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

All right. Let's get started with our next session. Thank you, everyone, for taking the time to join us today. My name is Stephen Laszczyk, and I'm the lead analyst for the entertainment sector here at Goldman Sachs. We are excited to welcome to the GSP communacopia and Technology Conference. Robert Zeisel, the CEO of Warner Music Group. Robert, thanks for being with us today.

Thank you. It's great to be here.

Great. So let's start with a high-level question. Last year at this conference, your predecessor, Stephen Cooper, in discussing the CEO search at the time, mentioned that his successor, would need to have a deep understanding of both content and technology and the vision for how those 2 things could come together to monetize future opportunities in the industry. Having got the job, I'm curious if you could share with us a vision -- your vision for what you pitch the Board on how content and technology come together and how you see that adding to what was already an attractive set of long-term growth opportunities for Warner and the industry?

Yes. So I don't think neither of us pitched each other. It was just a natural conversation that emerged and it emerged out of the fact that we had a shared understanding of the opportunity. I've known Len Blavatnik for a long time, over 10 years and a lot of the board members, et cetera. So they are long-standing relationships. And we just had a shared understanding where the industry is going and the size of it. So every person on earth consumes music, it's pretty unprecedented for any kind of a product. Music is now incredibly well aligned with the Internet, which is one of the most transformative forces in the world. So there are a lots of great things happening for the industry in terms of its future. So it's kind of like -- it's up to us to seize the opportunity. But what I think they probably saw in me was somebody who could help realize that opportunity because you can unleash that opportunity by deeply collaborative relationship with our distribution partners. And digital distribution partners specifically. And obviously, having spent 20 years on that side of the table, I understand how the companies work. What matters to them from a user standpoint, from a financial standpoint, et cetera. And and how to build win-win solutions for us. And so we firmly believe in that, the Warner Music Group. And I think our agreement with TikTok that we announced a couple of months ago is a testament to that approach already and not just on our side but also I would give credit to [indiscernible] and his team for having embraced that as well. And -- but at the same time, we're not -- we're focusing also on what matters most, which is music. And you probably saw yesterday, we announced an acquisition of 51% of 10-K projects, which is Elliot Grainge's company, where we're bringing incredible talent both on the artist side as well as on the executive side into our pool. And obviously, we continue to recruit and invest into technology talent as well as to set up the company. So all of that comes together in order to unleash the tremendous potential that our industry offers.

And I certainly want to touch on a lot of those topics there. Maybe the start in the opportunity in streaming, and we've have seen over the last year, some movement on pricing. It's been a long time coming. And most recently, Spotify raised price on their base subscription plan by $1 after being at $9.99 for the better part of the last decade. That said, I think the both of us would agree that the music remains undervalued. Having sat on the other side of the industry at YouTube, I'm curious for your thoughts on why you think it took the industry so long to make the initial price move? And what's necessary looking ahead to get the industry to a place where it can work together to close the gap on value and price.

Yes. So yesterday, since I'm here on the West Coast, I took the opportunity to visit my old company in [indiscernible], YouTube, and I spent a few hours with them. And we spoke about these topics, right? Because I know how genuine everyone is at the company about building value for users, building value for artists and songwriters. And so we spoke about the opportunity of how we can build this for the next decade or the next 2 decades. And it really comes down to the contractual relationships, which are in place between us and the DSPs. And what you have to consider is that the last 15 years, was exactly what should have happened, right? The industry was down and then Daniel Ek came up with a great idea, pushed it through, made it happen. We all ended up -- when I say we -- on the DSP side back then, we all ended up doing a similar thing. And jointly, we built an incredible growth engine for the industry. And effectively, I call it hunting, right? We were basically hunting for users and just got 600 million to 700 million people into a premium experience, get used to it, pay it personalized, pay for it, payment instruments on file and get excited about it. And it was the right thing to do. However, it doesn't mean that, that is how we should approach the next 15 years. And in my opinion, we need to be more thoughtful about not just hunting, but also harvesting and we should be harvesting in regions which are growing much lower and are much more mature, and we should continue to hunt in the ones that have tremendous growth opportunity and different ARPUs today. And so it's much more thoughtful and nuanced approach to it. And it just requires a deep collaboration between us. So I think this is just the beginning.

Do you think the DSPs, and to your last point there have gotten to the point where they view a lot of the domestic markets switching from hunting to harvesting. And the genesis of my question here, and I think it's top of mind for a lot of investors do you expect continual pricing increases at the major DSPs in the major developed markets?

