Universal Music Group N.V. (UMG) Earnings Call Transcript & Summary

Good evening, and welcome to Universal Music Group's Third Quarter Earnings Call for the period ended September 30, 2023. My name is Nadia, and I will be your conference operator today. Your speakers for today's call will be Sir Lucian Grainge, Chairman and CEO of Universal Music Group; and Boyd Muir, Executive Vice President, CFO and President of Operations. They will be joined during Q&A by Michael Nash, Executive Vice President and Chief Digital Officer. [Operator Instructions]. Please let me remind you that management's commentary and responses to questions on today's call may include forward-looking statements, which, by their nature, are uncertain and outside of the company's control. Although these forward-looking statements are based on management's current expectations and beliefs, actual results may vary in a material way. For a discussion of some of the factors that could cause actual results to differ from expected results, please see the Risk Factors section of UMG 2022 annual report, which is available on the Investor Relations page of UMG's website at universalmusic.com. Management's commentary will also refer to non-IFRS measures on today's call. Reconsoliations are available in the press release on the Investor Relations page of UMG's website. Thank you. Sir Lucian, you may begin your conference.

Thank you, and thank you all for joining us today. I'm pleased and proud to report that Universal Music Group's Third Quarter was our ninth consecutive quarter of strong growth since becoming a stand-alone public company, just over 2 years ago. Revenue was up 10% in constant currency and adjusted EBITDA increased by 11%. These results demonstrate that our plan to create and assemble a broad-based and strategically integrated portfolio of businesses is delivering both commercial and creative success. Expanding our revenue streams positions us to navigate the inevitable ebbs and flows in any particular business as well as to seize opportunities in new and emerging categories. Our approach produces consistent top and bottom line growth and has done so in light of the highly complex macroeconomic environment and the ever-changing shifts in both technology and media consumption. Well today's results both demonstrate the future ones will is how our leadership on issues such as AI, streaming economics will benefit not only in UMG and our artists, but the entire music ecosystem. So before Boyd presents some more detailed picture of the numbers, I'd like to talk about 5 key areas of our business strategy, we're especially proud of. The artist-centric approach to streaming model innovation, we are fostering with the DSPs. The positive steps we are taking both in utilizing AI and its monetization as well as in protecting against its stages. Recent developments in our global diversification plans and the expansion of our best-in-class distribution partnerships and last but definitely not least, of a continued remarkable success of our artists. Let me begin with streaming. Back in January, I talked about how the streaming model needed updating to become more artist-centric. I outlined some of the poor principles that we would use to guide our work with platforms to strengthen the artist-fan relationship and better reward for the fan engagement they drive. And I stressed how important it is to address fraud and the oversupply of content that's drowning out the real music and real artists that fans actually want to hear. Last month, after months of collaboration, these are announced the launch of the first artist-centric model. This new level honors realized despite better rewarding them for music [indiscernible] and engage fans and by protecting against bad actors who deprive artists for their compensation. Based on its own index data analysis, Deezer is integrating several major enhancements to its service that will, one, boost streams of music by what they define as professional office as well as the songs that fans actively engaged with. Two, replace noise such as non-artist content; and three, implement a much stricter fraud detection system. In the words of one prominent independent label executive for labels who invest every year relentlessly in new talent. This has to be good news. But this is an important step forward is only the beginning of this critical evolution in streaming. We are determined to bring an artist-centric approach