Much of Pershing Square’s three-hour, 128-slide presentation Wednesday -- which included a 15-minute intermission and 45 minutes for financial details and a Q&A session -- served as a necessary primer on copyright, intellectual property, the intricacies of royalty payments and the state of music in the age of streaming and smartphones. Beyond that, Pershing Square explained how UMG meets PSTH’s desired characteristics in a target company: a “capital-light, rapidly growing royalty on greater global consumption and monetization of music.”
UMG has “a massive addressable market, strong customer value proposition” -- meaning music is affordable way to access nearly the entire world’s music -- “and dominant market position [that] supports double digital growth,” said Ackman. And Pershing Square likes that UMG will be an uncontrolled company with an independent board of directors. Current owner Vivendi will own a 10% stake after distributing 60% of UMG’s shares to its shareholders. (The other 20% is owned by a consortium led by Tencent.) In contrast, as Ackman pointed out multiple times, Warner Music Group is still majority-owned by Access Industries and shareholders have little voting power.
There was much more to PSTH’s attraction to UMG. Ackman cited UMG’s market leadership and 31% share of global music consumption; an attractive capital structure with little debt -- only 2 billion euros -- and no stock options or warrants; and strong free cash flow. Streaming margins are improving by the year and UMG outsources physical manufacturing instead of owning CD pressing plants, which it did in the past.
Ackman frequently gushed over UMG’s leadership. He compared chief executive officer Lucian Grainge to “iconic CEOs” such as Walt Disney, Apple co-founder Steve Jobs and Netflix co-founder and CEO Reed Hastings. “The best indication of the quality of a leader is the team they’re able to recruit behind them,” said Ackman. “The team is extremely strong.”
Ackman said he’s attracted to how Grainge gives his executives the autonomy to act as entrepreneurs and compete against one another. “In the proverbial ‘get hit by a pie truck’ world” -- meaning music companies are constantly face unexpected events and challenges -- “this is a company that will survive and thrive.”
The most interesting aspects to Ackman’s presentation were the viewpoints he offered on UMG as an industry outsider: Pershing Square was able to come into UMG, through an introduction by PSTH director Jacqueline Reses to Vivendi, with fresh eyes and without bias. Its interest in UMG’s business model can be boiled down to two sentences: “The way to think about it is if you own Universal Music Group, you own a royalty on people listening to music,” explained Ackman. “And I can’t think of an asset that I could have more confidence in being consumed over time -- other than food and water.”
In the case of subscription services, licensing labels’ intellectual property is crucial to their businesses. “Today, Universal is a pure IP company selling IP to extremely well-capitalized companies that are highly motivated to acquire customers.” For Spotify, a rare standalone company, licenses are crucial to its business model. Apple and Amazon use music to sell other goods and services. In any case, Ackman likes that streaming services, not UMG, are funding the infrastructures of today’s music business and paying to build their customer bases. In other words, UMG is using other people’s money to build a new business model.
Music is no longer a manufacturing and distribution business. It’s built on recurring revenue, not discrete purchases of CDs, LPs or downloads. Money comes from anywhere music is played: subscription services, ad-supported streaming services, video games, digital fitness companies and a plethora of public performances, from radio to retailers, all license UMG’s music in one way or another.
So, Ackman encouraged investors to compare UMG to a SAAS -- software as a service -- company that collects recurring revenue and has fixed operating costs. Or, as Ackman phrased it, UMG is a “MAS” -- music as a service -- company.
“It’s digital bits and bytes in the same way as software,” said Ackman. “And it has a similar trajectory.” First came the physical products, when Microsoft Windows was sold in a box at brick-and-mortar retail. Then Windows was downloaded on the internet. Next came the SAAS model where consumers pay a fixed monthly fee to use applications in the cloud.
What is the biggest company that licenses a third of music consumed worth in 2021? Pershing Square is buying into UMG at a 35 billion euros valuation ($41.8 billion), with 33 billion euros ($39.4 billion) of equity and 2 billion euros ($2.4 billion) of net debt. But it believes UMG is worth far more than that and PSTH investors will effectively acquire UMG shares at a discount. The average of 11 equity analysts’ valuations of UMG is 39 billion euros ($46.6 billion), according to Pershing Square. But Ackman frequently cited JP Morgan’s 50 billion euros ($59.7 billion) valuation, the highest of the group, and a 43% premium over the price PSTH negotiated.
Memory of the music business’s recent history could be affecting analysts’ judgement, Ackman argued. When Warner Music Group was a public company under Edgar Bronfman, before Access Industries acquired it in 2011, the music industry was in decline and WMG’s share price suffered. Today’s WMG is in a growing market and management has helped stabilize the business. “We think Warner is a meaningful undervalued company,” Ackman conceded. “But we also think UMG is a much more valuable company.”