UMG: Business Breakdowns ResearchBy: Robin Chab

Primary Research Sources • Prospectus

(transaction bits no longer relevant but still a source of good info on UMG� • $PSTH / $UMG Presentation

 • Historical Audited Financials

 • Capital Markets Day Presentation

Company History & Key PeopleThe origins of Universal Music Group �UMG� date back to 1934, with the foundation of an American branch of UK-based Decca Records. American Decca acquired Universal Pictures in 1952, and merged with MCA, a media company, in 1962. The combined entity would go on to absorb and acquire several smaller record labels over the following decades.

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In 1995, Canadian drinks distributor Seagram acquired a controlling stake in MCA. The company would subsequently be renamed to Universal Studios, with its music division being branded as “Universal Music Group”, a name first used in December 1996.

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Seagram’s entertainment assets were sold to Vivendi in 2000. Vivendi sold Universal’s theme parks and other entertainment assets to GE in 2004, but crucially kept UMG within their stable.

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UMG signed its first multi-year licensing agreement with Spotify in 2011. Though difficult to envision at the time, it would be the growth of the streaming sector that would revive UMG’s fortunes after several years of secular decline in the music industry following its 1999 peak.

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Across the broader industry, revenues declined approximately 63% from 1999 to 2011, primarily due to the ease of music piracy. Many labels struggled and were forced to re-structure while several smaller labels failed outright and were bought up by the majors.

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�Source: )RIAA/Chartr

In 2012, UMG acquired the music assets of EMI, at the time one of the Big Four record labels, after years of mounting losses at EMI. This was a big boon for UMG which already controlled an extensive catalog of music featuring superstar artists such as Bon Jovi, Lady Gaga, U2, Eminem and Kanye West. In the acquisition they acquired the major works of acts including the Beatles, Pink Floyd, Radiohead, Coldplay and the Beach Boys.

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UMG went public on September 21, 2021 in a de-merger from Vivendi, who retain a 10% stake in the new entity. Other major shareholders of note are Tencent Holdings �20%�, Bolloré Group �18%�, and Pershing Square Holdings �10%�. The spin-off allowed for the realization of the considerable value within UMG, and a reduction of the conglomerate discount applied to Vivendi’s share price.

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UMG was initially set to go public via merger with $PSTH, a Bill Ackman-led SPAC, but the deal collapsed in July 2021 after the SEC raised concerns over its complexity and structure.

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UMG is currently trading on the Euronext Amsterdam exchange, with plans to explore a dual-listing on the Nasdaq or NYSE over the coming 18 months.

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Key People

The current CEO & Chairman is Sir Lucian Grainge, who joined the company in 1986 and has been CEO since 2010. The company’s valuation has increased approximately eightfold since Grange took over as CEO.

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Jody Gerson is Chairman & CEO of Universal Music Publishing Group, its music publishing arm. She has been working in the music business for four decades.

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UMG’s CFO & COO is Boyd Muir, another well-respected music industry veteran. •

Business Model & Secret Sauce

The Business ModelUMG is a music label that operates two main divisions: recorded music and music publishing. The former deals with sound recordings (also sometimes called a master), which is the actual final studio recording that is heard, while the latter deals with compositions – the lyrics and melody of a song that has been written. One composition can have multiple different sound recordings created from it. This is a distinction that is critical to understanding UMG’s business.

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�Source: )Sleepwell Capital article is a great resource that gets into the weeds of the complexities and differences between the twoThis

It operates an oligopoly alongside Warner Music Group �WMG� and Sony Music Entertainment �SME� � who between them control about 70% of the recorded music (globally a $23.1 billion market in 2020� and publishing markets.

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UMGs Recorded Music Business

UMG has the #1 global market share �32%� in recorded music, with a portfolio of over 3 million songs. •UMG’s recorded music business comprises 80% of its revenues and is all about the discovery, development and marketing of artists and their content. It encompasses finding and signing the most talented artists, financing the production of sound recordings, and then distributing (digitally and physically), promoting and marketing these.

