Warner Music Group Faces Distribution Shift - Analysts Are Bullish On Long-Term Growth Prospects

J.P. Morgan analyst Sebastiano Petti reiterated an Overweight rating on Warner Music Group Corp WMG with a price target of $40.

WMG shares declined 6% on September 20 following Bertelsmann's decision to end its recorded music distribution agreement (digital + physical) with Warner Music Group's subsidiary Alternative Distribution Alliance (ADA) - announced on September 18. 

As per WMG's 10K, ADA distributes and sells the products of independent labels to retail and wholesale distributors (ex: DSPs). 

BMG will in-source distribution to all major streaming platforms, beginning with Apple Music and Spotify, on January 1, 2024.

Petti expects BMG to in-source other DSPs as WMG's distribution agreements are renewed. 

BMG's physical distribution will continue to be outsourced, with a new deal likely shortly. 

While the headline revenue impact will be sizable, as distribution revenue is recognized on a gross basis, Petti expects the near-zero impact to group AOIBDA and FCF, given typical distribution agreement economics and BMG's scale as the largest independent label in the world. 

In BMG's press release, WMG CEO Robert Kyncl said this will allow WMG "...to focus on developing new partnerships, and for WMG to continue to grow our investment behind artists, songwriters and labels." 

The analyst sees the pullback in WMG shares and recent underperformance relative to peer UMG as an attractive buying opportunity as business momentum accelerates driven by recent growth drivers (DSP price increases, TikTok renewal) and market share improvements (Zach Bryan, Barbie soundtrack). 

WMG remains one of the best secular growth stories across Petti's coverage and is well-positioned to benefit from long-term industry tailwinds of paid streaming adoption, additional (and potentially recurring) streaming price increases, and improved Emerging Streaming Platform monetization. 

Truist analyst Matthew Thornton reiterated a Buy rating with a price target of $37.

WMG shares have been under pressure the past two days due to reports (MBW) indicating Bertelsmann taking its Recorded Music (RM) distribution in-house with the BMG-WMG Digital (streaming, other) deal set to expire "towards the end of" C2023 and the Physical (CDs, vinyl, other) arrangement set to expire in C2024. 

BMG is the largest of the independent (i.e., non-major) labels and is under new leadership (new CEO). 

Thornton believes BMG to be by far WMG's most extensive distribution relationship. He expects BMG revenue to transition out gradually (starting early C2024 and likely completed by C2025). 

The analyst estimates BMG's total RM revenue to be in the range of ~$400 million (based on the MBW report).

However, he estimates revenue applicable to WMG to be much lower (we assume closer to ~$300 million) when excluding things like social, sync, licensing, and artist services. 

Thornton estimates a 5% AOIBDA margin, which, taken together, yields ~$15 million or only ~1.0% of WMG's AOIBDA in F2025. 

WMG shares have sold off -8.5 % over the past two days (S&P -1.2% over that span) for a development that the analyst estimate equates to a -1.0% impact to F2025 AOIBDA. 

Price Action: WMG shares closed higher by 1.18% at $30.08 on Thursday.

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