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

Okay. We're going to get started. I'm Ben Swinburne, Morgan Stanley's media analyst. Good afternoon, everybody. Quick disclosure statement just to get us going. Please note that important disclosures, including my personal holdings disclosures and Morgan Stanley disclosures, all appear as a handout available in the registration area and on the Morgan Stanley public website. I'm really excited to welcome to the conference for the first time and in-person -- first time in person, Warner Music Group and their CEO, Steve Cooper. Steve, great to see you. Thank you for being here.

Thanks for the invitation. And hopefully, they've been paying their heating bills because hopefully I won't freeze to death by the end of this. Little brisk in here.

Like to keep everybody on their toes or something like that.

Well, maybe we could start. For a lot of investors, I think Warner is still a bit of a new story. The business has changed a lot over the last 5 to 10 years. Maybe you could talk a little bit about what's driving the growth in the business. I mean last year -- last fiscal year, you guided to 20% revenue growth, 30% adjusted EBITDA growth. What's driving the business and why do you think you can keep growing at a healthy clip looking forward?

Well, I like to think of our growth drivers in several distinct buckets. The first is traditional streaming, which is very vibrant on both a global scale and local scale. We have partnerships with roughly 300 streaming entities around the globe, but we continue to see in both the mature markets and in the emerging markets an enormous amount of growth potential. In the mature markets, there are projections that saturation will hit at about 70% of the smart device population. In emerging markets, we are in the low single digits by way of penetration. So just traditional streaming from our perspective has an enormous amount of growth. The second bucket are new emerging models whether it be social platforms, whether it be exercise platforms, gaming platforms. They are now providing albeit in a little different contractual format meaningful growth and we expect that growth to continue. The third bucket, which we're also very excited about, is the possibilities that are being created by Web3. It's going to allow our content creators and people that hold the rights to this content a tremendous opportunity to form communities to be at the intersection between artists and fans. It should allow us to have a direct relationship with these communities and fandom. And I think this is an area of opportunity and growth that's just begun to emerge, but it's something we've been driving at and investing in for, I don't know, over the last 3 or 4 years.

Right. We're going to talk I think about all of those growth drivers. Before we do, I wanted to also ask you about margins. When you guys went -- the last update we got from you around the IPO was around getting to the mid-20s by '24 and you've been running sort of ahead of that since the IPO. Can you just talk about the opportunity with margins and whether maybe there's some upside long term to what you've laid out for us?

Well, one of our goals is to really be a 21st century digital company. So as that digital transformation continues to take place, that revenue mix allows us to enhance our margins. Now in 2022 my expectation is that with the return of our lower margin lines that are attributable to physical, we've got vinyl coming back, CDs actually are coming back, we've actually got requests for the tapes, which I find really mind boggling. But as those come back, as merch comes back, we should expect to see 2022 transitioning from what's been a very favorable mix over the last couple of years to one that's not as favorable. But with that in our cost control, we expect '22 and beyond to continue to march to our IPO projections or beyond.

Got it. You mentioned the emerging platforms, maybe we could talk a little bit about how you see music consumption evolving. I mean there's the growth in new service offerings where people can consume music obviously is growing rapidly. How does that impact the business and sort of use cases as you look out at the evolution of these services over time?

Well, the good news is in any model that offers entertainment or a social context, what we found is music is one of the foundational building blocks that these new models employ. If you think about Peloton, without music, it's just a lot of people sweating and doing painful exercise on a bike. With music, it's far more of a community and a lot more fun albeit personally I find sweating on a bike with lot of other people sweating to be painful. But music is really foundational in so many of these models. What we do see is based upon the use cases and how they emerge, our relationship is oftentimes somewhat different. In established streaming businesses, our relationship is typically transactional and consumption in nature because they are more predictable both by way of where they are and where they're going. And with new emerging models, typically there is no deeply established pattern of behavior. So our contractual approach to here's a license fee for x amount of time versus here's a deal that's based on consumption, it differs. Oftentimes we also see in many of these startups or emerging models or what we're seeing in Web3, the need to invest in these models differently by way of our relationship and our music relationship to those models so that we become more confident that these will get off the ground and actually be very healthy meaningful long-term revenue streams.

And I know every deal is different, but as we think about moving from fixed deals to consumption based deals for new service -- new platforms, we get a lot of questions on TikTok as an example, Facebook, et cetera. What are the things that have to come together from a Warner point of view that it now makes sense to move that relationship over to make sure that you're getting fairly compensated -- you and your artists fairly compensated for the consumption?

Sure. It's typically anchored in growth, anchored in the adoption of music on those platforms and then anchored in how important music in that adoption is. I mean I think that most people would agree that TikTok without music would be an entirely different offering. I'm not sure that all people would agree that in some of these social platforms, Facebook by way of example, that everyone believes it's essential. Now we believe it certainly enhances the functionality of Facebook and what they offer their users. But how it's adopted, how it grows, transaction levels; all drive our decision to move from a kind of a buyout mentality over 1 period of time to a far more consumption based model.

And do we think that that transition is revenue growth enhancing as you start to move from fixed to variable on some of these emerging platforms?

