Stock pitch: Warner Music Group
The recorded music industry is dominated by three major labels that have a 68% market
share. One of which, Warner Music Group (WMG), went public in 2020 and is an equity
that I believe is worth adding to any portfolio.
WMG has a focus on hip-hop and other youth-oriented genres that include artists such as
Lizzo and Zach Bryan. Additionally, WMG owns a massive back catalogue that includes
legacy acts such as the Red Hot Chili Peppers and others that generate large amounts of
passive income. Since streaming accounted for 63% of WMG’s total revenue in 2022, the
estimate of WMG’s continued growth is largely based around the assumption that A.
music streaming will continue to grow, B. that the streaming economy and access to data
has allowed WMG to become less reliant on artist development and C. that recorded
music is resistant to economic downturn.
One of the big reasons for the increase in recorded music revenue is due to international
expansion. At the time of writing this, roughly 1/3 of songs on the Spotify top 50 chart
are by artists from developing or non-traditional music markets. This is partly due to the
continued adoption of smartphones and data access in developing markets, which has led
to more music streaming in those territories. Many DSPs (digital streaming platforms)
have also started experimenting with price hikes in developed markets and introduced
lower priced plans in developing markets. As a result, Morningstar predicts streaming
revenue will continue to grow by 17% YOY until 2027, while Yahoo Finance predicts
16% growth.
WMG will also continue to increase revenue by buying, acquiring, and developing new
artists. However, with Warner’s access to data and proprietary algorithms, WMG has less
pressure to take “bets” on artists and can more easily acquire the rights to songs and
artists that are already gaining traction. This reduces their risk substantially and will
decrease Warner’s reliance on developing talent, which is a cost-intensive business
model. I believe many stock analysts are undervaluing the significance of Warner’s
changing business model.
Economic Moat
WMG has created a strong economic moat because of the collusion with DSPs such as
Spotify, which allows it to have preferential treatment with DSPs. As a result, WMG’s
only real competitors are the two other major labels (Sony and Universal). No
independent labels currently appear to have a shot at competing with WMG.
Technical analysis
WMG has shown consistent revenue growth and had a 25% return on capital to
shareholders over the last three years. Additionally WMG, has an ROCE of 16%, which
is a relatively normal return, but is much better than the 10% standard for the
entertainment industry.
WMG song vs. SPY
Another component that I don’t believe has been accurately priced in is that Warner’s
primary source of revenue (royalties from streaming) is resistant to economic downturn.
To illustrate this, I have included a chart below that shows the daily Spotify stream count
of Mike Mago’s hit dance track and Warner Music release “Otherside” against SPY
returns throughout 2021. 2021 was a period of massive volatility for the stock market, but
the stream count (and therefore the royalties paid out to WMG) were quite consistent.
Note: The stream count of the song is decreasing, but this is very normal. Song streams
usually decline ~20% to 30% annually regardless of economic conditions.
Volatility
While Warner has been volatile, this is in part because it has only been a publicly traded
company for about three years, so a lot of the early volatility was based on fear and
uncertainty. For example, one of the major selloffs came after a change in the executive
team, even though Warner surpassed earnings estimates that same quarter. As time
progresses, I expect volatility to decrease, which may be appealing to investors and lead
to price increases.
Possible threats
One of the main threats to WMG is the possible rise in music piracy and the treat of
another “Napster-like” collapse of the music industry. Multiple “stream-ripping” websites
do exist but they seem to have little appeal because DSP subscription prices are already
very reasonable and provide a curated user experience that other sites cannot. I believe
many analysts are overstating the likelihood of another Napster-like collapse.
Summary + takeaways
Overall, Warner Music Group is a well-rounded company that pays out solid dividends,
has a ton of intrinsic value in the form of IP, has consistently increased revenue year over
year, and has many future growth opportunities that will increase profits.