CMA merger enquiry into Sony acquisition of Kobalt’s AWAL & KNR

CMA merger inquiry into Sony acquisition

The Competition and Markets Authority (‟CMA”) did a stellar job, with the information and data it was provided with, during the phase 1 and phase 2 investigations of Sony’s acquisition of Kobalt’s assets, AWAL and Kobalt Neighbouring Rights. Why is this merger enquiry important, for the music industry? How did it come about? Was the merger enquiry’s outcome fair and appropriate, to preserve healthy competition in the music distribution and rights management sectors?

1. What happened?

Kobalt Music Group Limited (‟Kobalt”) is an independent rights management and music publishing company founded in 2000, in New York, USA.

Kobalt has several subsidiaries, all providing services relating to rights management and music publishing, such as, in particular:

  • AWAL, a music platform providing marketing, distribution and other services to independent recording music artists and independent labels, and
  • Kobalt Neighbouring Rights (‟KNR”) which collects neighbouring rights royalties arising from the public use of music recordings on behalf of artists.

On 18 May 2021, Sony Music Entertainment (‟SME”), one of the three major labels in the music industry and a wholly-owned subsidiary of Sony Group Corporation (‟Sony”), acquired AWAL and KNR from Kobalt, for around USD430 million in cash (the ‟Acquisition”).

In other words, SME acquired all the issued shares of AWAL and KNR, from Kobalt, for USD430 million in cash, on 18 May 2021.

2. Why the Acquisition?

2.1. Kobalt’s rationale

Kobalt’s rationale for the Acquisition was twofold: a sale would allow the company to reduce its debt and return capital to long-term shareholders. Kobalt considered SME’s offer to be the best means of achieving both of these aims.

Kobalt also justified its decision to sell to SME by saying that AWAL and KNR would benefit from the Acquisition for a number of reasons, as follows:

  • being part of Sony’s global network would able AWAL and KNR to grow internationally, supporting the global aspirations of their artists;
  • AWAL artists would gain access to the expertise of The Orchard (one of Sony’s subsidiaries), including tools to manage digital advertising campaigns, optimise YouTube channels, and pay out royalties to collaborators;
  • AWAL would benefit from exposure to Sony’s frontline labels and AWAL artists would have easier access to Sony’s resources, including the potential to achieve increased exposure and investment, and
  • being part of Sony would open up more opportunities for AWAL and KNR in the form of financial support.

2.2. Sony’s rationale

Although Sony would never say so openly, buying competing companies, such as AWAL – which provides services quite similar to those offered by Sony’s subsidiary, The Orchard -, is an astute way to beat the competition and force consolidation in the music industry and, in particular, in the music rights management and distribution sectors, to its advantage.

3. Why and how did the CMA review and control the Acquisition?

On 16 September 2021, the CMA, in exercise of its merger control duty under section 22(1) of the Enterprise Act 2002 (the ‟Act”), referred the Acquisition for further (i.e. phase 2) investigation and report, by a group of CMA panel members.

This was after a lengthy investigation process into the Acquisition:

During the phase 2 investigation, the CMA gathered further evidence, in particular by requesting third parties to make submissions on the issues statement and provide evidence, and then:

4. What was the outcome of the CMA review of the Acquisition?

As mentioned already, the CMA cleared the Acquisition, at the end of its phase 2 investigation.

The 158 pages’ long Report provides not only a detailed analysis of the phase 2 investigation process performed by the CMA on the Acquisition, but also a detailed snapshot of the UK streaming industry for recorded music.

It is therefore an excellent educational document, for anyone who wants to learn about the current UK streaming market for recorded music.

4.1. The industry

In the Report, the CMA makes it clear that the Parties (i.e. Sony, SME and AWAL) overlap in:

  • the wholesale digital distribution of recorded music and related artist and repertoire (‟A&R”) services, including artist and label (‟A&L”) services, and
  • the supply of neighbouring rights administration services.

The wholesale distribution of recorded music is a two-sided market. One side is artist-facing where providers of recorded music distribution (the ‟Providers”) compete to provide services to artists (for example, music distribution, supporting A&R, marketing and promotion). The other side is where Providers compete to distribute their content, in particular to Digital Service Providers (‟DSPs”), such as Spotify, Apple Music, Amazon Music and YouTube/Google for their streaming services, which account for the majority of consumer spending on music.

Providers offer the following recorded music distribution services:

  • A&R services, which relate to the discovery, signing and development of artists, as well as the recording of their music (for example, talent scouting, signing and negotiating artist contracts, payment of any capital advances, funding and provision of artistic and creative support and direction, organising tour support and other supporting services);
  • marketing and promotion, for example, advertising, publicity, radio promotion and playlist promotion, and
  • wholesale distribution of recorded music, which refers to music companies bringing their artists’ music to market, primarily through DSPs. It is also common for Providers to offer physical distribution and digital distribution to download formats although these are of declining importance.

