Analysts at investment bank TD Cowen have concluded that markets are wrong to peg the value of music streaming businesses higher than the value of music rights.
In a new report, the bank’s analysts suggest that because of Spotify’s skyrocketing value and breakthrough to profitability, record labels and music publishers may - ironically - have an upper hand over the streaming service during the next round of licensing deal negotiations. As a result, it recommends people ‘buy’ shares in Universal Music and Warner Music, but ‘hold’ on Spotify shares.
By the bankers’ maths, the whole music rights business - including recordings and publishing, majors and indies - has an enterprise value of $169 billion. However, Spotify’s enterprise value alone is $177 billion. Although Spotify is the dominant player in music streaming, and commands about a third of the market, it - unlike Netflix - doesn’t own any content. And - as everyone knows - “content is king”.
That’s certainly what TD Cowen thinks at least. “We firmly believe that ‘content is king’”, says a new update from the bankers, before adding, “it is hard for us to square that belief with the market's current verdict that, in the music industry”, platforms like Spotify that simply distribute content to consumers are “worth several times more than content ownership”.
Good news for Papa Grainge’s €100 million megabonus perhaps - but maybe not such a rosy outlook for Daniel Ek’s bank balance.
This could all be a bit of a problem for Spotify in the future, say the analysts, pointing out that while “Spotify clearly has the best platform” in the music streaming market, “it isn’t sufficiently superior to allow for a meaningfully higher price than their competitors” and “if they were uniquely lacking music from one of the major record labels due to a contract dispute, we believe they would suffer rapid and significant share losses”.
The deals between streaming services like Spotify and the music industry are renegotiated every few years. That always poses the question: who has the most negotiating power, which is to say, who needs who the most?
In the very early days, when streaming was a new business model generating nominal revenues, the platforms needed the music much more than the labels and publishers needed the platforms. But, as streaming became the primary recorded music revenue stream, and with Spotify so dominant in the market, its negotiating power increased.
However, Spotify has become profitable in recent years, mainly by significantly cutting back its overheads. While that was good news for Spotify and its investors, it may have also opened a door for music companies to become more demanding in their licensing negotiations.
When there’s no spare money floating around, it’s difficult to ask for more cash. When a company like Spotify is turning a profit, though, maybe things are different.
Says the TD Cowen update, “The rapid rise of margins at Spotify over the last year, combined with a slowdown in streaming revenue growth at the record labels, has - we believe - helped catalyse a new deal structure” during the most recent round of licensing talks between the majors and the streaming service.
While we know that the majors successfully pressured Spotify to demonetise whole swathes of artists in order to ensure more money flows to the superstars and big catalogue owners, there are other ways the majors have seemingly sweetened their deals with the streaming giant.
That includes what the bankers call “step-ups in contractual floors, allowing the labels to secure revenue increases that are independent of the decisions of the streaming services to raise (or not raise) prices”.
Or, in other words, rather than hanging around for years waiting for Spotify to put up its prices so that the revenues in which they share go up, the majors have negotiated themselves revenue increases that aren’t tied to Spotify increasing its price point.
Of course, the upshot is the same, because - doubtless - in order to increase what it pays to the majors Spotify will have to increase its prices. However, according to what TD Cowen implies, the difference is that future price increases will, at least in part, be dictated by the contract Spotify has with the majors, rather than by when Spotify feels consumers can stomach a price hike.
The bankers also note that, in recent deals with Spotify, Universal Music and Warner Music directly licensed their Anglo-American publishing catalogues for use in the US, rather than Spotify relying on the compulsory licence that usually sets the rates for songwriters and publishers. That means Spotify can no longer apply the controversial bundling discount when those songs are streamed.
As a result they expect that publishing payments will be “closer to what the publishers earned before Spotify initiated its bundled offerings”.
All of this means that, TD Cowen concludes, as new licensing deals are negotiated and go into effect, “we expect growth in the music value chain to accrue more significantly to content owners than [streaming services], and we ultimately expect share valuations to reflect this”.