7digital (7DIG) – Streaming set to take off (Part 1)

7digital (7DIG) – Streaming set to take off (Part 1)

Many of you are aware of my belief that 7digital will deliver large shareholder returns one day. I am heavily down in this stock, and as a trader first this does not sit well with me. I am used to cutting losses small because I like not working, but I realise my mistake in this investment – I was too early. Rather, I should have waited until the company was making profits and generating cash.

According to a recent interview (17 August CEO interview), that moment was “just weeks away” for operating cash breakeven. The goalposts have been moved and profit pushed back to 2019, which is disappointing, and I do not intend to add to my position until they are net profitable. I still believe in the in the board and in the business’s potential. Here’s why.

Company Description

7digital (latest share price 1.9p, market cap £7.6 million) describes itself as the global market leader in digital music solutions. It provides a mix of scalable technical infrastructure (platforms) and extensive musical rights, with an additional creative business for radio and media production, and a legacy business selling downloadable music. It has a growing catalogue of 60m+ songs and technology that can deliver them on any platform, in any country in the world. The company is a white label service provider for anyone who wants to create something that involves digital music. Aside from Napster, there is no other company in the world capable of doing what 7digital does.

Bull case

1) Streaming has turned the receding music industry into a growth industry
2) 7digital has only one competitor (Napster) after consolidating a fragmented market by buying two competitors and another going out of business
3) Anyone wanting to build a music catalogue with 60m+ songs and agreements with 65,000+ record labels built up over nearly 30 years which can deliver these to any platform, in any country in the world, is not going to do so overnight (economic moat)
4) Management heavily aligned with CEO Simon Cole owning several million shares and putting £30,000 of his own money into the last placing.
5) The December 2017 placing was heavily oversubscribed and went to 16 institutions
6) The margins on licensing are 90%; with a fixed cost business, this offers huge scalable upside

Streaming music

The changing digital music ecosystem had left lots of small local companies doing a similar service to the one 7DIG provides on a global basis. 7digital’s goal was to consolidate the B2B marketplace in digital music, with the acquisition of Snowite and now 24/7 recently marking the culmination of that strategy. 7DIG now stands almost alone in terms of its core business in licensing to companies – this is done by providing an API for third parties who want to create digital music services, either standalone or bundled within their own device or product offering. With further cost savings to come, and a fixed cost business, 7DIG is geared to capitalise on the opportunities in digital music.

The Company has benefitted from the global acceleration of music streaming over the past year and is ideally positioned for continued growth of streaming in 2019 and beyond. Streaming now accounts for 75% of music revenue, but the B2C market is struggling. Spotify are not making any money. Subscription services are struggling to convert people from free models to 9.99 no advert models. One of the reasons why 7digital has not made it onto the watchlists of many investors is because they think of Spotify, but 7digital are B2B. It’s a completely different business.

7digital is not competing with Spotify or other unlimited subscription businesses, rather it is the picks and shovels play for the companies that want digital music services but don’t want to build it themselves. In my opinion, availability bias has meant that 7digital is very off the radar, as streaming leads to Spotify, Spotify leads to loss-making, and this mental heuristic means the company is then skipped across.

By providing the infrastructure and music rights, 7digital provides a service that enables customers to utilise digital music services simply and easily, this includes (but is not limited to) retailers, the automobile and aviation industries, wearables, social media platforms, etc. 7digital provides the music for Electric Jukebox, whose early indications suggest that if you give people accessible music in a user friendly way, people actually consume more music than they already do.

The opportunity

Of all music listening in the world today, ~90% of it is currently not digital. CD and vinyls are used because of their quality – listeners are unhappy with the quality of streaming music. 7digital has worked with a Cambridge company called Meridian Audio to create a technology called MQA (Master Quality Authentication) which has now become the de facto streaming technology of high quality music – 7digital’s platform is the only platform in the world to deliver it B2B. The company sees high resolution music to be a fast development over the next eighteen months.

The advantage of MQA, aside from being able to deliver studio quality music the way artists intended their audience to hear it, is that it can deliver a 24 bit 48kbit per second audio file, on a stream smaller than 1.5bmb, or a 3G phone connection. This means that it does not rapidly deplete bandwidth. The traditional way was to use FLAC for high quality audio files. A company called Tidal streams FLAC files, which is great aside from the huge bandwidth it requires. MQA is the highest quality using lowest bandwidth, and is supported by all three major record labels.