A recording artist typically has five possible Providers’ options when releasing music, depending on their circumstances, as follows:

  • sign with one of the three large companies that account for the majority of recorded music revenues, i.e. Sony, Universal Music Group and Warner Music Group (the ‟Majors”);
  • sign with a smaller, independent label (such as Beggars group, BMG Rights Management or Domino Recording Company);
  • use an ‟artist services” provider (such as AWAL, Believe, PIAS, Empire and Virgin);
  • choose to distribute their music as a self-releasing artist using an established platform (known as ‟DIY” platforms, for example DistroKid, CDBaby, OneRPM, DITTO, United Masters and Amuse), or
  • some artists secure the services of a manager and team for various levels of promotion and other support, and arrange distribution via a ‟label services” provider.

Providers offer three broad deal structures to artists:

  • traditional recording agreements with the Majors or independent labels offering high-touch (i.e. with significant artist support) A&R, marketing and promotion, and distribution services, where the artist agrees to long-term commitments, and sometimes assigns their copyright for an extended period or in perpetuity;
  • services deals with A&L service providers where an artist retains their copyright and receives marketing and A&R services, and
  • distribution-only agreements with DIY providers.

AWAL is an example of an A&L provider with a tiered offering: AWAL Core, where artists join AWAL Core either by direct referral or, more commonly, following submission of their music to AWAL’s online DIY platform; AWAL+, in which select AWAL Core members are ‟upstreamed” based on the number of their played streams, other factors and the judgment of AWAL’s expert team; and AWAL Recordings, which is a service designed to support a select group of established and developing artists and provides a customised high-touch service (i.e. with significant artist support) via elevated funding, digital marketing support, press and radio promotion, sync licensing, physical distribution and local marketing plans in international territories.

The Parties also overlap in the provision of neighbouring rights administration services. Neighbouring rights entitle performing artist and those who own copyright in the related sound recording to compensation for the public use of the recording. Artists and copyright owners collect royalties from Collective Management Organisations (‟CMOs”) directly, or use the services of neighbouring rights collection suppliers such as KNR, which collect neighbouring rights royalties from CMOs on their behalf.

The Parties submitted that Sony’s publishing arm, Sony Music Publishing, has no material market presence in supplying neighbouring rights administrative services. Also, the CMA’s phase 1 decision noted that there were a number of other close competitors to KNR operating in the UK. For these two reasons, the CMA found, at phase 1, that the Acquisition did not give rise to a realist prospect of a SLC. The CMA confirmed, in the Report, that it did not investigate the supply of neighbouring rights administration services as part of its phase 2 investigation.

4.2. Relevant merger situation

The CMA decided that the Acquisition had created a relevant merger situation, within the meaning of the Act, because (i) as a result of the Acquisition, the enterprises of Sony (including SME), AWAL and KNR had ceased to be distinct, and (ii) the Parties overlapped in the wholesale distribution of recorded music in the UK, with an estimated (by the Parties) combined share of supply of 20 to 30 percent, and therefore the share of supply test was met.

Then, the CMA applied the SLC test, which involves the comparison of the prospects for competition with the merger, against the competitive situation without the merger. The latter is called the counterfactual. In the Report, the CMA sets out that the counterfactual is that AWAL would most likely have continued to supply services to both artists and labels and to compete in a similar way as prior to the Acquisition, with a focus on improving the profitability of the business but would not have been likely to materially expand its label business within the next two to three years. In the counterfactual, the CMA adds, Sony would be most likely to have continued to compete in a similar way as prior to the Acquisition, and would most likely provide high-touch services to artists as it did, prior to the Acquisition; and would make ongoing efforts to expand its artist services offering in addition to continuing its label services through the Orchard.

In the Report, the CMA explains that it assessed two theories of harm:

  • the first concerns a loss of current and potential (future) competition in the supply of A&L services. This is a theory of harm arising from horizontal unilateral effects concerning in particular the loss of potential (future) competition from the future growth of AWAL and The Orchard in A&L services, including the possible further diversification of The Orchard and AWAL within artist services and label services respectively, and
  • the second concerns a loss of current competition and potential (future and dynamic) competition in the supply of high-touch services to artists. This theory of harm considers the impact of the loss of competition between AWAL Recordings and SME on competition in the supply of services to artists. The CMA considered the extent of current and potential (future and dynamic) competition between AWAL Recordings and SME and, in particular, the impact on SME or AWAL’s high-service tier offering which combines non-traditional contracts and high-touch services to artists. The CMA’s assessment considered the extent to which this offering had been, and was likely to continue to be, an important competitive constraint on SME, as well as the extent of the remaining current and future constraint from other A&L providers, independent labels and other types of Providers.