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In exchange for discovering and developing the artist, UMG secures the exclusive rights to their master recordings. UMG earns a royalty whenever one of these is sold (physical albums, vinyl, digital downloads) or consumed via streaming.

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There is a large suite of labels under the UMG umbrella, many of which have been acquired or spun up to fill specific niches. Some of UMG’s biggest labels are household names such as Interscope, Republic, Capitol and Def Jam. These labels are granted a high degree of autonomy and for the most part can freely compete with each other to attract talent.

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�Source: )FT

UMG counts several of the world’s biggest and most popular artists among its stable, including Taylor Swift, Drake, Billie Eilish, Eminem, Lady Gaga and Post Malone. In 2020, UMG artists occupied 4 out of the top 5 spots on Spotify’s year-end most streamed artists ranking. This success in turn helps to bolster UMG’s brand and attract new, fresh talent.

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UMGs Music Publishing Business

UMG’s publishing division �UMPG� is an IP business that focuses on acquiring and licensing the rights to compositions. UMPG administers these rights, licensing compositions for use in video games, movies, advertisements, master recordings (and even elevators), receiving a royalty in the process.

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There is big money in this � UMPG spent $300m in December 2020 to acquire publishing rights to Bob Dylan’s entire back catalog of 600 songs.

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Publishing makes up 16% of UMG’s revenue and it is the second biggest owner of compositions globally �23% market share), behind SME.

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The third legacy component of UMG’s business is merchandising – licensed artist merchandise available at concerts, physical retail stores and online – which represents about 4% of revenue.

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UMG has a global footprint, operating businesses in over 60 countries and its music is listened to all around the world.

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FinancialsUMG is in a strong financial position, with revenues, profits and margins all growing – a trajectory that is underpinned by the shift of the music industry from physical to digital distribution.

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Streaming & subscriptions represented 52% of UMG’s revenue �3.8 billion EUR� in 2020, up from 19% in 2015 �954 million EUR�.

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Streaming revenue is higher quality and more likely to be recurring. UMG is now more resilient and less susceptible to downturns in business and consumer behavior during times of economic weakness, as evidenced by revenue growing by 5% in 2020 despite the COVID-induced collapse of live music.

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�Source: )UMG

The resurgence of concerts, festivals and live performances following worldwide post-COVID re-opening should prove to be a minor tailwind for UMG and help buoy its figures over the next 18 months.

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UMG’s streaming partners aggregate listening/viewing hours by artist in order to allocate them to the label, and UMG uses this data to pass through the share to the artists themselves.

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For each $1 earned by a digital streaming provider, it retains approximately 30 cents to cover its operating costs, with the remaining 70 cents going to the label. Out of this remainder, the label keeps �70% while the rest is split approximately equally between the artist and songwriter.

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�Source: )Matthew Ball

The strong growth in the industry has expanded the size of the revenue pool, allowing it to increase its royalty payouts to artists while at the same time increasing its own profits.

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UMG do not break out their cost of revenues in detail but this metric includes royalty shares paid out to artists and songwriters, “artists and repertoire” expenses (the cost of identifying and developing artists), production and distribution costs. Gross margins are relatively stable at �47% over the last three years.

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Over the same time horizon, UMG’s net operating margin has expanded from 12.6% to 18.3%, as digital distribution is capital light.

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UMG has outsourced their physical distribution and closed their manufacturing plants. Instead, it is licensing its IP to well-capitalized technology platforms who are taking on the costs of building out the distribution platform and subsidize UMG’s cost of customer acquisition. In essence, they are owning the steaming business without bearing the operating cost.

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UMG’s administrative overhead expenses have shrunk from 34% to 30% of revenues from 2018 to 2020. The largest component of this is marketing.

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UMG’s recording business can in some ways be compared to a VC model. Their best ‘investments’ in artists compensate for the ones that don’t work out.

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The Secret SauceUMG enjoys a tremendous moat thanks to the decades it has spent building up its brand, portfolio of artists and labels, and intellectual property. This has positioned it to take advantage of the structural tailwinds available to it.

