Music is a daily part of our lives. With the rise of the internet, mobile phones, and music streaming services, billions of people around the world now have the opportunity to listen to millions of songs with the touch of a button. This trend has led the music industry to start growing again after declining in the early 2000s due to the prevalence of pirated content.
For companies that own the rights to these songs, like music labels, this has proven a huge opportunity. One example is Warner Music Group (WMG -0.69%), which has popular artists like Ed Sheeran and the Red Hot Chilli Peppers under contract. The company is set to benefit from the rise of streaming music this decade.
However, the stock is down 37% year to date (YTD), likely due to the broad volatility we are experiencing at the moment. This price drop can provide a buying opportunity for long-term investors. Here's why.
What is a music label?
Warner Music Group, or WMG, describes itself as a "major music company." This is not very helpful in understanding how the business works, so let's dive a little deeper. WMG is a conglomerate of different music labels. Music labels recruit and sign musicians under contract, allowing WMG to earn a royalty stream on all the money they make. In return, artists are provided upfront payments, distribution management across internet platforms like Spotify, marketing benefits, and other services. This works (theoretically) in a symbiotic way in which the artist and label both provide value to each other.
As one of the longer-running music labels, WMG has been able to retain its market share of recorded music revenue throughout the last few decades. In 2020, it was estimated that the company had a 16% market share. Since 2006, this market share has been in the range of 14% to 18%, which shows the durability of WMG's position within the industry.
Streaming and digital driving growth
As mentioned above, the music industry went through a tough time with pirated music in the early days of the internet. But with the rise of music streaming, this has all changed. From the fiscal year 2018 to 2021, WMG's digital revenue grew at a compound annual growth rate (CAGR) of 16.5%, hitting $3.5 billion in revenue last year.
The segment makes up 67% of WMG's overall revenue now and should be the biggest growth driver for the business going forward. According to third-party analysts, music streaming is supposed to grow at a 14.6% CAGR through 2030. If WMG can maintain its market share, this should directly translate to revenue growth.
On top of streaming, WMG is seeing strong growth from other internet outlets, including places like TikTok, Meta Platforms, and Peloton. It just signed a deal with Meta (owner of Facebook and Instagram) that management said will drive meaningful licensing revenue starting this quarter. While it won't be nearly as large as the streaming segment, these other licensing deals are a nice cherry on top for WMG to make more money for itself and the artists it manages.
But what about the valuation?
With the current stock drawdown, WMG trades at a market cap of approximately $14 billion. Over the last 12 months, it has generated $650 million in operating income, giving it a trailing price-to-operating-income (P/OI) ratio of 21.5. This is right around the market average. As an investor, what you should take away from this is that if WMG can continue growing its revenue and operating income by around 10% to 15% annually, the stock price should follow suit. Over a long enough time horizon, this can lead to nice gains for your portfolio.
WMG Operating Income (TTM) data by YCharts.
If you believe in the continued growth of music streaming around the world, WMG could be a great stock to bet on here. At current prices, the stock is not trading at a premium valuation either.
