Musonomics Podcast: Songwriters, Consent and the Age of Discontent

I was honored to be included on an episode of the Musonomics podcast hosted by the brilliant Larry Miller of the NYU Steinhardt Music Business Program.  “Songwriters, Consent and the Age of Discontent” is a deeper dive into the state of the songwriter economy with songwriters Brett James and Ari Leff, ASCAP General Counsel Clara Kim, New Yorker writer John Seabrook and me.

You can subscribe to the podcast on iTunes (which I recommend as I think it’s in the top 3 music business podcasts) or listen to it on SoundCloud.

What Does Spotify’s Billion Dollars of Debt Mean for Labels and Artists?

The Wall Street Journal reports that Spotify has raised $1 billion in convertible debt with this telling analysis:

Music-streaming site Spotify AB has raised $1 billion in convertible debt from investors, a deal that extends the money-losing company’s runway but comes with some strict guarantees, people familiar with the matter said.

Private-equity firm TPG, hedge fund Dragoneer Investment Group and clients of Goldman Sachs Group Inc. participated in the deal, which has been signed and is expected to close at the end of this week, these people said.

Tech startups are increasingly turning to convertible debt—bonds that can be exchanged for stock—as investors push back on rich valuations amid a volatile stock market and economic uncertainty.

By raising debt instead of equity, Spotify adds to its war chest without the possibility of setting a lower price for its stock, which can sap momentum and hamper recruiting.

That last paragraph is very telling.  As I have warned about before, the main reason for any privately held company to take on convertible debt, particularly large amounts of convertible debt, is to avoid a “down round”, meaning a round of investment at a lower valuation than the previous round.  This means the new investors buying in the down round pay a lower price per share, and receive certain rights and preferences that are superior to the rights of the previous rounds’ investors.

The main reason for existing stockholders (like the major labels and Merlin in Spotify’s case) to avoid a down round is to protect the preferences that the prior investors have built into their stock ownership.  Those preferences can require the company to issue more shares to protect the percentage ownership of the insiders and key executives, for example, and that can lead to washout financings and recapitalizations to incentivize investors in the down round (who often are not, as one might say, “babies”).

Down rounds are also one indicator that a bubble is about to burst but that investors have not yet capitulated.  (Down rounds are a precursor to failed capital calls, which are the real sign of a bubble bursting.)  Down rounds were very common in the dot bomb bubble burst.

An example of down round protection would be lowering (or “resetting”) the strike price of a warrant if the company issues securities at a lower price in the future–the down round.  In any event, the company must sell more shares than in the previous rounds in order to generate the new investment, so down rounds will almost inevitably dilute existing stockholders even if they give up their preferences.

So why did Spotify raise convertible debt?  To avoid a down round, which means that there is a good possibility that the company was told either that their proposed valuation that they wanted to get in their next round of finance was too high or that their last valuation (over $8 billion) was too high.

Convertible debt is secured debt.  That means holders of convertible debt will be at the head of the line in a bankruptcy.  This is almost certainly going to create a new hierarchy overnight and should start every royalty recipient thinking differently about Spotify because it introduces the concept of preferences in bankruptcy.  And if you find yourself thinking that Spotify could never go bankrupt, welcome to bubble mania.

Get what you’re owed out of the company as fast as possible.  You are now looking at a senior secured creditor who will almost certainly take the lion’s share of any recovery from a bankrupt Spotify after washing out all the equity the labels gave up in return for discounted royalty rates (which would be Daniel Ek’s last laugh on the music business).  I’m using Spotify as an example, but it could be any of them–Pandora also has a large debt financing.

Audit Early and Often:  The first thing that should happen is that instead of auditing at the “bankers hours” pace that the industry usually operates at (every three to five years), everyone who is owed royalties by Spotify should conduct a royalty compliance examination every year.  The longer you wait, the greater the chance that you will become known as an unsecured creditor.  This is true of artists, songwriters, labels, publishers, PROs, the lot.  Unions that have any residuals based on streaming?  Get in there.

Contractors, Get Your Money:  If you’re an independent contractor for Spotify, get your money paid.  Don’t wait.  Ask any independent contractor for a dot com that’s gone under and they’ll tell you–kiss that delivery payment goodbye after the whip goes down.  This especially includes lawyers–you will be the first to go.

