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

We have pushed for variable deals pretty rapidly out of the gate with these emerging streamers. It is a challenge to do in many cases. It is as simple as if they don't have the content tracking technology, then you can't track consumption and then you can't really pay variably if you can't report on it. You can't pay on it. And so encouraging and working with our distributors to develop that technology is important. But if they don't have that then we have to do, obviously, fixed price deals was what most of our emerging streaming deals. Rather a few now that have moved to variable or have a composite of fixed and variable components. And I think when we did our meta deal last year, we announced that user-generated content had a variable component, so moving towards, which is nice progress. But what we do have, even if we do fixed deals is the ability to look at the high-level data for how they've trended when we did generation deals 2, 3 years ago, who's very little, if any data to know what their trajectory was. Now we know a lot more about that so we can figure out or estimate what they're using the prior question, fair economics are and estimate what the right amount is. And so we can still try to get to fair economics even if it's fixed, although it's obviously easier to do if it's variable.

So still evolving.

Still evolving, and I'm sure it will be for some time to come.

So I'll go to music growth, streaming growth continues to accelerate in emerging markets. On the 2Q call, you talked about some of the WMG's initiatives in the Middle East and North Africa as well as Sub-Sahara in Africa, I mean how has the strategy evolved over time? And which markets within the WMG portfolio are you most excited about.

Yes. I think you hit the 2 key words. I don't think our strategy has evolved. I think we created it about 8, 9, 10 years ago, but I think the markets are evolving. And each market we assess and kind of in a bespoke or unique fashion to make sure we put the strategy in place for that market. So as far as strategy, what we have always prioritized is financial return. What we haven't done is invest in emerging markets that are still riddled with piracy and that streaming is not yet ramping up because you can invest a lot of money creating music that's not going to generate a return. You've been very hesitant to do that. When we see markets that are coming online with streaming and digital distribution, and we forecast we can generate a return, then we take very seriously entering that market in a very serious fashion. So when I started the company in 2014, that market was China. Tencent was looking to really roll out their music platform. They were also very committed to working with the government to combat piracy. We were the first major to license our content to Tencent. And at roughly the same time line, we acquired the Gold Typhoon catalog and built our market share very quickly. Both by developing local music, but also by having a catalog. And we've used that similar approach across the world in between years, whether it's in Central Europe, Southeast Asia, we've built a series of emerging markets. You mentioned Middle East and Africa. Those are 2 markets we've been investing aggressively over the past few years and continue to. 4, 5 years ago, we launched a label group in Lebanon as a headquarters use that and that team to do deals in Rotana, the largest label group, which we invested in Mid East and have global distribution rights to that. We acquired Qanawat, the largest music distributor and our market share went from single digits to roughly 20% in just a couple of years. Africa is earlier in the journey, but a similar strategy, where we have boots on the ground, but we've also invested in a label group in Nigeria, Chocolate City. We acquired Africori a major music distributor, and we're building out our infrastructure there. And there's other markets at early stages, whether it's India, Vietnam, Turkey, that we're looking at -- that we've launched labels, and we're looking at opportunities to expand our growth, and we'll continue to look for markets that are coming online. So emerging markets are very important to us, and we always have a series of next markets that we're looking at and tracking very carefully.

In light of what appears to be less catalogs coming to market versus the slew of deals maybe several years ago. In lieu of that slowing pipeline, do you lean into emerging markets more as you think about those, are they equivalent trade-offs from an ROI perspective?

We tend to look at them as coming from different bucket. So we never saw the kind of acceleration of catalogs, just coming into the market as permanent. It was driven our analysis, both by the lack of artists ability to tour and looking for an additional revenue stream, very low cost of capital and a lot of money willing to pay fairly significant multiples for catalogs just created a moment. And now it's reached a more normalized environment where there are some catalogs that come up, but not a massive influx all at the same time. We look at catalogs all the time. We always view it as opportunistic. If there are catalogs that are of size that we acquire, and we've acquired some, especially on the Publishing side, most recently, David Bowie, publishing catalog. We've generally financed them with debt. Part of the reason that we've done that is we -- is exactly your question, which is we don't want to divert internal operating cash flows that are slated to invest in A&R or emerging market expansion, we want that to be a continuous flow to drive growth, and we view these catalog acquisitions as somewhat opportunistic, and therefore, we funded them with outside capital, generally what we've done...

Okay. Just closing the loop on recorded music streaming here. If you think about the moving parts we've just discussed, potential rebound in ad-supported streaming likely to come, whether it's a back half of this year, but maybe in the next several quarters, what do you think the long-term composition of recorded music streaming will be going forward, right? I think we've talked about maybe 70% subscription teen supported merchant streaming platform, balance of the remainder.

