News that music streaming site Spotify has 10 million paying subscribers and over 40 million active users has significant read-across to rights specialist One Media IP (OMIP:AIM). As the owner of a growing catalogue of nostalgia-era songs, the small cap is well placed to profit from the structural shift for listening to music streamed via the internet instead of CDs or the radio. With Google (GOOG:NDQ)-owned YouTube launching its rival service to Spotify this summer, and rumours that Amazon (AMZN:NDQ) will follow soon after, it’s time to get into One Media’s groove.

The £9.7 million cap buys catalogues of songs, audio books, e-books and videos which are delivered to hundreds of web-based music and video stores including Apple’s (AAPL:NDQ) iTunes, Amazon, Spotify and YouTube. It takes a commission from any download purchase or when someone streams the song or video via the internet. If the latter service is free to use, rather than subscription, One Media gets a cut of any revenue from advertisements that are broadcast when the song or video is requested. Accountant PWC predicts a 13.4% compound annual growth rate in global digital music streaming revenues to 2018.

Big audience

YouTube plans to remove many famous artists from its forthcoming paid-for streaming service after their record labels refused to agree to the financial terms. We understand YouTube will keep 57% of any income attached to each song, nearly twice the 33% charge from Spotify. One Media is already signed up, saying YouTube’s one billion user base (for the current free-to-use model) is too big an audience to ignore, even if the commercial terms are less favourable than Spotify’s.

One Media is forecast to increase pre-tax profit by 50% in the financial year to October 2014 to £750,000, rising to £1 million in 2015 and £1.3 million the year after. Given that it is debt free, generates cash, pays a dividend, and is well positioned in a structural growth market, we’d argue that the firm deserves a premium rating. On prospective numbers for 2014, it trades on a price to earnings ratio of 19.7, falling to 15.5 on 2015 earnings estimates.

At the interims (17 Jun), the business reported a £1.4 million cash position. It has since agreed a $2 million (£1.2 million) cash advance from distributor The Orchard against future royalties. Remarkably the advance is interest free, although it is not know if there’s any change to the distributor’s commission rate. One Media says this is the fourth deal of its kind with The Orchard. ‘We are one of their top-five customers; they work with 5,000 or 6,000 labels. For us, it is an efficient way of raising money. For them, it means we can secure more content to run through their network.’

One Media has historically bought rights for relatively small sums of money and found ways to commercialise the content. This acquisition strategy will now include content that is already generating an income from web services. Such acquisitions by their nature will be more costly; the firm is targeting $1 million to $2 million per deal; and the return on investment could take longer but generate greater value over time. ‘If a song is earning $1, we can make it earn $2 by pushing the content and promoting through our network of stores,’ claims One Media.

One Media IP (OMIP:AIM) 14.75p BUY

Stop loss: 11.8p

Market value: £9.7 million

Prospective PE Oct 2014: 19.7

Prospective PE Oct 2015: 15.5

1-month relative strength: 0.0%

1-year relative strength: 34.9%

Prospective dividend yield: 0.8%

Bid/offer spread: 9.7%

Growth: HIGH

Ongoing profit growth is being driven by an expanding library of music and TV rights.

Risk: MEDIUM

Illiquid shares, most earnings derived in dollars, slowdown in music download growth.

Quality: MEDIUM

Strong balance sheet, cash generative but acquisition payback length likely to be extended.