to every DSP. This initiative will achieve many goals. It will support all artists regardless of the scale at which they're operating and regardless of the stage of their careers. It will enhance our discovery and it will also significantly benefit the DSPs themselves by returning them to their core mission of bringing great music to fans and in the process, increasing subscriber acquisition and retention as well as of course reducing churn whilst reducing costs associated with valueless content volume. We will have more announcements on this front in the near future as we work with other DSP partners. Next, AI. Last quarter, I said we soon have more -- to say about the commercial and creative opportunities that AI presents. I mean what I said, we subsequently announced that YouTube and UMG have agreed to partner in developing a commercially viable AI component within YouTube music and video ecosystem. As a further expansion of our artist-centric strategy, this historic collaboration underscores our belief that the best way to ensure responsible AI development is through market-led solutions. Specifically, we agreed that YouTube will embrace a set of AI principles that empower human creativity and embrace artists interests and a new AI music incubator co-founded alongside UMG artists and songwriters that will play a key role in developing -- in the development of AI-related musical tools and products. Let me mention just one important aspect of this historic initiative. Unlike past instances where new technologies was released into the world, and the music community was left to figure out how to develop a business model that would protect artist rights and compensation here. Thanks to our close relationship with YouTube, we're collaborating on opportunities and solutions and placing artists at the forefront. We will have more to say in the near future as our ongoing work with YouTube develops business models and products that further unlock the creative and commercial power of AI. Also, just last week, we announced an alliance with BandLab, the world's largest social music creation platform. The alliance will advance our shared commitment to the ethical use of AI and the protection of artists and songwriters. As our AI strategy progresses, you'll see more companies committed to responsible AI, development working with us on solutions to unlock creativity, explore new commercial opportunities for us and compensate artists appropriately. The third key area we're especially proud of is the accelerating expansion of our global presence. As I discussed last quarter, we accomplishing this by signing and developing local offices outside of the established music market, providing local labels and entrepreneurs with global promotion distribution and a full suite of artist services and post M&A that is acquiring local labels, catalog and our artists services businesses. Here's one example of a recent acquisition in the Middle East and North Africa, where the recorded music market grew 24% in 2022 to complement our current service offering and footprint in the MENA region. In August, we announced the acquisition of Chabaka Music, a UAE-based music company. Chabaka has agreements with more than 150 independent artists and local labels and specializes in digital distribution, marketing, publishing as well as artists servicing. They will become part of UMG's Virgin Music Group, working closely with the local virgin and UMG teams in MENA and around the world. With Chabaka's unparalleled regional expertise and Virgin Music Group's creative network and global footprints, the group will be uniquely positioned to reach and build the largest possible audiences for talent from the region. Along with our M&A strategy, we're strengthening our management teams in fast-growing markets. Last month, for example, we appointed Tim XU as Chairman and CEO of Universal Music Group, China, which includes our operations in Mainland, China, Hong Kong as well as Taiwan. A highly respected industry executive, Tim has had 3 decades of success in breaking Chinese artists and talents across the region, most recently at Taihe Music Group, China's leading independent music company. And we've also accelerated our artist signings in China. Two prime examples, Republic Records China has signed Chinese pop icon Hannah Rebecca Jin, and Universal Music Publishing China signed a global publishing deal with China. Chinese singer-songwriter, Tia Ray, the