There is only one pure-play music label trading on the American stock market, and that company is Warner Music Group (NASDAQ:WMG). This iconic music publisher, which has produced artists new and old ranging from Joni Mitchell and Madonna to Ed Sheeran and Lizzo, has fallen in sympathy with the rest of the stock market this year, despite the fact that 2022 was supposed to be its big comeback year (fading COVID pressures would ease the return of concerts and festivals, which are huge drivers of music sales).
Year to date, shares of Warner Music Group have corrected by more than 30%. This is in spite of the fact that the company continues to turn out strong results, especially in capturing its burgeoning market in music streaming. It’s a good time, in my view, for investors to re-assess the bullish thesis for this stock.
Let’s take a step back for a second: this year, the stock market has really punished streaming content distributors. Netflix (NFLX) and Spotify (SPOT), two of the main pure-play content distributors in the market, have each lost more than half of their market value. The main concern here is competition hampering subscriber growth – Netflix, for example, saw rare churn in its U.S. user count, presumably because of the flood of streaming options now available in the market.
But even as the distributors of video and music content continue to compete for subscribers, one thing is clear: the key differentiator between platforms is content. And so in the end, investors should bank on the companies that have the access to and ability to create content. Warner Music Group is exactly that in the music world.
Music, needless to say, is fundamental in our daily lives. Most of us pay for streaming accounts now. We watch videos with music playing in the background, for which labels like Warner Music Group receive a cut. When we ignore the short-term noise and look at the long-term picture, I can’t see a future in which Warner Music Group doesn’t thrive.
I continue to remain bullish on Warner Music Group and encourage investors to buy the recent dip. Here’s a rundown of the reasons why I’m bullish on the company:
- Strong artist discovery machinery. Warner Music Group discovered and produces some of today’s best-known entertainers. The company is continuing to create and monetize new content. For example, the company produced the new Silk Sonic duo (combining existing stars Bruno Mars and Anderson .Paak) which won four Grammy awards this year, including Record of the Year.
- Social media platforms, especially TikTok, need music to drive content. Warner Music Group signed a major deal with TikTok in December to supply music for its videos. Though there was no dollar figure attached to the deal, Warner noted that social media brings in “hundreds of millions of dollars per year” in revenue, which is still a small but fast-growing chunk of a ~$4 billion annual revenue base.
- Fitness classes are another digital revenue stream. Paying for music content is one of Peloton’s most significant expenses. As the success of Peloton spurs more and more copycats, expect online fitness to continue bolstering its demand for music.
- Music festivals are making a comeback. After a pandemic-driven hiatus over the past two years, music festivals are coming back. Coachella, in particular, happened just last month. A full lineup of regular concerts throughout the year will put music back into the spotlight and drive revenue growth.
Lastly, it’s worth mentioning that Warner Music Group offers a healthy dividend to keep patient investors enticed. At $0.15/quarter or $0.60/year, Warner Music Group’s ~2% dividend isn’t something to overlook.
From a valuation perspective: at current share prices near $30, Warner Music Group trades at a market cap of $15.32 billion. After we net off the $385 million of cash and $3.83 billion of debt on the company’s most recent balance sheet, Warner Music Group’s resulting enterprise value is $18.76 billion.
Versus the company’s trailing twelve-month adjusted EBITDA of $1.21 billion, Warner Music Group trades at 15.5x EV/LTM adjusted EBITDA. If we assume adjusted EBITDA growth can keep up with Warner Music Group’s current revenue growth pace of ~10% y/y, its forward multiple would be roughly 14.1x EV/FTM adjusted EBITDA, assuming forward-twelve month EBITDA grows to ~$1.33 billion.
While this doesn’t exactly scream “value” just yet, I do think the sticky nature of Warner Music Group’s revenue streams and the uniqueness of its music publishing business affords the stock a premium.
In other words, stay long here: I see a path for Warner Music Group to recover to the $40s.
Let’s now discuss Warner Music Group’s latest quarterly results in greater detail. The fiscal Q2 (March quarter) earnings summary is shown below:
The company achieved solid revenue growth, at least for a “legacy” business that has been around for decades. Revenue grew 10% y/y to $1.38 billion, beating Wall Street’s $1.37 billion (+9% y/y) expectations. Note that in the absence of currency fluctuations, Warner Music Group’s constant-currency revenue growth would have been even stronger at 13% y/y.
See a further revenue breakdown in the chart below. Streaming, now Warner Music Group’s biggest source of revenue, grew 9% y/y to $898 million in the quarter, or roughly two-thirds of the company’s total:
Note as well, however, that even vintage music formats are still seeing strong demand. Physical music revenue is up 3% y/y to $122 million, reflecting continued demand for vinyl records.
Here’s some helpful anecdotal commentary from CEO Steve Cooper on the company’s most recent hits and music deals, made during his prepared remarks on the Q2 earnings call:
We’re always developing the next wave of culture shaping music that will create the sound track of tomorrow. For example, Gayle kicked off the year with number one worldwide Smash ABCDEFU and Jack Harlow’s new single First Class debuted at number one on the Billboard Hot 100 last month. Dua Lipa and Megan Thee Stallion racked up over 40 million streams in just one week with their hit collaboration Sweetest Pie.
Our publishing team also continues to excel with an impressive 90 songs charting on the Billboard Hot 100 over the course of Q2. Some of the biggest hits that our songwriters contributed to this quarter were Silk Sonic’s Smoking Out the Window, Rauw Alejandro’s Desperados and Dave’s, Starlight. Warner Chappell had a superb showing at this year’s Grammys. In addition to Bruno and Anderson, who are also Warner Chappell’s songwriters, we saw big wins for Chris Stapleton for Best Country Song and Ojivolta for Best Rap Song. Warner Chappell is winning highly competitive deals for talent around the world and across the music spectrum. From Nigeria’s, Tay Iwar to Italy’s, Sick Luke to the U.S.’s, Nicolle Galyon.
In March, we signed two important deals with Patrick Moxey, the Founder of Dance Label Ultra. Warner Chappell now administers Ultra’s 6,000 copyrights throughout Europe, including songs from Drake, Rihanna and The Weeknd among many others. And Warner recorded music also entered into a strategic alliance with Patrick’s legendary Payday Records as well as his new label, Helix.”
Cooper additionally added that the music industry grew at 18.5% y/y in 2021, but Warner Music Group outperformed that benchmark by 250bps.
Adjusted EBITDA in the quarter also grew 5% y/y to $282 million. The slight decay in EBITDA margins to 20.5% (90bps weaker than 21.4% in the year-ago quarter) was driven by revenue mix, as the recovery in artist services revenue (which carries a lower ~20% gross margin) weighed down the overall revenue profile.
As one of the leading music producers that has continually proven itself capable of shifting itself to the times (both discovering new popular artists and adjusting its business model to the digital era), I continue to view Warner Music Group as a “forever company” trading at a reasonable valuation. Buy this dip and hold on for the long term.