The hidden trends in Warner Music Group’s IPO filing, visualized

Last week, Warner Music Group (WMG), one of the world’s largest music corporations, announced its plans to go public.

This isn’t WMG’s first rodeo: The company first went public on the New York Stock Exchange in 2005, but was then taken private when Access Industries acquired them for $3.3 billion in 2011. Today, the music landscape looks much different, with high catalog valuations and rising global streaming revenues boosting investors’ confidence in the future of the industry at large.

In the days since WMG’s latest announcement, the likes of Billboard, Variety and the MIDiA Research blog have published some good analyses around WMG’s estimated valuation (between $10 billion and $16 billion, Billboard estimates) and whether the company’s stock will end up being a good investment by Wall Street standards.

I want to take a slightly different approach and focus not on WMG’s future prospects as a public company, but rather on what the company’s filing with the Securities and Exchange Commission (SEC) reveals about the economics of major labels today.

Given that major labels and publishers are notorious for their historical lack of transparency, WMG’s filing offers a rare level of clarity into their internal business operations, enabling readers to fill in the gaps on questions that previously suffered from too much speculation.

How much money is WMG not just earning, but also spending, and where? How much has WMG spent on advances to artists and songwriters, and on equity investments in tech companies? What are the differences in the economics of its recording versus publishing businesses? Which are the most lucrative digital services for its catalogs? And how successfully is it diversifying beyond just recording and publishing into other kinds of revenue streams, including but not limited to touring, merchandise and artist management?

All of these questions and more can be answered by digging through the SEC filing and doing some back-of-the-napkin math, which I spent much of the last few days doing. I’ve compiled my four most interesting takeaways below, each of which features an original visualization that I cobbled together using good ol’ Google Sheets.

My aim with these visualizations is to shed new light on WMG’s shifting economics as a major label and publisher in the streaming era, in a way that hasn’t previously been discussed. Some of these findings could also serve as helpful comparison benchmarks for other major labels — especially for rival Universal Music Group (UMG), which is planning to go public by 2023.

But first: A financial summary

Let’s get some core financials out of the way:

WMG is mostly in the business of recorded music. In fiscal year (FY) 2019, the company made 86% of its revenues from recording ($3.84 billion), with the remaining 14% coming from publishing ($643 million). Subsidiary Atlantic Records commanded a 12.6% share of the entire U.S. recorded-music market in 2019 — the largest of any label, according to Nielsen Music — and also ranked as the No. 1 label on the Billboard 200. WMG’s publishing subsidiary Warner/Chappell is home to over 1.4 million musical compositions from more than 80,000 songwriters and composers.

44% of WMG’s total revenues last year came from the U.S., with the remainder coming from international territories. Recording/publishing and U.S./international revenue splits stay relatively consistent from quarter to quarter.

Moreover, WMG is profitable, having made $256 million in net income last year. That said, the company is only around half the size of its biggest rival, Universal Music Group (UMG), which made $1.1 billion in profit off of $7.1 billion in revenue in 2018. UMG’s publishing catalog also contains over three million titles, according to parent company Vivendi’s site, far outweighing WMG’s ~1.4 million.

Based on Tencent’s recent equity purchase, UMG is currently worth around $33.6 billion; WMG’s opening market value will likely be only half of that figure at best. (As another matter of comparison, Spotify’s market value as of publishing this piece is $27 billion.)

An important definitional note: WMG includes “artist services and expanded rights” — i.e. the company’s Artist Services division, plus occasional participation in their artists’ ancillary revenues, like modular 360 deals — in its calculations of recorded-music revenue, even if those services and rights don’t directly involve the recordings themselves. In FY2019, “artist services and expanded rights” accounted for 16% of WMG’s recorded-music revenue, and 14% of the company’s total revenue overall. That’s a pretty significant piece of the pie, the implications of which we’ll dive into later in this piece.

The takeaways

1. WMG spends much more money on A&R than on marketing.

Anecdotally, many music-industry insiders have told me that major labels spend a lot more on A&R and creative production than on marketing — usually a 70:30 A&R:marketing split. Some think that ratio is inefficient, whereby it might be better to allocate more budget to in-house marketers, who are often working with 15 or even 30 artists a head and are strapped for resources, than to court in-demand artists with ever loftier advances.