Well, when we move in that direction, it is typically because usage, transactions, engagement are on the rise. And when that happens, we believe that how we're contributing to that growth and the fairness of the deals has to get modified over time.

Okay. Maybe just one more sort of bigger picture question, which is we now have Warner Music Group and Universal Music Group as public companies. Investors have choices in this business. We often get asked about how we think about comparing the 2. My colleague, Omar Sheikh, covers UMG. What do you think differentiates Warner versus Universal and Sony in the market as investors evaluate these options?

Well, I'm 99% sure I won't get a knighthood. So that's one point of differentiation right there. When I look at those businesses and I look at the profiles, we operate much more effectively and efficiently. When you look at our margins versus theirs, we just do more with operating leverage than Sony and Universal. We have a very flat organization and we try and be nonbureaucratic. So we are very fast to adapt, to adopt, to pivot, to move. We have been a clear leader in investing in the next new frontier Web3 and everything that that holds out by way of promise. We differentiate ourselves on what we see as disciplined financial management in how we run our business. And just to get it said, we've been competing successfully for decades against them so -- but I think that kind of sums it up.

Yes. Okay. So let's go back to the biggest driver of revenue growth, which is sort of the traditional streaming business. I think you disclosed in your K, Spotify, YouTube and Apple are a little over 40% of the company's total revenues. That subscription business is still growing, but that growth is certainly decelerating. What's your perspective? You touched on it a little bit in the opening, but what gives you confidence there's room to grow that? And we think it can grow double digits for years to come. Maybe you could talk a little bit about how you think about the drivers of ARPU, volume and et cetera.

While there may be in any given quarter what people interpret as slowing growth, a deceleration versus an acceleration and more growth, that's at some point just a lot of big numbers. But when we look at adoption levels, when we look at how much room there is to further adopt, when we look at Spotify has been experimenting with, Amazon has been experimenting with, I'm convinced the others will experiment with increasing prices. Spotify hasn't seen much churn. They've announced price increases on their family plans, some of their other plans. Others will follow when they see that because people build their own house with the new services by way of their library, the music they prefer, the alerts they get that unless they feel really abused. It was this way with cable TV when they had monopolies even when somebody else came into the market, unless you felt incredibly abused, you would just stick with your regular carrier. So I think that the music services are beginning to realize they can uplift prices, that music represents an enormous value relative to services that provide long-term video. I mean the difference between the value they ask for bits and pieces of the long-form video universe versus what music asks for the whole universe is -- it's like day and night. Spotify reported an uptick in ARPU. We've had a view that over the last couple of years, that's kind of bottomed out and it's going to begin to swing up. So when we look at that traditional bucket, again as I said, we think that both with mature and emerging markets or more mature markets, there's still a boatload of runway. But to your point, that revenue concentration makes one of our critical objectives revenue diversification.

Sure. Steve, I'm sure you know after the last earnings call, there's a little more concern about your relationship with the DSPs and where the leverage sits. I think the market had gotten comfortable that there was no real risk to your share of streaming revenues. Maybe you could just update us on your perspective and whether anything has in fact changed in terms of your ability to monetize traditional streaming.

No, in fact overall I think our ability to monetize grows virtually every day. We had -- this is not voodoo. We actually came to the end of a licensing agreement that was from a good place out of market and what we did is bring that out of market from a good place just back into market. And if people track the underlying operational equivalents; number of streams, number of this, number of that; you would see that there has been just a steady dynamic growth of our business and our music. But from a value perspective, when you look at our ability -- long-term ability to preserve our economics. If you just take Spotify by way of example, roughly 75,000 new tracks are uploaded every day, 3.5 minutes a track is what 260,000-odd minutes which is 182 plus or minus days. So when you think about how hard it is to separate great artist, great music from 75,000 uploads a day, be able to program them from a marketing and promotional perspective across at least 300 streamers, all of these emerging models and the brave new world of Web3. There are only 3 organizations on this planet that know how to do that with decades of expertise. And as the world gets more complex, the people that can navigate through that complexity, their value just continues to accrete. So I think that by way of current and future added value, we are in the music ecosphere really in the catbird seat.

So just to put a bow on the DSP point though. As you have renewals with your streaming platforms, we should see those as opportunities to grow your business, grow your share, not representing risk to your wallet share.

Look, I think when you deal with tech world to say that there's never a risk is just not right. What I do believe is we have reached a very nice economic equilibrium with our partners and I believe that because of the structure of our agreements, we benefit nicely from price increases as well as just the organic growth attributable to more and more subscribers listening to more and more music.

Got it. Okay. I want to ask you about YouTube, which I think is still from a volume perspective probably the largest distribution platform for music globally. I think the industry has been focused on trying to close what they call the value gap sort of asserting that you're not monetizing YouTube as well as you could. Do you see that as a big opportunity at this point or is that now in a place where you think that's reached, I don't know, market for lack of a better term?

