Thread by @anthonyc3004

1/ Re $SPOT, helpful and positive take-aways from the IPO presentation for a digital label called Believe (believemusic.com), French domiciled and run but with strong market positions in a large number of geographies.

2/ Over time, they plan to be in all the 130-140 geographies that $SPOT are/ will be in.

Key to this business is they are positioned for a move to a digital music world, which they see fully playing out globally by 2030 and within 5 years in Europe.

3/ This is a helpful reminder of quite how powerful a secular tailwind $SPOT benefits from over the next many years.

4/ I came away with increasing conviction that Spotify are very well placed to participate over the next 5-10 years in a very exciting shift to digital which has only just begun and also with increasing conviction that the major labels are badly positioned and set to be…

5/ …disrupted materially over the coming years. Long $SPOT, short $WMG looks right to me (and probably short $VIV for UMG exposure too).

Key take-aways:

• They see the entire global market becoming digital by 2030 (v good for $SPOT).

6/ ○ They think all genres will be digital by 2030.
○ They think Europe will be digital by 2025, which is a big change vs now.

7/ • As $SPOT becomes more & more efficient at developing artists, they see artists reinvesting marketing onto direct platform tools over time (v good for $SPOT).

8/ • They see music fragmenting away from few big artists getting most of the revenues to many more artists sharing that revenue (supportive of $SPOT thesis).

• Labels deal structures look increasingly badly positioned for digital world:

9/ ○ Gave example of a big German band who switched from major label to Believe;
○ They were paying 30% extra away on non-German sales.

10/ ○ Made sense in physical world where there was extra cost associated with making CDs in Germany and then shipping them internationally.
○ Makes no sense in digital world. 60% of this bands revenues were from outside Germany.

11/ ○ They signed them by offering them much better economics and a much simpler royalty structure.

• They see their TAM as the entire music market over time minus a very small part which is back catalogues owned by major labels.

12/ ○ But even there they noted these deals were getting renewed with ever shorter time frame as the catalogue owners can see the shift from physical to digital sales happening.

Notes from presentation:

• Guiding to 20% revenue growth in 2021

13/ ○ Note Q1 was 26% growth.
○ Conservative guide given Covid still has some impact on advertising-supported revenues.

• Guidance is for 22-25% revenue growth from 2021-2025.

○ Longer-term revenue growth guide is high teens to low 20s. Includes M&A.

14/ • Guiding to 5-7% adj EBITDA margin by 2025 (note this is before stock options).

• Longer-term they see 15% EBITDA margins.

15/ ○ They noted there is a lot more operating leverage in the digital music business than in the old model which carried a lot more variable costs (costs to ship more CDs etc).

16/ • They have a strong market position in France, 25-30% market share in the digital music market.

○ They re-signed top hip hop artist Jul 4x despite him being the number 1 target of the Universal Music Group CEO in France and them offering him insane amount of money.

17/ This is because he is extremely satisfied with the service from Believe.
Also 80% of his revenues are digital, he started on YouTube and really understands the digital model.

18/ Jul speaks to other artists signed to major labels and hears about very different (lower) quality of service.

○ Are Believe going to take market share in traditional music formats?

19/ § No, major labels are better at making CDs but in 4 years market will be mainly digital.

• German case study - they signed big artist/ band called "Milky Chance" from major label.

○ They realised 60% of their revenues came from digital in 2019 (more now).

20/ ○ Big label wanted them to stay with 18m album release cycle.
○ This is not the right way to operate now - you don't get the benefit of building a digital audience that way.
○ New way is to release tracks every couple of months, with videos in between as well.

21/ § It's a much more active strategy.
§ Doing this, they increase digital revenues by 120-150% over 2 years.

○ The old deal with the big label had a base royalty rate for sales in Germany and then the label gets an extra 30% of sales outside Germany.

22/ § This made sense in the physical world - CDs made in Germany, then shipped internationally with much higher costs associated.
§ Makes no sense in digital world but labels still use this structure.

23/ § For Milky Chance, 60% of their revenues are from outside Germany so CEO was able to give them a deal with much better economics and a much simpler, more transparent royalty structure.

• In Emerging markets:

24/ ○ UMG, Warner, Sony are not real competition - they don't exist in most of these countries.
○ In Russia, Believe have 40 staff vs UMG have only 5.
§ In Russia, 6 of top 10 tracks in May are Believe artists.
§ 10 of top 25 Spotify tracks in Russia.

25/ ○ In Romania, Believe have 7 of top 10.
○ In India, Sony is a key player with Bollywood but Warner and UMG are not there at all.

○ Emerging territories are pure digital.
○ Artists use Youtube and Tik Tok now not radio.

26/ • M&A important part of their strategy, has driven one-third of growth in the last 3 years.