WMG’s SEC filing confirms this spending discrepancy. In FY 2019, the company spent $1.57 billion on “artist and repertoire costs” (hereafter A&R costs), versus $632 million on “selling and marketing expense” (hereafter marketing costs). In other words, WMG spent 2.5x more money on A&R than on marketing last year — pretty close to a 70:30 split.

Not all of that A&R money is going solely to artist advances; WMG’s filing defines “A&R” as “talent scouting and overseeing the artistic development of recording artists and songwriters.” That said, WMG did have $420 million in artist and songwriter advances on its balance sheet as of December 31, 2019, the majority of which ($231 million) is expected to take over a year to recoup.

It’s also interesting to compare A&R and marketing costs for recording versus for publishing. In FY 2019, WMG allocated only 18% of its total A&R and marketing spend to publishing ($406 million) — but that amount alone ate up 63% of the company’s publishing revenues ($643 million). That’s a much more expensive ratio compared to the recording side, where A&R costs accounted for only 33% of revenues (see chart above).

These kinds of figures frame publishing as a less lucrative business, and as a lower priority for WMG compared to recording — although, as we’ll discuss later, that could change quite soon.

2. Artist services and expanded rights are increasingly important for WMG’s business.

Many artists and industry professionals today wince at any mention of a “360 deal” — i.e. a contract between an artist and a music company in which the company provides diversified support across multiple types of businesses, such as touring, recording and merchandise, in exchange for a cut of revenue from all of those streams. The deal structure peaked during piracy’s heyday in the early 2000s, when labels realized they needed to diversify beyond just recorded music into more lucrative verticals, but has been criticized for its exploitative potential.

That said, a more modular version of a 360 arrangement, where artists can pick and choose additional services based on their own needs, has become in vogue in recent years — and now forms a significant part of WMG’s business.

Beyond traditional recording and publishing, WMG’s filing also discusses “artist services and expanded rights,” which encompasses “sponsorship, fan clubs, artist websites, merchandising, touring, concert promotion, ticketing and artist and brand management.” The company’s in-house Artist Services division oversees most of this activity; as mentioned earlier in this piece, these revenue streams are included as part of “recording revenue.”

In FY 2019, artist services and expanded rights accounted for 16% of WMG’s total recording revenue, with the dollar amount growing more than 60% year-over-year, from $389 million to $629 million (see chart above). This is in part thanks to WMG’s acquisition of EMP Merchandising in 2018 — which, along with “higher merchandising revenues and timing of larger tours in Japan,” contributed $240 million in international artist-services revenue for the parent company last year.

The filing also reveals some intriguing aspects of the economics of artist services, in the context of a primarily recording-driven business like WMG. For instance, the touring aspect of the company’s expanded-rights deals is among the most lucrative, as “participation in revenue from touring … typically flows straight through to operating income with little associated cost.” Revenue from participation in artist management and sponsorships are also “all high margin,” while that from merchandising tends to be lower-margin compared to traditional recorded-music revenue streams.

In addition, concert promotion seems to be out of the question. For instance, WMG used to own Italian concert promoter Vivo Concerti, but sold it back to the promoter’s managing director in 2018; thanks to the filing, we now know the price of that sale was $82 million.

One concern I’ve anecdotally heard from more and more people in the music industry lately is that WMG — or any major label, for that matter — might lose a lot of its cash-cow back catalog if more legacy artists decide to reclaim U.S. rights in their work under the U.S. Copyright Act. As the filing reads, artists have the right to do so “during a five-year period starting at the end of 35 years from the date of release of a recording under a post-1977 license or assignment (or, in the case of a pre-1978 grant in a pre-1978 recording, generally during a five-year period starting at the end of 56 years from the date of copyright).”

WMG claims that “virtually all of our agreements with recording artists provide that such recording artists render services under a work-made-for-hire relationship,” which allegedly gives them some protection from this risk factor. That said, as independent artists and distributors gain more influence in the wider music industry, insist on masters ownership and push back against the viability of a traditional major-label deal in general, these work-for-hire clauses will likely come under more and more scrutiny. Hence it makes sense for a company like WMG to diversify more aggressively into artist services, if their main mechanism for generating revenue (owning copyrights) is under threat.

