The Business of Music

TR – Hello, I’m Tom Record and I’m here with Tom Morris. Welcome to Global Infusions, an investment podcast from the Liontrust Global Fundamental team that takes a long term view of today's stories.

Last episode we chatted about families and the dynasties around them. This episode we’re chatting about music… emotive, thought provoking, artistic and a big industry. If your taste buds are tickled or you have any questions for our next episode, please do send them in via your client contact or through the contact us link on the Liontrust website.

So sit back, grab a cup of tea and remember that when we talk about individual companies we are not making a recommendation to buy or sell shares and that some of these companies may not be held across Liontrust’s global fund range.

TR – Music can change our moods, can inspire memories and feelings. But we’re interested in businesses, so Tom, let’s start by asking who is making the money?

TM – In the music industry, the answer is the record labels, the biggest artists and rights holders, and the companies that organise live events.

TR – Notably absent from that list are the streaming companies, despite them being responsible for the way that most music is consumed.

TM – Yep – I know they are very visible, as they’re the people that collect the money from listeners every month so they can access music, but the truth is that they don’t really make any money themselves. Spotify has literally never made a profit, not once.

TR – And its main competitors – services like Apple Music and Amazon Music – are part of big tech conglomerates, without separately disclosed profitability.

TM – Yes and the tech giants likely use their music services as a way of attracting and retaining customers, rather than as actual profit-making businesses.

TR – So how does Spotify manage to lose money when it has almost 200m paying subscribers?

TM – Well first it pays away about 75% of its revenues as royalties to record labels and rights holders, along with a smaller amount to payment processors and podcast makers. That leaves about 25% of revenues to pay all of Spotify’s other costs, like servers, marketing, software development etc, and ideally leave some left over as a profit.

TR – But I guess those costs are always bigger than 25% of revenues?

TM – So far, yes – in Q1-3 this year they’ve been around 30% of revenues, which means Spotify has made another loss.

TR – So the variable nature of their costs – having to pay around three quarters of revenues out to other people for the content rights – makes music streaming a much tougher business model than TV show streaming, where someone like Netflix can buy shows outright, meaning that every extra subscriber has a much higher level of incremental profitability.

TM – Yes exactly. Netflix owns Stranger Things, but Spotify has to rent all of its content from the record labels, and they want all the profit for themselves.

TR – OK so when artists get mad at Spotify for only paying them a fraction of a cent per stream, with the implication that Spotify is being greedy, that’s not really fair?

TM – Exactly - it’s not that Spotify is making loads of money and keeping it for itself – the reason artists don’t get much from an individual stream is really just because streaming services only charge around $10 or so per month to listeners who then stream thousands of songs, so there isn’t that much money to go around.

TR – And of course the labels keep a huge amount before anything is paid out to artists.

TM – Yes exactly – in fact let’s move on to the labels now.

TR – Right so the big three are Universal, Sony and Warner, of which Universal is the biggest, and also has by far the best disclosure by virtue of listing on the Dutch stock market in 2021.

TM – OK great, so we’ve got an annual report to dig in to.

TR – Yes – Universal Music Group had revenues of about €8.5bn last year, with an EBITDA margin of about 20%, and adjusted net profit of about €1.3bn.

TM – So actually lower revenues than Spotify, but way more profitable.

TR – It represents 8 of the top 10 charting artists of 2021, from BTS to Billie Eilish, so wields huge power when negotiating with streaming services who absolutely must have music from those artists in order to be viable.

TM – So along with the other two major labels, it squeezes the whole industry.

TR – Yes but it’s also worth thinking about how this might be changing.

TM – Go on.

TR – Well, historically the labels created value by discovering artists, helping them create and record their music and then promoting them across media, tours and merchandise…

TM – So a lot of very useful strings to the bow, but also a lot of things that can now be replicated without a label.