Employees, Don’t Count on Bonuses:  Employees should take some advice on how protected they are on bonuses or deferred compensation.  And of course, your common stock will likely get washed out completely in order to protect the holders of preferred stock.

Settlements and Preferences:  Get the money, get the money and be sure you get the money.  Consult with bankruptcy counsel to determine whether you are receiving a preference that can be undone in  a later bankruptcy filing.

Fiduciary Duties of Officers and Directors:  When a company becomes insolvent, there is a point along that path where the primary fiduciary duty of officers and directors shifts from the stockholders to the creditors.  Get smart about this.

 

 

What’s Next for Pandora?

Tim Westergren has returned to Pandora as the company’s CEO.  He’s got a golden opportunity to change how Pandora is viewed–we all want Pandora to succeed, but there’s little support for the path the company has been on for years now.  The 42% decline in Pandora’s stock price over the last 12 months hasn’t been helped by the company’s rocky relationship with the vendors of their main product: music.

pandora stock price

With some analysts giving Pandora a fair value stock price of $7, here’s a little unsolicited advice.

Overhead:  Pandora’s overhead is out of control.  They will blame it on royalties, but a closer look shows that the company has a problem with its operating costs that they would like you to ignore (hence the $7 fair value price target).

Pandora 2015 YOY

Integrity:  Westergren arrives at Pandora in a much different point in the zeitgeist than when he founded the company in terms of artist relations.  He made a huge misstep by associating himself with a string of attempts to lower Pandora’s royalty payment to artists and songwriters all of which have either outright failed or created more hostility than they ever would be worth.  In an atmosphere where artists are increasingly suspecting digital music services of cooking the books or operating without licenses, Pandora needs to be doing it better than the next guy.  Westergren doesn’t want to get stuck with Pandora’s “Enron moment”.

Legislation: Pandora backed the failed Internet Radio Fairness Act that was designed to lower artist royalties and created a huge backlash from the artist community.  Some refer to its spectacular failure as “lobbying malpractice.”  One time can be chalked up to bad advice. Don’t make it twice.

Litigation Against Compensating Artists: Pandora became the poster child for refusing to pay royalties on recordings made prior to February 15, 1972 which has come to be known as the “Pandora loophole”.  This would mean that if you were to record “Sophisticated Lady” or “Hello Dolly” tomorrow, Pandora would pay you but not the estates of Duke Ellington or Louis Armstrong.  In a move reminiscent of Spotify’s settlement with the NMPA, Pandora settled with just the major labels and is continuing to litigate against the class lead by The Turtles.  Westergren should settle Pandora’s case and treat all artists fairly.  Again, bad advice can get forgiven if the company does the right thing.  Avoid having loopholes named after your company on a go forward basis.

Litigation Against Compensating Songwriters:  Pandora has lead the way in using the rate courts against songwriters at great expense to ASCAP and BMI.  While Pandora is reportedly trying to make direct agreements with publishers, the company is using the rate courts to drag songwriters through the muck.  Westergren should stop trying to litigate royalty rates and ask yourself if you really saved that much money compared to your own legal fees and brand damage.

Lobbying With MIC Coalition:  Pandora is a member of the MIC Coalition, an alliance of companies against songwriters and artists—companies with a combined market capitalization of over $2 trillion.  (I stopped counting at $2 trillion dollars as I get confused by that many zeros to the left of the decimal place like I get confused by zeros to the right of the decimal place on Pandora’s royalty payments.)  There’s no good reason for Pandora to be in the MIC Coalition–whose first official act was to file an antitrust complaint against SESAC.  That’s right–because Google, Clear Channel (iHeart) and all the rest need protection from songwriters.  (The MIC Coalition even had a fake panel at SXSW moderated by their lobbyist who failed to identify her connection to the “McCoalition”.)

MIC Coalition

Tim Westergren built the better mousetrap, but it’s managed to catch a rat.   By pursuing a path of high integrity and fair dealing with creators, Pandora might have a chance to make it.  It would be a shame to see it go under.  Westergren’s brief should be to do everything he can to get the creative community back on board instead of looking like a stock-rich bubble boy having breakfast at Buck’s.

