Music Labels - The Most Profitable Internet Business and an Emerging Asset Class

                                                     **Music Labels** 
                     **The Most Profitable Internet Business and an Emerging Asset Class**

December 26, 2020

*Notes : * The Indian companies are not under research coverage and hence the database provides TTM numbers only. It must be noted that TTM numbers include atleast 2 quarters impacted by Covid -19 related lockdown. *
Given news paper reports of high growth in content consumption, and recovery in ad-spends in during Q3FY21, SIL and Tips may be trading at substantially lower PE multiples on FY21 basis. Forthcoming quarterly results will be the litmus test.

Background :
The Music Industry is conspicuous largely by its absence in most discussions / research reports on the media industry and also from institutional as well as individual investment portfolios in India.
Internationally, its already acquiring an asset class status with some of the largest pension funds and insurance companies investing in music rights through wholly owned subsidiaries or through private equity funds dedicated to acquiring music rights. In today’s environment its easy to see why these long term investors would covet steadily growing stream of cash flows generated from music rights. These rights would be a good long term asset to match their long term liabilities.

But why are they missing from portfolios of mainstream equity investors in India ?

Perhaps due to their small size, or due to past industry dynamics and/or due to contentions related to corporate governance. Whatever the reason, it has led to widespread ignorance about the industry’s transformation. A peek into history provides some insights :

A Brief History of the Music Industry

The Music label business has been a very profitable one throughout history. It has operated in classic FMCG fashion with a typical distribution network selling Vinyls, tapes, cassettes and CDs / DVDs. The control of the physical distribution chain afforded pricing power to the labels. All was hunky dory until the digital big bang.

Unlike the proverbial, creative big bang, the music industry’s tryst with digitization was hugely disruptive. It started with the introduction of Napster in 1999, which allowed free peer to peer file sharing. Piracy soared. While the music industry was successful in shutting down Napster in its initial avatar sighting copyright infringement, piracy became rampant with the spread of internet.

The truly lethal blow came from the introduction of iTunes. Apple’s radical strategy of offering singles for a dollar each broke the revenue model of the labels, which relied on bundling 10 to 12 songs in a CD and charging 10 to 12 dollars per CD. Listeners rapidly adopted digital listening devices such as the iPod and subsequently smart phones. As a result physical sales suffered and the music labels eventually lost their control over distribution channels. Consequently, their revenues and pricing power declined.

Resurrection
In classic fashion, industry reacted to challenges with consolidation. Between 2000 and 2014, over 300 music labels operating world wide merged into 3 entities viz; Universal Music Group, Sony Music and Warner Music Group. Today these 3 control close to 90% of global music content.

To bring back pricing power, the labels experimented with alternative technologies too. Each of the Big 3 took equity stakes in Spotify and offered use of their catalogues at concessionary rates to Spotify in a bid to promote streaming.

Music streaming eclipsed downloads to become the largest contributor of revenues in 2015. Every year since downloads have been declining, while streaming revenues register robust growth. The Music Labels’ revenues declined from USD23.5 bn in 2001 to USD 14bn in 2014. Since then they have recovered to USD 20.2bn in CY2019. Music is the first industry to emerge from digital disruption.

Metamorphosis Complete – Growth phase underway : The Music Industry emerged from these challenges completely digitized. It is now an internet business and a highly profitable one.

Gone are the costs of manufacturing cassettes, CDs, warehousing and transporting them to distributors and retailers. Music is now recorded, uploaded and consumed digitally. Technology allows every stream to be tracked.

The global music industry still derives a share of revenues from physical sales, primarily from Japan and Germany. But the share of physical revenues is declining rapidly. Most of the other markets are almost completely digitized or getting there rapidly. The Indian market is almost fully digitized.

This new avatar brings several favorable dynamics for the industry.

Distribution : The penetration that digitization has brought is underappreciated. In India today, to buy bread, candy, pan masala, soap or shampoo sachet, or any other daily necessity, a person would have to walk to the nearest “pan ki dukaan” at the street corner or go to the nearest convenience store or grocer. But music is available at the touch of a button, on a device sitting beside you 24 /7. Even in areas with low internet speeds, technology ensures uninterrupted streaming even on feature phones. That’s right, “distribution is now per capita”.

