Universal Music's SPAC Deal Gives It Armor — and a Potential Weak Spot

The U.S. may be the biggest recorded music market on the planet — it generates 37 percent of the globe’s trade revenues, according to 2020 data from the International Federation of the Phonographic Industry — but its music business is curiously un-American.

Whether due to historical precedent or recent deals, most of the country’s biggest rights-holding entities are currently owned by players that do not ground themselves on U.S. soil. For instance, Sony Music Group is wholly owned, via Sony Corporation of America, by Sony Group Corp in Tokyo; BMG is wholly owned by Germany’s Bertelsmann; Big Hit and HYBE, which just racked up a $9 billion valuation after buying Scooter Braun’s music company, are based in South Korea and traded on its stock market; the hyper-active catalog buyer Hipgnosis Songs Fund is listed on the London Stock Exchange; popular indie distributor TuneCore, via its $2-billion owner Believe, just went public in Paris.

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Now, things are changing.

Over the weekend, Pershing Square Tontine Holdings — a U.S. based special-purpose acquisition company (SPAC) led by billionaire Bill Ackman — announced it had agreed to a blockbuster $4 billion deal to acquire 10 percent of Universal Music Group. (Ackman is perhaps most infamous, as depicted in the documentary Betting On Zero, for his massive, albeit unsuccessful, bet on a stock short of Herbalife.) Pershing’s shareholders will grab their 10 percent stake in Universal after the music company’s current majority-shareholder, France’s Vivendi, floats 60 percent on the Amsterdam stock exchange in September. After that, Universal’s ownership will stretch the globe: It will be controlled partly in China (via a consortium led by Tencent, which owns 20 percent of Universal), partly in the U.S. (via Pershing’s 10 percent), partly in the Netherlands (via the 60 percent public listing), and partly in France (via the 10 percent of Universal that Vivendi will retain).

What’s the music business to make of this worldly panoply of owners?

While Tencent seems more interested in strategic alliance than direct return on investment, Pershing — which sniffed out Universal as its first-ever acquisition target — is more eagle-eyed toward Universal’s actual profits. In announcing the deal over the weekend, Pershing praised a “world‐class management team” led by CEO Sir Lucian Grainge in addition to UMG’s chunky market share. But then the SPAC told investors to look forward to “predictable, recurring revenue streams that require minimal capital despite high growth” from Universal, and reassured that UMG offers “significant fixed‐cost expense base allowing for long‐term margin expansion.”

Translation: Pershing doesn’t think a whole heap of money needs to be spent in order to achieve fast growth in the years ahead, and it also believes Universal’s profit margins will tick up with its revenues, keeping it from increasing expenditure.

Both those lines suggest Pershing’s agenda is more aggressive than might be ideal for UMG. The SPAC is keen to see returns from a vast catalog of artists, but it’s not so rosy on the idea of risking further investment to break new frontline artists. Ackman nodded towards this in a call with investors on Wednesday (June 23rd), when he said that Pershing investors “own a royalty on people listening to music.” He did not touch closely on Universal’s long-held acceptance of a perilous risk profile in its investment in new artists, nor on its pattern of outspending rivals on fresh signings — something which is arguably key to a record company’s continued success.

In January, the U.K’s British Phonographic Industry put a public figure on the industry-wide A&R risk profile: “Broadly, only one in 10 [signed] artists are expected to succeed commercially,” it reported. Senior sources working in major label A&R tell me that, in truth, the odds are even longer. (And when you consider that the major labels are signing on average more than 50 artists between them every month, you see why; not everyone gets to be Billie Eilish.) According to IFPI statistics, record companies collectively spent $4.1 billion on A&R in 2017 — around $11 million per day. Since negotiating power has shifted heavily towards artists in the years since, that figure will only have spiraled upwards in 2021. As Sony boss Rob Stringer said in 2019: “It’s much more expensive today to sign talent than it was six months ago, and it’s way more expensive than two years ago. And going back to the 2000s, the download era, it’s not even comparable.”

Frontline A&R is therefore very much not, to bring in Pershing’s phraseology, a “fixed-cost expense.”

Neither is the expensive catalog M&A boom currently taking place across music, driven by the likes of Hipgnosis, into which the major record companies have dived in headfirst. Last year, Universal Music Group spent over $1.7 billion on artist advances and catalog acquisitions, which included a $300 million-plus acquisition of Bob Dylan’s song catalog.

In 2021, Universal has made a pointed effort to curb expenditure. Vivendi proudly said in May that Universal’s EBIT profitability had grown 35.8 percent year-over-year in the first quarter of 2021, thanks to “strict cost control”. That kind of language will be music to the ears of Pershing and Ackman.

Compare this polite austerity to the actions of the rival Sony Music Group. In the same period of 2021, Sony couldn’t rip the pursestrings wide enough — buying Paul Simon’s catalog in a nine-figure deal, as well as Kobalt’s AWAL and Neighbouring Rights companies for $430 million, and the Brazilian label Som Livre for $255 million. More recently, Universal’s other rival Warner Music Group hopped on the big-spending train, too, splashing over $100 million on the recorded music catalog of David Guetta.

What happens to Universal if the company, cajoled by its new owners’ demands to expend “minimal capital,” is no longer able to keep up with its competitors’ eye-popping acquisitions?

It’s all, of course, hypothetical — for now.

In its most recent announcement, Pershing paraded the unique sell for investors that Universal, by floating in Amsterdam, is about to become the “only uncontrolled, pure‐play major music content company.” This threw a little shade in the direction of Warner, which is listed on the NASDAQ but remains majority-owned by Len Blavatnik’s Access Industries. But it also aptly pointed out that Universal’s newly fractured ownership structure means no single stakeholder will control its fiscal strategy. Which in turn means that Pershing, and its appetite for the plumpest profit margin possible, is free to energetically grab for the most influential spot at the table.

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