By Seerat Sandhu (Scripps College), Udhaav Jhunjhunwala (Singapore Management University), Chirag Gupta (NYU Stern)
Overview of the Deal
Warner Music Group (WMG), a global player in the music industry, made its stock market debut in early June by raising $1.93 billion at a value of $12.75 billion through the sale of 77 million shares priced at $25 each. The IPO was priced towards the high end of the range with an initial proposal to sell 70 million shares between $23-$26. In a rather unusual occurrence for an IPO, the listing consists entirely of the shares owned by existing investors which means that WMG will not receive any of the proceeds from the IPO.
The offering, which was initially announced in February, was delayed due to the coronavirus and comes after Universal Music Group, the world’s largest record label, was valued at $33 billion last year when Tencent bought a minority stake in it. The IPO gives WMG the ability to pursue further acquisitions using its publicly traded stock as they look to expand their portfolio. Morgan Stanley, Credit Suisse and Goldman Sachs were lead underwriters for the IPO.
Macroeconomic Trends
With the coronavirus pandemic impacting markets across the world, Q2 2020 saw a sharp decline in IPO activity. Globally, the number of listings in Q2 2020 was down 39% from Q2 2019 at 186 compared to 306. This was despite a flurry of deals in June after a sharp downturn in April and May, which saw a 48% decline in the number of listings compared to April and May 2019. The proceeds raised from IPOs tell a similar story, with Q2 proceeds down 32% as compared to the prior year on a global level. In contrast to the rest of the world, proceeds raised from IPOs in Asia were up 28% in Q2 2020 on the back of big-ticket listings in Hong Kong such as JD.com and NetEase.
Goldman Sachs’ “Music in the Air” 2020 report predicts that global music revenue will fall by close to 25% in 2020 driven largely by a 75% drop in revenue from live music. The report also predicts that the music publishing and recorded music sectors (WMG’s primary revenue streams) will still grow in comparison to 2019, albeit at a much slower pace than earlier predicted. They predict the record industry to generate $20.8 billion in 2020, a 3% increase from the $20.2 billion generated in 2019. Goldman also predicts that music publishing revenues will be resilient at $6 billion, up 3.5% from 2019, given the diversified revenue streams due to the rise of online streaming services.
Given that WMG’s business is likely to not be adversely affected by the coronavirus, and the market recovery that followed the depressed IPO activity in Q2 2020, WMG seems to have chosen an opportune time to go public.
Company Details
The record label conglomerate Warner Music Group (WMG) is the third-largest player in the global music industry. The music giant owns and operates some of the most successful labels in more than 50 countries worldwide. The company was publicly traded on the New York Stock Exchange from 2005 to 2011 until it's privatization through a sale to Access Industries. The company’s IPO in 2020 turns it into a public company yet again, albeit on the Nasdaq this time.
Founded: 1958
Headquartered: 1633 Broadway, New York City, United States
CEO: Stephen Cooper
Number of Employees: 5,400
Market Cap: $14.8 billion
EV: $17.66 billion
Revenue: $4.46 billion
EBITDA: $125 million
Table 1: Current Capital Structure of WMG (Capital IQ)
IPO Details of Warner Music Group
Warner Music Group (WMG) went public on June 3 2020 raising $1.93 billion at a market capitalization of $12.75 billion through the sale of 77 million shares priced at $25 each. The initially proposed offering by the bookrunners was between $23-$26 for 70 million shares.
In an unusual offering, all of the shares were sold by Access Industries and other shareholders allowing them to partially exit their investments from when they had taken the company private 9 years ago. This also means that none of the capital raised through the offering will go to the company’s accounts.
The existing shareholders, led by billionaire Len Blavatnik’s Access Industries, will retain 99% of the voting power through a separate class of stock. As per the SEC filing, the company insiders will hold Class B shares which have 20 times more voting power than each Class A share being issued through the IPO. This means that the company would be classified as a “controlled company” and would be exempt from certain corporate governance rules that public companies need to follow. For example, WMG will not need to have a majority of independent directors on the board or have independent nomination or compensation committees. This would allow the company to continue operating with the same governance structure as earlier, eliminating the need to restructure.
Figure 1: WMG Share Price Chart (Capital IQ)
On June 3 2020, WMG started trading at $27 and closed on the day at a price of $30.12, 20% above the IPO price of $25, suggesting a healthy appetite for its shares and a well-priced IPO. In the three months that the stock has been trading on the Nasdaq, the price has stayed steady between a low of $27.82 on 22 July and a high of $32.86 on June 19. The relatively tight trading range, especially in the current volatile market environment, indicates that the market has a consensus on WMG’s valuation.
Projections and Assumptions
Why was this deal done?
The Warner Music Group’s June listing marks the largest IPO in the US in 2020 (up to the date of listing). The issuance can be seen as the company’s effort to cash in on the streaming boom with a listing that has valued the company at $12.75 billion. The IPO has also been regarded as a possible valuation strategy with previous rumours of a Middle Eastern Investment Group’s interests in buying the company. Under such a strategy, the stock issuance can be regarded as the company’s tactic to help set pricing.
