Warner Music Group Corp. (WMG) Earnings Call Transcript & Summary

Good morning, everyone. My name is Meghan Durkin, a media analyst here at Crédit Suisse. I'm happy to introduce our next presentation. We have Eric Levin, the CFO of Warner Music Group. Eric, thanks so much for being here.

Thank you, Meghan. Thanks for having me. Looking forward to this.

Yes. So let's start from a high level. As we emerge from the pandemic, what is Warner Music Group's strategy to unlock value? And what does management have to do right to deliver on that value?

Yes. Certainly something we focus on, and we feel very good about where we are, and we're thrilled that certainly in the U.S. and parts of the world, the pandemic is starting to move behind us. With us, it all starts with great music. We have a series of strategies, but at the center of it is recording, releasing, marketing and distributing new great music, maximizing the value of our catalogs. We are really excited about the music we have been putting out. And what we have coming up over the next several quarters. I mean we have music from [indiscernible], which is the [indiscernible] pop, Bruno Mars venture. We have singles that are top of the charts and with an album coming out the second half of the year. Cardi B has been at top of the chart with new music in the past quarter. Coldplay has music gap. So our superstars have been recording and now releasing music. And we have a series of up and comers. We're excited about like Tion Wayne, Alec Benjamin and others, and we're excited about what's to come the rest of the year. And we add on top of that, our focus on driving the digital side of our business. Streaming continues to be a robust grower, grew for us 20% last quarter. And there are multiple vectors of growth. And we focus on making sure we're doing all we can to maximize the potential of each developed markets. Emerging markets are starting to come online with subscriptions. Advertising. Streaming is starting to reach its renewed growth similar to the subscription streaming which had been growing throughout COVID. And we focus a lot of attention on helping develop these emerging forms of streaming, whether from social, gaming, fitness, and so there's a lot of things we're focusing on. Obviously, we also focus on margin and cost to make sure that the revenue that we're driving drops to the bottom line as effectively as possible. We have a series of cost initiatives transforming our business with technology, reducing our cost of overhead, such as our financial transformation, which is going to come online in 2023 and generate $35 million to $40 million a year of savings. And we have an ongoing cost program even beyond that, that we're driving into the business. We've also seen ample investment opportunities, not just in music but in music rights. We spent $330 million in the past 6 months, acquiring both recorded and publishing rights. We acquired a Russian label, Zara, and we continue to look for opportunities. So we see it as a really kind of robust time of growth in the music business, and we're trying to work up and down kind of the ecosystem. And I didn't mention music publishing but there as well to continue to drive growth and making sure we're turning into bottom line contribution.

Okay. So there's a lot there, and I think we're going to touch on a lot of it in our discussion here. But why don't we start with recorded music streaming revenue. It's now close to 60% of your company's revenue. There are definitely some big debates out there around the outlook for growth in this line. So first, let's hear it on paid, where the cue debate right now sort of centers around pricing? Spotify is, raising price, what -- if they're successful, how should that flow to the labels? And how meaningful could it be for your business?

So just a caveat that we don't talk about deals with individual companies, so I'll talk a little bit more general. So I would say, generally, our deals with DSPs are variable. And so if their pricing went down or their pricing went up, that would have -- we'd have a pro rata contribution in both directions. But given that pricing is starting to show signs that we are really highly supportive of and have been vocal about for years to show signs of price increases in the market. We were anticipating the way up on that.

So do you expect other large streaming platforms to ultimately follow suite. I mean, Apple and Amazon effectively lowered their price when they added HD into the service. So how do you motivate DSPs to raise price?