Investors Deserve a Standard for Measuring Music Service Subscribers

“Today, Spotify CEO Daniel Ek officially announced that the streaming service has hit the 30 million paying subscribers.”

Digital Music News.

Spotify “officially” announced today that it has 30 million paying subscribers.  What does “officially” mean?

I wonder if that’s like its announcement that it pays 70% of its revenue to rights holders–except when it doesn’t as David Lowery’s class action and other challenges to Spotify’s arithmetic credibility have revealed.

How do we know that Spotify has 30 million subscribers?  Because Spotify’s CEO says so.  Moral hazard much?  Isn’t that the same guy who claims to be the savior of the music industry but is underpaying songwriters to the tune of millions of dollars?

The ability of advertising supported media to deliver a reliable audience is hardly news, so it is hardly news that someone figured out that these numbers need to have some independent third party auditing those statements.

The Alliance for Audited Media is just such an independent third party.  AAM describes itself:

The Alliance for Audited Media connects North America’s top advertisers, ad agencies, media companies and platform providers. Our clients stand for trusted media analysis across all brand platforms—print, web, mobile, email and more—to make smart decisions. AAM delivers insightful, audited cross-media metrics that matter. We are one of the world’s most experienced providers of technology certification audits to industry standards established by the Interactive Advertising Bureau, Media Rating Council and Mobile Marketing Association. As a third-party auditor, we deliver media assurance via our verification and information services and provide solutions that empower media professionals to transact with greater trust and confidence.

It would be helpful for investors to know exactly what a “subscriber” means to Spotify (and other DSPs for that matter).  If the user is “subscribing” to an ad supported service, such as Spotify’s dearly beloved “freemium” service with Ads by Google, what does that mean?  Does it mean that a user has paid their bill for 90 consecutive days, or does it mean that the user is on their fourth 90 day free trial?

Given complaints by experts like WPP’s CEO Sir Martin Sorrell that click fraud and false billing is rampant on YouTube, shouldn’t investors expect to have subscribers audited by an impartial source?  (Harvard Business School Professor Ben Edelman called it back in 2009 with his prescient “Toward a Bill of Rights for Online Advertisers“.)

In this particular context, “investor” takes on a broader meaning.  Spotify and its defenders routinely ask that artists and songwriters “trust” but “don’t verify” to help Spotify grow–that is, to “invest” in Spotify’s future by taking a low royalty today for a burger on Thursday.  Now that class action lawsuits from songwriters are motivating the company to cover its tracks, it’s starting to look like Spotify is asking for a burger today for a dollar on Thursday.

It’s time that all investors in music services got independent verification of exactly what these subscriber numbers actually mean.

YouTube Revenues Explainer

I had the good fortune to participate in a SXSW panel about the mechanics of YouTube revenues.  If I say so myself, it was a wonderful panel with some deep expertise (“Stop Complaining and Start Monetizing“).  There was a real interest in the audience about the mechanics of the rights involved and the revenues paid.

If you have that same interest and you weren’t able to go to SXSW, here’s a basic chart of revenue splits that may help you:

YouTube Chart

Source: Billboard

YTP, YTPC= “YouTube Partner“, “YouTube Partner Channel”
SR= Sound Recording
WW= “Wild West” meaning no particular rule.

Notice that the basic categories are song, sound recording and video which track the main three copyright categories of musical work, sound recording and audiovisual work.

The percentages refer to shares of “Net Ad Revenue” often defined as:

“Net Ad Revenues” means all gross revenues recognized by YouTube attributable to any sponsorship of or advertising displayed on, incorporated in, streamed from and/or otherwise presented in or in conjunction with any User Video displayed on a Covered Service including, without limitation, banner advertisements, synchronized banner advertisements, co-ads, in-stream advertising, pre-roll advertising, post-roll advertising, video player branding, and companion ads, less ten percent (10%) of such gross revenues for operating costs, including bandwidth and third-party (affiliated or unaffiliated) advertising fees. Net Ad Revenues excludes any e-commerce referral fees received by YouTube from “buy buttons” or “buy links” on the Covered Services that facilitate recorded music “upsells” when a Publisher separately receives payment from a third party in connection with such an upsell (e.g., royalties for a CD or sheet music sale); provided, however, for the avoidance of doubt, that such exclusion does not extend to (a) advertising of the type described in the first sentence of this Section for recorded music products, the revenues from which shall be included in Net Ad Revenues; and (b) all other types of e-commerce referral fees and revenues, which shall be included in Net Ad Revenues.