What I'd say is, traditionally, what we've seen is steady growth in subscription streaming. And I think that would be reasonable to expect certainly when we look at third-party forecast, that's what's forecasted and with, I think, good logic. Ad-supported has generally grown in line with subscription streaming, except with a bit of a sign curve, more cyclical based on how economic factors are doing, but generally tracks that line with more cyclicality based on slowdowns, when the economy is more and then rapid acceleration, when it recovers and when the economy is solid, grow stably. Emerging streaming is the interesting 1 because that's not really limited by a TAM. Subscription streaming, generally, people are going to have one subscription to a streaming service, and that gives them the product that they need. But with emerging streaming, you have potential for multiple products in a home, multiple products per person in a home. People use multiple social media products. They play games. They have fitness products, all can be within that same home. So you have the ability as products develop and products roll out for emerging streaming to become 2, 3, 4 use cases in a home, and therefore, has the potential to grow faster. I don't know for sure that it will. But certainly, so far, we've seen it growing faster. But as emerging streaming reaches scale, we hope it has the innovation of that side of the business continues and it continues to accelerate that growth.

Increasingly, sounds like Spotify will raise prices this year, but noted that this is part of the discussion with their partners and labels. You've also said that they're looking at optimized growth. So if we think about -- besides seeding perhaps some economics to Spotify to incentivize a price increase, what are the other areas or other levers at your disposal to help them optimize growth?

Well, it's a tough one to answer. I mean, we're generally pretty careful not to try to negotiate in public. So I'm not going to directly answer, I'll kind of more approach wise say that several of the largest players in the industry, Apple, Amazon, Deezer have taken upon themselves to raise rates. They've done it successfully. I think the market has beared -- has proven it can bear rate increases, the price value of music is extraordinary, when compared to other media products, especially other streaming media products, video, for example, there has not been rate increases historically over the past decade. So it's long overdue. And certainly, we encourage our partners to look very, very, very, very seriously at raising rates, but I wouldn't want to signal any private discussions in public.

Fair. Much to the chagrin of some in the room perhaps. How do you think -- what, I guess, gives you confidence or how do you think about the industry is shifting to more recurring price increases? How does that factor into -- yes.

Look, I grew up professionally at HBO, where price increases were something we did every single year. And in the cable industry did every single year while growing subscribers. I think and I am hopeful that now that the industry has done a round or at least much of the industry has done a round of rate increases successfully and continue to grow that they start to understand that the industry can bear it. They start to have confidence in the ways to do it successfully that they continue to look at the price value of music relative to what consumers pay for other products and understand that there's more room for increases and starts to build, if you will, a confidence in understanding that pricing can become and should become a normal part of the industry. And certainly, in our conversations with our distributors, we are doing what we can to try to encourage not just up price increase, but a recurring set of price increases as part of the industry.

Now in that regard, with -- if you look at ecosystem-wide amongst the labels, they're not only is just RM streaming growth maybe slower or below industry at WMG, but you're seeing a little bit of that at UMG as well as your peers as well. I mean, does this create more urgency to update the terms of trade or the monetization within the DSP model?

So the updating the terms of trade is an issue that has been building for a while. I think what I would do is put it in the historical context, when the current deal structures were created, generally, it was when the industry was starting, call it, 10 to 15 years ago, when the content being uploaded on services was generally the content from majors in India labels. As the industry has evolved, and as there are now tens of thousands of tracks uploaded every day of different types of different qualities, from different places. The compensation formulas just haven't evolved to keep up with the structure of the industry, modernizing the payout structures is something important to look at and update to make sure it's consistent with the value that different content brings. And we believe very strongly that the content that we bring is a huge part of what brings acquisitions and retention to the platform, and it's important that would be recognized. So it's something we're leaning into pretty meaningful.

We were talking before -- before starting the session here that in your daily headlines about AI and Forbes article over the weekend as well, about the impact on the music industry. It seems to be a bit overblown at the moment with limited impact, it perceived limited impact on the WMG business or the overall labels. On the call, Robert suggested he was looking at AI in terms of using it for offensive as well as defensive purposes. Our investors are spending too much time thinking about the negative impacts on the industry, while underestimating the potential benefit to the industry.