We don't -- I view the HD play a little differently. And I have a background in TV. I worked at HBO for 14 years, and we had high-definition television and pricing and packaging discussions there. What we found is that the most important product is the main product, called the $9.99 product, and adding value to that product, which gives the potential ability to raise prices in that product is the single most important product. So if HD tiers, which have -- or high res tiers, which have relatively low distribution or penetration, are -- if that product is being folded into the main product and adding value, and over time, that's one of the things that allows the main product to be increased in price, we think that's a net win. So we think over time, the potential for that to be a win is important. And look, I don't know if the others will follow suit. We think that in the market, when the largest player and one of the leaders starts to show that price increases -- now that they're doing price increases, but that it doesn't have a negative impact on subscriber growth and churn, should give confidence to other players that, that is a real opportunity in the market. And we certainly hope that others take that very seriously and follow suit, but that will be their decision.

Understood. So you mentioned new markets, Spotify's entering new markets. Do you expect a meaningful number of paid subscriptions from these emerging markets? How big could it be for your business? And how are you positioning Warner Music Group to capture that?

We think it could be very substantial. I mean, emerging market penetration is still -- globally is still mid-single digits. And developed market penetration is probably in the neighborhood on average about 30%. And the highest penetrated earliest markets where streaming was launched, can already be in the 50s and still growing. We think the emerging market penetrations are just in their infancy, and can grow multiples over the next several years. The fact that there's now significant competition, both with global players and local players in many emerging markets, just creates competitive dynamic and an aggressive push to sign up subs to get share locally in each market that we think is really constructive to the growth and development of the industry. We at Warner Music group are very engaged in these emerging markets. We have always had a strategy of analyzing when we see these markets coming online with streaming, pre streaming for many of these markets. There was not a lot of monetization, it was sometimes piracy. But not a lot of monetization. So investing significant money in building out label infrastructure and investing in music would often be a financially losing proposition. But once streaming comes online and the monetization starts to grow, that dynamic shifts and the economics of developing, acquiring or investing in label operations becomes quite a positive IRR venture. And we have been doing a series of things for years now, whether it's building our infrastructure and acquiring catalogs in markets like China, where we bought the gold typhoon catalog, or whether it's organically investing and building out our own label like we did in Brazil and other markets, Latin America, like Mexico, or whether we've done it through acquisitions like in Russia where we bought Gala a few years ago and just bought another way Zara to add to our leading position. We've also launched labels recently in India, Turkey and Vietnam, which we see as markets that are reaching their growth cycle, and that can go on and on. But it's really about building out both the infrastructure and the catalog in these emerging markets to take advantage of there coming online with streaming. And we've been doing just that to make sure that we're building out our footprint to play into that growth profile of these markets.

And just getting back to that developed market penetration, you said 30%. So where do you think that could go ultimately?

Well, the most -- the earliest and most developed markets are already in the 50%, in some cases, higher area, and they're still growing. And so I don't know if their peak is 65%, 75%, 80%. But over time, we think these can become highly, highly penetrated markets. And again, we think it's still very early days in developed markets. And the data shows that the markets continue to grow robustly.

Got it. So let's go to streaming advertising revenue. It took a hit during COVID. So shouldn't this line show meaningful growth the next few quarters? And how should we think about the growth in this part of the business, longer term, given the opportunity from emerging markets?

Yes. The first quarter or two, certainly, streaming advertising was hit as companies really kind of were cautious with their marketing spend and advertising spend, which didn't affect the number of streams ad-supported services, it certainly affected CPMs. We have seen app supported streaming already come back and be growing double digits the past few quarters and start to, in effect, replicate the growth of subscription streaming. So we've been very pleased to see that. And you're right, the next couple of quarters have favorable comps. So we would expect to see strong ad-supported streaming numbers given how the market is performing and the relative comps. That's totally fair.

And then you touched on it earlier, but one of the most exciting areas for investors is the emerging platform revenue from social media, gaming, meta verses, fitness. You recently reported that this line is at a run rate of $200 million. But what is the near term outlook? Aren't the bigger deals in this line fixed? And then what is the potential for this line longer term?