Convenience : The pulls and pressures of today’s busy life has made convenience a top priority for consumers of all ilks. Evolution of technology has brought convenience to music consumption. In ancient times, when one went to college in the late 90’s, a music aficionado required to carry a Walkman, head phones and cassettes to listen to music on the go and spend on frequently dying batteries to power the contraption. Now everything has converged into the smart phone and one need not even buy music. High fidelity sound quality is available for free on multiple apps and listeners can access 60 million songs on Spotify, “on demand”.

Piracy : Technology has disrupted piracy the most. There is no longer an incentive for people to visit obscure websites for downloading songs and risking virus / trojan attacks on their expensive devices. Licensed music is available for free on You Tube, Spotify, Gaana, Saavn and a host of other apps.

Cheap Data : India has the lowest data costs in the world and that provides impetus to consumption of licensed music. Globally too, declining data costs are aiding subscriber penetration and growth of streaming.

Smart Devices : Penetration of smart phones and smart speakers like Google Home, Amazon Echo are making music available through a voice command. Imagine a person working from home says, “Alexa play Arijit Singh songs”. Music streams without the person having to “lift a finger”. Such innovations and advances are increasing time spent on music consumption, by making it available seamlessly. Consumers are now listening to their favourite music at times, which would have been unthinkable previously.

Sticky Business : According to IFPI, in 2019, Indians spent 19 hours/ week listening to music compared to a global average of 18 hours. Americans spent 26.9 hours on average but American teens and millenials spent 32.6 and 29.7 hours respectively, listening to music. Despite the gyrations of the industry and emergence of new options such as video games, music remains a popular mode of entertainment.

Pricing Power : Globally 3 companies own almost 90% of music rights. Telecom, Television, Radio, and OTT pay licence fees to music labels to use their music. In almost every country there are more than 3 players in each of these categories while there are only 3 music licensors. Clearly, pricing power has shifted back to music labels. Additionally, the internet provides alternate monetization models for content, which has weakened the hold of distributors such as television channels.

Its also visible in the revenue sharing arrangements with OTT players. Spotify pays out almost 70% of its revenues to music labels. You Tube pays 55% of advertising revenues to content providers.

Intellectual Property Rights : The key driver of pricing power is copyright protection accorded to music. In India copyrights are protected for 60 years. In USA, the protection is for 70 years with ongoing lobbying to extend it to 100 years.

This is the longest IPR protection available to any industry. For eg : New drugs discovered by pharmaceutical companies get patent protection for only 20 years.

Paid Subscriber Growth : Spotify has the distinction of growing its paid subscriber base at 45% CAGR since its inception in 2008 until its listing in April 2018. In the first quarter of CY2020, the number of music streaming subscribers worldwide amounted to 400mn, up from just under 305mn at the end of the first half of 2019. This means 5.3% of the global human population now pays recurring monthly subscriptions to music service platforms.

Spotify has 144mn paying subscribers across 92 countries (out of 195 countries in the world). This provides reasonable hope that the willingness to pay for music is a global trend. It is mirrored in Netflix’s 195mn paying subscribers too and believe it or not, mutual fund SIPs are a form of monthly subscriptions too.

FICCI – EY Media and Entertainment Report 2020 cites Indian subscription revenue growth at 50% yoy. It expects total subscription revenues to cross Rs 2000 cr in the next 3 years. This amount is expected to be equally divided between music and video.

Where Will Advertisers Go ?
Indian media industry is largely advertising driven. However, in this age of cord cutting and “Content On Demand”, television is unlikely to remain the mainstay of marketing strategies.

As such, advertising attracts no viewership and therefore has to be couched within content and viewers lured with the offer of free content. In the “On Demand” age, advertisers will continue to follow audiences and embed advertising into content streams. Since internet makes distribution a more level playing field, popular content and not distribution heft, will attract more advertising revenue. This is a stark departure from the existing television ecosystem. Music being a popular entertainment option will now see more flows than before.

