A case study for students of business — How to see the future: Len Blavatnik & the 2011 purchase of WMG

Hi all - I was very interested in Warner Music's IPO at the start of the month and went down a rabbit hole. I ended up doing an absurd amount of research, and I ultimately created a case study that students of business should find very interesting. An excerpt is below. Your feedback is very welcome 💪

The case study covers:

the impact of the internet on the music industry (remember that 2010 was a scary time for traditional media with Netflix & Amazon killing Blockbuster and brick-and-mortar bookstore Borders)
the rise of music streaming
Russian Billionaire Len Blavatnik’s business deals
The purchase and recent IPO of Warner Music Group
Concise analysis and actionable insights you can use today

📰 Scenario

It’s January 1st, 2011 — New Year’s Day — and the music industry is a mess.

Music industry revenues ($ billions) Music industry revenues 2000-2010

Piracy is widespread and, as a result, global industry revenues have fallen for the sixth year in a row. Just ten years ago revenues were $23B; in 2010 they fell to $15B — a 35% decline.
Digital music sales (mostly iTunes downloads) are growing but don’t come close to offsetting lost CD revenue and, in any case, this growth has started to slow.
And while music streaming has begun to emerge, no one knows yet whether it will reverse the industry decline or accelerate it; streaming just might cause the remaining honest consumers to stop buying music, further depressing industry revenues

🕵️ Overview

In 2011, there are four major music companies: Universal Music Group (UMG), Sony Music Entertainment (SME), Warner Music Group (WMG), and EMI.

(🔒 2010 Record Label Market Share of Revenues. Chart omitted in this excerpt)

With WMG lagging and the industry collapsing, its private equity owners are ready to make a big play. They’ve owned WMG for seven years now, whereas they typically look to exit investments in five years or less.
So in January 2011 they start an unusual dual M&A process: they hire a set of investment bankers to sell WMG, and at the same time, they engage another set of bankers to try to acquire EMI in order to create a joint WMG-EMI.

- WMG’s revenues have fallen from $3.52B in FY 2006 to $2.98B in FY 2010; and they’re projected to fall further to $2.7B in FY 2011

- WMG losses are growing and its stock has severely underperformed the NYSE market index

- Digital (including downloads, ringtones, ringback tones, webcasting, and streaming) now accounts for 25% of WMG’s FY 2010 revenues, mostly due to the sudden deterioration of CD sales

(🔒 WMG Selected Historical Financials & Comparison of Cumulative Total Return. Chart omitted in this excerpt)

❔ Questions for the reader

Against this backdrop, would you recommend buying WMG? Why or why not?
Who might be interested in buying WMG? Why and under what conditions?
What would a potential acquirer have to believe in order to buy WMG?
What are potential risks of buying WMG and how could they be mitigated?
What’s the potential upside in buying WMG and how could it be maximized?

🎭 Players

Warner Music Group
Warner Music Chairman and CEO Edgar Bronfman Jr.
Other music companies: Sony/ATV, BMG Rights Management, EMI
Private Equity firms that own WMG: THL Partners, Bain Capital, Providence Equity Partners
Private Equity firms interested in buying WMG: Guggenheim Partners, KKR, Platinum Equity
Billionaires interested in buying WMG: Ron Perelman, Tom & Alec Gores, Len Blavatnik

🚶 Walkthrough

In January 2011, WMG began an auction to sell itself and by March 2011 the company had received more than 10 first-round bids. After examining these bids, WMG advanced the following bidders to the 2nd round:

Sony-owned music publisher Sony/ATV, in a joint-bid with billionaire Ronald Perelman and private equity firm Guggenheim Partners LLC
Music publisher BMG, with a bid backed-by private equity firm KKR
Southern California private equity magnate brothers Tom and Alec Gores (and their PE firms Platinum Equity and Gores Group)
Billionaire Ron Burkle’s private equity firm Yucaipa Companies, in a bid endorsed by Napster founder Sean Parker
Billionaire Len Blavatnik’s investment holding company Access Industries

Ultimately, with a bid of $8.25 a share (a 34% premium to WMG’s average stock price over the previous six months), Len Blavatnik’s Access Industries won the auction in May 2011. In July 2011, WMG’s shareholders officially voted in favor of the deal.

The price tag, $3.3B, represented just 1.15 times WMG’s previous 12 month revenue of $2.9 billion, but many observers suggested that Blavantik overpaid:

“For Warner Music, it’s almost the perfect scenario…the value they’re getting is at the high of any estimate.” — Tuna N. Amobi, media analyst, Standard & Poor’s Equity Research
🔒 “Quote omitted in this excerpt” — The New York Times
🔒 “Quote omitted in this excerpt” — The New Yorker
🔒 “Quote omitted in this excerpt” — The Economist

“I was risking my money, not their money.” — Len Blavatnik

✔️ Rationale

Why buy WMG? One key consideration mentioned at the time (and talked about since 2004) was the possibility of merging WMG and EMI:

“If a single buyer could acquire both Warner and EMI, people in the music industry estimate, the combined operation could save up to $300 million in overhead.” —The Wall Street Journal

Blavatnik, sometimes referred to by his employees as the “King of Optionality,” did ultimately bid $1.5B for EMI. He was outbid however by Vivendi, the French media and telecom company, who paid $1.9B.

