December 31, 2019 - 5:50pm EST by
2019 2020
Price: 25.82 EPS 1.07 1.25
Shares Out. (in M): 1,212 P/E 24 21
Market Cap (in $M): 31,294 P/FCF 27 22
Net Debt (in $M): 1,800 EBIT 1,775 1,950
TEV (in $M): 33,094 TEV/EBIT 18 16

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Earlier today (12/31/19), Vivendi announced an agreement to sell 10% of Universal
Music Group to a consortium led by Tencent at an equity valuation of 30 bn euros.
The deal also includes an option to sell an additional 10% to the consortium at the
same valuation at any time before 1/15/21. This deal with Tencent had been in the
works for most of 2019, but was expected to be closed weeks or months ago, which
led some investors to question whether there would be a haircut to the rumored 30
bn valuation or if the whole deal would be taken up by strategic investor Tencent
alone, with no one else willing to pay a price viewed as too rich. The presence of
other investors, especially financial ones, in addition to Tencent further validates
the 30 bn euros valuation of UMG, which equates to roughly 20x forward EBITDA.
While the financial investors were not disclosed in today’s press release, they are
rumored to be the sovereign funds of Singapore and Qatar. Plugging 30 bn euros for
UMG into a SOTP valuation yields an equity valuation of 33.61, approximately 30%
upside from today’s close. While some HoldCo discount is appropriate, and a 15%
HoldCo discount would imply a one year target of 28.57 euro, and only 10% upside
from today’s close, the real opportunity here lies in the future appreciation of the
UMG asset, which is a true jewel, and was enhanced today with the culmination of
the Tencent deal, which should enhance opportunities for future growth in the
currently underexploited Chinese market. Rolling out 3-5 years, if the global
streaming subscription music market evolves as bullish observers expect it to, it’s
not hard to imagine UMG appreciating to 45 bn euros in value, at which point shares
would be worth 43.50 euro with no HoldCo discount, or 37.00 with a 15% HoldCo
discount, holding everything else equal.
For those unfamiliar with the recent history of the music business, I would refer you
to VIC member avahaz’s write up from 8/29/17, which offers a good overview of
UMG and Vivendi’s other businesses. To summarize a very long and complicated
history of music in the developed markets…people used to buy physical media
(albums then cassettes then CDs). The music business was hit-driven and volatile.
People would buy physical media once, and listen to it forever. Music publishers
would have to take the risk of making physical units ahead of unknown demand, and
could be stuffed with returns if there was a flop. Tons of advertising and
promotional spending went into new releases; in addition to the continual artist
development (A&R) spending that was required to keep the roster of artists current.
When digital music came along, it was a great opportunity to increase margins.
While A&R (artist and repertoire) and A&P (advertising and promotion) costs
would remain, the physical production and distribution costs would be eliminated.
It was theoretically great except that two factors killed revenues: piracy and
unbundling (where a fan would buy the two best tracks off an album for 99c each
versus the whole album for $9.99 or more). But the industry has come back with the
advent of paid streaming services like Spotify and Apple Music. For $10/month, the
customer can have access to almost all recorded music ever created in their pocket.
It is a much better experience than spending $10 to own one album, and the
resistance to paying for media has dissipated somewhat as people have gotten used
to paying for multiple streaming video services. When you are paying $7-10 per
month or more each to get Netflix, Hulu, Disney+, etc., getting all the music in the
world for $10 seems less objectionable. Music companies generally get about $7 out
of $10 paid per month per user, and the revenue split between the companies is
determined by their share of listening…so Universal gets paid when someone listens
to the Eagles, Donna Summer, or Duran Duran the same as if they listen to Taylor
Swift, Shawn Mendes, or Ariana Grande. Getting paid on old music makes the
business less volatile than it was when it was all physical, and increases the value of
the back catalog of old music.
Global paid streaming music subscribers grew to 255 mm at year-end 2018, up 33%
from the prior year. This rapid growth has propelled UMG’s revenue growth to a 4
year estimated CAGR through 2019 of 9%, with 2019 growth expected to be in the
18-19% range. The UMG business, beyond having potential for continued high single
digit to low double digit revenue growth for many years to come is a great business
for a number of reasons that go beyond its secular growth potential. Some of the
factors that make this an exceptional business:
1. High Incremental Margin Business: While there isn’t a lot of gross margin
expansion potential because of contractual revenue share arrangements with
artists, the annual A&R costs to keep the roster current and A&P costs to
support new releases are relatively steady on an annual basis (with some
notable quarterly volatility). While they may creep up over time, as UMG
diversifies geographically, they certainly won’t grow in lockstep with the
overall music industry, so if UMG maintains its industry market share, it will
get substantial operating margin leverage over the next 5+ years.
2. Oligopoly with High Barriers to Entry: Three companies account for about
70% of music listening. It is literally impossible to replicate the back catalog
of music from the 1960s to the 2010s, and even when vying for new artists,
only the 3 majors have the resources to offer a new artist a chance and
breaking out on a global level.
3. Massive Emerging Market Opportunity: Outside of the US, Europe, Japan, and
Canada, not a lot of people in the world pay for music. The proliferation of
smartphones makes music accessible to people all over the world. While
ARPUs will come down as streaming services move to the emerging markets,
the overall addressable market can grow considerably as it expands potential
users from 3 bn to 5 or even 7 bn. Since UMG takes a percent of revenue from