Indian digital advertising spend is growing at 30% CAGR and expected to reach Rs 50,000 cr by 2025. This provides a natural tailwind to the music label business.

Music Business

There are only 3 listed music companies (to my knowledge), of which the largest is Warner Music Group (WMG) which listed on the Nasdaq in June 2020. The other two are Indian, Saregama India Ltd (SIL) and Tips Industries Ltd. (Tips)

The global music industry is driven by rock stars (literally) while the Indian populace cavorts to the rhythm of film music. These are deeply entrenched cultural tastes and not easily changed. Therefore Universal Music Group (UMG), WMG or Sony are not able to bring their global repertoire and grab market share. Moreover they do not have sizeable catalogues of Indian music and therefore remain marginal players in India.

The differences in business model are reflected in margins. The global giants have seen their EBITDA margins improve from 15% to 20% over the past 4 years. However, Indian companies steal the limelight with 50 to 70% EBITDA margins. Tips has reported the highest CFO both as a % of EBITDA and Music Sales in this small universe. It also displays superior capital allocation compared to SIL.

Emergent Asset Class : Large pension funds and insurance companies are investing in music royalties. A glance through the following articles provides enough evidence to conclude that music rights are being seen as a separate asset class due to the non-correlated and inflation protected nature of their royalty streams.

  1. Hipgnosis Songs Fund : USD 1.6bn of AUM listed on LSE to provide pure ply exposure to music rights.
    Hipgnosis Songs Fund - Wikipedia

  2. Kobalt Capital – Fund 2 raised USD 345mn to invest in music copyrights, from institutional investors led by UK pension fund RPMI Railpen in 2017.

  3. Round Hill Music Royalty Partners a private equity firm dedicated to investing in music copyrights raised USD 291mn as equity commitments for its third fund in November 2020. Fund two raised USD 260mn in December 2017 and Fund One raised USD 202mn in July 2014.

  4. Dutch Pension Fund Manager : APG Opportunity Fund invests in music royalties ( 2013)
    Rock ‘n’ roll yield | Features | IPE

  5. Ontario Teachers Pension Fund, CPPIB investing in royalty streams since 2010. CPPIB has USD1bn investments in royalties at end of 2014.
    Intellectual Property: For music copyrights the beat goes on

  6. USD 3.2 bn invested in funds focused on music royalties by September 2019.
    Investors in Search of Yield Turn to Music-Royalty Funds - WSJ

Scalability : The following is a purely hypothetical scenario :
What if, by 2025, there are 5 cr Indians paying Rs 100 / month (USD 1.35 at current exchange rates; not factoring further depreciation of INR) for music ?
Then subscription revenue would total to Rs 6000 cr. Assuming the music labels retain 70% of subscription revenues, they would collect Rs 4200 cr from subscriptions.

Digital ad-spends are already growing at 30% p.a. and contribute bulk of industry revenue. Taking the current industry size at Rs 1300 cr and assuming that grows at 20% p.a. Advertising’s contribution would be Rs. 3234 cr. That brings the potential market size to Rs 7434 cr.

While these macro numbers seem probable to me; I re-iterate these calculations are purely hypothetical and every investor should do their own ground work and arrive at their own conclusions.

Valuation Disparity

Despite the higher growth and superior profitability the Indian companies are trading at substantial discount to WMG. Before going private in 2011, WMG was listed on the NYSE. However in June 2020 it chose to relist on the Nasdaq instead of the NYSE, clearly indicating the internet driven nature of its business. Occam’s razor suggests there’s information asymmetry due to which Indian capital markets are not yet viewing these companies as internet businesses or pricing in the growth and inflation protection offered by music copyrights.

Given the higher margins, cash flows and ROCE’s of Indian music companies, I would argue for the Indian companies to trade at multiples similar to WMG. UMG’s listing is planned towards the end of 2021. May be that will provide a fillip to Indian companies’ valuations.