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Music is a fabulously unique product and UMG are at the heart of it. Their catalog is loved by both five and ninety-five year olds alike and is enjoyed while cooking, exercising, working and commuting. Our favorite songs tend to be evergreen and passed through generations, making UMG’s back catalog more important and valuable compared with film or TV.

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Thanks to advances in technology, music now has very low initial and ongoing costs to the customer (with ad-supported streaming, all you need is a device and a connection) and a vast total addressable market. UMG’s strategic partnership with Tencent should help it penetrate the China market which still lags behind much of the developed world for both smartphone penetration and paid streaming subscription services.

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The technological shift also gives UMG access to a large quantity of data – trends in listening hours, engagement levels, social media sentiment, which helps guide UMG as they sign and develop the next generation of artists and produce new music.

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The UMG proposition will always be desirable for artists who seek to leverage UMG’s powerful and established distribution and marketing channels to reach a global audience. Within the industry, UMG offers the biggest

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reach and greatest opportunity for publicity. The strong portfolio of artists creates a network effect where aspiring artists follow in the footsteps of their idols and hope to emulate their success.

Another source of strength for UMG is its management team – senior executives at UMG and the heads of individual labels within the stable are music industry veterans who possess decades of experience. The team is nimbly and adeptly navigating the changing landscape of the music industry, in particular by expanding into several new and exciting growth areas as it seeks to diversify its content base and push its music portfolio into new forms of media.

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UMG has formed partnerships with social media giants TikTok and Snapchat. These two platforms have the potential to be serious threats to UMG � though not direct competitors, they are competing with music for users’ attention and time. UMG has licensed songs to TikTok allowing users to produce content incorporating clips from UMG’s song catalog.

  

UMG has entered into agreements with FIFA and Wondery to produce podcasts such as “PlayOn” where UMG artists chat with footballers about their favorite songs, and deep-dives into different styles of music such as “Jacked” (about new jack swing). With podcasts on the rise and taking listening time away from music, UMG is capturing this space and cross-promoting sections of their existing portfolio.

  

UMG’s library is available on the Peloton platform and on other connected fitness apps like Variis. During an earnings call, Peloton’s CFO Jill Woodworth stated that “Music licensing agreements mean the world. Most people would agree that music is an incredibly important part of their fitness routine”.

  

UMG-signed British band Easy Life hosted an interactive concert at a virtual representation of London’s O2 Arena in Fortnite. Exclusive skins and in-game content to people who attend. Promotes UMG’s portfolio.

  

UMG has shown a willingness to embrace the NFT/collectible space, with Katy Perry (a UMG artist) participating in an NFT drop in July.

  

The upshot of all of this is that UMG is becoming one of the most prominent companies in the world – music is everywhere, and UMG is always taking a clip.

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Competitive PositionUMG’s competitive position is dominant but not immutable. Record labels have been around for 100 years and there is good reason to believe they will be around for many more.

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UMG has the largest share of an ever-growing pie. The global size of the recorded music market was $23.1 billion in 2020, and expected to reach $56.3 billion by 2030. �Source: GS Estimate)

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The three biggest players in this space, UMG �#1 with 32% market share), Sony Music Entertainment, and Warner Music Group control 70% of the market between them, with smaller/independent labels making up the rest.

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�Source: )Pershing Square Holdings

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The work that a good record label does is still important to artists (arguably, the advent of new monetization opportunities such as gaming/NFTs will make finding someone to manage this well even more important), but technology is reducing the barriers to entry. YouTube and TikTok are now the preferred vehicles for discovering up-and-coming talent, when combined with digital distribution and online advertising, operating a record label is much simpler than it was four decades ago.

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This is evident by the proliferation of new, independent record labels being launched across the world, many of which are led by former executives of the big 3 record labels. These are making some headway, with more artists choosing to stay independent, but this trend is not showing up in declining market share yet.

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One downside to the shift to streaming and a possible future threat to UMG’s business comes in the form of pricing power – it no longer holds sway over the cost of a record like it used to. This leaves it vulnerable to a range of factors:

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Music streaming platforms either getting embroiled in a price war that squeezes UMG’s take, or raising prices too aggressively and causing consumers to abandon the platform resulting in a sudden loss of revenue to UMG.

