Global music investing:Top picks to ride the next music wave

Our deep dive on the entire music ecosystem, including content ownersand retailers, highlights key factors that support an acceleration inrecorded music revenue growth. We also look at the impact on the terms oftrade from technology and regulation and predict some value shift infavour of the record labels. Our top picks for music investing are Vivendi,Sony, Amazon and LOEN Entertainment.

Converting listeners to customers.

Consumers’ willingness (especially younger demographics) to pay for streamingservices benefits all industry players. The proliferation of successful platforms, arecord high free-to-pay conversion rate and an ARPU generally higher thanprevious technology cycles, all support our view that the global music market willdouble in the next ten years (8% CAGR 2015-25E). We argue that music isabout to start the journey that has led the video entertainment industry toquadruple over the past 40 years.

Raising forecasts for music revenues.

With Apple Music we have entered the steeper part of the adoption curve formusic revenue growth. We believe consensus erroneously focuses on the fivelargest countries, while our new proprietary model shows that smaller countrieshave a much greater contribution to growth. We raise our near-term forecasts forrecorded music sales growth by 100bps per annum (4% in 2016 rising to 11% by2020), at the top of consensus range.

Changes in the terms of trade favour the content owners.

A relatively higher concentration of record labels compared to fragmenteddistribution across different models and regions means that bargaining power ismoving up the value chain in favour of content owners, just as has occurred invideo entertainment. Still, we think increased segmentation of consumers andnew value-added functionalities (e.g. VR concert video) leaves plenty of room forretailers to grow revenues ahead of premium content cost inflation.

Top picks are Vivendi, Sony, Amazon and LOEN.

Among the content owners our preferred stocks are Vivendi (nearly 60% of itsoperating profit from music in 2015) and Sony (20% of OP from music in 2015).

Together they account for 56% of recorded music and 51% of music publishingglobal markets (2015), which gives both strong bargaining power in theupcoming renegotiations of retail licence agreements.

Among the tech/internet giants, Amazon has the most sophisticated pricingstrategy and a good hardware integration (Echo). Apple competes more directlywith a strong Spotify, and YouTube is facing potential regulatory headwind andnew competition from SoundCloud.

Of the local distributors we pick LOEN for its undisputed market position anddemonstrated pricing power. We believe Sirius XM’s execution is impeccable butits business model is most at risk from growth in streaming. Pandora is acredible takeover target as widely reported in the press, while QQ Music andKKBOX are relatively small within Tencent and KDDI, respectively.