Vivendi As A Better Way To Play The Global Music Streaming Trend

Summary

• Vivendi's Universal Music Group is a clear platform-agnostic winner of the global music streaming trend as its market share has surged past Sony and Warner Music.
• UMG has a better business model than Spotify and future growth in UMG  can be found in emerging markets as well as new licensing deals with platforms such as TikTok.
• Sum of the parts valuation of Vivendi suggests an equity valuation of 33.2B euros, 41% undervaluation at current prices despite assigning a zero value to assets other than UMG and Canal+.

I previously wrote several times about Spotify (SPOT):

1. Article on Spotify's business model and unique advantages
2. Article on Spotify's future plans and valuations
3. Article on updating Spotify's podcasting plans.

While I believe that Spotify is the best music streaming platform despite numerous competitors from Apple (AAPL), Amazon (AMZN), Tencent (OTCPK:TCEHY) and others, I am less positive about Spotify due to its business model. In its recent Q1 release, MAUs increased by 31% but Premium revenue only increased 23% and Ad-Supported revenue only increased 17%. Premium revenue increased significantly less than premium subscribers growth (also 31%) probably due to Spotify's increasing reliance on promotions and packages (such as family plans and packages with third parties such as Samsung (OTCPK:SSNLF) and telecoms).

Furthermore, I believe that Spotify's model is inherently flawed based on its current relationship with the large music publishers such as Sony (SNE), Warner and Universal Music. This is reflected in Spotify's gross margins of 25.5%, which is relatively low compared to most technology companies and has remained stable. While operating margins, EBITDA and FCF have improved significantly from 2016 to 2019, I believe that Spotify's upside is limited by both its relatively low gross margins and inability to significantly re-accelerate revenue growth. Hence, while Spotify's current market cap of roughly $26 billion isn't extremely high or overvalued, I'm not convinced of future upside. Furthermore, Spotify pays publishers royalty per stream which depends on a number of factors including in which country people are streaming the music, # of paid users as % of total users, etc. However, paying by a per stream rate even if it's not fixed means that Spotify is unable to benefit from increased use of its service (much like Netflix). As a user, I pay a fixed cost per month but if I increase usage of Spotify, Spotify actually loses more since it has to pay more to the record labels. Furthermore, Spotify also has a minimum guarantee payments to record labels which in its 2019 AR was set at 1 billion euros.

Source: Manatt

Instead, I believe that an alternative way to play the explosive music streaming industry is through the record labels, the ones earning 58.5 cents + 6 cents (total of 64.5 cents) for every dollar of streaming royalties. Publishers would pay most of the mechanical royalties to artists but only 16% of the 58 cents, which means music publishers get to keep majority of streaming revenue paid to them by streaming sites. Furthermore, publishers and record labels' streaming revenue is not limited to any certain service such as Spotify but more than half a dozen large services.

Introduction to Vivendi

Vivendi (OTCPK:VIVHY) is a French conglomerate that owned 100% of Universal Music Group (UMG) before selling a 10% stake to Tencent (OTCPK:TCEHY) at a 30-billion euro valuation. As of March 30, 2020, Vivendi's entire enterprise value stood at 25.84 billion euros from an equity value of 23.49 billion + net debt position of 2.35 billion. There is clearly a disconnect even if one takes into account the recent COVID-19 pandemic impacting UMG's valuation.

Vivendi also owns the CANAL + Group which is France's biggest film and television studio as well as distributer. In 2013, Vivendi purchased Lagardere's 20% share in CANAL + for 1.02 billion euros, giving it a valuation of 5.1 billion euros. Since then, revenue has remained relatively stable at 5.27 billion in 2019.

Vivendi also owns other businesses such as EDITIS (book publisher), Gameloft (video games publisher), Vivendi Village, Dailymotion (video sharing platform) and significant stakes in other companies such as Telecom Italia, etc. While this article will be focused on Vivendi's UMG business, it will also attempt to value Vivendi using a Sum of the Parts (SOTP) method.

Universal Music Group's Business Model

As can be seen in the image below, UMG is clearly the crown jewel of Vivendi's holdings, enjoying an 18.86% YoY revenue growth in 2019 to 7.159 billion euros which is actually higher than Spotify's 2019 revenue.

Source: Vivendi

UMG has three main business:

1. Recorded music which makes up nearly 80% of revenues by discovering and developing recording artists and then marketing and promoting their music. UMG has licensing agreements with more than 400 digital services and subscription & streaming revenue generated 59% of recorded music revenue - around 45% of total UMG revenue.
2. Music publishing which licenses music for use in sound recordings, films, TV, advertising, video games and live performances.
3. Merchandizing for artists which are sold through retail stores, online, at concert tours and through limited edition retail experiences.

