What UMG’s IPO Means for the Business of Music

Finishing 2019 on $6.4 billion, Universal Music is to go to IPO hot on the heels of Warner Music’s announcement to do the same. This of course also follows the Tencent-led agreement to acquire 10% of UMG for $3 billion with an option to acquire another 10%. Added into the context of a total of $10 billion in music rights mergers and acquisitions (M&A) in the last decade, we have a clear case of capital flowing into the booming recorded and music publishing businesses. The global recorded music market looks set to have reached a little under $21 billion in 2019, up 10% on 2018 (MIDiA’s definitive market estimate will be ready within the next few weeks). That 10% growth was up on the 8% seen in 2018. Investors of all sizes are either already invested in the music business or are looking for a route in, and UMG just gave them a new, very attractive option. But where is all this heading? How far can it go? And what are the implications for the business of music itself?

Looking for a return

The power behind UMG parent Vivendi is Vincent Bolloré. Although he stepped down from the board last year, he helped instigate a share buyback programme that will leave his family the majority shareholder and could even trigger a mandatory takeover. Additionally, Vincent Bolloré remains as a ‘censor and special advisor’ to Vivendi’s chairman, his son Yannick. This all matters because the motivations of Vivendi’s prime mover are, according to investors we’ve spoken to, focused on maximisation of value for Bolloré Group and for investors. This is not inherently a bad thing. The Bolloré Group has invested billions in Vivendi, so it is only natural that it will be seeking a return on that investment. And the likelihood is that Vivendi will only list a minority of UMG stock, otherwise Vivendi – Bolloré Group’s key financial interest here – would most likely lose value.

Why an IPO?

The IPO announcement follows a previous statement from Vivendi that it would look for other equity buyers for UMG. The IPO may well reflect that this course of action has not delivered fruit. But this does not mean the IPO would struggle. Equity buyers may have balked at the valuation and the lack of company control they would acquire. Stock investors, however, have a different perspective. For example, asset managers will be looking to add a profile of asset class that slots into a particular segment of their portfolios. Meanwhile, hedge funds would see UMG stock as a way to directly bet for (and against) rights in the emerging ‘rights versus distribution’ investment thesis. Finally, publicly-traded stock inherently reflects what the market values a company at, not what the company values itself at.

Investing back into the music business

Sales and IPOs during the peak of markets are usually a good way of maximising return. The question is how much of the income from the equity sales and IPO will flow back into the UMG business, compared to profit taking by investors. The same question of course applies to Len Blavatnik’s Access Industries’ proposed WMG IPO.

In its earnings release Vivendi stated that the income from the various UMG transactions “could be used for substantial share buyback operations and acquisitions”. Share buyback suggests further potential consolidation of the Bolloré Group’s relative dominance of Vivendi shareholding, while acquisitions could refer to activity at both Vivendi and UMG levels. There is a strong case for IPO proceeds being reinvested in the businesses of both UMG and WMG. The music market is growing and both companies outperformed total market growth in 2019 – but a slowdown is coming. Both UMG and WMG added less new streaming revenue in 2019 than they did in 2018. Not by much, but the early signs are there.

Time for plan B, C and D

Emerging and mid-tier markets will drive much of the growth over the next half decade, but the lower average revenue per user (ARPU) rates mean that subscribers will grow faster than revenue. So, the record labels need a new revenue driver. UMG actually saw physical sales grow a little in 2019 (due in part to deluxe editions of Beatles classic releases). But physical is not going to be the long-term revenue driver. Innovating in new revenue streams (e.g. creator tools) and new business models (e.g. streaming services that monetise fandom rather than consumption) is more promising. There is an opportunity here for UMG and WMG to supercharge growth beyond the coming streaming slowdown. In fact, MIDiA would go further and say there is an imperative to do so. Larger independents such as Downtown Music Holdings, Kobalt, BMG and Concord are collectively taking billions worth of capital and investing it in growing their businesses. If the majors do not follow suit, then they will lose ground to this emerging generation of innovative music companies.