Yes. So longer term, we're extremely kind of optimistic. The -- not optimistic, I would say, enthusiastic in putting a lot of effort and energy into helping these lines of business really continue to continue their momentum that they've built. When we went public just a year ago, we were saying that these emerging forms of streaming were at $100 million run rate. Now just a year later, we're saying $200 million. So the growth rates there are kind of self apparent. What I would say is we expect growth across the full ecosystem, whether it's all the areas you said, social, gaming, fitness. What I would say is that there are new areas that have emerged since then. They won't all be streaming per se, but they're all digital centric use cases, whether it's NFTs or Avatars and metaverses and how they incorporate music either into their broad portfolio of their service, or into certain kind of mini games or whatever -- I don't -- my son uses these games like [indiscernible]. And so we think that there's tremendous opportunity to continue to add licenses we were kind of a founding launch partner of Adaptr. Adaptr is a service that allows innovators and new companies to use digital tools to license music quickly and easily. So that if you're focused on building a product and building a business. You can certainly get Warner Music group's content up and running quite quickly and not make the focus licensing, make the focused product and getting consumers. So we're supportive of this evolving ecosystem. In the digital world, there is more and more content being consumed across more and more products, which consumes music as part of their offering. Often now, it's music paired with video or were paired with graphics, but all of which has to license music, and we get compensated for that. So we're really excited about the increasing number of licenses and diversity. And -- but you're right, over the past 3 years or so, several of these have started to reach scale. Certainly, in the social area, there is a series of relationships that have just gotten quite big and we're really enthusiastic about that. Yes, a significant number of those deals are fixed until these services have the systems to track, track by track, artist by artist, songwriter by songwriter. It's hard to do variable deals until they have test systems and infrastructure. But what I would say is fix doesn't mean that we generally do medium-term licenses, 1 to 3 years. And when we renew the licenses, as those business and the consumption of music grows, so does our compensation. So that does mean that our compensation should grow with the market, but sometimes long kind of a chunky, not smooth basis because it's not growing necessarily with consumption every year, but growing with the renewal of a deal as their business has grown. We do try to anticipate the growth of each business within each churn within each, call it, 1 to 3-year cycle. But that's impossible to perfectly predict, but we try to anticipate that. But certainly, it gets corrected on renewal, noting that some deals outperform, some services outperformed the deal, some underperformed the deal. There are services that have gotten very big, but there's also a series of licenses we've done with services that may not have been so successful, that we still got paid for. So we're building out a broad portfolio, and we know we see the categories growing, but not every single service we licensed will be successful at their business model. And again, every cycle when we renew the deal, we try to get the compensation right for the next license term, even if it's an estimate of their forecasted growth over that period.

Got it. And just a clarification, where do virtual concerts go? So do virtual concepts end up in this emerging growth line, or is that still an artist services?

Well, the answer is it depends on the component. Virtual concerts have a series of revenue streams associated with them. So if it's things like virtual merch that isn't streaming, but it's digital, a digital piece of merch that we're providing and selling, then that would go into artist services, it's not a form of streaming. If there is a stream that we're creating and selling, then it would -- the actual stream itself, that would go through streaming. But -- and the mix of what the revenue will be in the use cases, I would say, is still in the, I don't know if the word is experimentation mode, but still being developed and expanded and played with to see what works and what resonates with audiences and what doesn't. But that is an area where depending on what the monetization is which line. But yes, I would expect it to be either in artist services or screening, depending on the stream.

Right. I noticed that Ed Sheeran has an upcoming concert on June 25, so that should be pretty well attended. So switching to artist services. Let's talk about that line just excluding EMP first for e-commerce business, which we'll get to. But how should we be thinking about the outlook for this line given concerts are starting to ramp up, COVID concerts are impacting that line, what should we see in the back half of the year? And then what's the recovery path going to look like for this part of the business?