So first of all, I'll start with Robert comes from a tech media background. AI hasn't been an issue before, but there have been other issues in the past that have similar profiles. On the earnings call, he talked about UGC, where UGC was a threat, and call it, 10 years ago, and UGC was a threat to monetization, a threat to diluting produced content, et cetera, et cetera. And those at YouTube and with Robert in a leadership role turned that challenge into an opportunity. They turned it into a multibillion-dollar business. They develop the technology to track UGC so that what was legitimate and not legitimate could be taken down or compensated for as appropriate. And that industry has evolved into a very successful framework for the music industry. AI, although not the same, I think requires the same mindset of someone that understands tech and media Robert not just himself, but he's brought in a series of people both from Google, YouTube to run the technology and strategy teams and other tech companies, to work with the preexisting management team on the issues of our business. AI is clearly one. We and they are taking this very, very seriously. And absolutely, the objective is not just to see this as a challenge is to make sure we understand the challenge in the risk and that we manage it very thoughtfully, but also to see the tremendous opportunity and make sure we develop the strategies and potentially the technologies to help drive revenue and efficiency from them. And so we say AI is another exciting development in the industry. I don't think we think overreacting to some negative concern is fair or balanced. It's appropriate to realize there are risks. But I think it's also really appropriate to recognize there could be huge opportunities across the business and that we're prepared to really, really work that through and attempt to become someone that takes advantage of it.

A little over 4 minutes left here. I want to make sure we hit a couple more items. But I think one thing was jumping ahead here, but one of the things that I thought was interesting was Sony's announcement this week to make a majority investment within proactive entertainment. So I mean as you think about WMG's capital allocation, does it make sense to perhaps widen the aperture of potential investment areas beyond DSPs and into some interesting opportunities or investment areas like Sony just delved into?

So what I think we'd say is so again, I'll bring it back to Robert. So Robert, one of his first hires was to bring in a head of strategy and Ops. And the team, the strategy team, Robert and the business team are working together on a forward-leaning strategy. That is not something that is completed, certainly not in terms of its capital allocation. That's something that will be developed going forward, including through the budget process. So what I would say on that is as we complete the strategy and financial allocation process from that, that easily could -- I'm not saying it will, but could impact how we deploy capital, including M&A. So I think that's something that we need a minute to work through with Robert and the team, but it's something that is actively being developed. What Robert has said and what we've said is we are reallocating some resources towards technology. So certainly, looking at technology as a driver of efficiency or scale in the business is a major kind of focus in lens and how specifically that plays out we'll see over time.

So again, not asking for guidance here, but I think along those lines, in terms of the reallocation of resources, just thinking about you're still in budgeting or Robert and the team are still in budgeting planning mode. But if we think about potential tech investments in products in terms of your CapEx profile $100 million was kind of like the baseline many investors had assumed. Could we assume that there is perhaps some upside to that, sizing timing magnitude might TBD, but in terms of Robert leaning in on some of these opportunities, they probably -- as we look out in fiscal '24, safe expectation...

I think that's a reasonable expectation. I think that what I had signaled prior to Robert coming is that our CapEx would remain elevated as we finalized our financial transformation. But once we started to wind that down, that our CapEx would come down to, call it, roughly $100 million a year, ballpark. As Robert is reallocating resources towards technology, it's reasonable to assume a portion of that would flow into CapEx and the CapEx would be higher. And as you said, I think it's TVD as the strategy and allocation of capital are worked through in the coming next section of time. So I think we need a little bit of time to get to that kind of more budget level direction. But yes, I think that the direction of travel, I think your thesis is correct.

And some -- but some of the cost initiatives, the RIF right, that will help perhaps pay for it...

The headcount reductions and restructuring is absolutely a portion of that being allocated to fund the increase in tech investments, yes.

And last question here, lightning round. You guided to 50 to 100 basis points of margin expansion this year. The first half is actually within that range towards the lower end, but within that range. what underscores your confidence in that 50 to 100 basis points of margin expansion maybe in light of the slower "RM" streaming growth in the back half of the year?

So remember that our RM streaming growth, we expect to increase in the second half relative to the first half. So we grew margins in the first half of the year in the range of 50 to 100 basis points. And so with accelerating streaming growth, we think that's attainable in the second half of the year. We think that's attainable. The other thing I'd say is the first half, we had a tough comp. We had an extra week in the first quarter, first half of fiscal '22, which is really an extra week of revenue without -- at high margin. So we had a tough comp, and we delivered margin growth in the first half of the year. We have a stronger release schedule, expect improving streaming growth the second half of the year, and so that should be positive to margin enhancement. So we feel good about margin for the year.

Well, Eric, thanks again for joining us here today. Again, congratulations on the retirement, and thank you all for joining us. Have a great day.

Thank you. Thanks, Sebastiano and thanks for joining us.