Wednesday, January 30, 2008

Singing More "Bad Days" At Warner Music Group

The bankruptcies of record retailers (bye-bye Tower Records and Musicland) and wholesalers, growth of new formats for recorded music distribution (legal downloading of digital music using the Internet), maturation of the CD format, and digital piracy—factors which continue to negatively impact the operating results at Warner Music Group (WMG-$7.59), which generates more than 80 percent of its annual revenue from recorded music, split 90/10—physical (such as CDs, cassettes, LPs and DVDs) and digital (such as downloads and ringtones) formats, respectively. The remainder sales are generated from music publishing.

Aiming to effectively address the continued development of digital distribution channels along with the decline of industry-wide CD sales, Warner Music, home to acts such as Faith Hill, Green Day, Led Zeppelin, Red Hot Chili Peppers, and R.E.M, announced a re-alignment plan in its second-quarter of fiscal year 2007. New business initiatives included cost-structure savings (i.e. layoffs) and the evolution from a traditional record and songs-based business to a music-based content provider (across online and mobile platforms).

Shares in the world's third-largest record company are up almost 60 percent in three-weeks, primarily attributable to investor anticipation that the music label is close to signing a deal with Yahoo! for ad-supported online music offerings. A digital distribution partnership of this kind would be the best action—to date—to jumpstart its sputtering digital marketplace and offer leverage in future content-pricing negotiations with Apple, whose iTunes product remains the dominant online distribution outlet (controlling more than 70 percent of digital download music sales).

Financial Trends

We do not favor buying Warner Music, for we do not believe that Chairman & CEO Edgar Bronfman [not a big fan!] and his management can
embrace the digital world fast enough to offset plummeting CD sales and lost revenue due to counterfeiting (approximately $63.0 million, according to our estimates), and digital piracy.

A public service announcement followed me home the other day.
I paid it nevermind.
Go Away.
Shits so thick you could stir it with a stick-free Teflon whitewashed presidency.
We're sick of being jerked around.Wear that on your sleeve.

In addition, we believe the 52 cents a share annual dividend—yielding 6.8%--will be cut in coming months.

Broadcast me a joyful noise unto the times, lord,
Count your blessings.
We're sick of being jerked around.
We all fall down.

It will take time for Warner Music to adapt to the changing economics of the music industry. As for now, the Company remains highly leveraged. As of fiscal year ended September 30, 2007, total net consolidated indebtedness was $1.94 billion, with shareholder equity of $(36.0) million.

Have you ever seen the televised St. vitus subcommittee prizeInvestigation dance?
Those ants in pants glances.
Well, look behind the eyes.
It's a hallowed hollow anesthetized
"save my own ass, screw these guys"
smoke and mirror lock down.

Warner Music recorded a loss of $21 million, or 14 cents a share, on revenue of $3.385 billion during the fiscal year ended September 30, 2007. That compared to a profit of $60 million, or 40 cents per share, in the 2006 fiscal year.

Broadcast me a joyful noise unto the times, lord,
Count your blessings.
The Papers wouldn't lie!
I sigh, Not one more.

We caution investors that the Company has limited financial flexibility (debt covenants) to absorb operating losses in the coming year. In 2007, the interest coverage ratio fell to 1.08 times EBIT, down from 1.57 times EBIT in the prior year.

It's been a bad day.
Please don't take a picture.
It's been a bad day. Please….

Our risk assessment also includes the massaging of accounts receivable (decrease) and accounts payable/accrued liabilities (increases) of $73.0 million and $78.0 million, respectively, to positively impact cash flow from operations (which totaled $305.0 million)—barely enough to fund debt service, capex requirements, and quarterly dividends of $199.0 million, $30.0 million, $76.0 million, respectively.

Broadcast me a joyful noise unto the times, lord,
Count your blessings.
We're sick of being jerked around.
We all fall down.

In addition, Warner Music has firm commitments (in the aggregate) owed to signed talent (such as artists, songwriters, and co-publishers) that approximated $424 million, as of September 30, 2007 (usually payable over a ten-year period).

Its been a bad day...
~ R.E.M. [
Bad Day Lyrics]

In fiscal year 2008, analysts are expecting a loss of 12 cents per share on sales of $3.16 billion, on average, according to a poll by Thomson Financial.

The Company will release fiscal first-quarter financial results (for the period ended December 31, 2007) prior to the opening of trading on Wednesday, February 6, 2008.

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

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