first and only Chinese singer so far to reach the IFPI's top 10 global singles chart. UMG has the world's leading capabilities in global distribution, best-in-class technology and a flexible infrastructure to allow us to easily expand our distribution partnerships. And that's the fourth area I want to highlight today. Our global distribution business, in particular, our newly announced relationship with BMG. We're delighted that BMG will be moving the distribution of physical formats to UMG, commencing in the second quarter next year 2024. This exciting development marks the start of potential future collaborations between the two companies. [indiscernible] finally, but always foremost there are our artists are brilliantly creatively created an enormously popular office. I'd be remiss if I didn't talk just about a few of the incredible success stories. So many UMG artists have all had around the world during the quarter. For example, Olivia Rodrigo down with GUTS, which debuted #1 in the U.S., U.K., Germany, Australia, Sweden, Norway, Spain, the list just goes on and on and on. In the U.S., she became the first female artist, whose first and second album debut at the top of the album chart since Ariana Grande did 9 years ago. In the U.K., and it's debut week has outsold the rest of the top 10 albums combined and is the country's most stream out of the year so far. In September, Olivia is opening single Vampire returned to the #1 spot in the U.S. and became her third #1 song in Europe. The Korean Quintet New Jeans pulled their first #1 on the U.S. Billboard album chart with the second EP Get Up. Interestingly, roughly 80% of first week sales were actually physical CDs, a phenomenal attributable to superfan focused collectible packaging with 14 different iterations individualized to members of the group with branded merchandise, including Lyric book, Photobook and cards. And on Billboard's Hot Latin Songs, Karol G made history as the woman with the most interest since the chart debuted almost 40 years ago. Her fifth [indiscernible] landed 9 debuts on the chart, giving her a total of 60 chart appearance, so far, to top it off. She won 5 awards at the 2023 Billboard Latin Music Awards, and prudently, that included [indiscernible]. I'll mention just one more office success, someone who you may have heard of recently, Taylor Swift. Taylor Speak Now her version launched with the year's biggest week in the U.S. for any album. She became the first woman in history with four albums in the top 10 at the same time. The album hit #1 in the U.K. where Taylor became the first office in 59 years to achieve 6 studio albums in the top 10, simultaneously. In Australia, where the album also hit #1 to get all 5 of the top 5 albums in the country. Other #1 countries were Belgium, Canada, Ireland, Netherlands, New Zealand and Spain. On the U.S. Singles chart, Taylor became the first artist since the Beatles where singles from three separate albums in the top 10 at any time. She is a phenomenon. This level of performance can only really be described is truly astonishing. Astonishing I suppose is an understatement when it comes to describing Taylor's breathtaking talent, popularity and career. And of course, her version of 1989 comes out tomorrow. Continuous worldwide phenomenal artist successes like these are one reason Universal Music keeps attracting new talent to its roster. A new talent is indispensable for our future growth and success. Our relentless leadership in pursuing progress and evolution for the industry is yet another reason why we've become such a powerful magnet for label and artist-partners alike. It's how we keep producing and we will keep producing remarkable results like those that we're reporting today. Now before I hand it over to Boyd, I would be remiss if I didn't mention the historic event that occurred earlier this morning. And no I'm not talking just about our [ earnings ]. I'm talking about the announcement of our forthcoming releases the last Beatle Song ever recorded. The song titled Now and Then, written and sung by John Lennon and worked on by Paul McCartney, George Harrison, and Ringo will have its global premier on November 2. The fact that more than 4 decades after its original recording we can use the latest technology to bring this recording to fans everywhere is truly remarkable and something that we're very proud of. And on that basis, Boyd, I'd like to hand over to you. Thank you.