Comparing the listed plays on internet in India, i find that most lack IPR protection. Additionally, their growth rates are similar or lower and cash flows abysmal, compared to the music companies. Accounting is complex and attribution of returns is difficult in the best of cases.

In contrast, the music companies provide a pure play on growing internet penetration and on the prevailing trend of “on demand” content consumption (possible only over internet). Like other internet businesses, their revenue models offer non-linear growth, which flows down to bottom line due to negligible variable costs. At current market caps of SIL and Tips, its difficult to overemphasize the potential for value unlocking.

As the information asymmetry narrows, I believe there will be a substantial re-rating of these companies.

**Risks :**slight_smile:

Smart Phone Prices : Import curbs on Chinese products can lead to higher smart phone prices, slowing their adoption.

Data Prices : Rising data costs could cause a shift from streaming, although no alternate technology is visible just now.

Execution : While there are several tailwinds supporting the sector, management’s execution capabilities will matter in creating value. Optimal re-investment of free cash flows will be critical.

Regulations : Any change in regulation favouring platforms over music labels could adversely impact sales and profit growth.

Disclosure : Invested in WMG, SIL and Tips

32 Likes

First of all excellent write up.
I think above paragraph is the crux. It’s a boon on one hand that indian players are protected from global repositories onslaught while a challenge as well as probably this cultural difference would not make indian young or even mid/old generations hooked up addictively to latest movie songs while their global counterparts would wait in line for next songs of their chosen super stars …and to get a first show of that would happily subscribe to the monthly paid option. Indians on contrary could rather pay for the movie OTT where they get to watch the moves of their super stars along with music…or would wait to get music at cheaper rates as they are not addicted yet…views invited

5 Likes

Hi, thank you for posting!
Would like to share my thoughts
Have been looking at Saregama for a while now.
The issue holding me back is simply “Capital Allocation”.
It has a lovely streaming business which can be a cash cow but what it needs is able hands to allocate that cash well.
Where are they putting money received from streaming business?

  • Carvaan: first time sales with heavy marketing worked but has been loss making overall. As during pandemic sales weren’t pushed hence we saw better Q1 results.
  • Yoodlee films: low budget ott movie/teleseries business might look good but is not at all as profitable as the music streaming business as ott royalties are one time whereas streaming business gets you cash every time the song is played.
  • Print publishing: that is a small but recurrent loss making business which Mr. Mehra also agrees but mentioned that will stay where it is!

So the question is whats the most prudent way to utilise the cash? Its quite similar to ITC in that way where a legacy business is a sure way of generating cash but question that arises is how to pour back the capital back in the music business which is being done albeit not aggressively as other avenues are taking much focus.
If a good path can be found then I feel the business can be a good compounder !
My 2 cents.

PS: @desaidhwanil sir tracks the company and might have some insights to add.
Further reading:

  1. Why spotify wont be the netflix of music
2 Likes

The Risks for listed Indian music cos are far more than what has been mentioned.

  1. The 2 most powerful music labels that get the cream of the music are Tseries and Sony. You haven’t even mentioned them in your analysis. They are market leaders for the music the new generation wants. Check the top views in YouTube, invariably you will find music from Tseries and Sony dominate compared to Tips/Saregama.
  2. Music distributors have more power than we think. Beyond Apple/Spotify/Saavn/Gaana, there is this giant called Youtube and its algorithms can make or break popularity of songs in India. Youtube is free. So am skeptical about “pricing power” with the labels. In digital, getting distribution at scale is very very difficult… due to network effects, big guys get even bigger. An example is movies/tv original content and digital distribution: new OTT players like Eros, Balaji, Sun, Zee, Voot, Sonyliv are figuring out, they can’t unseat Netflix, Hotstar, Amazon, Youtube in OTT market share.
  3. Paid subscription for music is still weak in India for music as people are used to getting it for “free”. So even if piracy is reduced, the ad-supported model is only way out. And advertising as main source of revenues means, you re again dependent on another gatekeeper: Google ads, which dominated the display ad ecosystem in India.

