It has been a little more than a year since SoMa Equity Partners Chief Investment Officer Gil Simon left Apex Capital to focus solely on technology, media and telecommunications investing in February. Inception to date the hedge fund’s Founders share class is up 16.77%, according to a letter to investors reviewed by ValueWalk, while the S&P 500 is up 16.71% and the Russell 3000 Tech index is up 34.68%.

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Simon, whose fund has $435 million under management, is excited about the opportunity in the convergence of technology and media, which has undergone a dramatic change with the advent of the Internet and multi-channel content distribution. Looking at the massive convergence that has already taken place – major record label revenue has been nearly halved since the popularization of the Internet – Simon sees a new trend coming back and favoring content owners in the space.

SoMa Equity Partners

SoMa Equity Partners: Streaming services dominate music industry and this will help record labels

The music industry has seen technology and the advent of the Internet dramatically ravage the business model. With channels such as YouTube being the cow that gives the milk away for free and services such as Spotify, Pandora, Apple Music and Amazon Music Unlimited paying pennies on the dollar for the rights to sell music to consumers who once paid full price for records and CDs, that tide is changing.

The online streaming services have been significantly ramping up to the point where they have nearly 100 million subscribers providing the record labels a royalty, albeit a small one.

The streaming services don’t offer record labels as much a profit as selling CDs and physical forms of content delivery, which were more easily controlled and restricted that encourage product purchase. But with mass adoption they are starting to provide record companies meaningful revenue.

SoMa Equity Partners: Music industry revenue fell dramatically but is now on the rebound

After music industry revenues hit a top at near $30 billion in 1998, revenue significantly dropped, with 2005 to 2008, as the internet and smart phone adoption was raging, providing the most significant period of revenue decline.

Revenue growth rebounded after the 2008 financial crisis but from 2001 to 2015 stagnated to the point where, after significant industry consolidation, 2015 record industry revenue was $15 billion, a year that saw revenue increase by only 1%. With the streaming services ramping up subscribers, revenue increased in 2016, up 11.4% year over year.

Consolidation in the music content creation industry has significantly compressed, with three record labels – Universal, Sony and Warner – controlling nearly 85% of the US market and nearly 70% of the global market. Simon thinks this is part of a major mean reversion trend that will provide record labels pricing power, particularly meaningful with an addressable market of nearly 500,000 users.

Of the available stock plays, SoMa doesn’t like the content distributors as he thinks margins will be pressured as they don’t offer unique content. He thinks the play is with the content creators, who will enjoy increased pricing power and will grow as the subscription services grow. His recommendation: Universal Music Group:

UMG is the world’s largest music label, with roughly 35% global market share, and some of the world’s most popular artists including Lady Gaga, Maroon 5, and Drake. It is also the only music label in which public investors can own a meaningful stake given that UMG represents nearly 70% of Vivendi’s consolidated EBITDA, compared to Sony Music at only 15% of Sony Corp’s profits and Warner Music which is privately held. We see significant upside to this asset, as revenue growth accelerates to double?digits with high incremental margins over the coming years. On a standalone basis, we think UMG today should be worth more than Vivendi as a whole, and on a sum?of?parts analysis the holding company has upside to $30, 60% upside from current levels.

In other plays, SoMa was hit by a pullback in its largest holding, YELP, which subtracted  1.7.% During the first quarter positive positions contributing 10% or more included Netflix (NFLX), Autodesk (ADSK), Workday (WDAY) and SBA Communications (SBAC).

It was the shorts that hurt the fund. On the quarter they were positive by 2.9% on long exposure but short exposure subtracted -2.5%. The letter strongly hints that the short is MBLY, without directly saying it, noting:

We were hit by …… a surprising acquisition of one of our shorts with Intel’s announcement to buy Mobileye (MBLY, ?1.2% contribution).

SoMa Equity Partners – Operational

Jeremiah Atkisson, formerly of Partner Fund, joined the hedge fund as head of training at the firm