Thank you, Lucian. I'm pleased to be reporting on another quarter of solid revenue and adjusted EBITDA growth at UMG. As usual, all of the growth figures I'll discuss today will be in constant currencies. While I recognize onetime items complicate modeling, they are a reality of our business, and there are a couple that I need to mention regarding this quarter and the prior year. As we previewed last quarter, the third quarter of 2023 includes an accrual for a catch-up payment from certain DSPs related to the copyright royalty board for the record 3 ruling and music publishing. The accrual is larger than we had estimated when we spoke last quarter and amounted to EUR 53 million in revenue and EUR 11 million in EBITDA. Note that the cash receipt for this accrual is not expected until the back end of 2024. As disclosed last year, the third quarter of 2022, included a recorded music settlement from a copyright infringement lawsuit with an Internet service provider, which was included in other digital and amounted to EUR 71 million in revenue and EUR 52 million in EBITDA. I will present figures both including and adjusting for these items in my remarks and all the details are also laid out in today's press release. UMG's revenue for the quarter of EUR 2.75 billion grew 10% and adjusted EBITDA of EUR 581 million grew 11%, leading to margin expansion of 0.3 percentage points. However, excluding the onetime items I just mentioned, revenue grew 11% and adjusted EBITDA grew 20% driving margin expansion of 1.8 percentage points on an underlying basis. I'll come back to this in a moment. Our revenue growth continues to be broad-based with an expanding array of opportunities ahead of us. This drives our confidence in the outlook for the business as we play an increasingly important role to artists at each stage of their career. In the third quarter, recorded music revenue grew 5%, but underlying growth was actually 9%, excluding last year's legal settlement. Subscription revenue grew 13%, driven primarily by the continued solid growth in the number of subscribers. Subscription revenue benefited from the same price increases in the third quarter that benefited the second quarter, including those from Apple and Amazon. It's worth pointing out that our third quarter did not benefit from the recent Spotify price increase. We expect the fourth quarter to benefit from the Spotify and YouTube music price increases. As a reminder, each of these services raise prices in certain markets and on certain plans not across all subscribers. In particular, with regard to YouTube, the price increases were announced for the U.S. to start with followed by several other markets a few weeks later. But YouTube has a particularly global subscriber base so the benefit will initially be more limited. In the third quarter, and supported streaming had a similar growth rate to Q2, up 5% again. Right now, what we are seeing in our ad-funded streaming revenue is that the recovery is not uniform across all partners nor all markets. In addition, our ad-supported streaming revenue comes from a mix of both fixed and variable deal structures. So the results in any given quarter are not solely a reflection of trends in the advertising market. We remain cautious on the level of growth in ad supported streaming in the coming -- in the upcoming quarters. We do, however, continue to see opportunities for improved field terms and product innovation driving higher levels of growth in this business over the medium term. Physical revenue grew 20%, driven by strong vinyl sales in both the U.S. and in Europe. Physical revenues in Japan also grew across all formats, including CDs, DVDs and vinyl. Physical sales came from artists, including Taylor Swift, Seventeen, New Jeans and Olivia Rodrigo, to name a few. License and other revenue declined 7% as it faced a difficult comparison against the prior year quarter that grew 30% due to live touring and stage productions activities where we participate in certain markets. Licensing revenue in itself continued to grow in the quarter. Download and other revenue declined 53% primarily due to the legal settlement included in last year's figure as well as the continued format shift away from downloads. Moving on to music publishing. Revenue grew 25% in the quarter and 11% when excluding the phonorecord 3 catch-up accrual. Within Music Publishing, digital revenue grew 34% and grew 10% excluding the accrual driven primarily by the growth of streaming and subscription. Performance revenue grew 22% reflecting the continued COVID recovery, particularly in Europe and in Asia, and synchronization revenue grew 4%. In Merchandising and other revenue increased 28%, driven primarily by the growth in direct-to-consumer sales. Touring revenue also increased, thanks to higher activity in the U.S. and the U.K. while retail revenues declined. As I mentioned at the start of my remarks, Third quarter adjusted EBITDA grew 11%, but grew 20%, excluding the onetime items in both years. Also excluding these items, adjusted EBITDA margin improved 1.8 percentage points to 21.1% compared to 19.3% in the third quarter of 2022. Part of this year-over-year margin improvement is related to an easier comparison. As we discussed in last year's third quarter call, A&R expenses were elevated in the third quarter of 2022 due to timing. While the incremental A&R expense last year was EUR 40 million, it would be inaccurate to consider this as a onetime as the amount for the 9 months and for the year were not unusual. In addition to the easier comparison on A&R expense, margin expansion was driven by the revenue growth and operating leverage as well as by cash compensation savings of EUR 21 million related to our equity plan implementation. This was partially offset by revenue mix as revenues in the third quarter of 2023 were more heavily weighted towards merchandising and physical, which carry a lower EBITDA margin than digital sales. We saw strong growth in line with our expectations across all of our segments and especially strong growth that exceeded our expectations on our lower-margin physical and merchandising businesses. That drove strong EBITDA growth, but limited the amount of margin expansion across the entire business. Even with the mix impact from higher physical and merchandise revenue growth we expect to meet our guidance for more than 1 point of adjusted EBITDA margin expansion in 2023. Moving on to share-based compensation expense. The total impact was EUR 103 million in the quarter compared to EUR 14 million during the third quarter of 2022. We now expect our share-based compensation for 2023 to be just over EUR 550 million below the EUR 630 million we anticipated when we announced the details of our equity plan earlier this year. About half of these savings are permanent while the other half were timing related with the cost likely coming in 2024. Lastly, we are currently conducting a careful review of our cost base which we will complete over the coming months, and we will update you when appropriate about an anticipated cost savings program to commence in 2024. We remain focused and optimistic as we continue to execute on the growth prospects that lie ahead for UMG. We see enormous opportunity for value creation, both for our artists and for the company as we advance our artist-centric initiatives and work to further capture the value of the engagement being driven by our unparalleled roster of artists and songwriters. Thank you. Lucian, Michael and I will now take your questions. So operator, please open the line for Q&A.