Well, I think there we also are in, relatively speaking, a state of equilibrium. But that being said, YouTube's done a nice job with their subscriber service. There are over 50 million subscribers now, which is good news. What we have done is we've actually reorganized meaningful parts of our business that face off with YouTube and others regarding ad and ad revenue. So what we've done is consolidate our approach to generating ad revenue across all of our lines of business so that when we go to brands as opposed to offering this artist from Warner, this artist from Elektra, this artist from Atlantic; now our WMX people go and say "Here's the Warner Music Group portfolio" and that portfolio in conjunction with the audiences that we have created, which are 400 million-plus discrete audiences, we are able to generate and push people in conjunction also with our social platforms; UPROXX, P.O.P. DX:, SongChecks; to drive them to our premium videos. And I expect our ad revenue to actually accrete very, very, very nicely. People don't appreciate the scope of what we do. We have in the Warner Music Group ecosphere 50 billion views a month. We have roughly 0.25 billion unique monthly visitors to either our controlled channels or other social sites. We are -- from a Comscore score, we are the fifth largest media company by way of Comscores in the 18 to 34 age group. So we have an enormous amount of interaction with fandom and we are able to move that fandom to more premium versus less premium offerings on YouTube.

Great. So it sounds like you'll be able to hopefully keep more of the money yourself as you push these initiatives forward. You talked a little bit about the role of the label and the value you provide to your artists, particularly as the number of ways music is consumed grows. I want to ask you about royalty rates, which is a big investor focus, royalty advances. How do you look at the sort of cash out the door and your ability to continue to drive free cash flow and margins in a market where we're all reading about headlines of massive checks being cut by the industry and even financial buyers for rights?

Well, let me separate the 2. One is actually an acquisition activity and the other is the ordinary course of business. As artists getting more and more successful, the way our contracts are set up is that very often within the same contractual framework, we renegotiate royalty rates. Now the good news is as we renegotiate those rates, what we have to put in marketing and promotion has an inverse relationship to fame and fortune. When you look at our balance sheet, we are very, very conservative from an accounting point of view. When we are advancing to a new artist, an unknown artist, we write it off just like that and then we recover later. The advances on our balance sheet are to establish artists where we know what their next album cycle is going to look like, we know what we're going to derive from touring, we know what we're going to derive from merch. So as that flows into balance sheet, that is with very rare exceptions money good and the issue is how quickly we're going to turn it over. With respect to money flowing in, that's a different -- that's an entirely different activity. In fact many of these financial investors refer to music and music rights as an asset class. They don't look at it as something that they've got to actively manage. Warner Music Group, we're an operator. So when we either have an ANR advance or we acquire a catalog or we acquire another label. We know, because we are an operator, how we can synergize, how we can integrate, how far we can push and what these assets or these businesses have left on the table because they don't have a global footprint like us, they don't have the marketing and promotion machine like us.

Maybe in the time we have left, I wanted to make sure we spent time on metaverse monetization and Web3. So I think investors are trying to figure out what the opportunity is, are there risks associated with blockchain and other technologies that might disintermediate the labels? But I've argued that you guys have an opportunity to really monetize a lot of these things, but back me up on that. Can you talk a little bit about your current thought on metaverse growth and monetization and why your role as a label is important in all that?

Well, if we don't monetize it, somebody will be in trouble, probably me. So look, it is -- blockchain is just a technology, which enables a number of the aspects of what one is beginning to see as part of Web3, whether it be NFTs, whether it be crypto, albeit NFTs, I think, can be looked at as a form of crypto. But what the promise that we see is that it is unlike where we've been in Web1 and Web2. It is far more interactive by way of us being face-to-face with our artists and with fandom. If you look on any of the large traditional streamers today, the artists don't really have a presence. I mean, yes, this track by this artist, but there's not interactivity. So what Web3 does for us is creates the opportunity to not only engage fans, but to create communities around our artists, create literally within some of these metaverses places that we can place our artists and draw fans and where we have the -- historically, this is the path for content creation, this is the path for distribution. But in Web3, we see a tremendous possibility where they converge and we are one of the convergers. So that as we bring together the creation of content and the convergence and distribution, we think it puts us in an incredibly great place by way of the opportunities that are going to be presented in this new world. I wish that I could size them and I wish I had a better handle on timing. What we are sure of is it's coming and it will be big.

Yes. And are your artists looking to you to help them figure this out? And are your economic relationships with your artists going to allow you to monetize this whether as it's an NFT or a virtual concert or I'm sure lots of other more creative things that I'm not thinking of?

Yes. And we -- if you just begin to think about artists or managers or their lawyers, the skills you need -- the tech skills, the marketing, the promotion skills, how to move across seamlessly all of these platforms, how to negotiate with the platforms, our leverage looks like this. It could get down to a single artist, the leverage. So when you think about the leverage, when you think about us having a more efficient cost structure, when you think about the skill requirements all brought together under the Warner Music Group envelope. That's why our artists are coming to us instantly. That's why Web3 companies are coming to us because we've established in the marketplace a reputation for being a first mover.

Great. Well, that's a great overview, Steve. I appreciate the time. And hopefully, we can have you back next year to continue the conversation, and we'll get the heat turned up.

The stress in travel.

Thanks, everybody.

Thanks so much.