Warner Music Group Corp.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 3/5

Warner Music Group Corp. is one of the world’s leading music entertainment companies, with operations spanning recorded music and music publishing, as well as licensing and digital services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Competitive Landscape: Warner Music Group (WMG) is a global music powerhouse with operations in recorded music, music publishing, and distribution. In the Recorded Music space, WMG discovers and nurtures artists, produces and distributes music across physical and digital formats, and exploits their recorded music rights. WMG’s Music Publishing arm, on the other hand, licenses musical compositions and collects royalties. The global music industry is rapidly changing in the digital age, so WMG has been making significant investments to grow their digital revenue streams, improve production and distribution of new music, and engage artists in the digital world.

Here’s a more detailed overview:

  1. Recorded Music:
    • This segment focuses on discovering and developing artists, as well as the marketing, distribution, and sale of music through both physical and digital formats. A key aspect of this division is the management of intellectual property rights associated with recordings.
    • Revenue is derived from the sale of recorded music (both physical and digital), streaming and other forms of digital music licenses, and performance and synchronization fees.
    • This business is particularly impacted by the shift to streaming, which has fundamentally altered consumption and revenue patterns in the music industry.
  2. Music Publishing:
    • The Music Publishing segment owns and acquires copyrights of musical compositions, and licenses the rights to others for use in recordings, live performance, and synchronization with other media.
    • This division generates revenue from royalties received when its songs are streamed, broadcast, or otherwise used.
    • Digital licensing of music, both for recorded performance and public broadcast, has expanded with new forms of online music distribution.
  3. Digital Services:
    • This segment focuses on leveraging technology to distribute and promote music on various digital platforms, including social media and interactive streaming services, where this business is booming.
    • Revenue is earned through royalties from digital streaming, sales through digital outlets and direct licenses for digital uses.

Industry Trends:

  • Streaming Dominance: The continued growth of streaming platforms is driving revenue for most companies in the industry and, has profoundly changed how music is consumed and distributed. In 2022, Digital sales represented roughly 70% of Warner’s revenue, a trend that’s expected to grow.
  • Globalization: Music consumption is global, with emerging markets like Africa, Latin America, and Asia playing an increasingly significant role in growth, particularly in digital streaming.
  • Intensifying Competition: As digital channels increase and new music creation platforms are introduced, the competition in the music space is growing immensely, increasing the pressure on music labels to be creative and innovative.
  • Technological Disruption: Music distribution and consumption are constantly being reshaped through technology. New ways of creation and delivery of music can influence the power balance between the different segments of the music industry.
  • Shift in Power Dynamic: The power dynamic is shifting from labels to artists, who are increasing asserting more control over their intellectual property.

Financial Performance: WMG’s financial performance can be described with the following points:

  • Positive Recent Growth: WMG saw impressive revenue growth over the past three years, driven by the adoption of streaming, which has offset the decline in physical sales. The overall revenue was 5.7B in 2023, compared with 5.3B in 2022 and 4.8B in 2021. In terms of music publishing, the revenue was also steadily increasing, reaching 868 million in 2023, 793 in 2022 and 723 in 2021.
  • Slower Sales Growth: However, in its latest earnings call, the company is showing reduced growth rate of overall revenue.
  • Declining Margins: The adjusted EBITDA is at 1.1B in 2023, the previous year was 1.2B, and in 2021 was 1.1B. The operating profit increased a little to 688M in 2023, compared with 605M in 2022 and 555M in 2021. The profitability seems to be declining despite increased revenue in the company, and increased expenses.
  • Increasing Digital Revenue: The company is reporting increases in Digital revenue. For Recorded Music in the fiscal year ended on September 30, 2023, Digital revenue represented 69% of total revenue. For Music Publishing, digital revenue was 50% of total revenue, as of the end of the fiscal year, on September 30, 2023.
  • Debt Structure: WMG has a large amount of debt, close to 4 billion, with a leverage ratio near 3.5x EBITDA. Although this leverage is concerning, it allows the company to acquire other music rights and other businesses.