[Operator Instructions]. And our first question go to Silvia Cuneo of Deutsche Bank.

Good evening, everyone. My first question is related to the growth trends. And looking into Q4, in particular, since you mentioned there will be the contribution of more price increases, especially from Spotify and to some extent, YouTube in [ central ] markets. Can you help us think about the potential contribution of these price increases comparing the Q4 at least versus Q3, if possible? And the second question is on the margin. Like you mentioned during the remarks, you are still comfortable with the full year guidance of over 1 percentage point for the full year, in the first 9 months, you delivered 95 bps. Can you please tell us about the areas of improvement in Q4, probably coming from the price increases drop-through. But just wondering if you could say any more thoughts about this. Thank you.

Thank you very much. I mean just firstly, kind of turning to price increases. As I mentioned a few minutes ago, our Q3 did not include any price increases from Spotify nor for YouTube, and we expect to actually see those price increases falling into Q4. But I would like to point out that the price increases impact different geographies and different plans in a way that giving you specificity right now is not really going to be particularly helpful. I mean we're encouraged by the price increases. The value for -- the value proposition for music is an incredibly compelling one. So we are encouraged by the developments that we're actually seeing with regard to price increases. And clearly, as the platforms are communicating the level of churn is de minimis, which is also very, very encouraging. Just turning to your question on margins. Our guidance for more than 1 point of adjusted EBITDA margin for 2023 still stands. However, I would like to point out as we continue to see revenue growth beyond our expectations and guidance, which is what we are seeing, the revenue growth is beyond our expectation and guidance. The revenues that are incremental to our expected growth are actually coming from lower-margin areas of our business, for instance, merchandise and physical. In Q3, 75%, 3/4 of our revenue beat compared to consensus came from merchandise and physical. These incremental revenues are not substitutional to our core revenue growth. They are EBITDA accretive, but margin dilutive. But there are business segments that we must pursue. And so I'm going to encourage you to focus on absolute growth rather than solely focusing on margin improvement.

And the next question goes to Lisa Yang of Goldman Sachs.

So two questions as well. Just on the artist-centric model, I think Deezer has implemented it, I think this month in France, could you maybe share the sort of initial impact you are seeing on your market share in France? And also comment on the discussions you've had with other players, I think you announced a deep data partnership with Spotify. There's been some press reports that they might also be looking to move to the artist-centric model. So that's the first question. And the second one is on your potential cost-cutting program for next year. I'm just wondering what's sort of triggering this sort of review of the cost base, how meaningful this could be, will the savings be reinvested? And is that also part of the ambition to meet your midterm margin target will be 20%.

Lisa, thank you for your questions. Let me tackle the question regarding artist-centric. So it's a little too soon with Deezer having announced that they were rolling out the artist-centric model at the beginning of the month for us to have any readout from the implementation itself. But as Lucian discussed, we're very encouraged by the approach that's being taken there. The three different buckets that they're going after in terms of rewarding real artists, authentic and engagement with the plan to boost qualified artist streams and active engagement artist streams. We see the platform's push to reward real artists and the fan engagement associated with that content being elevated above anonymous content that's being sorted up by an algorithm being an excellent approach that embraces the artist-centric core tenant around rewarding real artists authentic fan engagement. And then the moves that they're taking to remove noise and clean up clutter and to attack fraud I think, are very important complements. And so taken together, we think that this is an excellent example of a model that embraces the principle. So we're looking forward to following the progress of the implementation as they take on additional partners as they move from France to more broadly roll the model out, the CEO of Deezer in public remarks, talked about their ambitions to scale their implementation into and through the end of 2024. So I think it will be important to enable the implementation of the model to give us the readout in terms of the results. But with respect to the break of the principles around artist center, we're very encouraged of what Deezer has done.

