Music companies are hot investments again — but the bargains are becoming hard to find.
Sellers of record labels and music publishing assets are reaping the benefits of a music business that’s being transformed by subscription streaming services. The industry's total revenue from recorded music doesn't yet match its highs in the CD boom — 2018 revenues were 67.1% of the apex in 1999, but 45.6% when adjusted for inflation — but sales are booming nonetheless.
Despite the high price tags, at least one Chinese company wants in. Tech giant Tencent Corp., majority owner in streaming company Tencent Music Entertainment, plans to purchase 10% of Universal Music Group for $3.3 billion, according to an Aug. 6 announcement by parent company Vivendi. The investment would value UMG at $33 billion — or 32 times earnings before interest, taxes, depreciation and amortization (EBITDA), based on its 2018 figures — and would come with the right to purchase an additional 10% stake later. UMG parent company Vivendi has stated its desire to sell up to half of the company and confirmed in July it had hired an investment bank to advise on a transaction.
UMG’s valuation has been rising for years. Back in April 2017, Bank of America analyst Daniel Kerven succinctly described Universal's appeal in a note to investors: “It would be hard to conceive a better story — a transformed product that drives a multiple of revenue from a very low base after 20 years of disruption, whose take up is being paid for, subsidized by telco and internet companies.” Vivendi raised eyebrows during its 2017 shareholder meeting by saying UMG’s value was $22 billion. The same year, Goldman Sachs put the figure at $23.5 billion. Earlier this year, JP Morgan estimated a $50 billion value. Deutsche Bank hit the nail head with $33 billion in January.
(1) A Tencent investment in Universal Music Group at $33 billion, or 32x 2018 EBITDA, reflects the value in a fast-growing company in a surging market.
(2) A 32x multiple would far surpass multiples paid in previous industry acquisitions, such as Terra Firma’s 18.5x EBITDA price paid for EMI in 2007.
(3) While large, a 32x multiple would not overvalue UMG when compared to other large, high-growth companies like Netflix or Amazon.
A handful of recent deals reflect investors’ interest in music, though none have seen sales prices near 32x EBITDA. Scooter Braun’s Ithaca Holdings acquired Big Machine Label Group. Sony/ATV bought the remaining interest in EMI Music Publishing. Hasbro acquired Entertainment One (where music is only part of the overall business). Concord bought punk label Victory Records and Another Victory publishing company. Downtown Music bought the catalog of label Strictly Confidential. But these acquisition prices haven't matched the high expectations built into the Tencent-Universal deal’s price, nor the 18.5x EBITDA paid by Terra Firma for EMI.
Acquisitions are often priced in terms of EBITDA, which gets to the heart of a company’s performance. Interest and taxes are removed from the equation, because they aren’t directly related to operations. Depreciation is an accounting measure — also not a direct reflection of operations — that writes off the value of an asset. And amortization is effectively depreciation of intangibles, like music rights.
A company’s value divided by EBITDA is called the EBITDA multiple — 10x EBITDA, for example. Multiples are commonly used by analysts and investors to value a company. Finding the appropriate multiple requires finding a comparable company as a basis. For example, say Company A is worth $100 million at a 30x EBITDA multiple. Four other companies have a similar growth rate, industry, operating margins and geographic reach. You get an appropriate multiple by using an average of the four companies’ value-to-EBITDA multiples.
A 32x EBITDA multiple is high by historical standards. Investors consider publishing catalogs to be extremely expensive at 16x or 18x net publisher share, a version of earnings. But a high-growth company, with a top market share in a fast-growing industry, can earn a higher-than-average valuation; investors will pay a premium for a company with the potential for sustained double-digit growth. UMG’s revenue grew 10% organically (at constant currency) in both 2017 and 2018. Available numbers suggest revenue will grow by 10% or more in 2019, too. In the U.S., for example, recorded music revenues were up 18% at the mid-year point, according to the RIAA.
Past music acquisitions make the Tencent deal look expensive. Vivendi bought BMG Music Publishing in 2006 for $2.09 billion at a pricey 19.6 EBITDA multiple; at 32x, the deal would have cost $3.3 billion. Private equity firm Terra Firma paid 18.5x EBITDA for EMI Music in 2007 — a leveraged buyout using cheap capital a moment before the Great Recession and during the music business’s 15-year downturn. At 32x, Terra Firma would have spent $8.2 billion. More recently, Warner Music Group paid 7x EBITDA for Parlophone Music Group in 2013, a time of optimism in streaming but continued revenue depression.
Universal won't appear as expensive next year. If the Tencent deal terms remain the same — 10% stake for $3.3 billion — the multiple will fall over time because UMG’s EBITDA will grow every year. If 2019 EBITDA improves by 15% — a plausible outcome given previous years’ gains — a Tencent investment would be 27x EBITDA. Even so, 27x is still high by music industry standards.
But UMG certainly isn’t overvalued when assessed using the same criteria applied to large, high-growth companies. Netflix currently trades at 67.8x EBITDA nine years after launching its streaming service. Amazon may be more than two decades old but the all-consuming e-commerce giant has a 70.7 price-to-earnings ratio and trades at 26x EBITDA. Vivendi is currently trading at a 24.8 price-to-earnings ratio. That said, a 32x EBITDA multiple is relatively high in other sectors. Information technology stocks have an average EBITDA multiple of 18.8, according to the latest data maintained by New York University professor Aswath Damodaran (of companies with a positive EBITDA).
An investment at $33 billion would set a precedent for further investments. Vivendi has indicated its interest in selling up to half of Universal. It seems unlikely that Vivendi would sell the remaining 30 to 40 percent of Universal at a lower valuation. Vivendi has certainly made its case. It rejected an offer of $8.5 billion in 2013. Two years later, supervisory board chair Vincent Bollore turned down interest from Liberty Media chairman John Malone (who prefers undervalued companies). Vivendi chief executive Arnaud de Puytontaine indicated in 2017 that he believed UMG’s value topped $40 billion. He hesitated at first, saying “I wouldn’t put a number [on the value], but I think that number is higher than the highest one that is currently expressed by the markets,” he said at a Morgan Stanley conference in Spain. As Reuters recounted, the interviewer asked de Puytontaine if he thought UMG was worth more than $40 billion. “Yes,” he said. It seemed high at the time, but he wasn’t far off.
And if the stocks of companies like Netflix are any indication, the value of UMG and other big music prizes may still have further to climb.
Content companies may have received less respect than they deserved. Streaming companies' stocks — Netflix, Spotify and Tencent Media — are sagging on growth concerns. The chants of "music wants to be free" in the 2000s have been replaced by "content is king again" at the end of the 2010s.