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famed investor blackman recently confirmed his spat company pershing square tontine holdings is in discussions to acquire 10 of universal music group for approximately 4 billion us dollars this values umg at 35 billion euros or 40 billion us dollars at the current exchange rate a very big valuation especially for what is supposed to be a spec transaction and the announcement wasn't exactly taken well by investors with the stock dropping 13 before climbing back up again to recover some of its losses and i think to a degree the bearish view may even be justified and there's a couple reasons firstly just how complicated they have made the transaction changing it from a typical spat merger to something that's more complex leaving room for a lot of uncertainty in investors minds and then secondly the valuation of the company it seems punchy at first glance 35 billion as an enterprise value and then you also realize that psth the spax stock is trading at 15 above its cash value or its net asset value meaning that the multiple you're paying if you buy through the stack now is an even bigger multiple than the valuation that bill ackman is setting out for it in the first place you couple this with the fact that umg is going to be going public anyway on the amsterdam exchange they've already said and we'll get into that in a moment so there's the possibility that you could buy it cheaper directly through the amsterdam exchange not even through the spac merger but there's also the possibility that you could be buying it at a higher cost so in this video we're going to cover uh all of those three concerns in some more detail and then to summarize at the end i will give you my thoughts on the potential transaction and if i feel it's a good investment opportunity today right so firstly let's explore the transaction details and its complexities and and we're going to listen to a short clip first from cnbc which i feel breaks it down well although still leaves a lot unanswered and then we'll go over it on the press release in a little bit more detail bill ackman's big play for a piece of universal music group through his spac pershing square taunting holdings i spoke with ackman a little while ago he told me he was very excited about that deal and that he expects it to be signed later this month likely by june 22nd it's a complex deal as you've heard for sure but if you look at recent analyst reports as i did it would suggest that ackman is getting a pretty good deal goldman for example in a report published last month right here they put gold a universal music group's valuation 44 billion dollars whereas ackman's deal would have an enterprise value of some 35 billion a significant discount at least by goldman's calculations made last month further if you look at an apples to apples comparison to where say warner music currently trades the price ackman is paying is about a 10 to 15 discount and warner is the number three player in the industry behind both universal and sony according to data i saw from earlier this year it's also a more levered company in comparison with universal and comes with fewer voting rights for shareholders given that company's control structure by comparison universal has the most market share in the us about 41 percent and 30 percent market share globally it's also been taking share margins have been increasing as like many players in the space it's been benefiting from the tremendous growth in streaming but there is more ackman's investors will also get roughly five dollars in cash in what remains of taunting which essentially now becomes a smaller version of itself with a billion and a half dollars in cash to go looking for something to go look for something opportunistic to buy and they'll get an opportunity to participate in what ackman is calling a special purpose acquisition rights company it's a mouthful or a spark which will trade on the new york stock exchange and what is essentially a long dated option or warrant to take part in the next deal unlike a spac though there's no time limit on when ackman has to find a target which means he doesn't face that pressure to do a deal and investors get to opt in if they like what he ultimately finds in other words they don't have to put up any money up front and if they don't like the deal they don't have to participate and can sell take a look at shares today of ackman's spac pershing square taunting holdings down by about 11 okay so as cnbc say it's a fairly complicated transaction and not what investors were expecting i'll just summarize what was said there and essentially what you'd be getting by buying pst h stock today so they confirm that they're discussing to acquire 10 of universal music group for approximately 4 billion now they plan to distribute the acquired shares to psth shareholders later this year because unlike a usual spac transaction the ticker symbol psth isn't just going to change to umg as of the merger that umg are actually going to list themselves on the amsterdam stock exchange and the shares which psth acquires are going to be distributed to shareholders on a pro rata basis now because that four billion dollars isn't actually as much as the capital that was raised initially for the spac uh they're going to have to leave 1.5 billion in cash which is going to be in the form of psth remainco another separate company which is going to reflect 5.25 per share in cash and that is going to chase after another acquisition and then lastly and what seems to have grabbed most people's attention is this new formation of a spark and pershing square spark holdings essentially what ackman's doing here is distributing out transferable rights to purchase shares in this new spark company the spark itself is not the same as a spac in the sense that people aren't committing capital upfront without knowing the company in which the spark will merge with instead the spark intends to issue rights to shareholders to acquire the spark company at its net asset value or agreed valuation only after they know which company they're in a definitive agreement to acquire so slightly different in that sense and then also it carries a five-year waiting period rather than just an annual limit or a year's limit to find a company to merge with so it benefits ackman in that sense but then it also benefits shareholders in the sense that they don't have to