“I think it’s very important to maintain discipline and be financially sound. So Universal just paid four hundred million dollars more than we were planning to pay. More power to them.” — Len Blavatnik

Whereas Blavatnik was aggressive during the WMG auction (at one point even threatening to abandon his bid if WMG delayed the selection process), he was relatively passive during EMI’s sale process. This contrast suggests that consolidating WMG and EMI was not a primary driver for his WMG purchase. So what did Blavatnik see? The future.

🎯 Results

"He is risking a third of his fortune on a number three business in an industry that is headed for a precipice…He may know something we don’t." — music industry analyst Alice Enders.

(🔒 Music industry revenues breakdown (2018). Chart omitted in this excerpt.)

Streaming’s contribution to the industry exploded. Today in 2020, Digital accounts for ~60% of the global music industry’s $20B annual revenue. Streaming alone contributes ~50%, up from its 3% contribution at the time of Blavatnik’s purchase.
WMG rode the streaming wave extremely well. In FY 2019 WMG’s revenues were $4.5B with 58% coming from Digital, up from $3B and 25% in FY 2010; Streaming alone generated $2.13B in revenue, nearly half of the firm’s revenues.

- Spotify alone accounts for ~14% of WMG’s revenue, its single largest revenue source

- Apple Music accounts for another ~13% of WMG’s total revenue

- In 2016 WMG was the first music major to report that streaming was its largest source of recorded music revenue

WMG went public in an IPO that was very well-received by the market. On June 3, 2020, WMG made its debut on the Nasdaq in an IPO that valued the company at $12.8B (nearly 4x Blavatnik’s 2011 purchase price).

- During the offering 77 million WMG shares were sold at $25 per share, raising $1.93B — 100% of which went to Blavatnik’s Access Industries, not WMG

- This valued the company at ~2.8 times revenue, compared a 1.2x multiple at the time of Blavatnik’s purchase

Blavatnik cashed out but still has control. Including more than $1.35B in dividends WMG has paid out since 2011, Blavatnick has fully recouped his 2011 purchase price.
Blavatnik still has a lot of upside left in WMG. Blatvatnik sold 77 million out of 510 millions shares in the IPO, thus he still owns ~85% of WMG. And with WMG’s stock soaring over $30 at the time of writing, Blavatnik’s remaining 85% stake in WMG is currently worth over $13B.

This means his initial $3.3B purchase, of which ~$1.3B was in cash, has turned into ~$16.3B ($1.35B in dividends + $1.93B in IPO secondary share sales + $13B value of WMG stake)

So, in what may very well go down as the greatest deal in the music industry in modern times, Blavatnik earned ~2.5 times his equity consideration for the 2011 WMG purchase, while still owning 85% of the entity and controlling 99% of its voting power.

🔍 Analysis

“Basically the idea is we buy low and sell high. We are here to make money.” - Len Blavatnik

(🔒 Music industry revenues, before and after Blavatnik’s WMG purchase. Chart omitted in this excerpt.)

Blavatnik clearly benefited from the internet’s transformation of the music business, particularly the rise of paid streaming. And while from today’s vantage point streaming’s rapid growth may seem to have been inevitable, for Blavatnik and others in 2011, predicting its whirlwind ascent required uncanny foresight.
While it’s not certain that Blavatnik specifically predicted the emergence of streaming, several facts suggest that he had a strong conviction that the internet would have a positive commercial impact on the music business.
Blavatnik gained low-risk, high-learning exposure via limited stakes. In the decade preceding his WMG purchase, Blavatnik’s Access Industries made multiple cautious entries into the telecoms, media, and entertainment space, allowing him to gain a front-line view of how internet distribution could amplify media and entertainment content.

- 🔒 Analysis details omitted in this excerpt
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Blavatnik was intimately familiar with WMG. 🔒 Situational details omitted in this excerpt

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Blavatnik deeply appreciated that circumstances can change quickly. 🔒Situational details omitted in this excerpt

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💎 Actionable Insights

Look for opportunities to take contrarian risks
- 🔒 Actionable insight omitted in this excerpt
When you find top talent, act boldly
- 🔒 Actionable insight omitted in this excerpt
Go big or go home
- At the time of the WMG deal—for which he paid $1.3B in cash—Forbes estimated Blavatnik’s net worth at ~$9.5B.

- While wagering nearly 15% of one’s net worth on a single deal may seem imprudent, today, Blavatnik’s WMG stake is worth well over $16B, realized & unrealized return included.

- In baseball, the most important thing for a batter is to wait for the right pitch — every now and again there’s a juicy opportunity firmly in one’s wheelhouse. Be patient, but ready to pounce. And as George Soros once said, “When you see it, bet big.”

🏆 You made it! Thanks for reading!

The full version with all the content unlocked is available as a PDF on Gumroad: 👉gum .co/casestudy-wmg👈 (copy & paste but delete the space after "gum" -- sorry, I don't have enough IH points yet to post links)

You can also use the code INDIE during checkout to pay just the cost of a cup of coffee.

Any thoughts? Would you be interested in business case studies like this? How can I improve this? What's one thing you would change?