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After Months Declining, Music Stocks Tick Up as Fed Raises Interest Rate

Borrowing money will become more costly, reducing businesses and consumer spending to rein in inflation.

Music stocks that had been pummeled in recent months received a respite on Wednesday (March 16) after the Federal Reserve moved to combat inflation and soaring economy by raising the federal funds rate from 0.25% to 0.50%. The federal fund rate is the benchmark rate for inter-bank loans and borrowing costs for credit cards, mortgages and auto loans. Shares of Universal Music Group rose 5.0% on the day to 21.96 euros while Spotify improved 7.9% to $133.58 and Warner Music Group climbed 1.4% to $35.47.

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The Fed’s move had been expected since its first announced its intention to do so on Dec. 15, 2021. By raising the federal funds rate, the Fed will make borrowing money more costly, reducing businesses and consumer spending to rein in inflation. The Fed stated on Wednesday it “anticipates that ongoing increases in the target rate will be appropriate.”

The markets dropped sharply in anticipation of the Fed’s move: from Dec. 15 to Wednesday, the Nasdaq composite fell 13.7% and the New York Stock Exchange composite dropped 3.3%. Some music companies’ stock prices fared even worse. Over that time span, Universal Music Group’s share price dropped 8.5% while Warner Music Group is down 15.5% — after each rallied more than 20% in the last week. French label-distributor Believe is down 23.1% since the Fed’s mid-December announcement.

“Investors are selling expensive growth,” says Barclays analyst Julien Roch.  For years, as interest rates and inflation were low, investors poured into companies with above-average growth rates.  A good example is the Nasdaq 100 Technology Sector Index, which is up 92% in the last two years but has fallen 15% since Dec. 15. Now, value stocks are more fashionable and earnings — the sooner the better — are all the rage.

The music business has been an attractive growth story since Spotify went public in 2018. The allure of rapidly rising revenues and expanding margins attracted investors to Warner Music Group in 2020 and Universal Music Group in 2021. Spotify had a peak market capitalization of $74.3 million in Feb. 2021 when Wall Street was enthusiastic about its plan to invest in podcasts to help compensate for the thin margins of music licensing.

Now, Spotify trades at $133.58, after falling to $118.20 on Monday — its lowest since April 2020 when the markets plummeted at the pandemic’s onset. Other streaming stocks have suffered lately, too. Netflix shares are down 29.7% since the company announced disappointing forecast for first-quarter subscriber growth on Jan. 20 and 40.2% down since the Fed’s Dec. 15 announcement. Roku shares are down 31.3% since Netflix’s announcement and 48.1% since Dec. 15.

“Right now, the markets are not kind to promises of long-term synergies from M&A or unclear returns from catalog investments,” says Bernstein analyst Matti Littunen. “If a deal doesn’t increase cash flows next year in a way that’s easy to understand, it’s viewed with suspicion.”

That’s a challenge in the music industry because some — not all — growth comes from acquisitions of recording and publishing catalogs. But understanding the benefits of these catalog deals is difficult for people on the outside of the transactions. Record labels and publishers tend to provide financial details only on acquisitions of smaller labels and publishers, not more common purchases of individual catalogs. For expensive deals for rights to Bruce Springsteen or David Bowie catalogs, for example, Billboard often estimates what companies omit by calculating annual royalties and backing into a multiple of revenue based on the known or reported acquisition price.

As catalog deals become more expensive, returns might not come immediately. “The labels have said they are uniquely positioned to improve the returns” through licensing and other exploitation, says Littunen, “but that might take some time to do.”

In the meantime, a higher interest rate climate could affect the value placed on royalty streams, says Craig-Hallum Capital Group analyst Alex Fuhrman. “Some investors might look at music catalogs and apply a higher discount rate to what they can generate in the future.” In other words, a higher discount rate will reduce the present value of future income streams. So, even if investors don’t change their expectations for future royalty payments, they would place a lower value on those royalties and adjust their value of the company’s share price accordingly.

For all the recent drama, the Fed’s move was a bit anticlimactic after three months of anticipation and broad sell-offs. In fact, investors seemed encouraged by the Fed’s approach and chairman Jerome Powell’s assurance the U.S. will return to 2% inflation. “The plan is to restore price stability while also sustaining a strong labor market,” Powell said on Wednesday. “That is our intention, and we believe we can do that. But we have to restore price stability.”

The Nasdaq composite grew 3.8% on Wednesday, its best day since Nov. 2020, while the NYSE rose 2.3%. For the most beleaguered stocks, Wednesday’s rate hike could be the start of a promising new phase.