Warner Music Holds Strong Competitive Edge in Music Label Industry (NASDAQ:WMG)

WMG’s future looks promising thanks to its strong position in the music industry, which is bolstered by its scale and a significant content advantage. At a current 21x forward P/E, WMG trades at a major discount compared to Universal Media Group, providing a potentially undervalued investment opportunity.

WMG stands as one of the largest music label companies globally, owning several record labels and running Warner Chappell Music, a global music publishing business. The company’s revenue mainly comes from the sale of recorded music—both physical and digital—services offered to artists such as sponsorship, merchandising, promotion, and brand management, and licensing and royalty fees for the use of music that WMG owns.

The company operates in two segments: Recorded Music (RM), which contributed to 82% of its FY23 revenue, and Music Publishing (MP), which made up 18% of FY23 revenue. The RM segment focuses on discovering and developing recording artists, covering associated activities like marketing, promotion, distribution, sales, and licensing of music from these artists. The MP segment generates royalties from musical compositions, which are promoted, marketed, and administered by Warner Chappell Music.

The music industry has experienced substantial structural improvements over recent decades. Historically, physical sales were dominant, but the surge in internet adoption led to rampant music piracy, causing physical sales to drop dramatically. Streaming services have since emerged as the dominant format since 2015, significantly driving industry growth. This shift to streaming is seen as a structural change and a major growth factor for WMG.

Global recorded music revenue from streaming grew from $2.6 billion in 2015 to $19.3 billion in 2023. This expansion highlights streaming’s capacity to grow the market. While streaming growth has decelerated, there remains significant potential for future growth. Two primary drivers for this are increasing internet accessibility and higher penetration of streaming services. About a third of the global population still lacks internet access, notably in developing countries. As internet penetration increases in these regions, driven by economic growth, the potential market for streaming services, and hence WMG, expands.

Currently, there are over 700 million music streaming subscribers globally—a 14% penetration rate of total smartphones, which has improved by 300 basis points since 2021. While 100% penetration is unrealistic, using the US as a benchmark—with about 82.1 million paid subscribers and 300 million smartphone users implying a 27% penetration rate—the global market still has ample room to grow.

WMG’s ability to grow alongside the industry rests on its clear competitive advantages. One of its foremost advantages is its significant scale. WMG can allocate substantial financial resources toward marketing, promotion, and the development of artists. Signing new artists is akin to investing in startups, with no historical performance to reference. WMG’s scale allows it to take a portfolio approach in managing risk, enhancing its chances of discovering the next big artist. WMG’s artist and repertoire (A&R) costs reached nearly $2 billion recently, a significant increase from $1.3 billion in 2017.

Additionally, WMG’s substantial data resources grant it an edge in sourcing and analyzing music trends, enabling more efficient allocation of A&R funds. Another advantage lies in WMG’s established distribution channels, which are crucial for monetizing music. WMG’s long history allows it to maintain deep relationships with key distribution channels like advertising agencies, TV studios, and radio stations, enhancing its value proposition to artists.

Moreover, WMG’s extensive catalog of music, encompassing over 1 million songs across various genres and periods, strengthens its market position. Catalog music constitutes about two-thirds of industry revenue, and WMG’s ownership of this extensive collection offers continual monetization opportunities.

Recent earnings indicate that WMG’s efforts to monetize its catalog are yielding notable results. Furthermore, based on my evaluation, WMG shares could be worth 32% more than their current price. My target price leverages FY26’s $989 million in net income and a forward revenue multiple of 21x. Given that WMG historically traded in line with Universal Music Group, the current valuation gap offers an opportunity. Should WMG’s multiple align with Universal’s at 27x, the potential upside becomes even more attractive.

For potential investors, it’s important to consider risks such as the slower-than-expected growth in developing countries and increased competition for artists, which could pressure earnings. However, WMG’s position in the industry, bolstered by a large scale, strong distribution capabilities, and an extensive music catalog, provides a solid foundation for growth. At its current valuation, WMG offers an appealing investment opportunity, especially if the valuation disparity with Universal Music Group narrows.

Source: IFPI, Goldman Sachs