Which will be a better investment, Warner Music Group stock or Spotify stock? Four factors to consider

Happy Wednesday everyone!

I wanted to share a members-only addendum to my writeup last week on the hidden trends in Warner Music Group’s IPO. This time, I want to zoom out and compare WMG to another publicly-traded company on which WMG relies heavily for its growth: Spotify.

When WMG first announced its plans to go public, some early conversations I had with folks in the music industry centered around why anyone would want to buy shares in the major label if they already owned Spotify shares. The inherent assumption was that Spotify was a better investment than WMG. Here’s roughly how I and those who agreed with me were approaching our thinking:

• Major labels like WMG don’t own direct relationships with most of their fans or customers; tech companies and content aggregators like Spotify do, at the scale of hundreds of millions of users.
• Even though WMG is profitable and Spotify is not, the latter brings in around 66% more revenue annually than the former, and commands a higher market value by around $10 billion to $15 billion by industry estimates. WMG is also the smallest of the three major record labels, and is only around half the size of the biggest major, UMG (which is also planning to go public sometime in the next few years).
• Spotify is diversifying more aggressively into multiple kinds of content and media beyond music — particularly podcasts — whereas WMG seems mostly focused on music for now (unlike some of its other competitors like Sony Music).

To check my assumptions on a wider scale, I ran the following poll on Twitter:

I was expecting the votes to skew much more in favor of Spotify, but the results were actually hovering around a 50/50 split for a long time before edging onto Spotify’s side at the very end.

If you look through the comments on the poll, the most popular reason to choose WMG over Spotify was that tech trends come and go, but IP in the context of a major-label operation is owned and monetized for decades, in a passive and profitable manner, independent of any individual format or distribution channel.

So who’s right? Full disclaimer: I’m certainly not in any position to give investment advice. And I’m not sure I have a clear answer to that question myself.

Nonetheless, I thought it would be useful to break down four key factors in the business models of WMG and Spotify that people tend to miss in these kinds of discussions, which will hopefully help you come to your own conclusion about which company would be a better investment. And as of now, despite hearing others’ perspectives, I’m still not totally convinced that WMG stock would be a better choice than Spotify stock.

1. WMG and Spotify are now in the IP business

This was one of the biggest misconceptions I saw play out in IPO discussions — namely, that WMG would be a better investment than Spotify because the former is in the long-term IP business, while the latter is merely in the software business.

In reality, Spotify is just as deep into the IP business now as WMG, spending hundreds of millions of dollars per year acquiring podcasting and media companies like The Ringer and Gimlet Media. Just because that IP is primarily non-musical, doesn’t mean it isn’t valuable.

It’s also significant that Spotify is slowly eating up market share of listening and content ownership in the podcast world. In contrast, for music, WMG benefits from a large market share of content ownership, but owns only a small set of pipes to help deliver that content.

Which brings me to the next factor:

2. WMG and Spotify now own, and are trying to become, digital-media companies

Funnily enough, WMG and Spotify now both own their own ad-supported digital-media website, albeit for opposite reasons.

In August 2018, WMG acquired pop-culture news site UPROXX for an undisclosed sum. At the time, WMG claimed that UPROXX’s various editorial operations “will function as stand-alone entities with journalistic and creative independence” — but I argued soon after for MBW that the move was part of the growing trend of artists and labels buying and building out media companies, for the sake of having more control over their own brands.

WMG’s F-1 filing underscores UPROXX’s lack of independence in the context of the major label’s wider business. “Our acquisition of UPROXX, one of the most influential media brands for youth culture, not only provides a platform for short-form music and music-based video content production to market and promote our recording artists, but also includes sales capabilities to monetize advertising inventory on digital audio and video platforms,” reads the filing.

It’s interesting to compare UPROXX’s benefits for WMG to The Ringer’s benefits for Spotify. WMG already has millions of songs worth of IP, and, as previously discussed, needs more direct-to-audience platforms like UPROXX to market that IP effectively against its competition. In contrast, Spotify already has that direct-to-audience platform by nature of its product, but needs The Ringer’s IP to reduce licensing costs and help differentiate its overall service offering against its competition.

From a reach perspective, though, I think The Ringer helps Spotify much more than UPROXX helps WMG. According to SimilarWeb, UPROXX has attracted between six and seven million monthly views since September 2019. In contrast, The Ringer’s slate of podcasts gets 35 million downloads a month as of January 2019, while the website gets 46 million views a month as of June 2019. Plus, there are myriad opportunities to spin off The Ringer’s owned content into TV and film adaptations, as the company is currently doing with HBO.