Yes. So obviously, our artist service line overall has been recently flattish, slightly down. And you're right, it's because the strong growth of EMP has really become a natural hedge to the if you will, the hiatus of the live business that has affected the rest of artist services. So there are 2 parts of our artist services line that's been negatively affected. We have several European contract promotion businesses, which obviously haven't been able to function during COVID, but we remain fully ready to get back and running as soon as soon as regulation and markets allow us to do that. And noting that's a very low-margin business but does have revenue. And we have tour merch operations, most notably in the U.S., but again, if there's no tours, there's no tour merge. Both of those businesses are ready to go. As tours start, we will resume those operations. I would be cautious to predict any significant revenue for the rest of fiscal 2021. There may be some, but I would expect it to be limited. And I would say '22 and then '23 that we would expect there to be a stage return to normalcy. And we would certainly hope -- we hope as much as possible in '22, but certainly by '23 that these businesses get back to where they were and hopefully grow from there. And again, both of those businesses are more revenue contribution than OIBDA comp or EBITDA contribution. But their services, again, are to services, we provide the artists that are part of the equation of the value we deliver to the artists, and they do have some contribution. So we're excited to get those back and running, and we're ready to go. We just have to wait for regulations and tourists to start happening, and we'll be off to the races.

So you touched on the EMP growth sort of offsetting the decline in the core business of RS services. So what should we expect as we start to comp COVID here in the second quarter. And isn't e-commerce sort of a secular winner post COVID? Or how are you thinking about that business?

Well, so EMP, when COVID did better and pretty much out of the gate, I think there was a week or 2 where there was like a total market freeze. And then when people started to realized they couldn't shop outside, they shopped online and e-commerce and EMP as a pan-European e-tailer did quite well. And they focus on kind of heavy metal rock themed merch, which I think as people worked at home became almost like comfort food. This is -- reflects my personality. And something that people drove to, we've seen growth over the last several quarters in the 30% and even 40%. I would say post COVID, we wouldn't expect that level of growth pre COVID that was growing, kind of high single digits. I think we would expect some sort of return to historical normalcy where it continues to be a growth business, but not in such an extraordinary way. I don't -- I just -- I wouldn't want anyone to think 30% perpetual growth is something we expect from EMP, but we've always seen it as a growth business. They've shown through COVID that they can be really dynamic and interact with their consumers in ways that drives more sales per consumer, but also is broadening their reach of consumers. So we're very excited about that platform, but I would expect more kind of -- again, we saw high single-digit growth pre COVID, and that might be more of a are reasonable as we return to normal a reasonable expectation.

Okay. So on Warner Chappell, much of the business was impacted by COVID. So maybe help us think about the recovery and the timing of the revenue coming back in that business?

Yes. So Publishing has 4 lines of revenue, 4 main focuses, and I'll kind of quickly touch on each one. So obviously, digital is driven primarily by streaming. Streaming is growing significantly through COVID. We would expect it to continue to grow long-term post COVID. And streaming has been growing in Warner Chappell, similar to recorded music, perhaps even a touch above. The rates are on recorded music, so we expect that to continue. Sync was affected in the first few quarters of COVID negatively as production companies weren't able to produce TV, films and kind of advertising. But in the past few quarters, we've seen that start to recover and get back to the strong growth we saw pre COVID, kind of double-digit type growth in the last quarter, which is a really strong rebound. And we would expect as production continues going forward, that, that line continues to be -- have the potential to be, and we would expect to manage it to be a growth driver. I see -- we see mechanical, which generally has tracked the physical markets, which have been in kind of long-term secular decline to continue to decline with the market. Again, just as people move from physical formats to digital and streaming formats, mechanicals will continue to decline, that's become a more modest part of the business. The last line is probably the most kind of dynamic. Performance. Performance is the second largest line of business after digital or revenue line after digital took a hit because of COVID as bars, restaurants and live, which are all significant contributors to performance, kind of really -- kind of went on hiatus, if you will, because of COVID. Those revenues were negatively affected as we return from COVID. We expect those lines to recover, and we expect performance to recover steadily over time. What's worth noting over with performance is much of that revenue is processed through PROs, Performance Rights Organizations, which means there can be a bit of a delay from when the market returns to when that gets processed and paid to Warner Chappell. So if the market recovers, let's say, this summer through 2022, there may be a several month delay before that bundles through to Chappell. But once the market recovers, that will certainly flow through to Chappell. And we're excited about the return of all of those components of the business, which will bring our performance line back into growth mode, and we're excited to start seeing that.