So, it's hard for me to predict what they're going to do -- I don't control the retail relationship. They do. We have a wholesale relationship. So I can't really comment on what they'll do. But -- what I can tell you is that the model does need to evolve and -- but not just for our sake also for the DSP's sake. And there is tremendous opportunity anyway you do the analysis. There's a very significant upside, which is currently -- nothing is structured for us currently. So I'm very, very focused on this. because it's just -- that's what excites me.

Well, let's talk a little bit more about the digital streaming economic model and how that could change. There's been a lot of discussion recently around the need for the industry to adopt a new economic model around streaming and how royalties are paid out. Many, including yourself, have argued that we need to move away from a more simplistic market share model to something that's more user-centric or articentric-based could you share your thoughts on why you think the economic model needs to change? What you're hoping to achieve in that change and which model you think is most equitable?

So I think there are -- to really parse it out, there are 2 issues at play. One is revenue per user issue, which is lagging inflation today. I think I've been quoted before, if you rewind back to 2011 when subscription launched in the U.S., so I'm not going back to when it actually launched globally, pricing would be 1,325 today. right? Adjusted for family plans, the ARPU actually is in mid-7s, right? So there's a tremendous opportunity that way. So focusing on the revenue per user is like a very, very important part of what the industry needs to do. And I think taking a page out of Netflix's playbook is a smart thing for all of us to do. You've seen price innovation from '20 to '22 to 2019, '18, '17, all the way down to 8, then back to 90 and then from 10 to 7, 15 and 20, right? So the amount of work and innovation that happens around price optimization and Netflix is incredible. And I think we all have a lot to learn from that, and we should adopt it. So that's one piece. The second piece is then how you divide the pie that's there. So I'm more focused on the former issue, mean personally, I'm more focused on the revenue per user. I'm also focused on the other part, but I view the revenue per user a very, very significant opportunity for the entire industry. But how things are divided is also important. And I think the artistic-centric model is something that's starting to get at that.

Could you maybe expand on the artist-centric model for a moment. What does that mean to you? How do you envision that being implemented practically at the DSP level or [indiscernible] yourselves and idea.

I think any of these, whether any of these models require wider cooperation, right? If you're on the DSP side, obviously, you don't want one partner with this, another partner with that. And so you want some kind of a scalable model that can function. So it's important that -- it's not just one company working on this, there is multiple companies in the industry working on it. And I think we're starting to see that, right, quite actively. So I think it's amazing that there is a push, especially amongst the major music companies. to change both sort of revenue per user as well as the pie distribution.

How long do you think it would take the industry to move to this new economic model? It seems like there's a lot of moving parts within the ecosystem I need to agree -- it seems like something the outsider is that would take [indiscernible] amount of time.

So I've been through this, I would say, about 3 times in my career. The first time was Netflix between 2005 and 2007, when we're trying to actually get streaming rights when they didn't really exist, then it was very difficult to do pull off and long streaming in 2007. So that took about 1.5 years to 2 years to pull off. The second time was at YouTube, it's a little bit more than 10 years ago when we sort of pushed through universal upload where you couldn't opt out of different platforms so that if you upload to YouTube, it's displayed on the desktop, mobile device, which were virtually nonexistent and television sets, which were not really well penetrated. And of course, those became massive growth drivers for the company over the following decades with mobile and TV driving most of the consumption. And the third one was when we expanded rights of Youtube to subscription. So we have this complex ecosystem that not just music, but across all creators and media companies and everyone. So these were all incredibly complicated. And any one of those took anywhere from 12 to 18 months to pull off because you're working on a massive coordination. If you're trying not to be competitive. If you're doing this in a collaborative fashion and deep partnership with partners and with lots of analysis and thoughtful consideration of users and all of that. It takes 12 to 18 months to really pull it off responsibly. So kind of been through it 3x. The timing is roughly similar. I can't guarantee anything, but that's kind of a baseline.

That's a helpful framework. On the [indiscernible], maybe switching gears a little bit. You mentioned TikTok, you recently signed a wide-ranging licensing deal with the platform. I think you called a first in its kind partnership that allows joint development of additional and alternative economic models. Could you talk some more about the components of the deal and your hopes for how you and TikTok work together in a more collaborative way to benefit the entire industry?

