Extreme Dependency On DSPs

For a long time, the general view was that music labels hold the power in the industry, whereas platforms like Spotify are fundamentally weak, as the labels are entitled to ~70% of their revenues.

This is a very interesting case in business strategy. On the one hand, the platforms cannot exist without access to UMG's music, and their basic offering to customers - music streaming, is capped in how differentiated it can be.

On the other hand, with regard to the two existential revenue streams for the labels - paid subscriptions and ad-supported digital consumption, they are mere revenue sharers and have zero control.

In many cases, there will be significant conflicts of interest between the labels and the DSPs. For instance, Spotify gets to keep more of the revenues it generates from podcasts, audiobooks, and music from indie artists. Therefore, it's incentivized to direct users to this type of content, rather than UMG's music.

Furthermore, the DSPs might have different priorities than the labels. UMG should want the platforms to push pricing as much as possible because even if customers leave Spotify due to higher pricing, they will go to a competitor like Apple which is similarly monetized by UMG.

However, the platforms should of course manage for market share and take possible churn into account.

These are just a few of the disadvantages coming from owning just the content and not the user.

For a long time, it seemed like UMG's power over the platforms was strong enough to offset this disadvantage, but as Spotify continues to conquer more market share, it's becoming more and more questionable.

Unexpected Divergence From Spotify

We should start here because this is the number one reason shares were crushed.

For a long time, UMG's results essentially tracked Spotify's. That was true for the paid tier segment:

🕶️🤍🌊 UMG Needs A New CEO PRONTO. Lucian Is Stuck In His Year. He Is Not Qualified To Run A Modern Publicly Traded Company. He Does Not Have The Vision Or The Skillsets. This Is 2025 Not 1988. If UMG Wants To Win It Needs New Management x It Needs To Make Its Biggest Money x Market Maker (Drake) Whole. I Said What I Said. - TAY TAY. 

So, what changed? Well, several things. First, when it comes to the paid tier, I estimate that Spotify's competitors have lost significant market share to Spotify's ad tier. Therefore, while UMG's paid tier is being cannibalized, Spotify's isn't.

Second, ad-supported, podcasts and audiobooks are a much better form of content for ad placement. So this is one area where Spotify is seeing success that has nothing to do with UMG. In addition, UMG lost revenue from the TikTok hiatus, and Meta's stopping to license music videos.

This emboldens the weakness of not controlling your own monetization destiny. What can UMG do to improve its ad-supported business? Aside from trying to squeeze out more economics from the platforms, nothing really, and the content leverage can only go so far.

Detachment From Artists & TikTok Dispute Fallout

UMG provides essential services for successful artists like Taylor Swift (Cap) , Drake (True) , and Kendrick Lamar (Super Cap), and plays a major role in the development of new artists.

Despite having an alignment of interests on many fronts, due to their revenue share arrangement, there are several points of friction between labels and artists.

For UMG, digital consumption of music is the number one revenue stream, whereas, for individual artists, digital is more of a top-of-funnel channel.

In digital, the 70% payout from the DSPs is shared roughly equally between the labels and the artists, while in live performance, merchandise, and more, the artists get to keep the majority of the revenues.

In addition, there's a subjective matter which is artists enjoy performing live, filling out stadiums and arenas. With the distribution they get from platforms like TikTok, they should potentially get more fans to come to their shows.

UMG, as an aggregator of the largest music library in the world, can leverage its content in talks with the platforms. Still, it's much stronger when its artists join the fight and support its cause.

As of late, it seems that UMG is trending in the wrong direction on both fronts. In the TikTok dispute, UMG didn't really get much support from its artists, and in fact, some of them criticized the company for taking their music off the most important discovery platform.

This reached a climax when Taylor Swift had its songs back on TikTok ahead of its recent album.

This is a constant problem for UMG. Its most successful artists are also the ones that have the most leverage and get the best deals. As a result, Taylor Swift, despite being the powerhouse (Stop The Cap. Don’t No Fly Nggas Fck With Taylor Stiff. Stop The CAP)  that she is, could very well be one of the least lucrative artists in UMG's portfolio, because she's probably getting much better terms than the average artist. (Taylor Ain’t It And Will Never Be It. Stop Trying To Make Fetch Happen. It’s Just Weird x Musty At This Point #2Much)

Unpredictable Business Model & Lack Of Transparency From Management

The music business is complicated and unpredictable. UMG's management is arguably the most experienced and savvy in the industry, and I'm not in a position to criticize their business decisions in any way.

However, from an investor perspective, I believe that the leadership team isn't as focused on the shareholder's interest as one might hope, which is somewhat of a common theme in European companies.

I thought that Bill Ackman being on the board and the Capital Markets Day in September were two very positive signs for the company. However, they were more than offset by the recent rout.

Let's start with the unpredictability of the business model.

I hope you're having a hard time seeing the trends in the above graph because that's precisely the point. UMG's cash flow trends are all over the place, and ironically, the only recurring theme is that there are one-offs every year.

Investors were expecting the story to become much cleaner at this point, and it didn't happen. A sharp increase in royalty advancements combined with an employee compensation program that was initiated last year and an ongoing restructuring program and you get a big salad of unpredictability.

Never in history have I seen a stock work for a long time based on Adjusted EBITDA. At some point, investors want real profits and consistent cash generation.

This gets even more value-destructive in light of management's lack of guidance, which doesn't provide any material outlook on key P&L items.

Moreover, on the last earnings call, management already had a month of data. Accordingly, I think it's reasonable to expect them to manage the market's expectations, which were much higher than actual results.

Valuation & Bottom Line

After the selloff, UMG is trading at ~23 times forward earnings. This is the lowest level since the company went public in 2021. However, the market's view of UMG and its prospects completely changed following the report.

In my view, this has now become a 'show me' story. Personally, I sold my shares, even though I think that UMG is worth more than the current valuation.

Because UMG doesn't disclose full numbers on a quarterly basis, its first chance to change investors' sentiment will be the Capital Markets Day in September.

Management has a lot cut out for it, as they'll have to convince investors that Q2 was a fluke. I don't see a clear path to achieve that and therefore downgrade the stock to a 'Hold'.

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