The case for Warner may be a bit diff as past music Catalogues have value in the US. The wealthiest consumers in the US, 50+ age group, have grown up on 70s-80s -90s music. So Warner has a good library. Plus, there is an established market for music licensing for ads and soundtracks. (Indian ad industry, still uses majorly original scores for ads. This is more a cultural thing, as major ad production houses, ad film makers and music directors have good relationships).

So am not sure, Saregama/TIPs deserve Warner Music valuations… at least for now.
Maybe if the performance grows and is consistent for another 3-4 quarters, we can look into potentially investing in these.

6 Likes

Excellent point. Yoodlee seems to be more formulaic, process driven & less idiosyncratic in their approach to chosing projects. More in this interview. https://www.youtube.com/watch?v=R1YpHKS0Tgo as a result they have so far ended up with a bunch of good films and industry recognition. The non core businesses seem like vanity projects with mediocre financial outcomes at best and losses at worst.

The good part is that the core business is the biggest chunk and growing fast. It has enough tailwinds, further accelerated by the pandemic. It can ride the growth of streaming platforms without needing much capital infusion. This portion of the business has very little to near zero cost of acquiring incremental new business. ITCs core business growth is slow & hamstrung by regulation. Further incremental growth will need creation of fresh capacities.
Another interesting and unique nature of their core music business is their impenetrable moat.

Disc, small exposure <1% of PF

All excellent points. Completely agree on Tseries and Sony leading the way in new latest launches. Regarding the point of unsettling old players or maybe even gaining some market share…what makes you think Hotstar and even Amazon prime stood a chance against already big Netflix and Youtube? What made them get a place and can others not replicate that?
Also regarding Sun nxt, dont you think a library of regional content and strong regional focus gives them that edge which is needed to gain market share?

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Can you pls elaborate on this point. It is not clear on what cultural difference you intend to point out and whats the difference in licensing music content for Ads in India and abroad? Also by licencing for ads, you mean the ads which may appear in between streaming like in You tube? Such ads are 100% deal breaker if you intend people to pay for subscription…perfect example is Amazon Prime music where you pay for Prime package subscription but music is Adfree…

1 Like

Hi,
It takes all kinds of people to make the world. Ofcourse many people will be price sensitive and some may be able to pay subscriptions. Assuming a low number of subscribers (5 cr/140cr = 3.5% of population; which is lower than the 5% of global population paying subscriptions) and assuming a low rate / subscriber ( Rs 100/ month, 5 years from now; Amazon Prime charges Rs 129 / month today…) point to conservatism.
But there’s no harm in discounting these assumptions by a further 50%.

Aside from the discussion on music : From my interactions with retailers in India and abroad, I have come to believe that Indians are not more value conscious than other nationalities. Senior managers in retail have told me that All consumers react to price signals and Indian behaviour is no different. So no need to be disparaging about ourselves :grinning:

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Hi Tarun,
Agree with you on the capital allocation front. If this is corrected, a lot more value will be created.
The numbers are suggesting that the streaming business is outgrowing the others divisions by leaps and bounds. Also as per management commentary, the streaming business will grow at least 25% p.a for the next 2 years(FY22 & FY23). This would bring the music royalty to about Rs 400 cr p.a.

The other divisions would just become insignificant and the market would per force look at valuing the primary streaming business (i hope).

1 Like

First of all I am not discounting the paying ability of Indians. We pay same amount for Netflix as anywhere in the world. I am only discounting the value that Indians might see in these pure play music streaming of film music as you pointed out.

In Rs 129 pm month today, Amazon provides not just Music but faster delivery, prime slots and deals (delivery and deals are the main reason people buy Prime), Prime video and what not. Comparing that or rather mentioning that Rs 129 pm Indians pay today for only music is not correct at all.

Rest the ability to pay for pure music or Indians seeing value in pure music streaming and paying only for music at a significant scale is hypothesis and you yourself are discounting it by even 50% so it is all at very nascent stage today. I am not saying it will not happen, just not sure about its economic scale in next 5 years or so.

