists. It meant that both indie artists and back catalogue over indexed in the early days of streaming. Because so many of these early adopters had previously been high spending music buyers, streaming revenue growth being smaller than the decline of legacy formats emerged as the dominant trend. $40 a month consumers were becoming $9.99 a month consumers.
  2. Surge: This is the ongoing and present phase. This is the inflection point on the s-curve, where more numerous early followers adopt. The rapid revenue and subscriber growth will continue for the remainder of 2017 and much of 2018. The demographics are shifting, with gender distribution roughly even, but there is a very strong focus on 25-35 year olds who value paid streaming for the ability to listen to music on their phone whenever and wherever they are. Curation and playlists have become more important in order to help serve the needs of these more mainstream users—still strong music fans— but not quite the train spotter obsessives that drive phase one. A growing number of these users are increasing their monthly spend up to $9.99, helping ensure streaming drives market level growth.
  3. Maturation: As with all technology trends, the phases overlap. We are already part way into phase three: the maturing of the market. With saturation among the 25-35 year-old music super fans on the horizon in many western markets, the next wave of adoption will be driven by widening out the base either side of the 25-35 year-old heartland. This means converting the fast growing adoption among Gen Z with new products such as unbundled playlists. At the other end of the age equation, it means converting older consumers— audiences for whom listening to music on the go on smartphones is only part (or even none) of their music listening behaviour. Car technologies such as interactive dashboards and home technologies such as Amazon’s echo will be key to unlocking these consumers. Lean back experiences will become even more important than they are now with voice and AI (personalizing with context of time, place and personal habits) becoming key.

It has been a great 18 months for streaming and strong growth lies ahead in the near term that will require little more effort than ‘more of the same’. But beyond that, for western markets, new, more nuanced approaches will be required. In some markets such as Sweden, where more than 90% of the paid opportunity has already been tapped, we need this phase three approach right now. Alongside all this, many emerging markets are only just edging towards phase 2. What is crucial for rights holders and streaming services alike is not to slacken on the necessary western market innovation if growth from emerging markets starts delivering major scale. Simplicity of product offering got us to where we are but a more sophisticated approach is needed for the next era of paid streaming.

NOTE: I’m going on summer vacation so this will be the last post from me for a couple of weeks.