The Ledger: Hits Are Great, But Labels & Publishers Seek Higher Margins Too

There’s little doubt record labels and publishers will continue to improve revenues in the coming years on the backs of streaming subscriptions, stronger internet advertising and burgeoning sectors like social media and connected fitness. But there’s less certainty about how their margins will grow as industry revenues surge. Investors and analysts are making their best guesses.

During Warner Music Group’s earnings call on Tuesday (Feb 8), RBC Capital Markets analyst Kutgun Maral asked management asked if recent deals “are indicative of a greater focus on M&A” and if they “are accretive or dilutive to margins.” CEO Stephen Cooper said WMG will “be quite assertive” in seeking deals it believes can be “immediately accretive [to margins].” Lou Dickler, senior vp, controller, added that the future revenue mix – less low-margin physical product, more high-margin streaming and other digital, including emerging platforms – should “contribute nicely to margin expansion.”

WMG has been as active as its competitors in closing deals lately. 300 Entertainment (Megan Thee Stallion, Young Thug, Gunna, Fetty Wap, Highly Suspect), purchased in December for $400 million, adds a stellar front-line roster and has the potential to be margin accretive, although it’s not as straightforward as buying relatively risk-free catalog titles. WMG’s acquisition of David Bowie’s publishing catalog — intellectual property without additional infrastructure — should be an instant positive to margins. Its global licensing deal for Bowie’s recorded music catalog should have a small impact: it gives WMG additional market share, not the financial benefits of outright ownership.

The latest earnings report shows margins are headed in the right direction. WMG’s operating margin was 19.8% in its fiscal first quarter ended Dec. 31, 2021. That was almost even with the same period in 2020 (20.0%) and a point better than two years earlier (18.8%). The rolling 12-month average gives a better view of the trend. In the last four quarters, WMG’s operating income before depreciation and amortization margins were 17.0%, 16.9%, 16.6% and 14.8%. Those were improvements from 2020, when margins slipped in a pandemic-affected year, and were better than the four quarters before the pandemic (14%, 13.7%, 13.4%, 13.0%).

In the music business, growth always comes from acquisitions of other companies (record labels and publishers), buying intellectual property (songwriting catalogs, recorded masters, name and likeness rights) and signing administration deals (to get the market share when an acquisition isn’t possible). Companies don’t want growth for growth’s sake, however. The goal is to leverage economies of scale to improve margins and become more profitable as the business expands. Then the same company, with roughly the same cost structure, should be able to efficiently handle the additional sales. If not, the company will be working harder only to get a lower rate of return.

The sources of labels’ and publishers’ future revenue will be crucial. Physical sales — which have lower margins than digital — grew 65% in the quarter. Artist services and expanded rights improved nearly 97% after many artists resumed performing live in the fall. Those two categories were only 31% of WMG’s recorded music revenue. Investors want to see growth in digital, where margins are 15% better than physical (according to WMG management in its previous earnings call). Those numbers are trending int he right direction: WMG’s rolling 12-month digital sales growth was 22.0%, 20.9%, 20.0% and 14.7% in the latest four quarters. Streaming growth was better yet: 24.3%, 23.7%, 22.5% and 16.6%.

STOCKS
Through Feb. 11, the % change over last five trading days and year to date.

Spotify: -7.2%, -47.8% YTD
Warner Music Group: -8.7%, -11.3% YTD
Reservoir Media: +0.9%, +13.6% YTD
MSG Entertainment: +6.9%, +6.0% YTD
NYSE Composite: -0.2%, -2.9% YTD
Nasdaq: -2.2%, -11.8% YTD

The Ledger is a weekly newsletter about the economics of the music business sent to Billboard Pro subscribers. An abbreviated version of the newsletter is published online.

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