Okay. So let's shift over to margins. I wanted to talk specifically on A&R costs. In recorded music, that's your biggest cost bucket. How will these costs trend over the near and midterm and how is digitization and data-driven tools impacting this line?

Yes. So we A&R has, and we expect our A&R costs to grow with the business. As the business gets bigger and generates more revenue and contribution, we would expect both our investment advances to increase. And we would expect our royalty payouts, earned royalty payouts to increase. So we're excited for that to be kind of part of our growth. Generally, that has grown in line with revenue. It is not consistent every year. Some of it is opportunistic. If there are investments in catalogs that we see or there's certain music that performs in a given quarter or year, that will drive it. But generally, it's associated with revenue in the same period. So yes, that's a growth driver. But again, in line with growth of the business. Data. We use tools and data has become a significant part of the A&R process. We acquired a company about 3 years ago called Sodatone, which is a machine learning tool that kind of scrapes data in the ecosystem and put together a profile of music that's starting to flicker in the market. Often early music to unsigned artists that may flicker on 1 platform, like a YouTube or a TikTok or something like that. And our A&R teams are kind of experienced music people all over the world are using that as 1 data point, a significant data point to find artists that have potential to become future stars. It is -- we do not look at that as the only way, our A&R people will use that as 1 way to find artists. And what our A&R people then do is spend time with the artists, historically face-to-face, now often by Zoom and see if they have what it takes to be a star. And being a star is a lot more than having one kind of track that streams. It's do you have a commitment to making this a career? Do you have the ability to collaborate with writers and producers? And I'm not -- in a series of other things to say, hey, this is a really long-term star that has potential. And now let's try to sign them and work with them to creatively to get their best music out of them, help build their brand, market them all over the world and help make them the next stars. And we sign dozens and dozens and dozens of new artists every year, and we work with them often for a long period of time to have them reach their potential. We signed Lizzo in 2015, and she became a star in 2019, even though she was releasing music well before that because it was really building her call it, her toolkit, to be a star, both with her incredible musical talent, but also making sure her personality reached the market in the right way that really resonated in her. And it's exciting to see those kinds of stories happen. And every year, there's a series of those stories of the new and next-generation of stars, reaching the market, reaching their potential and exploding. We're excited about that.

Yes. So we only have five. We can go over a little bit, so maybe 5 to 10 minutes left. So I wanted to just quickly touch on your stated margin guidance, which is low to mid-20s over the mid to long term. And you were doing mid- to high teens in '19, '20. So what drives that expansion? And what is the trajectory to get there?

Well, we're trying to go already there. And some of this is COVID timing, and some of this is the continued progression of our business. Our margins are already in the '21 plus range this, the year later. The fundamental and long-term drivers are the continued shift in reported music from physical to streaming. Physical just has a more significant cost structure that streaming just doesn't have, whether it's production cost or distribution cost of physical products. So as we move more streaming, there's natural margin assent. And a lot of it is continued automation of our infrastructure to continue to become more and more efficient with time. I mentioned at the beginning our financial transformation initiative, which is starting '23, is going to take $35 million to $40 million of cost out of the business, that kind of approach applied to all of our business is how we are thinking of this. We have a cold time transformation office that reports directly to Steve Cooper, our CEO. They are working with recorded music, publishing corporate on the tools of the future. The processes of the future, driving efficiency in our business. And every year, we're expecting incremental benefits from that. And we see when you pull this all together, being additive to margin. And by the way, we see our businesses also -- and we see the music market as in significant growth mode for the long term. And we see that growth as being faster than the rate of growth of natural overhead even before this transformation initiative, which also is margin accretive. So this all adds up to a margin-accretive environment. The one kind of short-term dynamic that I'll talk about, and I mentioned before, some of the business lines affected by COVID, artist services specifically, our low-margin businesses. And as those revenues have been curtailed because of COVID, that's had a short-term margin uplift as the fundamental business continues to drive for margin improvement in parallel with the recovery from COVID, they will naturally kind of offset each other. So again, we're already -- we were, as you said, at 19% when we did the IPO, we're already above 21%, and we expect it to be in the low to mid-20s and the '23 to '24 time frame. So we would just expect the rate of increase from here to be a little slower kind of increased quickly because of COVID as opposed to a straight line. It's going to be a little bit higher growth in the first year and then probably more modest going forward as we get to roughly the same margins that we expect this IPO. We think those are realistic targets.