The main takeaway is that digital music itself is the opportunity as it allows companies to use it as they please with 7digital’s expertise and extensive catalogue. Companies are realising that in order to run an effective music streaming service they should outsource it to a specialist like 7DIG. Over 100 million people stream music from the big consumer suppliers, while there are 3.2bn people in total who listen to music every day. The future of digital music will be about music everywhere across the internet, and 7DIG are well placed to provide this.

Contracts

7digital has signed a multitude of contracts offering services in various industries:

  • DTS

A contract with DTS (now owned by Xperi) was signed for the world’s first full MQA high quality streamed music service. This is an opportunity as currently digital music does not exist in many automobiles. Some OEMs have offered their dashboard to Apple Music in an attempt to broaden the appeal of their cars (Tesla does not wish to go down this route and has been in talks with the major record labels), but when the customer wants a new car they sell the old car and keep the Apple Music subscription. They are creating customers for Apple and not using a digital music service to build brand loyalty.

On the same topic, Vodafone, which offers six months’ worth of Spotify premium for free, is also creating customers for Spotify and not for Vodafone. When we dump our contracts for someone cheaper, we are likely to keep Spotify!

If Vodafone had its own music service to build brand loyalty and create an ecosystem around the company, customer retention would be much better. Apple has made it difficult to switch to anything else due to its iOS system that connects across its laptops, tablets, and phones. This make things easy for the customer, and hard to switch. This is one of the main reasons for Apple’s continued success.

Vodafone provides a service similar to this to Danish telco TDC. Its own music service, YouSee, is used by approximately 8% of the Danish population (as subscribers) and this has been shown to successfully reduce customer churn in the past ten years of operation.

  • Global Eagle

Global Eagle, a leading worldwide provider of in-flight entertainment to the airline industry (examples include Southwest Airlines, Emirates, Singapore Airlines, Air France) offers Wi-Fi, movies, music and more, to regional and flagship carriers. 7DIG will provide Global Eagle with a new in-flight service launching in Q4 2017. Streaming music will be in cars, planes, and just about everywhere we can think of.

  • MediaMarktSaturn

MediaMarktSaturn, one of the world’s biggest three retailers (Walmart and Amazon being the other two), is rolling out a digital music service to all 15 territorities that it operates in. It is also 7digital’s biggest shareholder, and I would be wary of MediaMarktSaturn increasing it stake. However, it realised that in order to build customer loyalty it was much better to outsource this to a specialist, allowing MediaMarktSaturn to focus on its core competency of retailing.

Currently Walmart is the only one of the top three retailers without a digital music service. I think it is unlikely that it will let its two biggest competitors create an advantage and if it decides to follow Amazon and MediaMarktSaturn into building its own, then that would be a huge contract up for grabs. 7digital is working directly with Amazon on services for the Echo and also developing streaming music services for other clients that will be available on the Echo.

The provision of licensed ‘background’ music on location at bars, restaurants, cafes and other venues is another area 7digital has identified as having potential for growth worldwide. Several contracts have been signed in this field including with a global market leader. Given the size of the market this also has large potential.

Business model

The company is a fixed cost business with a B2B model; companies pay an initial fee to access the platform and then monthly recurring revenues. The platform itself is a fixed cost. Licensing revenues have a margin of 90% which means that as licensing revenues increase they drop to the bottom line very quickly. Licensing revenues produced 69.1% of total revenue in 2017, up from 59.5% in 2016. Licensing itself was up 73.9% year-on-year, and this shows no signs of slowing down, offering huge potential cash flow growth for the company.

The creative division creates content for TV and radio, for example several BBC programmes (comedy, documentaries, dramas), Sky art, Yahoo, Amazon. It works with broadcasters and global brands producing 1000+ hours of content every year. It stages events in iconic venues, and its entertainment news reaches 9.5m people weekly with music playlists, videos, and journalism.

The final business in the 7digital group is a legacy from the old group; a retail proposition where people can buy music. It is a complimentary bolt-on to the existing businesses and noncore. The business has transformed from this B2C download model to the much higher margin B2B licence model.

7digital is therefore mainly the geared tech platform for licensing and the creative suite which navigates the difficulty of procuring music easily and curating content for customers.

Please stay tuned for Part 2, in which we will discuss 7Digital’s financials and risks!

 

At the time of publication, the author holds a long position in 7DIG.

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