This is looking to be the time to capitalise on the music industry’s revenue renaissance. Which begs the question: if/when will Sony spin off some of Sony Music via an IPO?

Backing Both Horses: The Thinking Behind Tencent’s UMG Stake

As long expected, Tencent is poised to take a stake in Vivendi, reported to be 10%. While the news might not be surprising, there are a number of important factors at play:

• Tencent fast-tracked? Given that various entities stated their interest in investing in UMG, Vivendi appears to have fast-tracked Tencent. This might well be because Tencent showed the most appetite for paying a premium, and therefore Vivendi wanted to close the deal so as to create a price that subsequent bidders would have to work with.
• Betting on both horses: The investment community is increasingly viewing music as a battle between rights and distribution, with Spotify versus UMG as the publicly traded vehicles through which the contest can be backed. Tencent already secured around 5% of Spotify via its Tencent Music Entertainment subsidiary back in 2017, and it is now securing 10% in UMG. Tencent is backing both horses in the race.
• Investing within constraints: Back in 2016, concerned about capital flowing out of the country,Chinese authorities implemented restrictions on Chinese companies investing in overseas entities. This has compelled Tencent to focus on minority stakes rather than outright acquisitions. The UMG stake fits this investment framework.
• Outgrowing China: Tencent had a 74% market share of the Chinese music subscriptions market in Q2 2018. While growth in the market is solid, it is slowing. Tencent will recognize that there is only so much remaining near-term opportunity at home. Being a part of the global market is a way of ensuring it is not constrained by its domestic marketplace.
• Proxy wars: Back in 2018 I argued that Spotifyshould be wary of Tencent setting itself up as a competitor in markets where Spotify is not yet established (Russia, sub-Saharan Africa, some Asian markets etc). Tencent may still do this, and this may be part of the preparations, but for now ByteDance looks the most likely candidateto pursue this strategy.
• Look east:While streaming is giving an old industry new legs in the west, China’s music industry is effectively being built from scratch. As a consequence, it doesn’t have decades of irrelevant baggage. This is seen in China’s music apps. Western streaming is all about monetising consumption; China’s isabout monetising fandom. If the Western music industry was born today, it too would be putting social at its core. Many argue that apps like WeSing can only really work in China – but I remember people saying the same about mobile picture messaging when i-mode was getting going in Japan nearly 20 years ago. Just look at TikTok’s global success if you need any further convincing.

What the 2018 Success of the Beatles for UMG Tells Us About Where Streaming is Heading

Universal Music Group recorded an impressive €6 billion in revenue in 2018, bolstering a JP Morgan valuation of $50 billion. No doubt, UMG is enjoying a purple patch, riding and driving the wave of recorded music industry growth. But as with an any industry transition, progress is not linear and the past can have a lingering embrace. In UMG’s earnings report lies a small but crucial detail that point to the fact that the music industry’s path ahead may not be quite as straight as it first appears: the continued success of the Beatles.

The Beatles were UMG’s fourth best seller in 2018 

On page 13 of Vivendi’s year-end financial report, the Beatles’ ‘White Album’ is listed as UMG’s fourth best seller in 2018. It finished ahead of frontline artists including XXXTentacion, Migos and Ariane Grande. Above it were Drake’s ubiquitous ‘Scorpion’, Post Malone’s ‘Beerbongs & Bentleys’ and the soundtrack to ‘A Star is Born’. On the one hand this reflects the continued importance of the Beatles as a revenue driver for UMG. The Beatles, along with Abbey Road, were among the ‘crown jewels’ that UMG gained when it acquired EMI in 2012, so it is encouraging for UMG that the Beatles continue to deliver top tier revenue. However, Beatles revenue is not only a very different thing from Drake revenue, it also highlights the earnings divide between physical sales and streaming.