3. WMG’s digital revenues are heavily concentrated in just a few players.

It’s nothing new that Spotify and Apple Music are dominating not just the global music-streaming market by number of paid subscribers, but also in turn the bottom lines of the major labels that have those services on licensing lockdown.

Now, thanks to WMG’s filing, we know just how much they dominate: Over half of WMG’s digital revenues come from just Spotify and Apple.

Around 27% of WMG’s digital revenues in FY 2019 came from Spotify alone (~$627.2 million), while another 25% of digital revenues came from Apple Music alone (~$582.4 million).

The only other streaming service whose payments to WMG were publicly disclosed in the filing was Deezer, since WMG’s parent company Access Industries has a stake in the French service. Deezer lags far behind Spotify and Apple Music in terms of user and subscriber numbers, and accounted for only 2.1% of WMG’s digital revenues ($49 million) in FY 2019.

The most interesting aspect here is that every other streaming service in the world combined — including but not limited to YouTube, Amazon Music, Pandora, iHeartRadio, SiriusXM, SoundCloud, Tidal and Tencent Music (in which WMG has a stake) — is lumped into the remaining 47% of WMG’s digital revenue, or $1.1 billion (see chart above).

WMG’s filing frames this skewed revenue mix as a risk factor. “We are substantially dependent on a limited number of digital music services for the online distribution and marketing of our music, and they are able to significantly influence the pricing structure for online music stores and may not correctly calculate royalties under license agreements,” reads the filing. That said, I foresee Spotify and Apple’s market dominance waning over the next decade as the likes of YouTube, Amazon Music and Tencent Music solidify their international footing.

4. WMG spends more on equity investments in other companies than on its own publishing catalog acquisitions — for now.

This was one of the most intriguing findings to me, and took a bit more digging to understand in full.

WMG’s publishing subsidiary Warner/Chappell has over 1.4 million compositions under its wing, and has signed worldwide deals with the likes of Frank Ocean, A-Lin, Stephen “Di Genius” McGregor and Zack Dyer in the last few months alone. But the company actually doesn’t spend that much money on one of the biggest business drivers in the publishing world today: acquiring already-existing catalogs.

Amidst streaming growth, publishing catalogs are selling for as much as 16x or even 20x the net publisher share (NPS, i.e. net revenue received by the rights owner), versus the historical 10x to 12x multiples, and all kinds of investors inside and outside the music industry want in. In 2018, Round Hill Music Royalty Partners raised a $263 million fund solely dedicated to acquiring music copyrights; veteran artist-manager Merck Mercuriadis’ Hipgnosis Songs Fund is currently deploying $1 billion on the same field.

Yet, according to its filing, WMG’s spending on “acquir[ing] music publishing rights and music catalogs” totaled just $41 million in FY 2019. As a matter of comparison, that’s $7 million less than what the company spent on the “acquisition of equity investments” — i.e. on buying stakes in other companies, private or public — that same year (see chart above).

On one hand, this underscores WMG’s differentiation in the major-label world; while it might be the smallest of the Big Three, it’s also one of the most proactive when it comes to building a portfolio of outside business investments and acquisitions. Within the past three years, WMG acquired Songkick, Sodatone, UPROXX and EMP Merchandising, and has also invested in startups like Artiphon and Dapper Labs, in part through its relatively new seed fund WMG Boost.

On the other hand, 2020 could be the year that WMG starts spending much more on catalog acquisitions, as it tries to bolster its publishing business in an increasingly competitive landscape. In December 2019, WMG partnered with Providence Equity and Influence Media Partners to launch Tempo Music Investments, a new portfolio company with $650 million to invest in recording and publishing catalogs. And WMG now acts as an international sub-publisher for fellow catalog investor Round Hill as well.

Alongside the increasing importance of artist services and expanded rights, a more aggressive catalog acquisition push could make WMG’s financial makeup look much different from today by the time it goes public.