the streaming services, their interest is in the overall pie growing. China
represents an extremely large opportunity, so the deal with Tencent today is
important not just for validating the 30 bn euros valuation for UMG, but it
will help UMG reach more users in China.
4. The Bill for Industry Growth is Largely Being Footed by Others: Various TMT
players want to see the streaming music industry grow to support their own
interests they want to build their ecosystem, sell gadgets, or sell GB of data.
Whether it is the services themselves like Spotify or Apple Music, data
carriers like AT&T or Verizon, or connected home players like Amazon and
Google trying to sell Echos or Homes…there are a ton of megacap, deeply
pocked companies with a vested interest in industry growth.
5. Idiosyncratic Value of the Deep Catalog: Music is the only media where any
individual piece of content doesn’t have a steep decline curve. There are tons
of people listening to old UMG content whether it was from the Who 50
years ago or Lady Gaga 5 years ago. The catalog retains its value over time
much more than video content (how many movies or TV episodes get
watched more than 2-3x versus how many songs have you listened to 100s of
times?), and listening to a 4 minute song that was recorded 20 years ago
contributes to industry market share the same way a new track does, even
though there are virtually zero current costs associated with the old track.
UMG accounts for almost 80% of the SOTP, and publicly traded assets account for
another 7% and could be shorted out if you don’t like them (I am not a fan of
Mediaset, and I am more agnostic on Telecom Italia and Spotify). The only other
asset that is material to the SOTP is Canal Plus, which operates Pay TV in France, Pay
TV outside France, and Free to Air TV in France, and has a content studio. While the
Pay TV business in France has stabilized somewhat and gone through substantial
cost cutting and restructuring, I expect it to remain challenged. I am valuing Pay TV
in France at just 5.5x EBITDA and assigning zero value to the free to air business.
The 8.5x EV/EBITDA multiple on the consolidated SOTP is therefore a blend of 5.5x
on Pay-France, 9.5x on Pay-Intl, and 9x on the studio (and 0x on free to air). There
could be some latent value in the studio as the US-based streaming companies look
to bulk up their French language content.
I’m not a fan of the ad agency business, but I am using an industry low multiple for
Havas, which is only 4% of the NAV. You could also short a little OMC or PUB.FP to
get rid of exposure to this secularly challenged industry.
Putting it all together, my SOTP yields 33.61 with no HoldCo discount. I have not
given them credit for about 700 mm in tax loss carryforwards in my model.
Conglomerates tend to trade with some discount, usually anywhere between 5%
and 30%, with the amount of discount determined by the attractiveness and scarcity
of the assets they hold as well as the tax costs to break up the conglomerate and the
risk posed by the controlling shareholder. In this case, I think the UMG asset is
extremely unique and scarce. Its two primary competitors are buried in a
megaconglomerate (Sony Music) and privately held (Warner Music). So if you want
to own a music publishing company, this is your closest thing to a pure play.
Controlling shareholder Vincent Bolloré has a mixed record. Critics would say he
stuffed Havas into Vivendi in a self-dealing move (probably true), but defenders
would point to aggressive share buybacks at Vivendi, and that you would be a long-
term winner if you had invested alongside him in the past. Since both the positive
and negative are true here, I rate his presence a wash.
At a 15% discount, my one-year target is 28.57 euro, and only 10% upside from
today’s close. But the real opportunity here is 3 years out, as UMG appreciates along
with the growth of the streaming industry. If I substitute 30 bn for UMG in my SOTP
with 42 bn (80% of a forward valuation of 45 bn + 6 bn for the sale of 20% at 30 bn),
my SOTP goes to 43.50, or 37.00 with a 15% HoldCo discount. I believe the visibility
on the industry growing by 50% or more will be there in 2-3 years, so a 50%
appreciation in UMG could occur within a 3-year time frame. I think we are still in
the early innings for streaming. Clearly at least a couple of sovereign funds agree.
Where could I be wrong? It could go to a 30% HoldCo discount, which would imply
23.53, or about 9% downside. I am comfortable taking that risk, as I am buying it at
a 23% HoldCo discount today despite almost 80% of NAV coming from what I view
as a scarce and super high quality asset. The other main risk would be some kind of
insider self-dealing, like value destructive M&A from Vincent Bolloré. It’s possible,
but after spending a year trying to get the Tencent deal done, I would hope unlikely.
In terms of the core UMG business, the biggest long-term risk would be a slower
migration to paid streaming than I am predicting. It is also possible that gross
margins will ultimately come under pressure as artists demand higher royalties as
the revenue and overall profitability of the music industry expands. Renewals after
the initial 5 album contracts are fulfilled have always been a problem…although this
could intensify somewhat. There is the possibility of UMG market share loss on new
releases, although there is no sign of that now. In an outlier risk, Spotify or Apple
could get into the A&R business and attempt to disintermediate the existing Big 3,
but I see this as hard to pull off. In the short-term, UMG has a tough comp when they
release Q4, as 4Q2018 had some big releases. I do think any volatility quarter to
quarter on tough revenue comps or big seasonal A&R spends are buying
opportunities in the context of a great long-term story.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


1. Tencent deal completion allays concern from investors on the sidelines, increases visibility into the UMG current valuation

2. Tencent deal leads to acceleration of growth in China

3. Streaming music industry continues to grow and UMG revenues continue to grow high single digit or more

4. Operating margin expansion is realized

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