Streaming’s twin promise

The long-term promise of streaming is the combination of:

1. Delivering larger audiences
2. Replacing near-term, large volume revenue for a longer-term, annuity-like income model

Item number two happened very quickly; item number one is still in progress, but moving sufficiently enough to ensure many artists are now able to earn meaningful streaming income. However, we are not yet at our streaming destination, which is illustrated by the prominence of the Beatles in UMG’s 2018 sales. A ranking that owes little to streaming.

The Beatles are not a streaming powerhouse

According to the BPI, music from the 1960s accounted for just 3.6% of catalogue streams in the UK, which represents about 2% of all streams. Let’s assume the Beatles account for 40% of those streams – which is probably a generous assumption, this would mean the Beatles represented 0.8% of the $9.6 billion of streaming revenue in 2018, which translates as $79 million, which in turn equates to 2.7% of UMG’s 2018 streaming revenue. A meaningful amount for sure for a single artist, but not that significant in the greater streaming scheme of things. Therefore, the Beatles did not get to be UMG’s fourth biggest seller through streams. Instead, it did so through physical sales.

The main release in 2018 was the 50th Anniversary edition of the White Album. This premium physical release includes a $25 edition, right through to a $145 deluxe box set. With such high-unit prices, only small numbers need be sold to generate meaningful revenue.

To illustrate the point, let’s assume UMG collects around $15 of the $25 retail price and $100 of the $145 edition. To generate $7.5 million of label revenue, UMG would need to sell just half a million copies of the $25 edition and only 75,000 of the Boxsets. To generate the same $7.5 million from streaming UMG would need to have 62.5 million people each streaming 15 tracks from the album. $7.5 million is incidentally also roughly the amount a label would earn from selling a million copies of a standard priced album.

Streaming cannot yet match CD-era album revenue metrics

This gets to the heart of the matter of why streaming is creating, alongside a welcome growing body of middle-tier artists, a small handful of megastars. To replicate physical sales success, an artist must have exceptional streaming success. To replicate standout physical success requires as yet ungraspable streaming success.

For example, the number one album in the US in 2000 – NYSNC’s ‘No Strings Attached’ – sold over nine million copies, which would require 600 million people each streaming it all once — roughly 8.5 billion streams — to generate the same income. That is more streams than the entirety of Drake’s 2018 Spotify streams across the entire planet – Drake was Spotify’s most streamed artist. In short, streaming is currently large enough to make record labels grow, but not yet vast enough to create artist-level revenue on the same scale that that the CD peak once did.

Longer-term revenue may, or may not, add up.

The counter argument is that over a number of years the revenue will add up to the equal. But even with that assumption, an album would need to generate around a billion streams a year over eight years to replicate the success of NSYNC’s ‘No Strings Attached’. No easy task when you factor in the dynamics of streaming consumption i.e. playlists replacing albums, new music being pushed over catalogue etc.

None of this is to suggest that streaming is failing, nor that UMG’s revenues are in question. Both are doing well. Instead, it is evidence that we still have much distance to go with streaming before we can start seeing artist-level successes on a par with the peak of the industry. Though of course streaming-level success needs measuring differently than CD-era success, so these comparisons provide context rather than performance targets.

Will there ever be another Beatles’ greatest hits?

One intriguing post-script to all of this is that with download revenue falling by 15% in 2018, and physical by 7%, the days of large-scale album sales are long gone. When this is considered alongside the Beatles’ under-representation on streaming, the elephant in the room is whether UMG would ever risk releasing a Beatles greatest hits album for fear of underwhelming sales numbers damaging the Fab Four’s legacy. The last greatest hits was ‘1’ back in 2000 during the EMI years. Might it just be that UMG bought the Beatles too late ever to release their last ever greatest hits?

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.

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.