Recent Concerns, Problems, and Management’s Response:

  • Streaming Market Share: In recent earnings calls, managements have shown concerns on the slower growth rate of their revenue. Competition in the streaming space is increasing, which may hurt the company’s revenues.
  • Artist Deals: There are questions over some large artist deals and the economics of that. New agreements have allowed the artists to have more power, which means that they will take a larger share of revenue. The company is focused on maintaining their financial responsibility despite the new trends in the industry.
  • AI and Copyright Law: The company also acknowledges that there might be some uncertainties on the regulations around AI music development and the copyright that comes with it. They have a dedicated team that are looking at the opportunities and also the risks related to AI.
  • Global Growth: With the current global economic turmoil, the company is very aware that some local economies may struggle and has contingency plans if the company sees revenue decline or stagnation, but most of their emerging markets still show great growth, so they see their overall revenue as being consistent.
  • Ongoing Inflation: The company is carefully monitoring costs and using its data and analysis to control costs, and leverage scale.

Moat Analysis: Based on my analysis, WMG has a medium moat, given the following factors:

  • Intangible Assets: They have valuable intangible assets in the form of an extensive catalog of recording and publishing rights. However, the rights, particularly music recordings, have a life span of usually 50 to 100 years or more. Many new laws have been passed to extend these rights, but competitors can also try to create very similar products. As a whole, these assets are valuable, but not unique, so they can generate a narrow moat. * Switching Costs: They have sticky customers in the form of creators, since they have given up control over their content to them. Switching costs tend to be higher, however, it is usually the individual artists and content creators that are subject to the switching cost, not the end customer. This creates limited pricing power and gives the company a narrow moat. * Network Effects: WMG is able to make money from a very large set of recording and publishing rights, and they are usually the first choice of new music creators. Because of this, more musicians will prefer the company and its subsidiaries over others, and increase the moat of the business. The network effect can create a narrow to wide moat depending on how many more users are added over time. * Scale Advantage: The scale and global distribution network of WMG is also a differentiating factor. It is difficult for new entrants to build such a large network from scratch. The scale, together with the network effect, creates a narrow to medium moat for WMG. * No Cost Advantage: The company does not have any sustainable cost advantage over its competitors.

In the short-run, music copyrights and music libraries may give Warner some advantage, but that moat can get eroded fast with new technologies and new distribution channels, so the company will need to constantly adapt. The moat is also not as strong compared to pharmaceutical companies because intellectual property rights and licenses in music and entertainment are often not as sustainable as they are in pharma, and are also easier to recreate and replace. Rating: 3/5 - given the presence of several, but not very wide and sustainable, moats, the company has a medium rating.

Legitimate Risks:

  • Technological Disruption: As the industry rapidly evolves, they face the risk that current business models may be made obsolete through new music creation and consumption technology. Companies like Spotify, Apple Music, Tiktok, and many other competitors may change the way revenue is distributed among music labels.
  • Intensified Competition: The number of streaming services and music labels in the space is steadily growing, and may erode their pricing power and profit margins.
  • Changing Copyright Laws: Changes in copyright law may harm the value of WMG’s Intellectual property and hurt profits.
  • Economic Downturn: A global recession and reduced consumer spending may affect their revenues and limit cash flows.
  • Management Changes: Any strategic or management change can have a negative impact on company’s operation and business performance.

Business Resilience: WMG has shown great resilience in the face of technological changes by adopting digital distribution and partnering with digital platforms to increase revenue and market share. The strong revenue increase from recorded music suggests that the business is inherently strong and resilient, however, it remains to be seen how the company is going to face competition in the streaming space and navigate future changes. They have also been increasing revenues from digital music. The large back catalog and constant music creation also creates a steady and diverse revenue stream, which reduces reliance on any single asset or region, creating resilience.

Understandability Rating: 3 / 5

The business model is not overly complex and most people are familiar with the music industry. The underlying concepts are fairly easy to understand. However, due to the complexity of the company’s structure, numerous revenue streams, and different segments, one has to spend time to properly understand the company. All things combined make the company have a mid level difficulty to understand.

Balance Sheet Health: 3 / 5

While the company’s liquidity remains in a healthy range (with cash and cash equivalents of 350 million). It does have a considerable amount of debt, over 4 billion dollars. The leverage ratio is around 3.5 times EBITDA, which is relatively higher compared to the industry average, however, if the company can continue generating high revenues, it may not have any problems in handling such leverage. The current ratio is well above 1, which is a good sign, showing that the company has enough current assets to cover its current liabilities. So while the balance sheet is not at a very high point, it is also not at a low point.