TR – Exactly. The cost of the equipment and processing needed to produce the music for an album has collapsed and is just more readily available. My 8 year old son loves building music tracks on garage band…

TM – That’s cool, and the streaming services now allow anyone to publish music to them. They also have clever algorithms that suggest music you might like, so discovery is much easier… and then there’s TikTok, which can help tracks go viral.

TR – I suppose the best thing that the labels bring is the clout to negotiate with the streaming companies and TikTok, and it sounds like a heated debate is going on there at the moment as the labels want a bigger cut of TikTok’s advertising pie. Merlin, who represents independent labels has already had to use extensions to keep the music flowing, and it looks like this may happen with the big labels in the coming months.

TM – OK. Tiktok was tiny when the original agreements were written and now it’s a multibillion dollar advertising behemoth.  So the labels of course want a bit more. 

TR – Right, before we talk about touring, I want to share an article I read about how music has changed because of the way that it is put together now… and why modern songs don’t have nearly as many key changes.

TM – Oh yes, the uplifting key change when you get to the last chorus… The Westlife special!

TR – Exactly!  so we now have vertical song writing rather than traditional linear composing. In the past, musicians would jam and work their way through a song, creating a linear flow through it.  Perhaps riffing on a guitar or piano as they go.

TM – Like in those videos of the Beatles composing things together. But what do you mean by vertical?

TR – Right, so nowadays, songs typically take a 2 bar bass sequence and loop that through the song, then stack on top a layer of a drum sequence on a loop, then a harmony, then a melody… it’s much more like a vertical stack and so you don’t get the same progression and key changes, which used to be in almost a third of the top 100 and now are very rare.

TM – Ah I see – well to be honest I don’t miss them, they were mostly pretty cheesy.

TR – Ha! So let’s move onto touring.  Now, traditionally touring has been a big source of revenue for artists personally, and it’s something that most of them love doing.  It also ties into our episode on sport and the stadia that are built to house not just one sport but much more – including concerts.

TM – Exactly. Most artists make most of their money from live performances – often 80-90% of their total income. It’s a fascinating part of the industry, dominated by two companies, Live Nation and AEG. And the amount of money involved is huge – Live Nation reckon that global concert revenues were about $5bn in 2000, rising to around $22bn in 2019.

TR – And Live Nation itself has just under a 30% share of global concerts, and also around a 30% share of global ticketing via its subsidiary Ticketmaster.

TM – It’s a remarkable company – the pitch to artists is basically ‘we have the relationships with the best venues, and the experience of running the biggest tours, and a great in-house ticketing platform, so we can put together a great experience for you and your fans next year’. Most of the ticket revenue gets passed to the artist, while Live Nation makes good money on the food/drink/merchandise and other in-venue services.

TR – Yes and organising tours is not easy – do you go for theatres, arenas or stadiums? Perhaps an appearance at a festival? Or a residency in Vegas, which can suit an artist with young children who would rather stay in the same place for a while.

TM – And fan behaviour varies a lot across genres. When I met with Live Nation a while ago, we spoke about trends in drink sales – can you guess which genre of music tends to have the highest alcohol sales at concerts?

TR – Aah an excellent question! Perhaps hip-hop? Rock?

TM – Wrong I’m afraid – it’s Country! Whereas merchandise sales tend to be highest for pop artists like Miley Cyrus.

TR – Ha! Fascinating. Now we should talk about ticketing, because there’s been a lot of press recently about the difficulties some fans are having getting hold of tickets for big artists.

TM – So ticketing for big concerts is a tricky thing to get right. Every artists wants to make money, ideally more than they made on their last tour, but they also want to make sure that younger fans can afford to see them, so the name of the game is price discrimination.

TR – Trying to price front-of-house premium tickets as high as possible, and back of house tickets as low as possible.

TM – Exactly, which is why we’ve seen the rise of VIP packages costing $500 or more at a lot of the biggest concerts, while at the same time the platforms are trying to stop touts from buying the cheaper tickets just to resell them at higher prices.

