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On Music, Value and Guessing

“With the unknown, one is confronted with danger, discomfort and worry; the first instinct is to abolish these painful sensations. First principle: any explanation is better than none…”

- Nietzsche

These ups and downs sure are fun, aren’t they?

I own a stock that was ~$42 in the middle of May and then rallied 55% to ~$67 in 17 trading days. Over the next three trading days it dropped 18% to $55. (Today, we’re back over $60). All of this happened on no company specific news. I’m sure you have even more dramatic examples.

But questions come to mind when I reflect on the rapidity and range of these ups and downs: Does this seem like a market that is rationally weighing the strengths and weaknesses of the business? Or do these moves reflect a wash of emotions and great uncertainty? Or do they reflect mindless algorithmic trading?

Hard to say, of course... And it probably doesn’t matter. If I’m going to own the stock for a decade, should I care about these squiggles? Only to the extent they allow me to acquire shares at interesting prices.

Do I even have to explain these moves? Many investors feel compelled to have a narrative as to why stocks make the moves they make. But that implies a) the price moves themselves contain worthwhile predictive information and b) that these are knowable. I doubt both, but especially the second.

But when stocks start ripping higher, or diving lower, people reach for reasons why. Nietzsche is on target with his “any explanation is better than none.” A guess seems better than a shrug. But remember, everybody is guessing when it comes to market movements and nobody knows nothing…

My explanation for these moves is a shrug, which I guess is an explanation of a kind. Anyway, back to looking at businesses…

“Uncovering Value in a Time of International Crisis”

I listened to an online event called “Uncovering Value in a Time of International Crisis.” David Marcus at Evermore Global and David Samra at Artisan Partners were the two panelists. Professor Tanos Santos of Columbia University moderated.

Tanos put a variety of questions to these two thoughtful and experienced investors. They played ball and answered intelligently. Nobody asked me, but I’m going to give my answer to the opening question. I will give you a different answer than you’ll get anywhere else…

The Whole “Value vs. Growth” Thing

Santos started by giving a brief presentation about how “value stocks” have underperformed “growth stocks” for the last decade. What to make of this?

This line of thought seems pointless to me. There is no such thing as a “value stock” or a “growth stock.” It’s an entirely made up and arbitrary category. And that complicates the whole analysis, because what one person calls a “growth stock” another would say is a “value stock.” And vice versa. Why spend any time thinking about what to call a stock? Who cares?

The funny thing about this is the usual statistical data points that put a stock in the “value” bucket -- such as price-to-book, price-to-earnings and dividend yield – don’t tell you anything about whether a stock is a value or not. Too much information is missing – in fact I’d say the most important information. You need to know if the company creates economic value or not. That information is not in those statistical data points. If a company earns poor returns on capital, then it deserves a low multiple. One of the "cheapest" stocks I own trades for more than 30x earnings.

The whole profession wastes far too much time parsing arbitrary and meaningless distinctions like growth and value. In my letters and blogs, I try to push back against this tendency to create arbitrary buckets. And there are of a ton of them. They tend to bleed out the color and variety of the world as we experience it. They remove the most interesting parts of investing.

Some generalizing is inevitable to understand the world. But we also have to realize that these abstractions come at a cost – and a lot of times they are not worth the cost. To me, the value and growth distinction serves no purpose. It’s a distraction from the real task at hand for those of us who look at stocks as shares of businesses and should be shelved.

A Pretty Good Business

There were a few stocks briefly discussed. One of them was Vivendi. Both Marcus and Samra own Vivendi. It is the only stock they both own.

Vivendi owns a variety of businesses, but the crown jewel and the only asset that anybody ever cares about is Universal Music Group (UMG), a leader in recorded music with an estimated 40% market share. Sony and Warner Music Group are the other two big ones.

As described in Bolloré's annual report (Bolloré owns a slug of Vivendi):

“In 2019, the most listened to artists on the main streaming platforms (Amazon, Apple, Deezer, Spotify or YouTube) were all signed by UMG (Taylor Swift, Billie Eilish, J. Balvin, Post Malone and Daddy Yankee). More generally, UMG unites the biggest local and international artists of all time, including The Beatles, The Rolling Stones, U2, Andrea Bocelli, Lady Gaga, Taylor Swift, Queen and Helene Fischer.”

UMG sales were $8 billion dollars last year, up ~19% from last year, with $1.2 billion in EBITA, up ~25%. So, healthy growth. And margins are expanding as streaming dominates results (and other revenue sources, such as physical sales, grow much more slowly).

UMG benefits from the growth of streaming services and gets the lion’s share of subscription fees. The more Spotify subscribers there are, for example, the more revenue for UMG.

There are always rumblings about this revenue split, which heavily favors the labels over the streaming services. But the labels have a strong competitive position and these deals are unlikely to change.

I read an interesting interview by In Practice with Roger Faxon, who was CEO of the record label EMI and is currently at director at Pandora media. He makes the point that the streaming services need the labels and vice versa:

“It is absolutely true that Spotify needs 100% of the content, to be competitive. It is true that the record companies can’t afford not to be on Spotify. For all their arguing against each other and all the difficulties and other stuff that goes on, the deals are not going to move very much, if at all.”

Further, he points to the advantage of the labels’ catalogs:

“Their economic advantage is that they have huge catalogues. Those catalogues, based upon the economics that they represent, have very, very high margins. They’re able to buy successful artists.”

As you know, Warner Music recently went public. The initial price (~$25) put the valuation in line with Tencent’s recent purchase of 10% of UMG. Warner’s stock has subsequently rallied. At $30, it trades for a substantial premium to what Tencent paid for UMG. Yet, UMG is the superior asset. As Marcus said, Warner’s share price means “UMG is grossly undervalued.”

So, you could buy Warner and own a record label directly. I suspect Warner will be a good investment over time. Or you could own Vivendi, whose biggest investment is UMG (and whose market cap is less than the value implied by the Tencent deal), and get a bunch of other stuff for “free.” Or you could buy Bolloré, which owns Vivendi, which owns UMG. Or you could be buy Odet, which owns Bolloré, which owns Vivendi, which owns UMG. It’s like a Russian doll.

But… is Vivendi a value stock or a growth stock?

Does it matter?

(Disclosure: We own shares of Bolloré.)

Thanks for reading and have a great weekend!

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Published June 12, 2020

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