One key component of your YouTube earnings is the “CPM” paid by advertisers to Google.  Even if you have the right to audit YouTube (which few do), it is highly unlikely that you will ever be able to determine what the CPM is that Google uses to pay you on YouTube.  Multichannel networks (“MCNs”) like Machinima have reportedly tied creators to CPMs that were well below market, particularly considering that the highest CPMs on YouTube are often associated with exactly the kind of talent most frequently signed to an MCN.

“Official” or “Premium” Videos

When a label uploads an “official” music video on YouTube or Vevo, the video has higher production values than UGC and is usually supported by a sustained marketing effort outside of YouTube that drives traffic to the site.  If the premium video appears on Vevo, then 100% of the royalty is paid to the label, which in turn has licenses from the publishers for the song.  If the video is on YouTube proper, then the label’s share is reduced by the publisher royalty, often around 15% of net ad revenue.

Claiming and YouTube’s Content Management System (“CMS”)

Because of a combination of YouTube’s monopoly position in the market, Google’s controversial reliance on the notice and takedown provisions of the Copyright Act and its sheer litigation muscle, YouTube will let anyone upload anything also known as “user generated content” or “UGC”.  If you have access to YouTube’s “Content Management System” or “CMS” you have the chance to block UGC through YouTube’s “Content ID” fingerprinting tool.

Compared to the massive volume of videos uploaded to YouTube, a very, very small percentage of copyright owners have direct access to Content ID.  According to YouTube:

YouTube only grants Content ID to copyright owners who meet specific criteria. To be approved, they must own exclusive rights to a substantial body of original material that is frequently uploaded by the YouTube user community.

Participating in Content ID allows you to help YouTube create a vast and valuable library of reference versions of  your works.  (YouTube does not compensate you for participating in Content ID.)  Rightsholders usually participate in Content ID for two reasons which are not mutually exclusive:  Blocking or “monetizing”.  Monetizing means that you give YouTube permission to sell advertising against your works.  Naturally, YouTube hopes you will choose to monetize because over 90% of Google’s revenue comes from selling advertising online.

YouTube creates a reference version of your work in the form of a “fingerprint” (a psychoacoustic technique that has long been in use by the U.S. Navy among others to distinguish sound patterns–see Jonesy in The Hunt for Red October). A fingerprint is a mathematical rendering of the waveform of an audio file that essentially reduces a sound recording to a kind of hash that makes comparing fingerprints quicker and more accurate.

YouTube maps the reference fingerprint to other identifiers such as the International Standard Recording Code for sound recordings, song title, artist name and copyright owners for all of the above including song splits in many cases.  When a work is in the Content ID system, YouTube will compare an uploaded video to the Content ID database reference fingerprint and most of the time will follow the rules established by the copyright owner to block or monetize (often called “match policies“).  If the match is done before the UGC video is uploaded, then it won’t go live, and if the match is done after it is live, then the users will see one of YouTube’s controversial messages saying the file is blocked due to a claim by copyright owner X.

What this boils down to is that if you don’t have a label or publisher, you will need to go to a claiming service like Adshare, The Collective or Onramp in order to get access to CMS and Content ID in order to monetize your works outside of a YouTube Partner Channel (which is done through an Adsense account associated with your YouTube Partner account).  If you have a label, publisher or claiming service, then all of these entities should have access to CMS and Content ID and will be able to claim your songs, sound recordings or videos and monetize them if you wish.

Deciding if Monetization is Right For You

If you’re familiar with term recording artist agreements or publishing agreements (or what is normally called a “record deal” or “publishing deal”), you’ll probably remember negotiating “marketing restrictions” involving the use of your recording or song in advertising.  Those clauses usually restrict the use of your works in political ads, certain kinds of products (firearms, tobacco for example), or more artist-specific restrictions.  There are also restrictions on the kinds of movies or television programs (even videogames) in which your works can be used.