3. WMG and Spotify need to invest more in artist services to stay relevant

As I shared in my previous post, WMG made 16% of its total recording revenue from artist services and expanded rights in fiscal year 2019, a higher proportion compared to the previous two years. The absolute dollar amount of artist-services revenue also grew more than 60% year-over-year, from $389 million to $629 million, thanks in part to WMG’s acquisition of EMP Merchandising. Aside from merch, which tends to be lower-margin, the touring aspects of WMG’s expanded-rights deals are even more lucrative: “Participation in revenue from touring … typically flows straight through to operating income with little associated cost,” reads the filing.

In a world where more and more artists are scrutinizing the value of major-label deals amidst dozens of other self-serve distribution and financing options, I think we can expect artist services to continue to drive a growing amount of business for WMG.

Meanwhile, Spotify has been investing more in making its “two-sided marketplace strategy” a reality — “not just serving listeners,” but “also building tools and services for the creator community … from artists and songwriters to publishers and labels to podcasters and storytellers,” as its Q4 2019 earnings release put it. This spans acquisitions of artist-facing software like Anchor, Soundtrap and SoundBetter.

Based on Spotify’s financial statements, it seems like the artist-facing side of its two-sided marketplace strategy isn’t generating enough revenue yet to be broken out separately on its balance sheet. Rather, it seems more like an engagement play, to maintain and strengthen relationships with artists, songwriters, producers and podcast creators at large, and in turn to encourage audiences to view Spotify as the most trusted platform for consuming their content of choice.

This is a contrast to WMG’s approach, which mostly involves offering a modular combination of added services alongside more selective, IP-related deals (hence the term “expanded rights,” which Spotify would likely never adopt). Nonetheless, as long as both companies are involved in the artist-services vertical, I think they will being competing for business.

4. WMG and Spotify are equally dependent on each other — but WMG has a history of relying too much on formats for its sustainability

When WMG first went public in 2005, its stock price ended up tumbling significantly in its first few years on the market, largely thanks to declining CD sales. It was only when the iTunes stores introduced features like variable pricing that Wall Street analysts started having more optimism for WMG’s future.

Today, WMG will be going public in a vastly different technological landscape — but major labels’ dependence on the formats of the day to justify their valuations and bring in revenue is arguably just as strong. In particular, major labels rely Spotify for a large portion of their revenue and distribution; Spotify relies on major-label catalog to make their service appealing to mainstream consumers.

Thanks to the respective earnings reports from WMG and Spotify, we now know exactly how much those two companies depend on each other.

According to its F-1 filing, WMG made around $627.2 million from Spotify in 2019; that alone accounted for 14% of WMG’s entire revenue for the year.

Meanwhile, Spotify made around €6.8 billion (~US$7.7 billion) in 2019, according to its latest earnings report. Assuming that Spotify has to give around 70% of its revenue to rights-holders, that meant 13% of its licensing payouts went to WMG alone. If WMG’s contract with Spotify is like those with the other majors, most of that payout was likely made upfront in the form of an advance. In other words, the dependency seems mutually equal.

In its F-1 filing, WMG seems to imply that they will continue to rely on third-party platforms upgrading their business models in order to bring in more revenue. For instance, the company anticipates streaming prices rising in the near future; examples cited in the filing include Spotify testing out more expensive Family Plans in Scandinavia and Amazon Music HD offering high-quality audio-streaming for up to $14.99/month to users in the U.S., U.K., Japan and Germany.

“Streaming services are already at the early stages of experimenting with price increases,” the filing reads, adding that “we believe the value proposition that streaming provides to consumers supports premium product initiatives.”

But thinking about raising streaming prices at this point in music history might just be a first-world or Western-centric problem, considering that the majority of streaming users globally still don’t pay any price for music in the first place.

What about the vast majority of consumers outside the U.S. and Europe who are not paying for a subscription yet, and potentially never will? Spotify’s expansion into markets with much lower price points and relatively more underbanked populations, coupled with investment in discounted Family and Student plans and bundles, has driven down the service’s average revenue per user. In turn, this has also driven down average per-stream royalty rates for artists and labels across the board.

I’d be interested in hearing more of WMG’s perspective about what impact, positive or negative, these trends of lower ARPU along with more global exposure and more multimedia bundles might have on their recording and publishing verticals. After all, those seem to be factors that the company ultimately doesn’t control.  🌊