And I think that what you're also hearing is that the DSPs have shared interest in addressing full and the further content that has absolutely [ added ] value to fans.

Sorry. Hopefully, I'm still live. But the -- I mean, Lisa, just to touch base on cost cutting. This is something that we do from time to time. So this is a good time for us to look at our cost base. And I think in particular, we've added resources and to really position us to capture the opportunities that we're seeing in the marketplace. And I think really what we do need to look at now is to look at perhaps those resources that are more focused on the legacy business. In order for us to actually ensure that we actually do have the right level of resources to execute and benefit from all of the opportunities that we see ahead. So it's just a heads up for now. We'll come back to you when we've got something with greater specificity a little bit later on.

Also I would add to that. But as a management team, we've got decades of executing post-housing programs in the various cycles of the industry run back to the piracy days and the file sharing days. And we're seeing a change in the business, which, as Boyd said, in terms of -- there's not only legacy costs, we've always had a program called where we Cut to Grow and Cut to Grow is we will cut overheads in order to grow elsewhere. And we do have experience in managing the business and managing the teams and the businesses within that make up the group. And we've got a plan.

And the next question goes to William Packer of Exane.

Many thanks for taking my questions. So two, please. So firstly, you've been actively communicating your perspectives on AI regulation. And we saw the UMG General Counsel spoke before the Senate Judiciary Committee. And I suspect you've been active dialogue with European and U.K. legislators and regulators. So could you outline the areas you see as most important in this first stage of generative AI regulation? Is it government confirming LLM training data to copyright on permission and remuneration? Or is it carving out AI created music for copyright. And then as a follow-up, how do you think the regulators are responding to your priorities? And when should we expect to hear about new rules in the EU and U.S.

Thank you for your question, William. So with respect to our view on AI and the role of government. Government obviously does have an important role to play. I think, first and foremost, effective enforcement of current copyright law is at the top of the agenda. We believe that generally speaking, in those territories, copyright law is fit for purpose, with respect to our interest in terms of AI, as it implicates copyrights and the work of our artists. And I would emphasize all your question is really kind of focused on the role of government. Our core philosophy on AI, we hope becomes the vantage point from which various governmental oversight is considering the issues. Our perspective is focused on artists to bend their interests and protect their rights and from that basis, establish market led solutions that enable us to establish new commercial opportunities and the development of new tools. And you see an example of that approach with what we've announced with YouTube that Lucian outlined in his remarks. I would note that there are issues with respect to improper exploitation of artists name and likeness one has been characterized as right of publicity. And we do think that some shoring up in terms of law and especially current legislation being considered in the U.S. with respect to a Federal right of publicity could be very helpful in addressing the sort of baked artist AI issues that materialize. Because, by and large, more anonymous content that provides very low value to the services is not going to impact market share for the artists that are driving the business model to the platforms. But when that content makes a false association by invoking the name, the lightness of the artists in the metadata confusing consumers, you have a problem. And so that's why we would call out right of publicity as an area of important consideration. But again, the top priority is working on effective enforcement of current copyright law.

And the next question go you, Adrien de Saint Hilaire of Bank of America.

I've got two questions then. So maybe my interpretation was wrong, Boyd, but it sounded like you said that the price increases might be Spotify or YouTube would not have a particularly helpful impact in Q4, but maybe I heard this wrong. And then maybe a question for Michael or Lucian. We've seen a lot of price increases in the video world recently. Do you think the cadence of price increases in the streaming audio world will increase going forward, i.e., we're going to see perhaps more price increases around a shorter window of time compared to the previous cycle?