On thing would be good to know is that say if a Tips owned music plays in Amazon music app, how much revenue pie Tips get? If that is meaningful and Tips would gradually have pricing power with likes of Amazon, it would be good economics for content players.

But, one thing I agree with you is on the opportunity size and some leaders would emerge, point is if they would be listed and if minority investors would benefit, I do not know. Thanks

Hi,
We have opposite conclusions. It’s good to have different views, so thank you for sharing. I will keep them in mind w.r.t my positions.

Would definitely like to read about the risks that you mention and think it could benefit the forum too.

The three points you mention seem to be structural, so would like to understand how a few quarterly results could change the view ?

what makes you think Hotstar and even Amazon prime stood a chance against already big Netflix and Youtube? What made them get a place and can others not replicate that?

Hotstar and Youtube were the big guys in India. Both were free. ad supported.
Amazon gave their OTT free with Prime, and thats how Amazon grew. Other Indian OTTs cannot replicate this.
Netflix is growing in premium OTT segment (where it has no competitors yet.) Netflix moat is originals + high quality streaming, UX, recommendation engine. Again the $billions they invest, is impossible for locals to emulate.

Also regarding Sun nxt, dont you think a library of regional content and strong regional focus gives them that edge which is needed to gain market share?

Sun OTT is a victim of success of monopoly reach of Sun Tv channels. There is nothing original in their platform, which users can’t access on TV.

2 Likes

Hi,

Glad we agree on the Indians’ ability to pay. Beyond that, its a matter of individual choice and some may value music, others may not.

Saavn and Gaana both offer Rs 99/ month plans already.

Clarification : I am not discounting my numbers by 50%. I find them probable.
I was simply offering an alternative view for sake of conservatism. And this exchange just reinforces my experience that conviction is self generated. Have cited some reports in my post for people who find the business interesting.

1 Like

Can you pls elaborate on this point. It is not clear on what cultural difference you intend to point out
and whats the difference in licensing music content for Ads in India and abroad?

Just like the movie soundtrack in Hollywood consists of using hit pop sings etc vs in India, original songs created by music directors… something similar exists in the world of advertising. Ads made in the US routinely feature hit pop/rock songs. But most Indian ads use music crafted by ad jingle makers. Music licensing for ads (and movies) are a big revenue stream for artists/labels.
This part of the business is called “Music Publishing”. Very valuable and this is why the big news recently that Bob Dylan sold all rights to his catalogue for $300 Million (see https://www.entrepreneur.com/article/361109 ).

Also by licencing for ads, you mean the ads which may appear in between streaming like in You tube? Such ads are 100% deal breaker if you intend people to pay for subscription…perfect example is Amazon Prime music where you pay for Prime package subscription but music is Adfree…

No. Licensing here refers to the use of published songs in the “soundtrack” of the ads / movies/ tv shows and so on. Example: this famous ad here for Intel in the 90s used BEE GEES hit song “Stayin Alive”:

vs HDFC Life using an original composition sung by Kalash Kher in this ad:

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Good to know that, these platforms must offer music from all content providers like say a T series, Tips etc. Your bet is on the content providers, if I am right? and on their ability to charge subscription in their pure play apps?

Such platforms like Saavn will definitely grow, point is -

  1. if any individual content player streaming can grow like them?
  2. How much pricing power can content providers have with these platforms?
    3 .Are these platform owners listed? As they can also provide interesting investments at some point

As we are discussing this, Microsoft has acquired entire Sony Corp for USD130 bn. The motive of acquisition seems to be gaming and content.

None of the global majors have floated their own platforms and why should the Indian minnows ? The original post already clarifies that revenues will be shared with platforms.

As of now, there’s no reason to believe that music labels will agree to lower their share of platform revenues, which currently ranges in the 65 to 70%.

This also makes their growth directly proportional to the platforms’.

1 Like

Even I thought the same… but deleted the post. Its apparently a rumour.

This seems to be a rumour. Microsoft website does not have any disclosures right now.