When Vivendi rejected an $8.5bn offer from SoftBank to buy Universal Music Group in 2013, industry analysts and executives were baffled.
The French group turned down a price that was $2bn to $3bn more than analysts’ valuations of Universal. Hammered by piracy brought on by the advent of the internet, music revenues had shrunk every year for more than a decade — and no turnround was in sight.
Eight years later, the contrarian bet by Vivendi and its controlling shareholder, French billionaire Vincent Bolloré, looks brilliant.
On Tuesday, the group will spin out 60 per cent of Universal, listing it on the Euronext Amsterdam exchange. The prospectus gives Universal an indicative valuation of €33bn, but analysts believe it is worth much more — JPMorgan puts it at €54bn.
Each Vivendi shareholder will get one share of the newly independent company. Bolloré Group will own 18 per cent and Vivendi will hold 10 per cent.
There are no official lock-ups for the major shareholders, but Vivendi has committed not to sell any shares for two years and analysts expect a period of stability.
The music industry has staged a dramatic comeback since streaming services began funnelling billions of dollars to its biggest companies — Universal Music, Sony Music and Warner Music — who hold the copyrights to most of the world’s songs.
Their owners have taken notice. Leonard Blavatnik, Warner Music’s billionaire controlling shareholder, took the third-largest music company public last year. His net worth jumped by $7.5bn on the first day of trading, Bloomberg has estimated.
Bolloré and Vivendi have also been cashing in. Vivendi has sold a third of Universal since 2019 for about €9bn, first selling 20 per cent to a Tencent-led consortium at a €30bn valuation in 2019 and 2020 then selling a 10 per cent stake to Bill Ackman’s hedge fund Pershing Square at a €35bn valuation in 2021.
The deals have also transformed the wealth of Lucian Grainge, Universal’s chief executive. He received €17m for negotiating the Tencent deal and is due to get a $150m bonus for the listing.
The case for these deals is obvious. Recorded music sales, which bottomed out at $14bn in 2014, have accelerated to hit $21bn in 2020, according to the International Federation of the Phonographic Industry (IFPI) data. Streaming makes up most of that revenue, growing to $13.4bn in 2020, up 20 per cent year on year.
Global sales are still below their 1999 peak, but investors are starting to forget the Napster and iTunes era when piracy was rampant and CD sales slumped.
However, the valuations of the three dominant label groups had not really been repriced to match this growth. Universal and Sony Music were lodged within larger French and Japanese conglomerates, while Warner Music had been privately controlled by Blavatnik’s Access Industries. Investors could not easily bet on music’s renaissance.
Spotify’s stock market listing in 2018 changed that, but the Swedish company sells subscriptions to music — not the music itself. Public offerings from two of the big three label groups provide a clearer sense of how far the industry has come.
“No big master recording catalogue has changed hands [since EMI in 2012],” said one senior music executive. “There hasn’t been a chance to reset value based on where streaming has taken it.”
Investors dance as the music plays on
Wall Street analysts are salivating over Universal. JPMorgan called the company “an extraordinary asset”, predicting that its €54bn valuation “will prove conservative”. UBS noted Universal’s “irreplaceable” catalogue, valuing it at €45bn. Bank of America has valued Universal at €50bn — a 30 per cent premium to Warner Music.
The euphoria is based on a simple premise: as more people pay for streaming on apps such as Spotify, the value of music rights will grow. And Universal is the world’s largest owner of music rights.
The California-based group controlled 36 per cent of the recorded music market in 2020, according to the IFPI. Its roster includes The Beatles, Kendrick Lamar, Taylor Swift and Olivia Rodrigo. All of last year’s top 10 selling artists were signed to Universal.
Record labels now make money primarily by collecting royalties from tech companies. Spotify and Apple Music pay out more than two-thirds of every dollar earned to music rights holders. In recent years, Universal has also struck deals with social media apps such as TikTok and Facebook as well as fitness groups such as Peloton, which pay to use songs on their platforms.
This model is more profitable than the CD era because Universal no longer has to spend money on physical distribution. Profit margins climbed from 16 per cent in 2018 to 20 per cent in 2020. It has forecast annual revenue growth in the “high single digits” and earnings before interest, tax, depreciation and amortisation margins in the “mid-twenties” in the coming years.
Music executives also argue that streaming makes their revenues more predictable and less dependent on scoring hit albums.
“Music is now a utility . . . everyone’s happy to pay their $10 a month,” said Merck Mercuriadis, head of the acquisitive Hipgnosis Songs Fund that has gobbled up song catalogues in recent years at frothy prices. “I think Universal will end up being a $100bn company in a very, very short order,” he added.
However, per-capita music spending remains below its peak in the US, according to JPMorgan. In 1999, recorded music revenue per capita was $81 on an inflation-adjusted basis, well above the $37 spent last year.
Almost half of Universal’s recorded music revenue comes from music that is less than three years old, meaning that it must continue investing in finding new talent.
Universal’s revenue jumped from €6bn in 2018 to €7.4bn in 2020. However, it also spent €2.5bn on catalogue acquisitions and artist advances during the year, including re-signing stars such as Taylor Swift and paying more than $300m to buy Bob Dylan’s songwriting catalogue.
Will the streaming dream sour?
The big question is: why the race to list now? Sceptics say these deals are an admission that valuations are at their peak and music owners hope to cash in before investor enthusiasm putters out.
Guy Hands, the private equity executive behind a disastrous buyout of EMI in the late 2000s, praises Universal’s turnround but adds: “I can’t believe anybody could have expected the prices to get to the level of today. Anyone sensible would certainly reduce their exposure.”
Some analysts warn of risks to Universal’s future growth as emerging markets become bigger drivers of the streaming market.
With more established streaming markets such as Sweden reaching saturation, music companies are looking to India, China and other populous, low- and middle-income countries to add new subscriptions. China is the world’s seventh-largest music market by revenue, but analysts forecast that it will crack the top five and perhaps eventually the top three. However, subscribers pay far less to stream in these regions, dragging down the average revenue earned per user.
These markets are centred around local acts. Universal has been investing in developing talent to wade in, striking joint ventures in China with Tencent, for example. However, “betting on China is a dicey proposition”, warned Bill Werde, the former Billboard magazine editor who now directs a music programme at Syracuse University.
“The entirety of what’s being sold to potential investors in the music industry right now is the belief in the global future of streaming music,” he said. “That’s not entirely wrong but it’s also more fraught than most people understand.”
There is also a nagging fear that the internet will spur more artists to bypass record companies. The share of Spotify streams captured by the dominant labels and Merlin, a group representing indie labels, has been declining, from 87 per cent in 2017 to 78 per cent in 2020.
For now, Wall Street has brushed off this concern. “While a small group of top artists may potentially bypass music companies by going direct to the consumer, doing so at scale and on a lasting basis remains a daunting exercise,” said Société Générale analysts.
When asked by the Financial Times whether the music market had reached a peak in this cycle, Grainge unsurprisingly dismissed the notion. The company was making money from new sources, he argued, such as video gaming, fitness apps and social media companies.
“I’ve been through two recessions and two downturns. I know what can go wrong,” he said. “We’re just opening up new areas of monetisation that we couldn’t even predict before.”