Taylor Swift, Label Services and What Comes Next

Taylor Swift has done it again, striking a deal with UMG that includes a commitment from the world’s largest label group to share proceeds from Spotify stock sales with artists, even if they are not recouped (ie haven’t generated enough revenue to have paid off the balance on their advance so not yet eligible to earn royalty income). This follows Swift’s 2015 move to persuade Apple to pay artists for Apple Music trials. That Swift has influence is clear, though whether she has that much influence is a different question. Let’s just say it served both Apple and Universal well to be seen to be listening to the voice of artists. But it is what appears to be a label services part of the deal that has the most profound long-term implications, with Swift stating that she is retaining ownership of her master recordings.

The rise of label services

The traditional label model of building large banks of copyrights and exploiting them is slowly being replaced, or at the very least complemented, by the rise of label services deals. In the former model the label retains ownership of the master recordings for the life time of the artist plus a period eg 70 years. In label services deals the label has an exclusive period for exploiting the rights, after which they revert to full ownership of the artist. Artist normally cede something in return, such as sharing costs. Companies like Kobalt’s AWAL and BMG Music Rights have led the charge of the label services movement. However, Cooking Vinyl can lay claim to being the ‘ice breaker’ with its pioneering 1993 label services deal with Billy Bragg, negotiated between his manager Pete Jenner and Cooking Vinyl boss Martin Goldschmidt. It may have taken a couple of decades, but the recording industry has finally caught up.

Major labels in on the act

The major labels remain the powerhouses of the recorded music business in part because they have learned to embrace and then supercharge innovation that comes out of the independent sector. Label services is no exception. Each of the major labels has their own label services division, including buying up independent ones. Label services are proving to be a crucial asset for major labels. The likes of AWAL and BMG have been mopping up established artists in the latter stages of their careers, with enough learned knowledge to want more control over their careers. By adding label services divisions the majors now have another set of options to present to artists. This enables them to not only hold onto more artists but also to win new ones – which if of course technically what UMG did with Swift, even though it had previously been Swift’s distributor. As with all new movements, examples are often few and far between but they are there. The UK’s Stormzy is a case in point, signing a label services deal with WMG before upgrading it to a JV deal between WMG’s Atlantic Records and his label #MERKY. For an interesting, if lengthy, take on why Stormzy and WMG took this approach – including the concept of secret ‘Mindie Deals’ that allow more underground artists maintain some major label distance for appearances’ sake, see this piece.

The early follower strategy 

In August 2018UMG’s Sir Lucian Grainge called out the success of UMG’s label services and distribution division Caroline, noting it had doubled its US market share over the previous year. UMG was already not only on the label services deal path but had identified it as a key growth area and wanted the world – including investors – to know. UMG has stayed ahead of the pack by pursuing an early follow strategy of identifying new trends, testing them out and then throwing its weight behind them. Before you think of that as damning with faint praise, the early follower strategy is the one pursued by the world’s most successful companies. Google wasn’t the first search engine, Apple wasn’t the first smartphone maker, Facebook wasn’t the first social network, Amazon wasn’t the first online retailer.

What comes next

The label services component of the UMG deal was actually announced by Taylor Swift herself rather than UMG, writing:

“It’s also incredibly exciting to know that I own all of my master recordings that I make from now on. It’s really important to me to see eye to eye with a label regarding the future of our industry.”

While this might betray which party feels most positive about this component of the deal, the inescapable fact is that other major artists at the peak of their powers will now want similar deals. Label services success stories to date had been older artists such as Rick Astley, Janet Jacksonand Nick Cave as well as upcoming artists like Stormzy. Now we will start to see them becoming far more commonplace in the mainstream.

But perhaps now is the time. Catalogue revenues are going to undergo big change in the coming years, as MIDiA identified in our June 2018 report The Outlook for Music Catalogue: Streaming Changes Everything. Deep catalogue is not where the action is anymore. For example, 1960s tracks accounted for just 6.4% of all UK catalogue streams in the UK in 2017, while catalogue from the 2000s accounted for 60.4%, according to the BPI’s invaluable All About the Music report. So, by striking a long-term label services type deal, UMG secures Swift’s signature and can still benefit from the main catalogue opportunity for the first few releases without actually owning the catalogue.