Yes. So I can't really get into the details of the agreement because of confidentiality, but, look the important things to me and to our company was sort of the equitable treatment of our partners, all similar use cases. So from revenue per mile, for instance, is important for me to look at it and feel okay if traffic moves this way or that way and feeling agnostic about it. So that was one principle for me. Some of the things that matter to them and to us as well is work on attribution, like how does activity on TikTok impact paid streams on DSPs, for instance. It's a very important thing to figure out. And it's [indiscernible] and it's in our interest to do. So those are the things that we work on together. And there are many, many more. But -- so it goes beyond financials to basically build smart business together. And I think that's exactly the approach that I want to have with all of our partners.

Are there certain products or services that you're planning to collaborate with TikTok with that consumers or investors could expect to see at some point in the...

Yes, we have lots of plans in the future. And obviously, it develops on the -- it depends on their development cycles. But that's -- for me, what's important is that our teams get deeper and deeper together and just start collaborating on new things that developed and some of them work out. I don't mean between us, but in general, some of them become successful and some of them don't. But the pace of innovation is important and that we try different new things.

Warner Music recently reported third quarter results that showed a strong reacceleration in revenue growth for the company. And on the call, you mentioned that business momentum would further accelerate into the fourth quarter. Could you talk about some of the main drivers of that reacceleration in revenue? And what gives you confidence that, that momentum will continue to accelerate or continue to build momentum into the fourth quarter?

Yes. So I should start really with our catalog. I kind of view it as a natural resource of the company. It's incredible, deep historic and continues to deliver, and continues to grow and so that's an incredible baseline that we have. And so that is what's giving us tremendous confidence for the future. Having said that, we continue to replenish the catalog. With signing obviously, new artists and releasing songs from existing artists. And we had a lot of success in the past quarter with of breaking new stars. We have lots of new stars that Espa, Burna Boy, Zack Brian just hit #1 on billboard 200, which is incredible. And so we're having really great traction in that regard. But we also have lots of superstars who returned and have been releasing their songs, Ed Sheeran is a great example of that. And whenever that happens, their catalog also lifts at the same time. So Catalog is working on its own and the way of new issues coming out, whether it's the new artists or returning stars. Both shallow and deep catalog with us, and it just rises even further. So all of those things start working in unison together. And while we're doing that, we've obviously been having a great stride in publishing. We're going to carry on and have been executing incredibly well. So that continues and audit services also had very positive momentum. So things have been good.

And just to confirm, so the Spotify price increase in the TikTok deal, those will start to layer in as well over the next quarter or 2.

Forgot got to mention those important things Yes, those will start coming online as well.

Great. Maybe pivoting a little bit and talking about investments in the core business. You mentioned A&R as one of them. But could you maybe expand a little bit on how you're prioritizing investments in the core business to drive future growth at Warner Music A&R technology, you mentioned on the onset as well. How you see those investments really coming together over the next year?

So I generally think about 3 areas that we invest in. First one is artists and songwriters. And within that, it's either new or established, right? So it's sort of 2 different types. They have different risk profiles, obviously, if you establish there's more predictability. It's riskier. So that's that. And we continue to do that both on the recorded side as well as on publishing. Two, we do M&A for companies, whether it's for talent or for the roster or for catalog itself 10-K announcement yesterday is a great example of that. And then the third piece is investments in technology to make the company more efficient at more efficient, more effective and work at a greater scale. So I kind of think of these 3 buckets in that order, and that's our framework.

Could you talk a little bit more about the investments in technology? I know it's been a big question from investors coming in earlier this year. You mentioned that you were focused on the technology side of the equation coming from YouTube. I'm sure there's a lot that's top of mind for you. What does that road map look like? And then what are the core areas that you're looking to invest in?

Yes. So I don't think I'll be foreshadowing a road map of it. But one of the things I said in the beginning, right? The industry is exciting and what's exciting to me is because it's the most universally appealing content and it's incredibly well aligned with the internet, which means that we -- the company has to invest into technology to continue to take advantage of the internet. And I'm not talking about direct-to-consumer. What I'm saying is the way we function how we harness data and all of those things that make us smarter. So in order to harness this tremendous opportunity that's there, the company has to become more and more digital in every sense possible. So all of our technology investments are going into that. However, what I've said before and what we've done is they're self-funded. So we've done obviously some restructuring earlier in the year. Part of that went towards funding our technology costs. And the plan is to continue to self-fund our technology investments. So that is it.