• Have made 18 acquisitions in last 6 years, mainly of labels. Have a pipeline of 30 M&A targets.
○ Don't buy in new countries, build organically first.

27/ ○ Bought Nuclear Blast big heavy metal label.
§ Transformed it into a digital business, improved profitability and returned it to growth.

○ Also buy very fast growing labels that need Believe's help to scale up.

28/ ○ If they are competing vs major labels then they usually have the upper hand, it's not just about the money but also about what you can bring to the business.

29/ ○ 3 of the labels in their current pipeline distribute via major labels but they've agreed to come across to Believe as they recognise the service they get from the major labels is weak.

30/ • M&A is the main reason for the IPO - the €300m they are looking to raise covers their M&A needs out to 2023.

31/ ○ They had thought about raising €500m to cover needs until 2025 but advice from investors was to raise the lower amount to lower dilution, and because they are confident in beating their planned guidance.

32/ ○ They want to spend €100m per year on M&A, up from €40m per year last 2 years.
§ Have dedicated teams in place for integrations, synergy realisation etc.

• Difference between revenues and digital music sales in the slide below is:

33/ ○ Digital Music Sales are fully paid to the artists.
○ Revenues is the subscription fees they invoice to artists.
○ Two-thirds of the 36% CAGR in revenues is organic so 24% organic CAGR 2018-2020.
○ Note that 2020 revenue growth slowed to 12%.

34/ § This is because Covid hit the advertising market in 2020.
§ Half of the business in emerging markets is ad-supported (YouTube etc).
§ Artists responded to this also by postponing releases in 2020.

35/ § Q1 2021 saw recovery to 26% revenue growth, 23% organic growth.
§ Some countries are still affected by Covid.

• Costs before the adj EBITDA line are royalties to artists mainly and some for teams (sourcing artists etc).

36/ ○ Adj EBITDA is pre stock options.
○ Central costs as % of revenues will go below 2018's 6% of sales (vs 12% in 2020) as revenues grow.

Q&A:

• Spotify as competition:

○ They don’t think they will compete with platforms.

37/ ○ Music is different from video, product and distribution are not integrated.
○ They fight with SPOT etc each year to try to maximise revenue for artists.

38/ ○ Artists know that if over-expose to one platform like SPOT then that kills their ability to get exposure at Apple, YouTube etc.

39/ ○ As SPOT becomes more and more efficient at developing artists, they expect artists will reinvest more of their marketing onto platforms directly.
○ Believe are looking at M&A to bulk up tools to automate marketing onto SPOT, YouTube etc.

40/ ○ They note that SPOT backed away from getting into that business a few years ago - they looked at it, measured the consequences, and backed away.

• Is it deflationary for the industry if all moves to digital platforms?

○ No, but good question.

41/ ○ The model is different but whether they operate at top, middle level or entry level the economics are very similar.
○ They really measure EBITDA to revenues for each segment.

42/ ○ The cost of variable sales in the traditional world is very high (costs more to sell more CDs).

43/ ○ In the digital world, it’s essentially a fixed investment - they could manage €2bn, €3bn or €5bn revenues on their platform and would only incur €200m additional costs on storage etc but the rest of costs would be fixed (implying v high incremental margins).

44/ ○ They have high conviction that they can drive superior economics to major labels.
○ They manage 2x the number of artists with similar teams size vs traditional players & can extract better economics.

45/ ○ And they have made a lot of investments to further automate and get efficiencies.
○ Net net they have lower variable costs and are more profit generating than the traditional model.

46/ • When look at split of value between various players in the chain, it's very similar now vs how it was 20-30 years ago in the purely physical world.

○ Music industry is not winner takes all. A few years ago there were 10-12 big players.

47/ ○ The revenue pool used to be concentrated on a few very big artists - now that pool will be divided between many more artists.

• How do you think about your TAM say 5-7 years out?

○ They model market growth, it is extremely predictable.

48/ They see Spotify's ability to bring in new paid subscribers each month also have high predictability for YouTube and Apple Music.

49/ ○ They think revenues are extremely predictable; they think it is no longer a hit and miss business in the digital world, much more stable over time (TC: I think driven by move away from 18m album release cycles).

50/ ○ All market segments will become digital in the next 10 years.
○ Europe will be mostly digital in 5 years - very significant change vs now.
○ By 2030 all genres of music will be digital.

○ They see their TAM then as the entire music market.

51/ § Minus a very small part which is the back catalogue owned by major labels.
§ But even these are moving.
§ Gave Queen as an example - most valuable back catalogue out there.

52/ □ The last renewal was only for 3 years as the owner saw the make-up of revenues shifting from physical to digital.
□ So not only new frontline artists but also back catalogues are becoming digital.
□ Hence why TAM ultimately will be the whole music market.