In relation to the first theory of harm, based on the loss of current and potential (future) competition in the provision of A&L services, the CMA concluded that The Orchard and AWAL did not currently compete closely in the provision of A&L services, due to their different areas of focus on label and artist services respectively, and due to the constraints from other competitors (such as ADA, Virgin, Ingrooves, Believe, PIAS, Empire and FUGA). Accordingly, the CMA decided that the Acquisition had not resulted, and may not be expected to result, in a SLC due to a loss of current and/or future competition in the supply of A&L services in the UK.

With respect to the second theory of harm, relating to the loss of current and potential (future and dynamic) competition in the supply of high-touch services to artists, the CMA considered that AWAL Recordings’ business model faced some challenges regarding its sustainability. As such, AWAL Recordings would not have materially improved its competitive offering absent the Acquisition. Also, several other A&L providers offer non-traditional contracts and high-touch services to artist and some of these have growing market shares. A number of A&L service providers have credible expansion plans. In addition, the largest independent labels in the UK exert some current and ongoing constraints on the Parties. Considering the extent of the constraint from AWAL, which will be lost, and looking at the constraint from third parties in the round, the CMA concluded that the constraint from AWAL which will be lost is not significant because these third-party constraints are, in aggregate, sufficient to ensure that rivalry will continue to discipline the commercial behaviour of the Parties, post-Acquisition, in the supply of high-touch services to artists. Therefore, the CMA decided that the Acquisition had not resulted, and may not be expected to result, in a SLC as a result of a loss of current and/or potential (future and dynamic) competition in the supply of high-touch services to artists.

To conclude its Report, the CMA set out that, while the Acquisition by Sony, through SME, of AWAL and KNR, had resulted in the creation of a relevant merger situation, the creation of that situation had not resulted, and may not be expected to result, in a SLC within any market or markets in the UK as a result of (i) a loss of current and/or potential (future) competition in the supply of A&L services, and (ii) a loss of current and/or potential (future and dynamic) competition in the supply of high-touch services to artists.

5. Was such merger enquiry, and its outcome, fair, accurate and meaningful?

In this post-covid economy, it is important that companies be able to restructure, divest and invest, in a fast, smooth and efficient manner, in particular to raise cash (and therefore avoid liquidation or winding up), and/or to refocus their businesses on ever-evolving key services and/or products. It’s a matter of survival.

Therefore, it is commendable that the CMA struck the right balance, between:

  • interfering with the Acquisition, by taking seriously its concerns of a SLC which arose at phase 1 of the merger enquiry, and
  • letting Sony and Kobalt go through with the Acquisition, once suspicions of such SLC were cleared upon completion of phase 2 of the merger enquiry.

Having reviewed the Report, and the 22 other documents relating to the merger enquiry published by the CMA on its site, I am convinced that the CMA performed an exhaustive, systematic, thorough and very well organised merger inquiry of the Acquisition.

As mentioned above, I even think that the CMA’s final Report is so analytical and exhaustive, that it gives an excellent view and analysis of the current UK/global music streaming market, on a par, in quality, with the yearly IFPI’s global music report (which sells at a five-figure price now). The Report is educational.

My concern, however, is that the outcome of the CMA’s merger enquiry reinforces the worrying trend of massive consolidation in the music industry, with the Majors making the bulk of the acquisitions of cash-strapped and intellectual property-rich music companies. This, in turn, means that end-customers of the Providers, i.e. the artists and labels, have fewer choices, in the market, for the distribution and monetisation of their songs.

This point was made abundantly by Impala, the independent music companies association, in its response to the CMA’s issues statement, during the merger enquiry.

Also, the Report needs to be read with a pinch of salt because the CMA received a low response rate to their questionnaires sent to customers, with nearly half of artists and labels contacted by the CMA not having any views about the Acquisition. Moreover, the CMA noted in its Report, with respect to the Providers contacted for input as part of this merger enquiry, that there was a lack of consistency across Providers as to whether different elements of their business are accounted for separately or combined. For example, AWAL’s figures included its DIY platforms, where other Providers did not (for example, Believe reported separately from its subsidiary TuneCore).

To conclude, I think that the merger enquiry was fair, thoroughly performed, but not entirely accurate due to lack of factual and exact data. In terms of whether such merger enquiry is meaningful, it will definitely remain a landmark case for merger enquiries in the music industry for years to come, reviewed and studied by legal practitioners and law students around the world. However, I think that the outcome of this merger enquiry could have been more ‟pro-competition” in the music industry, by, for example, requesting from Sony a long-term commitment not to buy any other competitors of AWAL and The Orchard, in the future.

Since the Acquisition, Kobalt, as it stands today (Kobalt Music Publishing and AMRA), was sold to US-based private equity firm Francisco partners, riding the wave of lush equity financing on the lookout for smart investments in the entertainment sector.

Crefovi’s live webinar: CMA merger inquiry into Sony acquisition of Kobalt’s AWAL & KNR – 13 March 2023

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