If you allow your work to be used in UGC and you elect to monetize, you can just forget all that on YouTube.  “UGC” includes just about anything you can imagine short of explicit pornography, but would include, for example, sex tourist home movies, jihadi recruiting videos (although “songs” are unlikely to appear there), hate speech and the like.  All of those are on YouTube and frequently are not behind any kind of age restriction wall.

The ads that get served as preroll for these videos are themselves often unsavory.  For example, Google serves ads for “dating” sites that are in categories frequently identified as thinly disguised human trafficking operations.  There are ways to block these particular uses if you have access to CMS but due to YouTube’s “catch me if you can” business practices, you may have to spend the time to track down each use which otherwise can stay on YouTube for months or years.

Winning the Lottery

We often hear about “YouTube stars” with elite channels (1 million plus subscribers) who are very well compensated.  The source of this high level of compensation is rarely limited to advertising revenue.  Most of the time, their ad revenue is salted with a high number of payments for what are essentially sponsorships, endorsements or product placements, often called “brand integrations“.

In the music and movie businesses, the term “star” is usually reserved for a relatively small group of performers who have demonstrated ability over time to reach a large audience, often a global audience.  YouTube “stars” may have large YouTube communities and may be able to introduce products to fans on YouTube, but whether that will hold up on YouTube over time or translate to other platforms remains to be seen in most cases.

It is also important to realize that advertising is a highly regulated business, particularly when it comes to false or deceptive advertising that is regulated by the Federal Trade Commission.  Machinima has just entered a 20 year consent decree with the FTC to settle claims that it misled consumers by passing off paid endorsers as independent reviewers.  Given that Machinima and other MCNs are supposed to protect their talent from such missteps suggests that YouTube stars may well have more to watch out for on YouTube than do recording artists or songwriters on record labels or music publishers.

Online Advertising in Decline

Whether it is ubiquitous ad blocking software, “do not track” settings on browsers, or distrust of advertisers, online advertising is in decline.  Like a ship that is sinking very slowly, it is sometimes difficult to tell if you’re really lower in the water, or if that was just a wave.  And remember, over 90% of Google’s revenues come from online advertising, moonshots notwithstanding.

If the online advertising ship really does sink, all the driverless cars, military robots and Google Glass will not save Google or YouTube.  That’s something to keep in mind when you agree to participate in the YouTube monetization game.

 

Investor Alert: Multichannel Networks Have Exposure to Deceptive Advertising Prosecution

We’ve all seen “brand integration” videos on YouTube promoted or produced by multichannel networks such as Maker, Machnima and others.  I’ve been convinced that if these videos were on television, they would violate the “sponsorship identification” or payola rules that require disclosure of consideration paid or exchanged for placement.  (As an aside, David Lowery has raised this issue in the context of “steering agreements” by Clear Channel and Pandora.)

Even so, there’s a straight up false advertising claim that could apply in these cases and the Federal Trade Commission has now prosecuted a claim against Machinima, one of the biggest.  (Read the FTC endorsement guidelines for social media here.)  All MCNs and YouTube itself should take note.  (Good thing for YouTube that they have extraordinary political influence at the FTC, but that’s another story.)

The FTC first published the case on September 2, 2015:

A California-based online entertainment network has agreed to settle Federal Trade Commission charges that it engaged in deceptive advertising by paying “influencers” to post YouTube videos endorsing Microsoft’s Xbox One system and several games. The influencers paid by Machinima, Inc., failed to adequately disclose that they were being paid for their seemingly objective opinions, the FTC charged.

Under the proposed settlement, Machinima is prohibited from similar deceptive conduct in the future, and the company is required to ensure its influencers clearly disclose when they have been compensated in exchange for their endorsements.

“When people see a product touted online, they have a right to know whether they’re looking at an authentic opinion or a paid marketing pitch,” said Jessica Rich, Director of the Bureau of Consumer Protection. “That’s true whether the endorsement appears in a video or any other media.”

Seems pretty simple, right?

According to the FTC’s complaint, Machinima and its influencers were part of an Xbox One marketing campaign managed by Microsoft’s advertising agency, Starcom MediaVest Group. Machinima guaranteed Starcom that the influencer videos would be viewed at least 19 million times.

