Last year, UMG produced earnings before interest, taxes and amortization (EBITA) of €902 million ($1.07 billion), making it the first major label in more than a decade to top $1 billion for that performance figure. (Vivendi no longer reports UMG's depreciation, so it also no longer reports EBITDA, but based on past reports showing steady declines from €123 million in 2014 to €103 million in 2016, Billboard estimates UMG's EBITDA at €982 billion, or $1.165 billion last year.)
The EBITDA number is crucial in analyzing UMG’s potential sale price, because record labels currently trade on either a multiple of EBITDA or net label share, which is what's left of revenue after paying out artists' recording costs, royalties and manufacturing and distribution costs. Sources say that net label share for premium labels are headed above a 10-times multiple, but net label share is a useless financial barometer to private equity firms. That’s because those types of buyers wouldn't be able to realize any overhead savings, but as buyers might likely invite overhead cuts just the same.
Net label share is mostly only relevant to a potential strategic buyer who can realize economies of scale. Considering the size of UMG, it's unlikely that one of the other two majors -- Sony Music Entertainment and Warner Music Group -- could buy all of UMG and succeed in the regulatory process. And BMG, based on its past behavior, likely won't pay the kind of valuation Vivendi is seeking. As such, the suitors are interested in buying a stake in UMG will likely look at EBITDA, among other financial barometers.
How Do You Calculate UMG's Valuation?
To estimate a valuation for UMG, let's look at the company piecemeal, starting with publishing. Publishing valuations are still mainly based on net publisher share -- revenue left over after writer royalties are paid out -- and that metric is also aggressively rising, according to industry dealmakers. So regardless of whether private equity can realize savings that the net label share shows, such suitors will likely be dealing with net publisher share when it comes to publishing acquisitions because that’s the valuation metric sellers use when deciding on whether to do a deal.
The last time Billboard valued publishing, it was based on a ballpark estimate that Universal Music Publishing Group's net publisher share was 43% of revenue. But when Sony/ATV acquired EMI last year, that company’s net publisher share was 48% -- although that figure likely skews high because it was probably not making aggressive co-publishing deals like other majors back in the years before it was first sold in 2012. For the sake of this exercise, estimating UMPG's net publisher share at 45% of UMPG's revenue of €941 million ($1.117 billion) for 2018 would yield net publisher share of $502.6 million. (Since the industry is currently in growth mode, we can ignore the three-year average of net publisher share that is commonly applied in such deals.) With publishing valuations currently carrying a 15-18 times multiple (EMI traded on 15 times net publisher share in its sale, while SONGS Music Publishing sold to Kobalt for a supposed 18 times net publisher share), that would place UMPG with a valuation ranging from $7.54 billion to $9.05 billion.
To value recorded music, label services and merchandising, we will estimate UMPG's EBITDA and subtract that from UMG's overall $1.165 billion estimated EBITDA. Based on past conversations with Vivendi analysts, we can estimate UMPG contributes 31% of UMG's EBITDA, equalling $361 million, and leaving the recorded-music operation with $804 million. With topline labels currently valued at between 15- and 18-times EBITDA multiples -- while the 15-18 multiples are the same levels as publishing NPS multiples, the EBITDA base is always smaller because its been reduced by expenses -- the rest of UMG would be valued between $12.06 billion and $14.47 billion.
With those valuations for recorded music and publishing combined, UMG would command a valuation of $19.06 billion to $23.52 billion. This valuation is based on the highest multiples that a top-tier music company like UMG can command, according to industry deal-makers, but it is also near the bottom of the valuations issued by a half-dozen Wall Street banks. So, why the disparity? Because with streaming still rolling out around the globe, a potential UMG suitor has to consider how high things can go, and also what kind of premium one must pay to buy the dominant music company in a growing industry.
But private equity has a different view of the industry's valuation than the Wall Street investment banks. “The valuations being bandied about for UMG indicate a greater than 20 times EBITDA multiple,” says one financial industry executive who is involved in industry deal-making. “Private equity is not going to pay the kind of multiples that UMG is seeking.”
Another music industry executive familiar with music-asset acquisitions says the high-end of the UMG valuation coming from the investment banks are “insane,” noting it could only be achieved by breaking the entire UMG company up into pieces and selling those to various strategic players that can justify higher multiples based on the economies of scale. In addition, selling UMG in smaller pieces to a number of industry players, rather than all together at once, would sidestep -- or at least lessen -- the threat of regulatory issues. But Vivendi is looking to keep the company in once piece and only sell a stake, so it's unlikely UMG will be dismantled anytime soon.
Who Could Be Looking To Buy?
With a valuation in mind, let's consider who the suitors might be, starting with those strategic digital players suggested in the Bloomberg article. A deal with any of the digital firms like Apple, Amazon, Tencent and Google could provide a conflict of interest issue for both UMG and the services. Since UMG has to negotiate with those firms for royalty payments, that would likely create a worry for UMG artists and songwriters -- and their managers -- about what type of terms UMG concedes to the service, while on the flip side that’s service investors might worry that it is giving UMG a sweetheart deal.Beyond that, UMG's competitors would be worried that UMG would be favored by the digital service in deal negotiations. The conflict of interest issue likely would be negated by fiduciary responsibilities of each party but that doesn’t mean it would eliminate the worries of investors, artists, managers and competitors.
Some industry sources suggest an entertainment conglomerate like Disney or Liberty Media would make the most sense as an investor in UMG. Disney could even use its own stock to finance such a partnership with Vivendi, one industry deal-maker suggests. And, according to the Bloomberg story, Liberty has expressed an interest in UMG in the past. It also already owns stakes in Sirius/Pandora and Live Nation and a stake in UMG would give Liberty insight into the major label, allowing for possible synergies between Liberty's disparate music holdings. And while regulatory approval would be a question, it would probably not be as severe as with a digital service or a competitor.
Liberty's music holdings in Pandora and Live Nation also wouldn't present the same conflicts of interest that other suitors might. That’s because Sirius royalty rates for labels are set by the Copyright Royalty Board, and the same applies to Pandora, as most of its business is programmed streaming. While Pandora's on-demand business is growing and those licenses require direct deals with the majors where a conflict of interest issue could come into play, it remains to be seen if that component of Pandora' operations are still standing in a year or two: Prior to the Sirius acquisition, sources said that Sirius' management wasn't enamored with the on-demand portion of Pandora's operations, so the future of that business might still be a question. For publishing, Sirius and Pandora mainly need performance licenses from the performance rights organizations. That means that the PROs could do the negotiating, and not UMG, although a direct deal would still be needed for the mechanical license for Pandora's on-demand service.
One knowledgeable source says there have already been talks between Liberty and UMG, but that any deal between the parties would be complicated. But if such a deal could ultimately be reached, it likely would involve the creation of a tracking stock, meaning UMG's financials would be broken out from Vivendi with its share price set by market demand -- even though ownership in UMG wouldn't be involved with that vehicle and shareholders would still own the Vivendi stock. In that instance, shareholders would receive dividends based on UMG performance, separate from Vivendi's dividends.
No matter what way you look at a potential UMG deal, it will not be simple. And that, say industry deal-makers, means whatever deal does or doesn’t occur is still a long way off.