TR – Digital ticketing has helped a lot with that. It allows ticket companies and artists to have direct ongoing relationships with fans for the first time, and also allows for the secondary ticket market to be more tightly controlled.

TM – Some artists also use ‘verified fan programs’, where people who have registered as fans, bought albums and merchandise, watched music videos etc are given preferential access to tickets during presales and that sort of thing.

TR – And in general it works pretty well, but sometimes demand is so high that even the biggest ticketing systems get overwhelmed, as we saw recently with Taylor Swift’s Eras tour.

TM – Yes it looks like Ticketmaster messed up on their demand planning, with the website crashing under the load, and also possibly on their implementation of dynamic pricing, with regular fans being shown ticket prices that were unaffordably high. They said that demand on their systems was 4x higher than the previous record, with 3.5bn requests, suggesting that a lot of bots were trying to get involved too. In the end over 2m tickets were sold for her tour on November 15^th, the highest single day sales for any artist in history, and they all went to verified fans.

TR – At the end of the day all it really shows is that there is massive excess demand for live music from the biggest artists.

TM – Exactly. Live Nation said they think Taylor would have to perform 900 stadium shows, rather than the 52 she has planned, in order to satisfy all the demand. That would be a show every night for the next two and a half years!

TR – Gosh, by that time you’ll be ready to see her again!

TM – Ha! It’s also worth noting that even with just the 52 scheduled shows, it’s likely to become the highest grossing US tour of all time, but not the highest grossing world tour of all time, which was Ed Sheeran’s Divide Tour in 2017-19, which had 260 shows and grossed over $770m!

TR – Wow! OK so before we finish on music, it’s worth mentioning the value of back catalogues, where songwriters looking to retire sell the rights to their work as a big package either to private equity, or one of the big labels.

TM – It seems to be happening more and more, as the monetisation of older music gets easier thanks to streaming, and the use of songs for adverts and on social media.

TR – It’s a very complex area of IP, with rights for compositions and recordings, that can be sold separately

TM – Yes I think Bob Dylan sold his masters to Sony and his composition rights to Universal. It also ties in with Taylor Swift’s efforts to rerecord her old albums, where she had lost control of the master recordings to new owners that she didn’t like.

TR – David Bowie was pretty innovative here: back in 1997 he sold bonds backed by royalties from his back catalogue as he thought that music would become “free like water”, which was quite prescient as Napster and file sharing kicked off in the early 2000s.

TM – Bowie was a very forward thinking person

TR – OK so let’s move on to the news – Tom what do you have for us this episode?

TM – Well the first thing I want to mention this month is an interesting move from Meta to delete some of the data it has on its users.

TR – That seems out of character for Facebook

TM – Yes that’s why it caught my eye

TR – So what are they going to get rid of?

TM – Four fields of data on Facebook – your religious views, political views, address, and the ‘interested in’ box which had people’s sexual preferences.

TR – All quite sensitive stuff

TM – Yes and I think that’s the point. Meta has decided that the potential costs of holding these data are greater than the benefits. It stopped using religion, political views and sexual preferences for ad targeting a little while ago, and it doesn’t need your address as for most people it can see your location anyway.

TR – And those are the kind of data points that could be really problematic for Meta if they were ever leaked, hacked or abused in some way. It’s safer just not to collect or store them at all.

TM – Exactly. This seems like a sensible move.

TR – Agreed. On a related note, I was chatting to a marketing guru the other day and he was saying how what they are doing now focuses much more on intent than ID.  They don’t want you to hand over your email address so you can download content, but instead they want to know why you want to download the latest brochure: browsing, researching, thinking about buying?

Right, So the first thing I wanted to bring up this episode is on an explosion of Armenian imports of washing machines.

TM – ok, not something I’d expect. How many washing machines are we talking about here?