Streaming and subscription revenue is clearly the growth driver for UMG where Spotify's revenue growth rate (23%) is strongly reflected in UMG's streaming and subscription revenue growth. Furthermore, unlike Spotify, UMG is highly profitable with an EBITA margin of 15.7%.

Universal Music Group's Strong Position in the Streaming Industry

Source: Vivendi

UMG is clearly a great way to invest in the music streaming industry as it is platform-agnostic, unconcerned about who wins the music streaming war (Spotify, Apple, Amazon, YouTube, etc.) as it will still be paid by all of these services.

Source: Counterpoint Research

Instead, UMG will grow as the music streaming industry grows and as seen below, Statista continues to predict stable growth for the music streaming industry as seen in the below graph. Statista also estimates that the 7.9% penetration rate in 2019 will grow to 10.1% in 2024 though I believe that this is a conservative estimate given the continued rapid growth in MAUs for Spotify.

Source: Statista

Even better is UMG's position within the music industry where according to Midia Research its total market share grew to 30% and added more revenue in 2019 ($729 million) than Warner Music and Sony Music combined ($650 million)! However, current revenue growth at UMG has slowed significantly from around 40% in 2017 and 35% in 2018.

Will revenue growth re-accelerate or growth decline slow?

According to Rolling Stone, there are potentially 2 tailwinds for UMG.

1. Morgan Stanley suggests that streaming growth could "pick up speed again in future via the opening up of large emerging markets including China and India." This is a reasonable assertion given that emerging markets should see significant increases in average revenue per user (ARPU) given the extremely low ARPU in these large emerging markets. UMG's recent deal with a Tencent led consortium also sees Tencent Music Entertainment (the top music streaming service in China) to acquire a minority share of UMG's Greater China subsidiary to help UMG expand its Greater China operations.

2. Another potential tailwind is growth from emerging users of music licenses such as TikTok, Calm, Facebook (FB) and Instagram. I am most excited about TikTok which currently has more than 8,000 licensing deals which it inherited from Musical.ly after ByteDance bought the company in 2017. However, since then, TikTok has grown significantly, reaching 2 billion downloads, according to the Verge. Earlier in April, it was announced that TikTok secured a new licensing deal with UMG, Warner and Sony. According to the report, the licensing deal was shorter than the standard 18-24 month deals due to TikTok's struggle to monetize content. Hence the record labels "reportedly want TikTok to figure out how to increase monetization before signing long-term agreements, so how the platform develops over the coming months will be apparently be a key factor in determining whether it obtains future licenses."

According to this recent FT report, more than 50% of the music publishing market was unlicensed with TikTok and that UMG's publishing arm does not have any licensing agreement in place. Universal Music Publishing is also seeking payment for lost royalties in any licensing deal. FT also reported that the short term licensing deal (discovered above) "covers the recorded side of its music, only covers a fraction of its catalogue and expires soon, according to three people familiar with the matter." Hence, it is clear that UMG should be seeing a significant increase in revenue from TikTok in the near future as negotiations continue and TikTok figures out how to better monetize itself.

State of Vivendi's Canal + business

Other than UMG, Vivendi's other important business is its Canal + business where organic revenue growth is essentially flat as the traditional film and television business is being disrupted by OTT services such as Netflix (NFLX) and Disney Plus. However, I believe that Canal + has some positives going for it.

1. Sports rights: Canal + has the English Premier League rights in France as well as the France Ligue 1 rights.
2. Distribution deals with OTT services. According to Variety, Canal + has a long relationship with Disney (DIS) where it already had a programming agreement, giving it access to films from Disney, Pixar, Marvel and Lucasfilm. Canal + is now also the sole distributor of Disney Plus in France. This is important since most pay-TV subscribers use boxes to access content. Canal + also has a similar deal with Netflix.
3. Content. Given the large sums paid by Disney and AT&T for Fox and Warner Media, Canal + also boasts an impressive amount for quality content. Its StudioCanal subsidiary is the European market leader in the production, distribution and sales of films and TV series. It has over 6,000 films including Hollywood hits such as Rambo, Total Recall, Terminator 2, Mulholland Drive, The Pianist, Intouchables as well as thousands of other French and European films.
4. International growth. In 2019, the only positive business segment of its Canal + segment is TV international which saw a 6% organic revenue growth. It has since acquired M7 which is a bundler and distributor of local and international channels operating in European countries such as Belgium, Netherlands, Germany, Austria, etc.

