Artificial intelligence may be the best example yet of a development that is both a threat and an opportunity – and nowhere is that more the case than in the music rights business.
In the wake of the massive buzz around AI over the past year, some music biz analysts have leaned towards the “threat” side of the equation.
Earlier this year, BNP Paribas Exane analyst William Packer memorably double-downgraded his outlook for Universal Music Group’s stock, with AI being a key reason for the move.
Packer argued that “AI is a new disruptive threat” to large-scale music rightsholders.
He added: “While UMG is likely to remain a long-term winner from digital[z]ation, we think AI music is to emerge as a challenging thematic and drag on elevated multiples.”
Pershing Square, the NYC-headquartered hedge fund management company run by billionaire investor Bill Ackman – and the owner of approximately 10% of UMG – is at the other end of this spectrum.
It sees in AI an opportunity for Universal Music Group – on which the world’s largest music rightsholder is already capitalizing.
Pershing Square wrote in a half-year fiscal update letter to shareholders on Friday (August 18): “UMG’s business progress, as evidenced by its first half results, and the articulation of the company’s AI strategy, on both an offensive and defensive basis, has largely put [AI-related] concerns to rest.”
“We believe that investor concerns about AI displacing major labels and artists are misplaced. Rather, we believe that AI represents a significant opportunity for the company.”
Pershing Square bought around 10% of UMG in 2021, via a SPAC it controls, for approximately USD $4 billion.
In H1 2023 (i.e the six months to end of June), Pershing’s UMG holdings represented a -2.1% drag on the company’s gross return of 10.1%. However, by August 15, it represented a positive 2.1% contribution to a gross return of 14.8% year-to-date.
That can be explained by UMG’s stock price decline in H1, which saw shares drop from around €23 at the start of the year, to around the €18 mark by mid-year.
However, the music company has retraced all those losses in the past few months, and was trading once again around the €23 mark on the Euronext Amsterdam stock exchange by mid-August.
Ackman asserted last year that UMG has the potential to grow revenue by at least 10% per year for at least the next decade.
Pershing Square hasn’t revised that prediction since then, and UMG has just about delivered. The company clocked full-year revenue growth of exactly 13.6% YoY for 2022; Q1 2023 revenues were up 16.5% YoY, while Q2 revenues came in at 8.8% YoY.
In its new H1 2023 letter, which can be accessed here, Pershing Square laid out the evidence for its argument that AI is a positive for UMG and the industry as a whole, noting that despite the “proliferation” of AI content – which is contributing to some 120,000 new audio tracks being uploaded to streaming services every day – UMG’s market share has remained constant at around 30%.
“While excitement around AI will increase the proliferation of content even further, we believe that this long tail of AI-generated content will likely never be heard and will not displace legitimate artists’ work,” the letter to shareholders stated.
“In the handful of instances where unsanctioned AI-generated songs imitating well-known existing artists have achieved virality, they have been promptly removed by DSPs to protect artists’ rights,” it continued, adding that, if DSPs fail to take action on unsanctioned AI-generated tracks, that in itself represents “opportunities for artists and their labels [for] compensation.”
“AI… has the potential to make UMG’s current roster and vast catalog even more valuable by allowing the company and its artists to involve fans with user-generated content and monetize old music in new and revolutionary ways.”
Pershing Square
That comment was likely in reference to the “fake Drake” controversy that erupted this past spring, when a track using AI-generated vocals mimicking UMG-signed artists Drake and The Weeknd went viral – before being promptly removed by Spotify, YouTube and other DSPs.
That’s part of what Pershing Square refers to as the “defensive” aspect of UMG’s strategy – that is, the need to protect artists from unwanted or unlicensed use of AI that could compromise their works and public image.
By contrast, the “offensive” aspect of the strategy can be seen in the deals UMG has inked with AI developers – and the alliance, announced earlier this week, that UMG has inked with YouTube to develop new AI music tools with “protections” for artists built in.
“UMG’s partnership with Endel and HYBE’s recent release of a track in multiple languages provide a framework for how the company can monetize AI-assisted music,” the letter to shareholders noted.
That was in reference to K-pop giant HYBE’s release of a track by artist MIDNATT earlier this year featuring the “first-ever multilingual track produced in Korean, English, Japanese, Chinese, Spanish and Vietnamese”.
It’s also a reference to the “first-of-its-kind” deal that UMG struck with AI music startup Endel in May.
Under the deal, Endel, a developer of “functional music” (i.e., music for sleep, running, relaxation, etc.), will offer access to its proprietary generative AI tech to enable UMG artists to “reimagine” their music and create “science-backed soundscapes designed to enhance listeners’ wellness” with both new music and new versions of catalog music.
“While excitement around AI will increase the proliferation of content even further, we believe that this long tail of AI-generated content will likely never be heard and will not displace legitimate artists’ work.”
Pershing Square
Pershing Square’s letter was released just days before news broke of another partnership – this time, between UMG and YouTube, to jointly develop AI tools that offer “safe, responsible and profitable” opportunities to music rights holders.
A key element of this partnership will be a new “Music AI Incubator” at YouTube which will work on new tools and innovations in close cooperation with artists and the music industry.