TR – Well in the first 8 months of 2022, Armenia imported more washing machines than in the previous 2 years.

TM – I assume there’s something going on here that isn’t to do with cleaner clothes.

TR – You’re right and it’s not just washing machines – breast pump sales to Kazakhstan from the EU rose over 600% in the first half of 2022. So some of this demand is probably being sold on illegally to Russians who can’t source foreign imported goods since sanctions were imposed.

TM – And the rest?

TR – Well Ursula von Leyen, the President of the European Commission believes that many of the chips in these products are making their way into Russian armaments.

TM – so trying to find a way round sanctions?  I suppose it shows that the flexibility and versatility of many silicon ships has reached a level where it is very difficult to impose complete sanctions if the same chip can be used in a tank or a washing machine.

TR – Agreed. Now Tom, where to next?

TM – The next thing from me is on Disney, who are firing their current CEO, Bob Chapek, just a few months after renewing his contract, and bringing back the old CEO, Bob Iger.

TR – Iger only left in 2020 didn’t he?

TM – Yes that’s right, and he actually stayed on as chairman until the end of 2021, so he’s only really been away from the company for less than a year.

TR – That does seem like an odd move.

TM – Yes ostensibly it’s because the board were unhappy with Chapek’s performance, and in particular the decline in Disney’s share price this year, but really all Chapek had been doing was implementing the strategy that Iger had put in place. He hadn’t had much time to do anything else yet. Disney just seems to have got itself into a mental state where it believes only one man can save it, much like a Marvel movie.

TR – Iger had been a brilliant CEO over the course of his last tenure, from 2005-2020, acquiring things like Pixar, Marvel, Lucasfilm and 20^th Century Fox.

TM – Yes definitely, but he also timed his exit well, close to the peak of a lot of content cycles (with Avengers Endgame and Star Wars Rise of Skywalker both coming out in 2019) and near the apex of the streaming frenzy that was getting people very excited about Disney+.

TR – yes timing plays a huge role in business, and can really shape how shareholders and society at large view someone’s legacy. In that context, coming back is a bit of a risk for Iger.

TM – Yes indeed – it will be very interesting to see how it plays out.

TR – Right, next up from me is a tie up that the antitrust authorities in the US have put the brakes on.  This is the Random Penguin acquisition of Simon & Schuster.

TM – So these are book publishers? 

TR – Indeed. But the interesting thing here is that the reasoning for denying the deal has moved on from the usual antitrust approach of just answering the question “will this increase prices to customers?” to instead also asking “will this decrease the advances paid to authors”.

TM –  A much more relevant question, and quite a big move from the historical framing of antitrust decisions in the US.

TR – Yes, and so worth raising today.  Of course the reason all the publishers have been consolidating is that they are all stuck between a rock and a hard place, or Amazon, as it’s commonly known, who have 50% of the book market.  So perhaps the regulators are targeting the wrong people! Tom, where to next?

TM – The last thing I wanted to mention today is the collapse of the crypto exchange FTX, and in particular some of the comments made in its bankruptcy filing by the person overseeing the process, John Ray.

TR – This is the man who was also put in charge of navigating the bankruptcy of Enron

TM – Yes, so he knows a thing or two about spectacular collapses.

TR – So what did he say?

TM – Ok here we go: ‘Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.  From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.’

TR – Wow.

TM – Yeah. It sounds like an incredible mess. The court filings go on to talk about the company not even knowing how many employees it had, or how much cash it had, and about undocumented loans made to employees so that they could buy houses in the Bahamas. It’s crazy.

TR – Billions of dollars of savings lost… And yet again, a failure of regulation. Bad rules!

TM – Absolutely.

TR – Thank you for listening to Global infusions - a podcast that believes that the best discussions are had over tea and cake. We hope you've enjoyed your cuppa and our thoughts on music. Please do subscribe through Apple or Spotify and with that we wish you goodbye!

TM – Goodbye!