Label services have come a long way since Billy Bragg’s 1993 deal and Taylor Swift has just announced that they are ready for prime time.

Penny for the thoughts of Bill Bragg having paved the way for the queen of pop’s latest deal….

Could Spotify Buy Universal?

Vivendi is reported to be proposing to its board a plan for spinning out Universal Music. It is certainly the right time for a spin off (always sell before the peak), but a full divestment would leave Vivendi unbalanced and a shell of its former self. Canal+ is facing the same Netflix-inspired cord-cutting pains as other pay-TV operators (and is relying heavily on sub-Saharan Africa for subscriber growth), while other assets such as those in Vivendi Village have failed to deliver. With CEO Vincent Bolloré having invested heavily in Vivendi, he would be devaluing his own wealth. For a man who is not shy of saying that he’s in the game to make money, this scenario simply doesn’t add up. As one investment specialist recently suggested to me, this talk of a spin-off is probably exactly that, talk. Talk aimed at driving up Vivendi’s valuation by association and, at most, potentially resulting in a partial spin-off or partial listing. However, it is not beyond the realms of possibility that a big enough offer for Universal would persuade Bolloré to sell. So, let’s for a moment assume that Universal is on the market and have a little fun with who could buy it.

The Chinese option

It is widely rumoured that Alibaba was in advanced discussions with Vivendi to buy some size of stake in Universal. Those conversations derailed when the Chinese government tightened up regulations on Chinese companies buying overseas assets, which is why we now see Tencent buying a growing number of minority stakes in companies rather than outright acquisitions. So, an outright Chinese acquisition is likely off the table. This doesn’t rule out other Asian bidders (Softbank had an $8.5 billion bid rejected in 2013), though perhaps Chinese companies are the only ones with the requisite scale and access to cash that would meet a far, far higher 2018 price point.

The tech major option

The most likely scenario (if Universal were for sale) is that one of the tech majors (Apple, Alphabet, Amazon, Facebook) swoops in. Given Google’s long-held antipathy for the traditional copyright regime, Alphabet is not the most likely, while Facebook is too early in its music journey (though check back in 18 months if all goes well). Apple and Amazon are different cases entirely. Both companies are run by teams of older executives whose formative cultural reference points were shaped by traditional media companies. These are companies that, even if they may not state it, see themselves as the natural evolution of media, moving it from the physical era of transactions to the digital era of access. Thus far, Apple and Amazon have focused principally on distribution, although both have invested in rights too. Apple less so, (e.g. Frank Ocean, Chance the Rapper) but Amazon much more so (e.g. Man in the High Castle, Manchester by the Sea). Acquiring a major media company is a logical next step for Amazon. A TV studio and, or network would likely be the first move (especially as Netflix will likely buy one first, forcing Amazon’s hand), but a record label wouldn’t be inconceivable. And it would have to be a big label – such as UMG, that would guarantee enough share of ear to generate ROI. Apple though, could well buy a sports league, which would use up its budget.

The Spotify option

While the tech majors are more likely long-term buyers of Universal, Spotify arguably needs it more (and is certainly less distracted by other media formats). Right now, Spotify has a prisoner’s dilemma; it knows it needs to make disruptive changes to its business model if it is going to create the step change investors clearly want (look at what happened to Spotify’s stock price despite an impressive enough set of Q1 results). But it also knows that making such changes too quickly could result in labels pulling content, which would destroy its present in the hope of building a future. Meanwhile, labels are worried Spotify is going to disintermediate them but can’t risk damaging their business by withdrawing content now – hence the prisoner’s dilemma. Neither side dares make the first move.

That’s the problem with the ‘do a Netflix’ argument: do it too fast and the whole edifice comes tumbling down. Moreover, original content will not be the same silver bullet for Spotify as it was for Netflix. This is mainly because there is a far smaller catalogue of TV content than music, so a dollar spent on original video goes a lot further than a dollar spent on original music. It is not beyond the realm of possibility that Spotify will get to a tipping point, where the labels see a shiny-toothed wolf lurking under the lamb’s wool, and with its cover blown it will be forced to go nuclear. If this happened, buying a major label would become an option. And, as with the tech majors, it would have to be a major label to deliver enough share of ear.