French pay-TV group’s strategy to strike alliances with deep-pocketed streaming giants and potential rivals in order to position themselves as aggregators of premium services and content. Under Saada’s leadership, Canal + Group has been on a drive to recruit more subscribers in France, first by launching cheaper packages to lure millennials, then by forging ties with other local telcos, such as Free and OCS, and lastly by signing a distribution and sub-licensing deal with beIN Sports to gain access to football rights.

How much is Canal + worth?

As previously mentioned, Canal + was valued at 5.1 billion euros in 2013 but that was around 7 years ago. I will attempt to value Canal + using its American peers as a point of comparison.

Company	Revenue	Revenue Growth	EBITDA margin	Multiples :
Canal +	5.27B euros	-0.9%	8.25%
Lions Gate (LGF.A) (LGF.B)	$3.68B	-10.8%	1.47%	EV/S: 1.21 EV/EBITDA: 74.7
Comcast (CMCSA)	$108.9B	15.3%	31.28%	EV/S: 2.34EV/EBITDA: 7.38
Disney (ex Parks, Experiences & Products)	$43.35B	24.82%	18.71%	EV/S: 2.98EV/EBITDA: 11.58
ViacomCBS (VIAC)	$27.81B	2%	12.4%	EV/S: 0.94EV/EBITDA: 8.6

Click to enlarge

Vivendi has a net debt position of 2.353B euros and given the relative high debt levels for its American counterparts, it's safe to assume that majority of Vivendi's debt can be attributed to Vivendi. Vivendi also appears to be more similar to ViacomCBS and Lions Gate than Comcast and Disney. Hence assuming a reasonable EV/S range of 0.8 - 1.3, this would result in an equity value of 1.86B to 4.49B. We will then take the midpoint which is around 3.2B euros.

Vivendi's Total Valuation and Risks

I believe that it is reasonable to maintain UMG's 30B euros valuation given that Tencent has an option to acquire another 10% at the same valuation. Furthermore, given that majority of UMG's revenue remains safe despite the global pandemic, I am confident in UMG's long-term 30B equity valuation. Adding in the 3.2B euros that Canal + is worth, this would result in a 33.2B euros equity valuation. At its current equity valuation of 23.5B euros, this is a 41.2% undervaluation of Vivendi's equity. This calculation is also while assigning a zero to the rest of Vivendi's assets including Havas, Editis and Gameloft.

Why am I assigning a 0 to Vivendi's other assets?

I am assigning a 0 value to Vivendi's other assets due to Vivendi's poor capital allocation abilities and a history of lackluster performance of its portfolio companies under Vivendi's management. With the exception of UMG, Vivendi's other businesses are struggling and Q1 2020 results were even worse due to the impact of COVID-19.

An example of poor performance after being acquired is Dailymotion which Vivendi acquired in 2015 as a European YouTube and OTT competitor. It then merged Watchever into Dailymotion with both struggling as an OTT service. Another example is its acquisition of Gameloft, a gaming publisher that saw 2019 revenue fall 11.6% YoY and its EBITDA swinging into negative. As part of its conglomerate vision to expand into the entire spectrum of European media companies, it also took a significant stake into Telecom Italia with no clear or particular reason.

Conclusion

I believe that Vivendi is significantly undervalued despite risks which include its struggling portfolio of businesses and a history of consistently weak performances of its portfolio companies amidst many industry headwinds. However, its UMG stake is clearly incredibly valuable and to a much smaller degree, its Canal + stake also has some value in a media world where content is king. More reassuring is the fact that management has promised to return excess cash generated from any sales or future IPO of UMG into share buybacks with only a small amount allocated to M&A. I believe that this is the best path for UMG and Vivendi at large. Should investors prepare to wait until 2023 to own UMG directly through its promised IPO, that would also be a fair strategy. However, as Sony has proved, a conglomerate discount can exist for a long period of time before being finally unlocked.

Analyst’s Disclosure: I am/we are long VIVHY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[deadhead213]

Amazing, nobody has figured out what’s really going on. The fact is streaming is going global and this is a fantastic position to be in now thst Billy The Kid is involved with his sparc

[oliv21]

Thanks for the article @Dominic Teo , interesting comparison between the majors and the music platform.
IMO, assessing zero value to the assets of out Canal+ / UMG is IMO too much conservative as these assets can worth at least 7B with conservatives view. Here are the biggest part of the "others" assets :
- Havas worth at least 2,5B
- Spotify 5% stake is worth 1,1B based on current price
- TIM 20% stake worth 1,3B based on current price