You mentioned self-funding. That's this year. It also seems like a commitment for [indiscernible] years as well. Maybe talk a little bit about the progression of margins maybe as it relates to that and how you see those investments in technology which appears to be self-funded in A&R.

It does not appear to be self-funded. It is self-funded. I just want to be clear about it and will continue to be. Look, we've been -- since we've gone public, we've expanded our margin, and we've increased our dividend. We'll continue to do that, and we'll invest in technology at the same time, and we'll invest in artists and songwriters at the same time.

Let's pivot and talk a little bit -- very clear. Let's talk a little bit about the international strategy. Warner has invested in growth by buying record labels, especially in emerging markets to help geographically diversify the business. Why is international expansion and diversification an important strategic priority for Warner Music? And could you give us an update on the strategy for international expansion, particularly in emerging markets and how you see M&A as a component of that over the next several years?

So look, personally, for me, what's happening because of the internet is exciting. I grew up in a small country, right, in Europe and Czechoslovakia. So any small countries that can take advantage of a global marketplace, it's an incredible thing. And I think you're seeing that play out in music tremendously. The music industry really used to be very Anglo American industry that then exported its content everywhere and effectively all of the territories we're in marketing arms for that content. What you're seeing today because of the internet is that there's tremendous amount of talent all around the world that resonates with people all around the world, not just in their own countries. And to me, that's like, again, going back to the beginning of the total addressable market and the opportunity. To me, this is the exciting part when you start unleashing creativity everywhere. And I think now the real job is to find that great talent that can resonate not just in their country, but expands all around the world and punches above its weight class. And that is effectively what we started to focus on quite a few years ago. That's why we've made investments in different companies around the world, and it's been paying off. And you see markets like India, Africa and MENA growing in 40s, 30s and 20s solely, respectively. So obviously, there's tremendous amount of growth, smaller base, lower ARPUs, nevertheless important. They're GDPs as they arise. All of that will contribute to increasing monetization. But what's really exciting is that you can find talent there today that streams really well in the U.S. or Germany or other places around the world, and that's exciting. So our teams are very much focused on that.

What does success look like for you in international markets? Is it accreting market share to a certain level? Is it at this point, maybe you'll land and expand strategy in some of those core markets that you mentioned? Where is the focus over the next one.

Great stars and hits from around the world. Me finding the talent that resonates around the world is gold. It's beautiful. And I think it's great for the world, too, because it just sort of brings this cross-pollination, it gives people something in common and it's great for business. So that's what excites me.

I want to touch on the topic of the year, which is undoubtedly artificial intelligence and some of the opportunities and [indiscernible] around it. It's been a few months since most of us have had the opportunity to digest a lot of the initial headlines of AI. Could you maybe unpack some of the main opportunities that you see to leverage AI across your business and potentially some of the threats that you see on the industry more broadly?

So -- it really -- it reminds me of UGC from about 15 years ago. So when I joined YouTube early on, we had lots of issues related to that, and we've had to work on sorting. And -- but we did. And we built a very large multiple end dollar business for our partners from fan uploaded content of their copyrights that was using their copyright. And it required technology and deal making and partnership and all of that, and we applied it all and built it. And I see AI as UGC with super tools, right? It is a tremendous creation tool at your fingertips and the large catalogs of IP that you can use in order to do that. So I think we just need to follow that playbook. And when I say we, I mean, both the platforms as well as us as well as the Gen AI engines. And we'll build even a larger business from that. Now having said that, there may be artists who may not be okay with that. And therefore, we need to set it up in a way so that artists have a choice. They must have a choice because it's their voice and their voice is personal and their voice is they're living, and it's everything, then so it must be respected. And again, that's why our collaboration with our partners is really, really important and make sure that we lean in, in the most thoughtful manner.

Could you maybe unpack some of those conversations you're having with the partners around AI, copyright infringement is a big priority, especially for the artists monetizing the IP and the rights on your services is a big priority. Where are we at in the layer of those conversations with the DSPs with the platform?