And while that is certainly a part of UMG’s “offensive strategy” on AI, it appears to include some of what UMG has been campaigning for on the “defensive” side as well – that is, protections for artists and copyrighted music.
The incubator’s development will be guided by a set of principles that “include appropriate protections and unlock opportunities for music partners,” as well as the scaling of YouTube’s “industry-leading trust and safety organization and content policies” to “meet the challenges of AI.”
Pershing Square’s letter notes: “AI also has the potential to make UMG’s current roster and vast catalog even more valuable by allowing the company and its artists to involve fans with user-generated content and monetize old music in new and revolutionary ways.”
The letter also asserts that the debate around AI has “distracted from recent positive developments that are improving the monetization of streaming.”
Noting that all the major DSPs have recently enacted price hikes of 10% for their individual subscription plans, it predicted that higher revenue at the DSPs will “benefit UMG’s subscription revenue growth rate” beginning in the current quarter, through the pro-rata payment system by which recording companies and publishers are paid by streaming services.
“Over time, we expect regular price increases will become the norm in the audio streaming industry as they are already in the video streaming industry,” Pershing Square added.
The letter also echoed an idea being championed by UMG Chairman and CEO Sir Lucian Grainge: a shift towards an “artist-centric” payment model at the DSPs, which will “generate more value for the artists that drive subscriber growth, engagement, and retention.”
Pershing Square predicted that UMG “will be an important beneficiary of this shift, as the power of its immense high quality artist roster will result in a greater share of streaming royalties.”
The letter concludes: “Given UMG’s continued strong market positioning and long runway for sustained earnings growth, we believe that the company’s current valuation represents a discount to its intrinsic value.”
Which is about as far from Packer’s “sell” rating on UMG as one can get.
Pershing Square’s full H 2023 investor update on UMG can be read below
UMG’s share price has been volatile year-to-date as some investors questioned the impact of generative AI on the music industry and UMG’s ability to reliably expand margins. UMG’s business progress, as evidenced by its first half results, and the articulation of the company’s AI strategy, on both an offensive and defensive basis, has largely put these concerns to rest. The share price has responded accordingly. We believe that investor concerns about AI displacing major labels and artists are misplaced. Rather, we believe that AI represents a significant opportunity for the company.
AI is not a new phenomenon to the music industry. Over the last several years, more than 100,000 tracks have been uploaded daily to digital streaming providers (DSPs), a substantial proportion of which were already AI-assisted. Despite this proliferation of content, UMG’s global market share has remained consistent at ~30%. While excitement around AI will increase the proliferation of content even further, we believe that this long tail of AI-generated content will likely never be heard and will not displace legitimate artists’ work. In the handful of instances where unsanctioned AI-generated songs imitating well-known existing artists have achieved virality, they have been promptly removed by DSPs to protect artists’ rights. If DSPs or other industry players fail to protect artists in these instances, we believe that federal copyright law and protections for artists’ name and likeness will mitigate these risks and create opportunities for artists and their labels compensation.
“We believe that investor concerns about AI displacing major labels and artists are misplaced. Rather, we believe that AI represents a significant opportunity for [Universal]”
More importantly, we believe investors are missing the potential for AI to serve as a tailwind to UMG and the music industry broadly. AI is already accelerating the music production process. UMG’s partnership with Endel and HYBE’s recent release of a track in multiple languages provide a framework for how the company can monetize AI-assisted music. AI also has the potential to make UMG’s current roster and vast catalog even more valuable by allowing the company and its artists to involve fans with user-generated content and monetize old music in new and revolutionary ways. We expect UMG to announce additional AI-related partnerships over time.
The debate around AI has distracted from recent positive developments that are improving the monetization of streaming.
We have long believed that music is one of the lowest-cost, highest-value forms of entertainment. With Spotify and YouTube’s recent price increases, all major DSPs have now increased prices by 10% for their individual subscriptions and more for family and student plans.
Starting this quarter, these price increases began to benefit UMG’s subscription revenue growth rate. While some investors were concerned that certain DSPs were delaying price increases in order to negotiate preferential terms, both UMG and other smaller music labels have confirmed that these price increases are governed by existing agreements and that the labels’ revenues will increase pro-rata along with the DSPs. Over time, we expect regular price increases will become the norm in the audio streaming industry as they are already in the video streaming industry.
“led by UMG’s industry-leading management team’s initiatives, we believe that streaming is moving towards an “artist-centric” economic model that will generate more value for the artists that drive subscriber growth, engagement, and retention.”
Furthermore, led by UMG’s industry-leading management team’s initiatives, we believe that streaming is moving towards an “artist-centric” economic model that will generate more value for the artists that drive subscriber growth, engagement, and retention. While these changes may take time to be fully implemented, we believe that UMG will be an important beneficiary of this shift, as the power of its immense high quality artist roster will result in a greater share of streaming royalties.
Ultimately, UMG is the dominant player in an oligopolistic industry with decades-long secular growth. UMG’s market presence should allow it to successfully navigate technological change and take its fair share of improving industry economics, as it has done numerous times over its multi-decade history. Given UMG’s continued strong market positioning and long runway for sustained earnings growth, we believe that the company’s current valuation represents a discount to its intrinsic value.Music Business Worldwide