In the first phase of the marketing campaign, a small group of influencers were given access to pre-release versions of the Xbox One console and video games in order to produce and upload two endorsement videos each. According to the FTC, Machinima paid two of these endorsers $15,000 and $30,000 for producing You Tube videos that garnered 250,000 and 730,000 views, respectively. In a separate phase of the marketing program, Machinima promised to pay a larger group of influencers $1 for every 1,000 video views, up to a total of $25,000. Machinima did not require any of the influencers to disclose they were being paid for their endorsement.

While it’s good that the FTC brought this case, the dollars are truly small potatoes in the world of YouTube stars with elite channels boasting over 1 million subscribers.

YouTube star Nikki Phillippi told Frontline:

“[W]hat is happening with YouTube is there is this weird line where I won’t rep a product I do not like, but, that being said, I don’t work with brands that don’t understand the value of YouTube either. I would rather not make as much and do stuff by myself, for free, with stuff I have picked up from the drugstore, than work with a company who either doesn’t understand the value of it, or does understand the value of it, but they think that we don’t, and are like here is $100, and I realize that that sounds really strange to people […] but it’s really what is going on in the industry and a matter of trying to elevate and help the entertainment industry kind of segue and understand the value of digital marketing.”

The FTC announced the consent decree today (songwriters take note–it’s not just you).

Following a public comment period, the Federal Trade Commission has approved a final consent order with Machinima, Inc., requiring the company to disclose when it has compensated “influencers” to post YouTube videos or other online product endorsements as part of “influencer campaigns.”

According to the FTC’s complaint, announced in September 2015, the California-based online entertainment network engaged in deceptive advertising by paying influencers to post YouTube videos endorsing Microsoft’s Xbox One system and several games. The influencers paid by Machinima failed to adequately disclose that they were being paid for their seemingly objective opinions, the complaint alleges.

The final order settling the complaint prohibits Machinima from misrepresenting in any influencer campaign that the endorser is an independent user of the product or service being promoted. Among other things, it also requires Machinima to ensure that all of its influencers are aware of their responsibility to make required disclosures, requires Machinima to monitor its influencers’ representations and disclosures, and prohibits Machinima from compensating influencers who make misrepresentations or fail to make the required disclosures.

On PBS’s Frontline, YouTube star Tyler Oakley says:

“If you want to get involved, then you have to play by our rules. This is our platform. We have built this up in our own capacity, in our own way without you. So if you want to come on and if you want to get involved, you can’t just come in like a bully and kind of get your way. You may have to like, play by our rules a little bit. Which is FUN!”

Actually, we all have to play by the same rules.  MCNs take note: You could be next.

As Ben Popper in The Verge summed it up:

As consumers increasingly turn to ad blockers, brands and the media companies are blurring the boundaries of advertising and independent content. Add in teenagers with little business experience and millions of passionate followers on platforms like YouTube, Instagram, and Snapchat, and you have a recipe for unscrupulous advertising that the FTC is clearly working hard to bring under control.

Is It Possible for Songwriter Metadata to Be Delivered to Retailers?

Metadata delivery is a hot topic at SXSW this year.  On a panel about data featuring representatives from two large digital aggregators, a question from the audience raised a salient issue:  If retailers are being sued because they are not licensing songs properly, is it even possible for labels or aggregators to deliver song share information to retailers directly?

If aggregators were able to collect the split data on songs, particularly the long tail, at the time the tracks were “ingested” into the aggregators systems, would that do any good if the retailers aren’t set up to take delivery.

One aggregator said that they didn’t collect publisher information “because publishers change all the time.”  That’s really not entirely true.  Another said that they don’t require the information, and that they don’t collect splits.  That suggests that the information is being collected for credits purposes.

In a separate conversation with a songwriter, it turns out that she had been told by a third aggregator that they don’t collect the data because the retailers don’t accept delivery of it. Between those three aggregators, I would guess that they cover over 50% of the market, and probably closer to 2/3.

This is pretty good anecdotal evidence that even if the “global rights database” existed, retailers would be unable to take full advantage of it without retooling their systems.  At the moment, it seems that the consensus thinking at aggregators is that since the retailers don’t collect the information, why bother requiring it as delivery item?

Aside from the fact that the market is failing to produce the information from an accurate source (the sound recording owner) at a key moment when transaction costs would be lowest (before the track and song go live).