What Will Warner Music Be Worth When It Goes Public?

Matt Winkelmeyer/Getty Images for Warner Music
Len Blavatnik attends the Warner Music Pre-Grammy Party at the NoMad Hotel on Feb. 7, 2019 in Los Angeles.

Expect plenty of speculation on WMG's valuation and share price ahead of a planned IPO.

With Warner Music Group's announcement Thursday of plans to go public with an upcoming IPO, now begins a waiting game to see how much of the company will be sold and how the shares will be priced, determining the company's overall valuation. That job will be left up to Morgan Stanley, Credit Suisse and Goldman Sachs, the stock offering's underwriters.

According to the prospectus on file at the SEC -- which leaves blank key information such as stock price and number of shares being offered -- the proceeds of the stock offering are going to current shareholders, not to WMG.

Currently, there are basically three groups of shareholders: EI Entertainment Holdings LLC, Altep 2012 L.P. (both of which are controlled by billionaire Len Blavatnik and his Access Industries) and the management team and directors. It's unclear exactly how ownership is structured, but in WMG's most recent filing the two entities owned by Blavatnik owned 94.8% of the company's Class A shares while the management group, through a long-term incentive compensation plan, owned the other 5.8%.   

It's likely that EI and Altep will be selling some of their shares, which means proceeds will mostly flow to Access Industries. And while WMG currently only has Class A common shares (which will be sold in the stock offering), the process will also create Class B shares that will each have the voting power of 20 common Class A shares. It's still unclear how the existing Class A shares will be converted into Class B shares, but what this means is that only Class A shares will be sold, while the existing shareholders, through the Class B shares, will still control the company.

"After the completion of this offering, we will be a controlled company," the prospectus states. That means that Blavatnik will likely retain control of the company, even if his two entities sell 51% of the common shares, and Access will be the recipient of whatever proceeds the IPO brings in.

The prospectus spells out that controlled companies may not elect to comply with certain corporate governance standards, like having independent directors among other common public company practices that WMG may not adapt. Normally, shareholders can have input into a publicly traded company's governance, if nowhere else than through proxy votes at the annual meetings.

Consequently, controlled companies are not as popular as a stock investment among institutional investors. In fact, some institutional funds won't buy shares in "controlled" companies.

Beyond that, the big question is what will be the target stock price when and if the company finally comes to market and what valuation will that imply. Expect plenty of speculating on WMG pricing, especially those who follow the music industry but whose investment banking firms weren't picked to underwrite the share offering. Also, industry financial executives will be watching this closely to see if they need to reassess any deals they are currently in or contemplating, while others may be likewise considering a public offering and wondering how the WMG pricing will impact their company. In other words, there will be plenty of speculation on WMG pricing.

In fact, as recently as last Friday, the day the company posted $122 million in net income on $1.256 million in revenue for its fiscal first quarter ended Dec. 31, 2019, WMG's executive vp & chief financial Eric Levin implied that the company itself was in the process of re-calculating the company's valuation. During a conference call with investment analysts on the WMG results, he reported that the company's expects to pay $250 million to $300 million to the company's senior management longterm incentive plan, which apparently is based on the company's valuation.

"That said, we are in the process of evaluating what impact Tencent's investment in Universal [Music Group] have on current valuation; and the resultant impact to variable compensation expense and future cash payout," to the plan, he added.

When Tencent and a consortium of investors agreed to buy 10% of UMG for 3 billion euros, that gave UMG a 30 billion euro valuation ($34 billion). Since the company had $972 million in earnings before interest taxes, depreciation and amortization for the year ended Dec. 31, 2018 -- the financial results that Tencent probably used to value the deal, that means that if the deal closes at that price, UMG will be trading on a nearly 31 multiple of EBITDA -- UMG's financial results come out next week so that will likely lower the multiple, considering the successful year the company has had in its first nine months.

As it is, industry valuations have been escalating over the last three years, thanks to the success of streaming and the glowing industry overview reports with huge growth projections from investment banks like Goldman Sachs and others. But just because UMG traded at about a 30 times EBITDA multiple that doesn't mean all music assets deserve that type of pricing, says one industry financial executive. He says that UMG likely got a premium for being the largest music industry company in the world.

