Caledonia Investments moves into global music sector with share of Warner Music

Secretive fund manager buys into Warner Music and increases the short ­positions of its flagship fund by 20pc.

Caledonia has emerged with a stake in Warner Music, the label beind acts including Cardi B and others. Photo: Getty Images

Caledonia Investments has made its first move into the global music sector by taking a strategic shareholding in Warner Music, the biggest Wall Street float since the onset of COVID-19, but the secretive fund manager remains wary of more market volatility and has increased the short ­positions of its flagship fund by 20 per cent.

The $10bn Sydney-based Caledonia, which counts the wealthiest people in the nation among its investors and is run by rich-lister Will Vicars and Michael Messara, delivered a 28 per return from its flagship Global Fund in the June quarter, taking its annual return for the financial year to 38 per cent.

Caledonia’s combined strategy performance of its Global Fund and its Global Co-Invest fund was up 38 per cent in the June quarter and up 31 per cent for the financial year, after fees.

Its benchmark, the MSCI World Index, was up 4 per cent over the past 12 months.

The co-investment fund is a long-only fund where investors can hold large positions in Caledonia’s best ideas for the long term at lower fees.

“We don’t have a crystal ball, and we aren’t macro investors,” Caledonia said in its latest confidential client update, obtained by The Australian.

“The pandemic is certainly an enormous shock to the global economy, perhaps matched or even exceeded by the magnitude of the monetary and fiscal response launched by governments and central banks to combat it.

“With that said, we believe the transition of marketplaces from analog to digital will move ahead with relentless force regardless of the ups and downs of the stockmarket, as we have observed for more than two decades. Caledonia thrives on such change, and we couldn’t be more excited about the outlook from here.’’

Caledonia added 20 per cent, or $2bn, to its long exposure in the second half of March as a global sharemarket rout took hold.

Fortress against turbulence

More recently, it says it has taken advantage of the rally in shares to “fortress” its portfolio against market turbulence.

The firm increased its short exposure by 18 per cent from April to June, bringing the market exposure of its flagship fund back down to 43 per cent, similar to its level before the pandemic hit.

It plans to use its flagship fund to carry on the hunt for new core holdings.

Powerful trend

“We have spent nearly three decades learning about marketplaces and the profound changes taking place as they move online and transition from analog to digital business models. This theme is the most powerful trend we have seen in our careers impacting huge swathes of the global economy including real estate, food, gaming, and cars,’’ Caledonia told clients.

“We now see opportunities opening up in markets such as music and entertainment, education, and financial services. The disruption will create new champions. There will also be structural losers, and they will become attractive fodder for our short book.”

Caledonia’s three big investments are in US online real estate group Zillow — alongside local billionaire Gretel Packer — online food delivery giant Grubhub and Canadian online gaming firm Flutter Entertainment, which last year merged with The Stars Group and is best known as the owner of bookmakers Paddy Power and Betfair.

Last month, European food delivery service Just Eat Takeaway agreed to buy Grubhub for $US7.3bn after the US firm spurned a takeover offer from ride-sharing giant Uber.

Caledonia’s long-only portfolio contributed 37 per cent to its performance over the past 12 months due to the significant share price outperformance of these core holdings. The outperformance of those stocks has continued during July, which looks set to drive an expected 8 per cent return for Caledonia’s combined strategy for the month.

Potential ‘core’ holding

Caledonia participated in Warner Music’s successful $US2bn IPO in June and has built a 6 per cent position in the shares across its funds. It says the investment has the potential to become a fourth “core” holding.

Chinese internet services giant Tencent was the third largest buyer in the Warner Music IPO, taking $US200m worth of stock. It had previously acquired a material stake in Universal Music over the past 12 months.

“We have wanted to invest in this space for a long time and began engaging more actively with the Warner Music management team in 2019. The other two major record labels are part of larger parent companies. This makes Warner Music the only pure-play,’’ Caledonia told clients.

“As a result, we see strong share price appreciation over the medium to long term primarily driven by what we expect will be prodigious free cash-flow growth.

“We think this asset also has significant strategic value given the size of the ultimate prize in streaming and digital recorded music. We expect to see more ‘jockeying for position’ in the ownership of the major record labels over the next few years.

“At the end of the day, it is worth remembering that only three companies own the rights to the majority of music on the planet.”

In 2015, Caledonia spun out part of its investments in Zillow, Grubhub and Stars into its Co-Invest Fund. Then, in 2018, it put more of those three investments into the co-invest fund and capped positions in its main fund at 25 per cent.

Because of its strong share price growth, Flutter is now a 30 per cent position in the main fund, so the group plans to make a distribution to the co-investment fund of about 25 per cent of its Flutter holding at the end of September.

This will leave the flagship fund with a weighting of 20-22 per cent in Flutter, similar in size to the holdings in Grubhub and Zillow.

Because of the concentrated holdings in the co-investment fund, Caledonia is also now allowing clients to recycle their holding from the co-investment fund back into the flagship fund where the returns are less volatile.

“Our goal is to ensure all our clients can retain full exposure to Caledonia with a risk profile they are comfortable with,’’ the fund manager said.