commit capital upfront they're just given a warrant to purchase and to be honest with you i can see why some investors are a bit disappointed with this press release i think they were expecting you know a full company acquisition they weren't expecting this to happen maybe it's reflective of the environment we're in too much money chasing after uh too little amount of deals it definitely does seem that way and apart from the umg deal nothing's really changed everything else that you're getting in this transaction from the 1.5 billion and 5.25 per share that's going to remain in cash as well as the spark company and the the warrants to purchase that company when it emerges again you're just betting on ackman so nothing has changed you're still betting on bill akman really if you buy psth stock and maybe that is what some people have got fed up with although a lot of people seem to be happy betting on bill ackman in the first place and so what i think's important at the moment is that we focus on this initial deal this universal music group deal that's the only tangible thing really we can analyze at this point everything else is going to be remaining the same in terms of betting on akman to find another deal so if we look at universal music group here i've got this workbook that hopefully will give us some insight into the transaction itself and the value proposition for universal music group on a financials basis now we've also got bill ackman's thesis here that he did give us uh in the press release so we'll run through that as well he gave us some narrative as to why he chose or why he's looking to choose a universal music group and what i also think is very helpful to provide some context into this deal will be to understand bill ackman as an investor and his rules for investing because he is known as an activist and quite a pushy investor someone who's very much involved but in his more recent years in current form he has a rule set eight rules specifically that drive him to be more like a traditional value investor and not stray off the bm pass so let's do that now actually the eight rules for investing so bill ackman's eight rules first of all simple and predictable businesses second free cash flow generative third he looks for a dominant market position fourth large barriers to entry five high returns on capital six limited exposure to non-controllable extrinsic risks like an economic downturn seven strong balance sheet where outside capital was not necessary and then a an excellent management team and good governance so that gives us some context into what bill ackman's looking for in a company what i will say is a lot of these rules they're mainly there to stop him and prevent him from making risky bets in which he has in the past and that's when his fund has lost a lot of money but at least that provides some context into what he is looking for now if we look at the thesis for the company before we get into the financials for universal music group we can see uh how the thesis actually runs in line with those rules and and where the value proposition is so first of all universal music group he calls one of the greatest businesses in the world led by seleucian grange is one of the most outstanding management teams that he has ever encountered so first of all we've got that great business and we've got that great management team that he's looking for importantly umg meets all of the acquisition criteria and investment principles like we've just covered it's the world's leading music company so dominant market position and it's in the royalties business which is what he loves he has these restaurant companies which earn royalties hilton the hotel companies that he owns which earn royalties so really these businesses are capital light businesses that just license out their products and they earn royalties on it and there's a growing demand for music globally as well which he mentions now we minimize that slightly has given us some more bullet points as well as to his thesis so again number one in the industry their market share is somewhere in the region of 30 to 40 globally i believe uh iconic world-class management team massive growing total addressable market he says everyone loves music that is very true streaming is definitely on the up i don't know if i'd say it's massively growing but it's definitely growing and it is already a very big market global consumer adoption of streaming will generate many years of growth so that is the value proposition although we haven't exactly seen that huge boost in growth the average has been nine and a half percent over the past three years we definitely are seeing some growth but he also sees their competitive advantage in the irreplaceable owned intellectual property and must have content that they own themselves no one else owns it they're the only one who earns royalties off of it and then from this they've got very predictable and recurring revenue streams that require minimum capital despite high growth so minimum outside capital another one of the qualities in which he looks for and then lastly which is where i think the value proposition really is for this company if i were to point one out is the significant fixed cost expense up front the cost base is all fixed not variable which allows for long-term margin expansion and this is mainly driven through streaming at the moment the way in which music is going we've seen this operating margin here expand in the past three years up from 14 all the way up to 18 and a half so we've seen some good expansion maybe he's guessing that they can get up into the 20s maybe 25 by 2025 and i think it's probably where bill ackman sees most of the value rather than in terms of top line growth one thing i will say is that this of course isn't a transaction that's a done deal yet this is just a discussion that they both have confirmed discussion so we know it's taken place it's likely it will get done but it could not get done now if a merger is announced then we're definitely going to get more detail than what is just here and we'll probably see it in the form of an investor presentation akman and pershing square will definitely point out what they see as the value proposition that is the point of these spac mergers after all they tell investors why they were acquiring this specific company and we may get more information out of that and see that the only value proposition