Although the music publishing industry has been relatively insulated from the effects of the pandemic, it hasn’t emerged unscathed. Goldman Sachs, in a report, projected a 25% drop in revenue because of the pandemic’s effects on live music events. Hence, the issuance can also be regarded as the company’s effort to emerge stronger post-pandemic.
Short-term Analysis
Warner, which generates its major revenues from its unchanging music catalogue, is in a relatively safe place in terms of dealing with the effects of the COVID-19 pandemic in the short-run. Despite this, the company has still been facing the spillover effects of the pandemic. It reported a net loss of $74 million in the second quarter ending March 31 compared to a $67 million profit during the same period in the previous year. The company could further lose physical revenue streams through its interest in live tours, merchandising and delays in releases of new recordings and licensing of its TV content.
In order to survive in a post-pandemic market, Warner has to devise alternative methods of generating revenue. The company has a history of making strategic investments that extend its capabilities. The recent appointment of Trenton Harrison-Lewis as SVP artist and Label Development Facilitator for WMUK is a step in this direction. Trenton’s unparalleled talent development skills and history of spearheading major trends will help the company benefit by helping establish new artists. Such alliances will help the company nurture new and upcoming talent while simultaneously facilitating innovation in a post-pandemic world.
Long-term Analysis
According to the Record Industry Association of America, streaming services make up to 80% of retail sales revenue in the United States. Warner’s recorded music streaming grew at a CAGR of 42% and increased as a percentage of total music revenues to 52% in 2018 from 24% in fiscal 2015. Through a long-term lens, the music label conglomerate is well-positioned to benefit from a growth in streaming services. The company adopts an innovation-focused operating strategy with a special emphasis on hiring songwriters and recording artists in genres such as hip-hop and pop which are popular among streaming platforms. In terms of future growth, the company aims to tap into paid streaming services in markets such as the United States, Japan, Germany, the United Kingdom and France, where paid subscriber levels are low.
Warner Music Group has been expanding its global footprint by investing in local talent such as independent recording businesses, music publishing houses, artists and catalogues across borders. More than half of the companies $4 billion in revenues is generated from markets outside of the United States. The company seeks to continue to drive maximum impact by partnering with local players and expanding their reach. The company’s deal with Nigerian Label Chocolate City in 2019 was one such action. Warner is taking recruitment measures to widen its reach in Asia and Australia. Other growth strategies of the company include targeting less mature markets such as China and Brazil, which have large populations and opportunities.
The company has a track record of investing in emerging technologies such as Apple, Mixcloud, SoundCloud and Peloton. WMG’s strategic alliance with the premier interactive media company Interlude has enabled the company to produce an impressive music portfolio including Coldplay's “Ink” and Damon Albarn’s “Heavy Seas of Love”. WMG intends to continue extending its technological reach by entering into strategic partnerships with new and upcoming digital partners in the future.
Financial Ratio Analysis
Table 2: Financial Ratios of WMG (Capital IQ)
The last few years have seen increasing Return on Assets and Return on Capital, signifying a more efficient use of its resources. LTM performance is poor due to the impact of COVID-19
EBITDA/Interest Expense has almost doubled from 2.5x in 2015 to 4.4x in 2019 in a healthy sign for the company. This increases the potential headroom to take on debt in the future to pursue opportunities for growth
The Quick Ratio has increased from 0.3x in 2015 to 0.5x at the end of Q2 2020. This suggests an improvement in the liquidity condition, but at the same time, there is further room for improvement in the Quick and Current Ratios.
The Altman Z-score has improved from a poor score of 0.21 in 2015 to a score of 1.63 as of Q2 2020. Again, there is room for further improvement on this metric
Risks and Uncertainties
WMG’s primary source of revenue comes from recorded music, i.e. the production and subsequent distribution of music. Over the past two decades, the nature of the recorded music industry has significantly changed. In 2019, 56% of recorded music revenue came via streaming services while physical music sales declined by 5.3% year on year to about 22% of total revenue. Looking at the bigger picture, WMG was able to attract and retain top talents in the past due to their huge distribution network through which artists could reach millions of people. With the advent of streaming services, artists might no longer need to rely on companies like WMG to reach their audience. Emerging record companies like AWAL and Downtown Music Holdings which utilize a data and technology-driven approach, are becoming increasingly popular with upcoming artists.
In FY 2019, 27% of WMG’s revenue came from Apple and Spotify, underscoring how reliant the music industry is on streaming companies. The rapid rise in streaming has seen the balance of power shift in the industry. With the widespread reach of streaming companies, they are able to influence the industry on multiple fronts - by being able to negotiate cheaper licensing deals, reducing revenue for companies like WMG and by influencing what kind of music is consumed on their platforms through tweaking their playlist and recommendation algorithms. There have not yet been any instances where streaming services have favoured certain artists or record labels. However, it is fathomable that in the future, streaming services sign artists on to their own private labels and then push their music towards consumers.
The music industry has been disrupted by the emergence of streaming services and new age record labels completely transforming how music is consumed and distributed. This has forced incumbents like WMG to evolve and adapt their business models. While WMG has managed to successfully grow at a stellar rate, they must continue to innovate and stay ahead of the competition, especially now with the added pressure of being a public company.
“For the rest of the fiscal year, we’re focused on delivering robust results and managing our costs carefully”
Eric Levin, Warner Music Group Executive Vice President and CFO