  

With more competition on the record label front, the possibility of artists squeezing UMG for a greater share of revenue is possible. Some evidence of this is emerging but the growth of streaming is more than compensating for this by increasing the size of the overall pie and reducing any impact on profitability.

  

In contrast to other forms of entertainment, the music industry model works because all of the major record labels’ catalogs are available on all music streaming platforms. Consumers are loyal to the artist first, the streaming service second, and the record label a distant third.

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Any shift in licensing agreements or partnerships that disrupts this dynamic or compromises consumers’ ability to access artists’ works in a convenient way will be problematic. Were the industry to see fragmentation/ring-fencing, piracy would likely re-emerge, as it has done for movies/TV shows, constraining potential future growth.

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UMG is also facing increased competition on the publishing side of its business. Since 2018, a buying spree has taken place as the established publishing giants and new entrants such as venture capital firms and pure-play IP management businesses like Hipgnosis �LSE� SONG� alike race to snap up the rights to artists’ back catalogs.

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Some tailwinds are starting to slow - while music itself isn’t going anywhere, it is competing against more distractions (gaming, social media, video streaming, podcasts) for our attention and dollars than at any time in its history. Paid streaming revenue growth is still strong, but has slowed from 61% YoY in 2016 to 20% YoY in 2020. Navigating this landscape and continuing to build on their partnerships with the likes of TikTok and Epic Games will prove crucial to UMG’s ability to maintain its current market share.

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Looking ahead to potential future threats – will the streaming platforms start to encroach on UMG’s space? The advantages of UMG’s business model are obvious. Will the likes of Apple, Amazon and Google look to get involved in owning the upstream production process and follow the path Netflix has taken by producing its own content and owning all of the IP? Will they start acquiring independent labels and squeezing the majors on margins?

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Daniel Ek: The Future of Audio Colossus Learn about the most important trends in audio from one of the streaming industry’s pioneers, Spotify CEO Daniel Ek.

https://joincolossus.com/episodes/71376147/ek-the-future-of-audio

Broken Record: Rick Rubin Podcast Esteemed music producer and co-founder of Def Jam Records Rick Rubin discusses his journey through the music industry.

https://brokenrecordpodcast.com/popular-episodes#/episode-1-rick-rubin-1/

Sleeping on Conviction with Podcast A discussion of trends in music streaming and https://open.spotify.com/ep

Title Type What You Will Learn �140 Characters) URL �Must be https://)

Useful Resources

Colossus,

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Sleepwell podcasts, and breaks down the failed PSTH / UMG deal.

isode/2kn1WdzZhDPWJ5sCG8KydM

How Major Labels Discover Their Artists

Video Warner Music Group’s head of artist & repertoire shares the role of a record label in discovering talent, and what they look for.

https://youtube.com/watch?v=AN_Owj90�P0

Music Streaming Royalties 101 Article A highly informative look at the nuts and bolts of how royalties in the music business work in the age of streaming.

https://sleepwell.substack.com/p/music-streaming-royalties-101

16 Years Late, $13B Short, but Optimistic: Where Growth Will Take the Music Biz

Article A detailed look at the trends leading to the recovery of the music industry in the second half of the 2010s after a decade and a half of structural decline.

https://matthewball.vc/all/music2

Warner Music IPO � The Streaming Renaissance

Article A breakdown of Warner Music Group’s financials and outlook at the time of its recent IPO �June 2020�.

https://alexandre.substack.com/p/-warner-music-ipo-the-streaming-renaissance

Meet Music’s Most Hated Man � And Its Top Dealmaker

Article Introduces Hipgnosis, a disruptor in the music publishing business, and frames the significance of the market they are competing for.

https://forbes.com/sites/maddieberg/2021/02/24/meet-musics-most-hated-man-and-its-top-dealmaker/

The Daily Adventures of Mixerman

Book A humorous take on what it’s like to deal with record labels on a daily basis.

https://amazon.com/dp/B084RGSH4W/

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