Wed, Sep 22, 2021|Whitney Tilson

Universal Music Group soars in market debut; The SEC's mistake; No More Apologies: Inside Facebook's Push to Defend Its Image

1) Shares of music giant Universal Music Group (UMG.AS), a spin-off from French conglomerate Vivendi (VIV.PA), soared yesterday when they began trading on the Euronext Amsterdam stock exchange.

We have long been bullish on the music industry in general, and Universal Music Group in particular. Here's what my colleague Berna Barshay wrote in her free e-letter, Empire Financial Daily (which you can sign up for here) on August 19, 2020:

Music is the most evergreen content there is...

No matter how many times you may re-watch a Friends episode or a classic movie like Star Wars or Dirty Dancing, the count will pale in comparison to the number of times you listen to your favorite song from high school or college. You can hear your favorite songs a thousand times and they don't get old.

An old tune is like a time machine for your soul, which may be why almost 50% of on-demand audio streams on services like Spotify (SPOT) or Apple's (AAPL) Apple Music come from the deep catalog, otherwise known as music that was released three or more years ago. A quick scan of the top 100 most streamed artists on Spotify recently included Queen at No. 46, Elton John at No. 79, Michael Jackson at No. 93, and The Beatles at No. 95.

Some of my favorite bands reached their peak output well before I was born. This ability of old music to be "new to you" reinforces its longevity as a valuable intellectual property ("IP") asset...

Music is a long-lived, enduring asset and streaming is booming, which makes the music publishers a great bet...

Three music publishing companies control about 70% of music listening today. The oligopoly includes Japanese conglomerate Sony's (SNE) Sony Music, French conglomerate Vivendi's Universal Music, and pure play music company Warner Music (WMG), which recently went public.

I'm a fan of Vivendi, which derives the bulk of its value from its music division. At Sony, which has a $100 billion market cap, music at 10% of total sales is too small of a piece of the overall corporate pie to drive the stock price.

All three music companies enjoy healthy margins from economies of scale on the hefty fixed costs of finding and developing artists and maintaining departments that collect and legally protect music IP rights. They also enjoy a sizable moat... Artists want to work with the proven leaders in the industry – the ones with the best track record of success in marketing musicians and getting them to the top of the field.

While there has been speculation that Spotify or Apple could get into the artists and repertoire (A&R) business – the scouting and developing of new recording artists – just like how Netflix (NFLX) got into original content, I don't think it will be so easy for Spotify or Apple to dethrone the big three music publishing incumbents.

The new artist universe is incredibly fragmented, scouting is a skill the other companies have been honing for literally a hundred years, and a strong roster of current artists helps nurture new ones. Up-and-comers can collaborate with established hit makers on their label, and music publishers have units focused on the TV, film, and advertising agencies which jockey to get music from new artists featured in new productions.

The music companies also sit in a good spot, because they get to piggyback off the investments of Spotify, Apple, Amazon (AMZN) and others to recruit new streaming customers around the globe. Not having to pay for the streaming customer acquisition that will drive their future growth means that as revenue from streaming grows, costs won't grow as fast.

This analysis, which has been spot-on so far, is why Berna, Enrique, and I recommended Vivendi 16 months ago in our flagship newsletter, Empire Stock Investor. Since then, it's up 83%!

It's also why Enrique recommended Pershing Square Tontine Holdings (PSTH) in his Empire SPAC Investor newsletter. After PSTH announced a deal to buy 10% of Universal Music Group at an attractive price, Enrique did a deep dive and published a 30-page report, which we shared with our subscribers and then released publicly in my June 7 e-mail, when PSTH was at $23.03 per share. He concluded:

Bill has put together an outstanding transaction that is taking advantage of complexity to put PSTH in a position to create tremendous economic value.

In light of Universal Music Group's stellar debut yesterday, you might be wondering why PSTH is down 14.4% since June 7, closing yesterday at $19.72...

The answer is that the U.S. Securities and Exchange Commission ("SEC") blocked the deal, which Ackman discussed in a July 19 letter to PSTH shareholders.

There's a theory floating around Twitter (TWTR) that Ackman made a mistake in structuring the deal, perhaps because he wanted it to fail so he could instead make the investment using the other funds he manages (which is what he ended up doing)... but this is total nonsense. Ackman wanted nothing more than to consummate the deal he'd spent months negotiating – that's why he called it "a dagger in the heart."

I understand why PSTH shareholders and Empire SPAC Investor subscribers are livid – they should be sitting on big gains right now, rather than losses.

But their ire shouldn't be directed at Ackman, who put together a fantastic deal, or Enrique, who correctly identified it as such, but rather at the SEC.

What could the regulators have been thinking? Clearly, they wanted to cool the overheated special purpose acquisition company ("SPAC") sector by sending a message to investors – something I'd been calling for, in fact.

To do so, there was no shortage of dicey SPACs the SEC could have targeted – ones that had announced terrible deals in frothy sectors with profitless companies making absurd pie-in-the-sky projections, yet where the SPAC sponsors were certain to make a fortune even if the stocks collapsed and shareholders took a beating.

But nooooo...

Instead, the SEC inexplicably chose to make an example of the very best SPAC in my opinion – one that had struck a deal with an exceptionally high-quality, profitable, global business, in which the sponsors weren't taking any warrants at all.

The SEC's mistake has cost PSTH shareholders nearly $1.5 billion (based on Universal Music Group's market cap today versus when Ackman struck the deal).

Let's hope it exercises better judgment in the future...

2) For years, social media giant Facebook (FB) has been widely criticized for a range of misdeeds.

The latest harsh scrutiny came from a four-part series last week by the Wall Street Journal entitled "The Facebook Files," which I covered in my e-mails last Wednesday and Friday. Here are links to the four WSJ articles:

In response to this criticism, you might think that Facebook would attempt to address these issues in a serious and transparent way, asking for outside help from researchers and other experts.

But, of course, you'd be wrong...

Further demonstrating why NYU marketing professor Scott Galloway has called Facebook's founder and CEO, Mark Zuckerberg, a "sociopath" and "the most dangerous person in the world," Zuckerberg approved a tone-deaf, brain-dead plan to put lipstick on this pig, as this New York Times article documents: No More Apologies: Inside Facebook's Push to Defend Its Image. Excerpt:

Mark Zuckerberg, Facebook's chief executive, signed off last month on a new initiative code-named Project Amplify.

The effort, which was hatched at an internal meeting in January, had a specific purpose: to use Facebook's News Feed, the site's most important digital real estate, to show people positive stories about the social network.

The idea was that pushing pro-Facebook news items – some of them written by the company – would improve its image in the eyes of its users, three people with knowledge of the effort said. But the move was sensitive because Facebook had not previously positioned the News Feed as a place where it burnished its own reputation. Several executives at the meeting were shocked by the proposal, one attendee said.

Project Amplify punctuated a series of decisions that Facebook has made this year to aggressively reshape its image. Since that January meeting, the company has begun a multipronged effort to change its narrative by distancing Mr. Zuckerberg from scandals, reducing outsiders' access to internal data, burying a potentially negative report about its content and increasing its own advertising to showcase its brand.

What a total disgrace. Our elected leaders and regulators need to rein in this rogue company – fast!

Best regards,

Whitney

P.S. I welcome your feedback at WTDfeedback@empirefinancialresearch.com.