But that scenario is a long, long way off. First, Spotify has to prove it can be successful and generate enough revenue and market cap to put itself in a position where it could buy a major. And that is still far from a clear path. For now, Spotify’s focus is on being a partner to the labels, not a parent company.

All of this talk might sound outlandish but it was not so long ago that an internet company (AOL) co-owned Warner Music and a drinks company (Seagram) owned Universal Music, before selling it to a water utilities company (Vivendi), and, long before that, EMI was owned by a light bulb company (Thorn Electrical Industries). We have got used to this current period of corporate stability for the major record labels, but this situation is a reflection of the recorded music business being in such a poor state that there was little M&A interest. Nonetheless it is all changing, potentially heralding a return to the past. Everything has happened before and will happen again.

What’s In A Number: Can Streaming Really Be Worth $28 Billion?

Goldman Sachs just made some headlines with its assessment that Universal Music is worth $23.5 billion and that the paid streaming market will be worth $28 billion in 2030 (up from $3.5 billion in 2016 and close to double the size of the entire recorded music business in 2016). For a little bit of perspective, the entire recorded music business generated $27.4 billion at its peak in 1996. Goldman Sachs’ numbers provide us with a salutary reminder of the risk that comes with taking a short-sighted view when building forecasts, or, to put it another way, predicting tomorrow based on what happened today.

Regular readers will know that I have been a music industry analyst since the end of the 1990s, witnessing enough industry cycles and getting close enough to business to build a deep understanding of the industry and its potential. As anyone involved in the business knows, the recorded music industry is more complex and more idiosyncratic than most other industries. Predicting its future is complicated by three factors:

• Market concentration: Three companies (UMG, SME and WMG) control the majority of revenues, and four companies (Alphabet, Amazon, Apple and Spotify) control the majority of the streaming market. Such concentration of power makes for an unpredictable market that can be reshaped by the decision of one company. For example, if HBO decided it was going to move out of streaming for good, Netflix would still be a viable business. Spotify though, would not if Universal made the same decision.

• Scarcity is gone: When Napster launched in May 1999 it threw scarcity out of the window. Until then, music had been a scarce commodity. Scarcity was the foundation upon which the glory days of the business was built. Unless you bought a CD, you had no other way of getting a high quality copy of the music. Nearly 20 years on from Napster, P2P may have faded but YouTube and Soundcloud have met the now-permanent demand for free music. Even if Safe Harbour legislation gets tightened up and YouTube scaled down, on demand free music will remain. The illegal sector will sprout a YouTube replacement in an instant. $27.4 billion in 1996 was a scarcity high-water mark.
• $9.99 is not a mass market price point: 9.99 is more than most people spend on music. In fact, it is what the top 10% of music buyers spend in the US and in the UK. Once the first two waves of adopters (early adopters and early followers) have been converted to subscriptions, growth will slow unless pricing changes. We are already seeing this happening in mature markets. More than 90% of the opportunity has been tapped in Sweden, while across the US, UK, Canada and Australia paid streaming growth has slowed over the last three quarters. So much of the subscriber growth Apple and Spotify have been reporting is coming from other, often emerging, markets. Eventually the 9.99 (or local currency and purchasing power parity equivalent) opportunity will be tapped there too. In 2016, 106 million subscribers drove $3.5 billion of growth, which translated into an annual ARPU of $32.79. Taking this as our anchor point (and ignore the fact streaming ARPU has actually been declining) then Goldman Sachs’ $28 billion would require 853 million paid subscribers. If we factor in emerging markets having much lower ARPU and driving much of the growth, the figure would be closer to one billion paid subscribers. Even with the most radical price point innovation it takes quite a leap of faith to support one billion subscribers.
• The world changes: It is very easy to think of tomorrow as being a bigger, shinier version of today. But things change, fast. Streaming is the driver now, but if it still is by 2030 then that will be a serious failure of innovation. When I first saw the Goldman Sachs numbers they reminded me of a similar report put out back in 1999 by another financial institution when the music business was last in vogue among that sector. It was a 130 page report called the Music and The Internet: A Celestial Jukebox and it predicted that online CD sales and downloads would be the future of the music market, because that was what the emerging market was then. It too had uber bullish predictions, claiming that the European music business alone would be worth $12 billion by 2010. It in fact reached $7.7 billion and in 2016 was $6.9 billion. With no little irony, the company that wrote the report was—Lehman Brothers. Look where they are now.

