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Universal Music & Major Record Labels

We could snip and discuss many parts of this interview with a Former Sony Music CEO but we will try and keep it brief. The interview is worth reading in its entirety for anyone following the space.

The investment thesis for major record labels is that with the growth in streaming, the royalty earnings streams from both recorded and music publishing are more predictable, higher margin, higher growth, and becoming a larger proportion of UMG's business.

There is also an opportunity to consolidate sub-labels to reduce the fixed cost base and drive higher operational leverage. With the growth in digital distribution, multiple sub-labels with duplicated cost structures isn't necessary:

A lot of that is due to the vast amounts of duplication within that organization. Today, a hit is driven by social media – I hate to admit it – and old media radio and TV are no longer proactive. Hits are appearing out of nowhere in many cases. You no longer need four or five full blown, fully staffed, front line labels with four radio staff. That will only create a disgruntled shareholding. - Former Sony Music CEO

Recorded music is ~80% of UMG's business. The catalog business drives ~80% of the profit because new, front-line music requires far more A&R (music R&D) spend to launch new artists.

Universal is a 50/50 split between catalog and front line, but profit wise it's a 70/30 split in favor of catalog. 80% of the overhead of a recording music company is dedicated to front line new release, versus 20% dedicated to catalog marketing and other support sides. The profit is reversed; 80% of the profit is with catalog and 20% is front line. - Former Sony Music CEO

The labels are attractive because most music consumption is of the higher-margin, catalog of which the major labels own the copyright. UMG is effectively a royalty on the global consumption of music. On top of this, the streaming platforms act as lead generators for the labels. Spotify and Amazon are effectively subsidising the growth in music consumption which drives more hours listened of UMG's catalog IP. On the surface, labels are enjoying a declining CAC, a larger market, and greater consumption of higher-margin IP.

However, the long run economics of the recorded music business is questionable.

Over the last decade, there has been a clear shift in bargaining power from labels to artists.

All deals used to be life of copyright but very few deals are life of copyright today. Artists used to sign six or even seven albums on an option basis; that is now down to three or four. The number of album commitments an artist has signed to has been reduced, and digital royalties are going up to the mid to high twenties, which is high royalty unless you're a superstar like Drake or Beyonce. - Former Sony Music CEO

Historically, labels would own the copyright of recorded music for life. Today, artists are taking back more control and share of the economics. This is gradually pushing UMG and the labels into a service-type model and further away from rights ownership.

Their deals with the likes of Beyonce are becoming distribution deals. Their business is no longer rights ownership and they are moving towards a service-based model. The Orchard label generates significant income for them by working with thousands of artists, without having to heavily invest in content creation. It also provides a pipeline for them to have conversations with artists showing them their proven model, level of profitability and audience growth. They can now make it a proper investment on a joint venture basis, but they have de-risked their A&R strategy. - Former Sony Music CEO

To become a global artist you may still need a major label to get the service and distribution required but artists can 'go-to-market' independently online and build an audience. Artists can start with indie labels and then sign with labels with a bigger following, for fewer albums, and ultimately demand greater share of the economics.

Although this reduces the IP ownership of UMG, it could benefit labels because it de-risks the A&R function of funding new front-line music. In the short-term, if UMG consolidates sub-labels and reduces the A&R spend, both margin and top-line can continue to grow. The question is what does the unit economics look like of recorded music in a decade?

Burford Capital H1 22 Results: Duration and Cash Income Reconciliation

We analysed BUR's H1 22 results reported last week. Once again, BUR's TBVPS didn't grow due to the backlog of court cases leading to slow cash realisations.

Source: In Practise, BUR 10-K
Source: In Practise, BUR 10-K

Duration is a hot subject for BUR and is the only missing ingredient to accurately model future cash flows. However, this shouldn't necessarily deter long-term investors; BUR management consistently communicate that duration is too hard to predict. It's a feature, not a bug. And we would posit that even if BUR could forecast duration, it wouldn't be wise to communicate this publicly.

One of BUR’s most unique assets is the proprietary data set of historical arbitration settlements. The cash settlement and total return of such cases are proprietary to Burford. This gives the company a data advantage that other players can’t compete with. Especially in the larger, more complex cases. BUR can price most effectively for the largest and most complex cases that have the potential to drive the largest dollar return. It wouldn’t be wise to explain how BUR forecasts duration even if they did know. - IP Analysis

Although BUR TBVPS didn't grow, commitments hit a record for the first half of a year. The company was also cashflow positive before deployments and break-even on a reported income level.

In our analysis, we share how we reconcile the capital provision income with cash receipts to better understand the cash flow BUR generates. We also explain how we build a 'normalised' cash earnings model for BUR excluding YPF.

