Business

Bill Ackman's UMG Play: A Bad Deal or Just Too Confusing for Investors?

Bill Ackman
Bryan Bedder/Getty Images for The New York Times

Bill Ackman speaks at The New York Times DealBook Conference at Jazz at Lincoln Center on Nov. 10, 2016 in New York City.

The Pershing Square Tontine Holdings plans to acquire 10% of Universal Music Group, but the proposed arrangement's totally unusual for the SPAC market.

UPDATE: PSTH shares climbed as much as 6.8% to $23.55 on Monday (June 7), gaining back about half of the value lost on Friday. The share price closed at $23.03, up 4.4% from Friday’s closing price of $22.06.

Investors are either confused or concerned by the announcement that hedge fund manager Bill Ackman intends to acquire a 10% stake in Universal Music Group through a novel – and unpredicted -- deal by the largest-ever special purpose acquisition company (SPAC).

On Friday the share price for the Pershing Square Tontine Holdings dropped as much as 14.9% to $21.33 and ended the day down 11.94%, at $22.06, after Ackman's Pershing Square Capital released details on the planned deal for PSTH. (PSTH rose 2.8% to $22.67 on Monday morning.) Unlike most SPAC acquisitions -- where a publicly traded shell company reverse merges with a private startup to take the company public without a traditional, lengthy IPO process -- PSTH's plan will invest in UMG and gives its shareholders the equity before the record company spins off from its parent Vivendi later this year.

The proposal calls for PSTH to put $4 billion into UMG ahead of its spin-off from Vivendi on the Euronext Amsterdam exchange that's expected to take place by September. The deal would value UMG at 35 billion euros ,or roughly $42.6 billion -- consisting of $40 billion of equity and $2.6 billion of debt.

It's big news for the music industry but based on the stock market's reaction Friday it's probably not what investors were hoping for. The deal's complexity turns what's normally a straightforward acquisition into a convoluted arrangement. For starters, PSTH is making an investment, not acquiring UMG -- even though the "A" in SPAC stands for acquisition. PSTH investors may get an acquisition eventually: The funds not used in the UMG deal will be set aside for another SPAC -- and that's part of the deal's complexity.

Even though PSTH has $5.6 billion in cash it will only use $4 billion in the UMG deal -- the record amount raised in PSTH's IPO on Sept. 11, 2020, at $20 per share. As a result, PSTH shareholders will get two securities instead of one: ownership of UMG as well as a Pershing Square acquisition fund representing the funding left over from the UMG investment. The third component is a warrant -- a right to purchase -- for a future Pershing Square SPAC.

Altogether, the arrangement is so twisted it evoked a chuckle from CNBC host David Faber -- never a good sign -- during a confused, three-minute explanation of the transaction's details on Friday.

What valuation investors should place on UMG could also be a sticking point for some PSTH shareholders. Ackman's deal values UMG at 35 billion euros ($42.6 billion), the midpoint of two other estimates. A Tencent Corp.-led consortium of investors purchased 20% of the company at a 30 billion euros ($33 billion at the time) valuation in two installments finalized in March 2020 and January 2021.

If investors want to know they're getting UMG at a discount, they won't find comfort in Warner Music Group's valuation. PSTH puts UMG's enterprise value at 24 times 2020 EBITDA -- the same as WMG. That means investors that wanted better terms from Ackman will need convincing given UMG is intrinsically worth more than WMG. Ackman said as much in a statement issued Friday by declaring that UMG has "one of the most outstanding management teams" that he's "ever encountered."

UMG is certainly a stable company with the most successful labels turning out the most hits of the three majors. And as the largest music company in the world, UMG should enjoy the benefits of economies of scale. If a market leader gets a premium over its rivals, UMG is worth more than 24 times its 2020 EBITDA.

But PSTH shares could have significant upside to take investors well beyond $42.6 billion. Goldman Sachs issued a report in April putting UMG's value at 44 billion euros ($53.5 billion) about 24% above PSTH's valuation and 61% more than the Tencent deal. It based its estimate on a litany of optimistic assumptions: an 11% cumulative annual growth rate for the global streaming market, culminating in revenue of $75 billion in 2030; "an accelerated shift to music streaming" that will continue beyond the pandemic.

Using Goldman's valuation of UMG increases the value of a share of PSTH to about $24.02 -- the proposal breaks up each $20 share into one piece for UMG at $14.75 and $5.25 for the acquisition fund. At Goldman's $53.5 billion valuation, the UMG equity increases to $18.52 per share (assuming the acquisition security remains at $4.25 per share). Friday's closing price of $22.06 implies that investors are unsure about UMG's valuation. But using the valuation from Tencent's investment, a share of PSTH would be worth $16.93.

There's also the matter of whether PSTH shareholders wanted something else and could consider UMG to be an unfulfilling target compared to some buzzy tech companies. PSTH shares were riding high in early 2021 amidst speculation the SPAC might target Airbnb, financial tech firm Stripe or Starlink, the nascent satellite-based internet provider founded by Elon Musk. Bloomberg and Chik-Fil-A were also tossed about. Given Ackman's celebrity status and reputation as an activist investor, some PSTH shareholders may have anticipated a more daring move that would give him greater influence in the target company.

SPACs became popular in part because investors want to invest in private companies that usually take investments only from hedge funds and venture capital firms. By the time a private company has an IPO, those early investors have already profited from their investments many times over. PSTH's plan for Universal still achieves that goal, but only for a fraction of the highly valued company, where the upside may not be as high as some were hoping.

Some investors might think a direct route to UMG is a better idea, though. Reuters columnist Liam Proud argued on Friday that investors who want a piece of UMG could instead buy Vivendi stock ahead of the spin off. Since Vivendi will distribute UMG shares as special dividends to its shareholders, buying Vivendi stock would  effectively be buying UMG shares directly and for less money. However, that could create tax issues for the shares' recipients, hedge fund Bluebell Capital complained in a May 21 letter to Vivendi. As a solution, Bluebell suggested that Vivendi pay a one-time dividend of 2.80 euros per share to accomplish to cover expected taxes from the dividends (Vivendi will have a chance to address the matter during its June 22 annual shareholder meeting).

Pershing Square's pitch for the complex transaction included a universal truth along with details of its financial wizardry: "Everyone loves music!" With more time to digest the details and mull over UMG's value, and more selling by Ackman, investors might give this proposal more love.