Got it. So music publishing has been extremely hot. Deals are coming at a furious pace every day. It seems like we see something new. Very high multiples according to Sony as high as 35 times. What is driving that? And is it impacting your ability to sign song writers and keep your song writers in place?

So what's driving that is the growth of the business. And so people view publishing deals generally is quite stable, predictable revenue streams and growing ones. And so noting we have an enormous catalog that meets that profile, and we're excited to have an asset that's both growing and stable. We are in the business of signing new rights, both songwriters that are writing new music and catalogs. We think we're one of the few companies in a unique position to sign new songwriters and help them develop new fantastic copyrights because we're not just a financier. We are here to partner with our songwriters to develop their careers, whether it is working with our songwriters to find the right collaborators because most songs today are written through collaborations. We work with [indiscernible] for them to create music, whether it's writer's camps or pairing songwriters together, getting them in the studio to start to work on music, whether it's pairing our songwriters or their existing songs with recording artists, so to define their way into the right albums and with the right artists that they reach their potential. So the work that we do around the world is really about finding great talent and giving them the best opportunity to have long, successful careers, that value-add that we bring differentiates us from all but a few other players who are active in the marketplace. And the development of new copyrights is an incredibly important part of this business and becomes the catalog in the future. That said, we are also very active in the discussions about deals in the market, often catalog, sometimes catalogs with artists that put out new rights. And in those, we're very financially disciplined. We think we bring a lot to the table. We think we bring more revenue opportunities than than some others to the market, especially players that are purely financial and don't have the infrastructure and the value-added areas like sync and others to drive incremental value. But we're very financially disciplined. If something gets -- if a deal gets to the point where there is not the IRR that we require, we'll move on. One of the things that we're very pleased to see is that we have not found any limit on the ability to deploy capital. There's just a lot of opportunity in the market and our ability to deploy our capital to grow our business is something that we've been very much able to do for years and are continue to be able to do. We're able to invest not just in well-known markets like the U.S. and U.K., but we have boots on the ground in 50 markets plus around the world. We can invest in every market around the world in some of the emerging markets and other developed markets that are growing streaming at very high rates, have great investment opportunities with great return profiles. So we found ample opportunity to invest our publishing dollars to drive growth, both current and future, and we're extremely optimistic about that now and going forward.

Okay. Just last one, and we only have a few minutes. But does scale matter in this business? Universal just got a pretty big valuation of a minority stake public. Do you think that the universal IPO and the second partner is, do you think the IPO later this year will be positive for WMG?

Well, look, we're -- we think it's terrific that universal is going public. We think having more information and more understanding of the music business in the market is a really good thing. So we welcome it. What I would say about our business is we have found that we have the size and scale that gives us the ability to do all the things that we want to do to drive our growth. We have global reach. We have the tools to find music to market music, to share information with our artists. So we have the scale to both drive our business and grow in all the ways that we think we need to, to meet our objectives. But we still have the intimacy with our artists and our partners to make sure that we've got really custom plans to make sure we're maximizing each opportunity and all that we work with feel our personal touch. So we feel very good about how we're positioned. And we're excited about the growth profile of the industry and our ability to take advantage of it. And we welcome to Universal, join us as a public company. We look forward to having company in that form.

Okay. Well, I think we'll end it there. Thanks so much, Eric, for being here. Appreciate it.

Thanks, Meghan. Thanks, everyone, for joining today.