Source: In Practise Estimates
Source: In Practise Estimates

Wayfair, CastleGate, & Damages: A Supplier's Perspective

This interview is with a Founder and Former CEO of a large US furniture wholesaler, once a top 10 vendor to CSN Stores, now Wayfair.

The damage rate is a major driver of online furniture unit economics, specifically for large items. The damage rate is what Wayfair's CastleGate middle and last-mile network is trying to minimise. Damages, and therefore returns, can be as high as 25% for large items. The thesis is that fewer touches on the product from a slicker supply chain will reduce damages, returns, and increase gross margins for Wayfair relative to competitors.

In 2021, when supply was tight, Wayfair's model is disadvantaged as it doesn't own inventory. Today, there is oversupply and Wayfair should see CG penetration and market share increase.

One question we have is: what would prevent suppliers putting product through CastleGate rather than dropshipping?

The challenge to increase CG penetration is that once suppliers put product into Wayfair's network, it has to sell. If it gets sent to the customer, and is damaged / returned, the supplier also pays. And when returned, the product remains in Wayfair's warehouse.

The cost and logistics to move the product out of Wayfair's warehouse wouldn't make sense. All returned and unsold product in CastleGate is deadstock for suppliers which can't be moved to their own warehouse. Once you commit stock to CG, it's uneconomical to move SKU's out of the network.

This stat from the interview is fascinating:

By the way, if you look at the warehouses of any wholesalers, if 50% of the warehouse isn't just dead, unmovable product, then they're doing something really good. Only a quarter to a half of the warehouse turns. But it turns a lot.

What stock will suppliers put through CG? Would it be the 50% that doesn't turn so they can free up their own warehouse space for SKU's that do turn? Or would they receive higher volume growth through Wayfair for their top items that outweighs the storage and logistics cost of CastleGate?

say I'm launching a hundred products a year; it's going to be more than that. At 100 a year, I wouldn't ship anything to a CastleGate or an Amazon warehouse that I don't have any run-through rate on. Because at this point, I need to know my velocity, and I'll probably short that velocity because I don't want to pay storage if it has to go there. There is a sweet spot of your top 5% maximum of sellers that would easily make it into that type of system, and then the rest of the stuff is what I call ineligible. Would you ship a bunch of things that you don't have pictures to a place you have to pay, call it, by the square inch? You don't do that. And/or if you have a dead product.

It will be interesting to see how Wayfair performs in Q3 / Q4 with easier comps and a supply / demand balance that better suits its model.

Cogent Communications

We love reading quotes like this about wealthy, founder-CEO's:

I don't need to walk into mahogany columns and all this stuff. You go to AT&T for sales training and they wow you with all this wealth. I don't think Dave's trying to wow anybody with wealth. While he has it, he's a rich man and it's a very wealthy company – valuable company I should say, not wealthy – he reinvests in the network. Sure, it doesn't look pretty, neither do his offices. You're not going to get continental toilet paper. It's going to be like sandpaper because he got it on a deal. But that's because he has to answer to folks like you and make sure that money is getting reinvested for the right things, not for the wrong things. - Former CCOI Executive

We are making a list of scrappy, founder-led CEO's - let us know your favourites!

Old Dominion Freight Lines vs Fedex Freight: Competitor Angle

Interesting competitor perspective of ODFL.

One of the things the gentleman we hired from ODFL stressed frequently, was the decentralization of leadership at ODFL. The individual terminals were their own profit centers, and organizationally, they were positioned with the right level of autonomy, guidance and direction from the home office in ways that helped keep those operations tightly profitable. ODFL have a terminal manager who has, among other groups, a sales manager/small team, to support demand in the area supported by that terminal market, along with a wide latitude of financial and pricing discretion to drive optimality in that market. That starts to lead to some differences, like more localized determination of what's “good freight” and “bad freight” in that market. Good freight being more profitable freight, more dense, more efficient to handle, and bad freight being the filler that might not be quite to the same degree. - Former Managing Director at Fedex Freight
FedEx was not felt to be as effective as ODFL in identifying and optimally pricing the good freight versus the bad freight. For example, on an operational basis, for customers with extended destinations, say in our Pennsylvania example, going way out into the country in Eastern Pennsylvania, those types of businesses that might be further from the terminal and might have less business activity in that area, were more effectively priced at the higher cost level that they would actually have. Unlike FedEx Freight with those geographically and regionally coherent transit service levels, ODFL is smarter about adding days of transit to build density into some of those rural areas, so that the operation can be more cost effective in some of those types of situations. ODFL's intelligence on creating that balance and understanding to a rigorous level their cost, and pricing accordingly and operating according at the margins, has added basis points of operating ratio to their financials. - Former Managing Director at Fedex Freight