Until recently, recorded music had been trading at a 20 times EBITDA multiple and even that is up from 8 years ago when it was trading at 12 times EBITDA or back in the 1990's when they traded at a 4 times EBITDA multiple. Meanwhile, music publishing assets generally trade on Net Publishers' Share (gross profit—after paying out songwriter royalties) and nowadays trophy publishing assets are trading at over 20 times NPS multiple, which is up from 16-18 times multiple that stood at over the last two years and the 12 times NPS multiple that most deals went fro back in 2010-2014.

Let's turn our attention to WMG. In addition to its latest quarter, it also recently announced annual results for the year ended Sept. 30, 2019 when it posted $256 million in net income on revenues of $4.475 billion. That was up 11.7% in revenue from the prior year's total o $4.005 billion but net income was down 17.9% from $312 million in the prior fiscal year. However, the prior year's net income was inflated somewhat by selling the Spotify shares the company owned when the digital service did its public offering. Looking at operating income before depreciation and amortization (OIBDA), the company turned in $625 million last year, a 30.8% increase over the $478 million in OIBDA generated in the prior year.

Using the multiples from the UMG/Tencent deal and using WMG's OIBDA—a similar financial metric to UMG's EBITDA—would price WMG at $19.25 billion. However, some financial executives point out that UMG may have achieved a premium multiple thanks to being the largest music company in the world. But other industry executives note it took a long time for Vivendi to find an investor willing to pay the kind of pricing inspired by the Wall Street investment bank analysts for UMG. It took over a year and in the end, Vivendi so far have only announced a deal for 10%, not the "up to 50% of UMG that Vivendi said it may sell, back on July 30, 2018. One music industry top financial executive suggest that Vivendi's plans to sell up to 50% of the company so far may have been stymied by the high valuation.

Meanwhile other music industry financial industry executives have been astounded with Wall Street projections and valuations of music assets in general and UMG in particular, even though their companies may be the beneficiary of such pricing.

Giving that, financial executives said that a 20-25 times multiple is more likely the going rate for valuing companies nowadays. At a 20 times multiple, that would value WMG at $12.5 billion.

But going for the 25 times multiple that some industry executives feel is a more reasonable price point in that it is not as inflated as some Wall Street valuations but it is higher than what music company assets were trading at a couple of years back, that would price WMG at $15.625 billion.

Looking at WMG valuation another way—by pieces—recorded music had $623 million in OIBDA for 2019 but when overhead is figured into the equation, Billboard estimates OIBDA for the recorded music operation at $482 million, which at a 25-times multiple comes out to $12.05 billion. Moving over to Warner Chappell, last year after A&R costs, its net publisher share was an estimated $228 million. Again, going with a mid-level music pubilshing multiple of 18 times NPS, that would produce a $4.1 billion valuation, which combined with the recorded music valuation would result in an overall $16.06 billion price. So mid-level pricing ranges from $15.25 billion to $16.06 billion but the controlled company aspect of the offering could stymie the stock offering's overall valuation.

Moreover, the company also has nearly $3 billion in debt or $771 million more in debt when Access Industries first did its leveraged buyout back in July 2011 for $3.283 billion, using $1.066 million in equity and $2.217 billion in debt. While the company has so far shown no inclination to pay-down debt—the $142 million in interest it paid last year to service that debt helps lower the company's taxes, which means that the debt is even cheaper than 4.75% interest rate it paid last year on its debt—its unclear how stockholders will react to buying into a company with that kind of debt level even though it produced $625 million in OIBDA; and had $619 million in cash and cash equivalents at year end.

Whatever pricing the WMG deal ultimately brings, Blavatnik and Access Industries have already hit a home run with their investment in the label group. Since buying the major, WMG has paid out dividends to shareholders totaling $1.3465 billion while Access Industries has been paid $90.2 million for managing its WMG investment and consulting on the company's acquisitions, for a total of $1.37 billion. That means Access and Blavatnik have already taken some $300 million in profits out of its investment, with billions  of dollars more likely to come their way, if it follows through and does an IPO and investors buy into the stock offering.

On the other hand, this stock offering may just be a way for Access to get a proper valuation for the company, especially if there are potential suitors interested in buying it. "Going through the motions of doing a stock offering—when a suitor is negotiating a deal to buy a company but has doubts about the pricing—is a classic M&A tactic to line up a stalking horse to help set pricing," says one Wall Street investor.


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