What Kind of Deal Did Peloton Strike With the Music Industry?

Peloton Interactive Inc. (NASDAQ: PTON) announced Thursday morning that it had reached an agreement with the National Music Publishers’ Association (NMPA) to settle litigation brought against the company last year by 14 NMPA members. No details were provided.

NMPA filed a $150 million lawsuit against Peloton in March of last year, charging that the company used more than 1,000 songs illegally in the company’s workout videos. In September, just a week before Peloton’s initial public offering (IPO), the NMPA bumped the amount it was seeking by an additional $150 million after discovering what the group claimed were another 1,354 songs being used illegally.

Peloton’s IPO on September 26, went out at $27 a share, below the expected $29 price. Shares closed on Wednesday at $29.19.

In addition to settling the litigation, Peloton and the NMPA have agreed to work jointly “to further optimize Peloton’s music licensing systems and processes.” So why did the company’s shares trade down by well over 3.6% Thursday morning? Settling a pending lawsuit is typically cause for investors to boost shares, now that one uncertainty about future returns has been removed.

Partly the share-price drop is due to another down day for equity markets. The Nasdaq was down about 2.5% and the S&P 500 was down about 2.2%. Even speculation that Peloton may benefit from the coronavirus outbreak because people would buy their machines and services in order to avoid having to go to a gym does not seem to carry much weight with investors.

The primary reason behind the drop probably has more to do with the music industry than it does with the spread of COVID-19. Here’s NMPA CEO David Israelite:

We are pleased the music publishers and their songwriter partners in this case have reached a settlement with Peloton that compensates creators properly and sets forth the environment for a positive relationship going forward.

Peloton’s head of music, Paul DeGrooyer, added:

Music is an important part of the Peloton experience, and we are very proud to have pioneered a new revenue stream for recording artists and songwriters. We’re equally proud to partner with David and the NMPA to ensure that songwriters are, and continue to be, fairly compensated.

In a footnote to its shareholder letter for the December quarter, Peloton said that agreements to settle or avoid costs related to using music nicked adjusted EBITDA margin by two basis points ($100,000) for the quarter and 15 basis points ($1 million) for the first six months of the company’s 2020 fiscal year.

The settlement announced today is virtually guaranteed to drive the number higher. In the December 2018 quarter, Peloton spent $2.3 million on content costs; for the six-month period the company spent $5.1 million. Going forward, it is reasonable to expect that Peloton will be paying closer to $2.3 million than $100,000 per quarter.

Music streaming services like Spotify Technology S.A. (NYSE: SPOT) and Apple Music currently pay between 60% and 70% of steaming revenues to music rights holders. That number is based on a per-stream payout of less than a penny per play. The rights holders (the four major label owners) then divvy up the payments among publishers, performers and others.

Peloton’s deal with the NMPA most likely covers just a few thousand songs, and the audience is limited by the number of subscribers to Peloton’s services. That likely means that the per-song rate will be higher. It could be much higher, but we’re unlikely to find out until the company reports quarterly earnings again.

Despite its current slide, there are believers in Peloton’s long-term growth.

In the noon hour Thursday, Peloton shares traded down about 3.3%, at $28.24 in a post-IPO range of $20.46 to $37.02. The consensus price target on the stock is $37.40.

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