We're at the beginning of it because lots of things are evolving really fast. And we're all trying to come up with the right frameworks. The -- but it's like literally all of those decisions and all of those discussions just remind me of what I went through 15 years ago or even longer. And -- and the -- because they're all similar issues to wrestle with, now they just may be at greater scale and speed, basically. And the -- the important thing to consider or to keep in mind is that users generally are not thinking -- they suspect or they're trying to do something bad -- they're being fans. They want to engage with the content, they love these artists, their voices, et cetera. So it's not -- it doesn't begin with a negative thought. It begins actually with a very positive thought. It may end up being something that the artist doesn't like, which is why they must have a choice in the whole thing. But it begins with a positive thought. And I think that is the approach to take for all of us, right, and say, okay, this is people want to engage with the IP. Therefore, IP holders will likely benefit tremendously. Large IP holders will likely benefit tremendously in the world of generative AI because of that. But -- so anyway, so I just take a positive lens to developing it. It doesn't mean that I'm not in favor of [indiscernible] I am and definitely artist's choice. But it's all in the very early innings of development, but we all have to move fast.

And what about on the risk side of AI? I feel like investors realize the potential of AI, at least for the music industry around the deep fake traits on that, that came out. in the spring. How do you view the strength of your productions on copyright infringement, the litigation that surrounds that. What needs to be put in place?

So the way I think about it is you have 3 parties here. You have the government, you have the consumption platforms, and you have these generative AI engines. Regulation always takes time. I've spent a lot of time working on that on the other side. And it's like no matter what the intent is, it takes time, right? It's like things don't happen super fast in government. So you have to expect that. Gen AI engines will continue to evolve. There's a race between all of them, right, to be as fast as possible. Everybody is spending a lot of money on GPUs that will continue. I think the primary responsibility today sits with consumption platforms, right, especially the open consumption platforms, where the content will end up because no matter what somebody creates new content with a third-party tool, they will want to get views or streams somewhere, and they'll go through large platforms. So my focus is, first and foremost, on the large consumption platforms to make sure that they have practices in place that help us protect the artist's choice and have the right attribution and the right monetization framework. Exactly what we did with UGC. So just slightly different, more advanced and faster, but the playbook is very similar.

Got it. I want to turn to leveraging capital allocation. Warner Music's balance sheet is in attractive position currently, sub-3 turns of net leverage. And at the same time, you're set to generate a substantial amount of free cash flow over the next couple of years. I'm curious, what are your top priorities for capital allocation today is ramping shareholder returns a part of that and increasing part of that you think over the next couple of years?

I think it goes back to those 3 things, which I mentioned, which is artists and songwriters, right, whether it's new or established both on publishing and recorded. Two, M&A with companies. Three, technology in that order, right? And it's just a machine just that keeps going. And obviously, doing it within our investment guidelines and return framework. And let's say -- so it's not really a complicated set of priorities. And now we just execute against it.

More of the same, it sounds like since...

It's more of the same. And I always say a company that has to change the strategy every year. I don't know. I would be kind of worried we're steady, right? Like we see our opportunity, we see the TAM. We see what the [counter] needs to happen, opportunities with increasing revenue per user. Opportunities with thinking how the pie is divided, new experiences, new partners. And at the same time, like we have to do it within the right financial mindset, and that's the focus. So it's a very steady strategy that is not changing, and we just have to continue to execute on it with excellence. And it will be great for all of us.

And maybe sticking with the high-level theme to close it out here with a few more minutes. You've been 9 months on the job as CEO. Already a lot has changed, 8 months on the job as CEO. A lot has already changed from subscription streaming prices increasing to a new deal with TikTok to AI coming front and center. Curious as you look ahead, what do you think is going to surprise investors the most about the industry and Warner in particular over the next year?

So I just kind of told you that we have a steady strategy. I want to make sure that we execute really well on it. My goal is to kind of be boring and not surprise you. And because I think surprises for shareholders are not great unless they are like tremendously positive surprises. But -- but I think saying what you're going to do and then doing it, I think, is gold. And I think that's what we need to do. And I just keep on doing that year after year. So my goal is to really not surprise you. However, what I generally see in the press and in the financial community is this sort of zero-sum type of corporate titans type of approach and discussion about us and the DSPs. And I don't see it that way because I don't think that's a great way to build long-term value for either of us. So I guess what I hope is that the surprise for all of you guys is deeper -- our deeply collaborative approach. And that is not a zero-sum game, and that is not a war between the music companies and the DSPs. But instead, it's sort of joint business plans that we're building and trying to grow the -- a, delight users, right, the users that they have and b, grow shareholder value, both their shareholder value as well as our shareholder value. And I think that maybe that will become the surprise and the tenor of all of the conversation changes in general.

Robert, that's a great place. And thank you for taking the time today.

Thank you. Great seeing you. Thank you. Appreciate it.