Warner Music Group's Quarterly Report Signals Future Trends

By Nathan Drake & Barry Neil Shrum

Warner Music Group’s (“WMG”) year-end financial reports for 2010 came as little surprise when you take into account two factors: (1) the general economic downturn in the U.S. and (2) the continued piracy in the global music industry. See the report on WMG’s website here. WMG has been the third largest record company in the world since at least 2004, when Time Warner spun off its music-related components. WMG’s stock was trading at $5.92 per share as of the date of this posting, 2/21/2011.

Although WMG posted positive revenue returns in the third and fourth quarter of 2010, WMG claims that total revenue in 2010 decreased sharply as compared to 2008 and 2009. This represents the eighth straight quarter that WMG has posted decreased earnings, a trend that is concerning to many in the music industry. To wit, the demise of EMI Music – currently No. 4 in the music world – as it crumbles under the weight of its massive debt, is a poignant lesson to WMG – and to Universal Music Group and Sony BMG (Nos. 1 and 2 respectively) – that no music conglomerate is immune to hardships and winds of change currently facing the music industry. The wide moat of physical sales that once protected the record labels’ castle from ultimate destitution now fails to provide a comfortable defense.

As a result, a new kind of business model has emerged on Music Row and throughout the music industry, and this business does include “traditional model” involving radio marketing or “physical distribution/sales.”. Rather, ingenuity and innovation include the most pertinent qualities of this business model. See my post, New Formula for the Music Industry. And though the “major record labels” while may be slow to adapt, revenue losses like those reported by WMG, is quickly teaching the behemoths that transformation is essential if they want to stay afloat and competitive in today’s music market. There are constant rumors afoot in Nashville that several of the major labels are shifting away from the traditional type deals toward more reasonable, tech-savvy and partnership-based approaches that fit the model better.

According to WMG’s reports, released on February 8, 2011, revenue totaled $789 million for the fourth quarter of 2010. Even though it reported positive cash flow for the fourth quarter, the reported revenue represents a 14% decline from the 4Q 2009. The impact of this comparative decline becomes clearer when you compare the reported digital revenues for WMG for the same periods. Digital revenue for 4Q 2010 accounted for a staggering 25% of the total revenue, or $187 million. This total represents an increase from the $184 million in digital revenue reported 4Q 2009. Thus, it is obvious that digital revenue continues to be an integral, and fast growing, aspect of the business model for record labels.

The growth in digital revenue and the effect it has had on WMG’s revenue stream is also highlighted in the international sales posted by the company for 2010. While domestic recorded music digital revenue declined 3% in 2010, international recorded music digital revenue grew 12.3% during the same year. International digital purchases of recorded music accounted for 19.7% of total revenue in 4Q 2010, increasing from the previous year’s quarterly earning of of 14.6% in the same sector. WMG’s figures show that marketing internationally provide great opportunities for augmentation, at least for the time being.

The impact of these trends in the music business on the future business model of WMG is also evident from the report for those willing to consider them. First, the news reported by WMG that it is hiring Goldman Sachs to investigate and explore the potential sell of the company offers tremendous insight. WMG has also proposed the option of selling only portions of the company in an effort to alleviate the debt and mere size of the company. Going in totally the opposite directino, a third proposed option in consideration is that WMG would acquire its struggling little sister, EMI Music. According to 2009 Nielson SoundScan® sales figures for each of the major conglomerates, the acquisition of EMI would position WMG as the largest record label in the music industry, with 32.72% of the U.S. market share, leapfrogging both UMG and Sony BMG to take the crown.

As noted earlier, EMI is the fourth largest music conglomerate, representing some of the largest acts in music today, including Katie Parry, Coldplay and Radiohead. Despite its stable of well-known artists, Terra Firma, EMI’s current owner, has been treading water for almost a year now to to repay CitiGroup, from whom it borrowed millions to acquire EMI a mere 2 ½ years ago. But as the repayment prospects for EMI are beginning to dim, as they reported massive losses of nearly $2.5 billion last year. So, while things may look gloomy for EMI, Warner Brothers views EMI’s plight as an opportunity to expand its catalog and artist repertoire. An opportunity of this magnitude is rare; therefore, acquiring EMI yields the potential for Warner Brothers to transform itself into a more profitable and diverse music industry conglomerate. I’m sure EMI hopes the third time is the charm here.

So, the music industry continues to morph and adapt into something that will not resemble the traditional “record label” models of the past. Gone are the days when such conglomerates are the only ones who will be able to produce multi-platinum superstar artists, sold through radio marketing and mass retail distribution on which they have a stronghold. The days of the Internet revolution are upon us and the industry is starting to see its effects. This drama will continue to play out over the course of the next few years.

My co-author, Nathan Drake is a senior at Belmont University from Northville, Michigan who graduates in May with a degree in Music Business from the Mike Curb School of Music Business. Nathan currently clerks for Mr. Barry Neil Shrum, Esquire at Shrum & Associates in Nashville, Tennessee. He plans on pursuing a law degree after graduation. Nathan is author of his own blog entitled “My Thoughts.”

About the Author: Barry Neil Shrum, Esq.

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