isn't just this margin expansion and there's other stuff that we haven't seen or maybe aren't able to see yet because at the end of the day umg is a privately owned company they're owned by the vindy which is a public company but they only publish limited segment results for universal music group which is what we're working with here so if i just edge over now to the financials and the forecast try and give you a quick valuation analysis dcf analysis just to give you an idea of maybe what this company's worth and if bill ackman is buying it a fair price and therefore shareholders are getting a fair price for the stock now currently at 35 enterprise value 35 billion euros enterprise value which is what he's proposing they're going to buy 10 of their company for that's roughly 25 times ebit or 25 times operating income at the moment not drastically high price considering the s p is up in the 30s and 40s but for a company that's growing top line at nine and a half percent on a three year average basis and only grew top line at four percent last year you could say it's a fairly punchy valuation especially for what was a private deal now with universal music group set to go public on the amsterdam exchange in the near future i think they've said july or august september maybe they could be trading or could be looking to ipo a bigger valuation than this i suspect that they are looking to go a slightly bigger evaluation than this otherwise blackman may not look at doing the deal so there may be that arbitrage opportunity there but i think it's clear in most people's minds that 25 times earnings when the company is growing earnings around 9.7 isn't exactly a steal but i guess if you have very simple and predictable cash flows then the present value of any asset is the cash flows that it can produce over a certain period of time so maybe he's discounting on that basis right if we forecast out though for the next five years just look at a scenario which maybe bill ackman is seeing where the value exists for this company and i've gone with 10 growth for next year and then the following years just growing at seven and a half percent getting them to around 10 and a half billion euros in 2025 as a revenue number now i've put in that margin expansion i've just penciled that in as 25 as of the end of the period that gets us to around 2.6 billion in operating income so doubling from where they are now i have to believe that if bill ackman is looking to purchase this company and this was the company he was getting so excited about he must be seeing something like this on the margin expansion side because i'm really not seeing the growth opportunity on the top line so a double in earnings would be pretty good that would usually lead to a good value return to investors so we're going to go with that now i've gone with 25 times operating income at the end of the period gets the company to a value of around 52 billion in 2025 now we haven't got free cash flow numbers so we don't know their capex numbers and things like that but i've penciled in here that they can convert around 70 of their earnings into free cash flow there's a good chance that they will be able to actually convert more than that number say 80 to 90 just because it is a capital like business for all the reasons that he talked about there they've got fixed cost basis so i don't imagine capex the maintenance capex of the business to be a very high amount but we've penciled it in as such and then discounting all of that back to today it looks like what he's seeing is a 12 return now if i went with my 15 required rate of return on this it would value umg on the limited information that we have around 30 billion dollars as an enterprise value now we're paying 35 billion dollars so if we're looking at that on a return basis i'll just change this to estimated return which is what it is we're looking at around 12 and i think if you're someone like akman who's a billion dollar hedge fund owner what they're looking to do is beat the other opportunities that are out there so he could be looking at that and this is a danger with investing and just and leaving your money with someone else for them to do the work when you don't know exactly what the company is that they're merging with you don't know what their target returns are bill ackman could be looking at this and going with the environment that we're in 12 is a good estimated return now it's a predictable 12 return as well that could be his thesis now fortunately this deal or 12 doesn't quite cut it for me so unless i see something in the investor presentation and in the press release when a deal is actually agreed that makes me think wow there is a much bigger value proposition here then it isn't probably something that i would go with or look to invest in then also couple this with the fact that the overall transaction make up you know the three legged stall that is the spark this transaction with umg and the one and a half billion that's going to be left in cash it almost sets us back at square one with the other two things where we're relying on ackman to find a deal and finding a deal has definitely proven hard for him on this occasion in my opinion there's going to be other things out there that are probably presenting better value and they're much less complicated for you to wrap your head around therefore providing less uncertainty but an interesting deal nonetheless more information will come out very soon and if we do get some more uh information that's exciting or either changes the picture i'll do another video just covering all of that i hope you enjoyed watching it guys just a quick overview of the potential transaction with psth bill ackman's psth and universal music group let me know in the comments below what you think of the deal if you think i've missed anything here if i'm not seeing any uh value that maybe you're seeing i'd be keen to know if you enjoyed the video subscribe to the channel if you haven't already i appreciate a thumbs up or like on the video as well that really helps the channel out i'll leave this worksheet evaluation model on the patreon with some of my thoughts as well so if you're interested in supporting the channel then go ahead and check out the patreon and all of its various benefits but until next time i will see you all in the next video good luck with your investments
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