Conflicts of Interest

There is one final important factor to consider regarding both Lehman Brothers and Goldman Sachs. In fact, it is probably the most important thing of all: conflicts of interest.

Lehman Brothers made money from buying and selling shares in the companies they wrote about. Goldman Sachs is the same. On its disclosures page there are no fewer than six items listed by Goldman Sachs’  for UMG’s parent company Vivendi. These include owning a substantial volume of Vivendi shares and providing investment banking services to the company. So, if Vivendi’s share price goes up as a result of Goldman Sachs’ report, Goldman Sachs’ Vivendi investment gains value. If Vivendi sells a stake in UMG at a price influenced by Goldman Sachs new valuation, Goldman Sachs will earn a bigger transaction fee if it provides the banking services. A Goldman Sachs hedge fund also has shares in Spotify while another division is helping Spotify prepare for its IPO. So, if Spotify’s IPO/direct listing is boosted by Goldman Sachs’ report, Goldman Sachs’ Spotify investment gains value and it earns a bigger fee for the listing.

No financial institution with a vested interest (unless its interest is betting against a company – which also happens­) is going to provide a cautious or skeptical view of the streaming market. It would go against its own interests to do so. But everyone likes big numbers, so big numbers do the rounds.

For the sake of utter transparency, MIDiA Research has among its research subscription client base both UMG and Spotify, along with the other majors, indies, the other streaming services, tech companies and telcos. In fact, anyone and virtually everyone of note in the streaming business is a MIDiA subscription client. But, unlike an investment bank, they pay to access our research because we tell them what they need to hear not what they want to hear. That can make the client-analyst relationship uncomfortable and tricky to navigate at times but I wouldn’t have it any other way. Nineteen years ago, I wouldn’t have put my name to research like Lehman Brothers’— nor would I do so today.

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 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.

 

 

What Frank Ocean’s Bombastic Blond Moment Tells Us About The Future Of Artists And Labels

When Frank Ocean’s latest album ‘Blond’ dropped, it did so like a nuclear bomb, sending shockwaves throughout the music industry. In one of the audacious release strategies of recent years Ocean and his team at 360 fulfilled the final album contractual commitment to Universal Music by ushering his breaking-the-mold visual album ‘Endless’ onto Apple Music.  Featuring collaborations from the likes of Sampha and James Blake and set as a loose soundtrack to art house visuals, ‘Endless’ looked like the sort of digitally native, creative masterstroke that would win plaudits and awards in equal measure. But no sooner had Universal executives started daydreaming about Grammys then along came what turned out to be the ‘actual’ album ‘Blonde’, self released by Ocean (Universal contractual commitments now of course conveniently fulfilled) and, for now at least, exclusively available on Apple Music. You can just imagine seeing the blood drain from (Universal CEO) Lucian Grainge’s face as the full magnitude of what had just happened came into focus. In truth ‘audacious’ doesn’t even come close to explaining what Ocean pulled off, but where it gets really interesting is what this means for the future of artist careers.

Artist-Label Relationships Are Changing

Quickly sensing the potential implications, Grainge swiftly sent out a memo to Universal staff outlawing streaming exclusives…though voices from within Universal suggest that this diktat had been in the works for some time . A cynic might even argue that it was politically useful for Universal to be seen to be taking a strong stand ahead of the impending Vivendi earnings call. As the ever excellent Tim Ingham points out, in practice Universal could put a streaming exclusives moratorium in place and still have a good number of its front line artists put out streaming exclusives. This is because many of the deals these artists have are not traditional label deals where Universal owns all the rights. And that itself is as telling as Ocean’s bombastic blond moment. Not so much that Universal is probably the major with the highest amount of its revenue accounted for by licensed and distributed works, but that any label’s roster is now a complex and diverse mix of deal types. Artists are more empowered than ever before, and thanks to the innovation of label services companies and next generation music companies like Kobalt, labels have been forced to steal the disruptors’ clothing in order to remain competitive.

Streaming Exclusives Represent Another Option For Artists

Just as labels had started to successfully co-opt the label services marketplace by launching their own – e.g. Universal’s Caroline – or by buying up the competition – e.g. Sony’s acquisition of Essential Music & Marketing – along come streaming services giving artists another non-label route to market. In truth, the threat has remained largely unrealised. Exclusives on Tidal have most often proved to be laced with caveats and get out clauses (e.g. Beyonce’s ‘Lemonade’ arriving on iTunes 24 hours after landing ‘exclusively’ on Tidal). Chance The Rapper’s (in name only) mixtape ‘Colouring Book’ and Ocean’s ‘Blond’ are exceptions rather than the rule. So all that’s about to change now right? Not necessarily…

Album Releases Require More Time Than Apple Probably Has

As anyone who works in a label will tell you, releasing an album is typically a long, carefully planned process with many moving parts. It’s not something you do in a couple of weeks (Ocean started building the hype and expectation for his latest opus a year ago). If, for example, Apple was going to start doing exclusives routinely, even if it just did 20, that’s still a new exclusive to push every 2 weeks. That might work, at a stretch, for music service retailing promotional pushes but is far short of a fully fledged album release cycle. Which means that even for just 20 exclusives Apple would have an intricate mesh of overlapping release campaigns. This is something that labels do with their eyes closed but would it require new organizational disciplines for Apple. Not impossible, but not wholly likely either.

In practice, exclusives are likely to be limited to being the crown jewels of streaming services, their most valuable players, creative playmakers if you like. Even for Netflix, that pioneering exemplar of the streaming originals strategy, only spends 15% of its $3 billion content budget on originals and probably won’t break 20% even by 2020. What Apple and Netflix have in common is that they are using exclusives as a customer acquisition strategy, achieving their aims by making a big noise about each one. But if you’re releasing exclusives every week or two the shine soon wears off. And suddenly the return on investment diminishes.

Streaming Exclusives Are Unlikely To Turn Into A Flood

None of this means that we won’t see more artists striking streaming exclusives. We will, regardless of what labels may actually want to happen. And most of those will probably be on Apple – the service with bottomless pits masquerading as pockets. But the trickle will not turn into a flood, a fast flowing stream perhaps (see what I did there) but not a torrent.

Although they might not realise it yet, Kobalt might find themselves hurting more than the majors from this latest twist in the Exclusives Wars. Kobalt has probably done more than any single other music company to drive change in the traditional music industry in the last 5 years, showing artists and songwriters that there is another way of doing things. But Frank Ocean has just shown that there is now new another option for established artists looking for options at the end of a label deal.

Most importantly of all though, is that streaming exclusives (and indeed label services deals) work best when an artist has already established a brand and an audience. Most often that means after an artist has had a record label recording career. Apple cannot be relied upon to build anything more than a handful of artist brands. One of the founding myths of the web was that it was going to do away with labels and other traditional ‘gatekeepers’. Now, decades later, labels still account for the vast, vast, vast majority of music listening. Make no mistake, a momentous value chain shift is taking place, with more power and autonomy shifting to the creators, but that is a long journey and ‘Blond’ is but one part of this much bigger shift.