THOSE WHO WOULD follow — and even dare to predict — the fortunes of the increasingly diversified showbiz congloms face an ever tougher task.
Screenwriter William Goldman’s oft-quoted, but never truly accurate, maxim “Nobody knows anything” is in need of updating. This column immodestly proposes a new rule for this new era: Nothing matters much.
The days when a hit movie, several chart-topping albums or even a highly rated TV series could lift stock prices of the likes of Time Warner, News Corp. or Disney are long past. Such successes may lift the spirits — and the bonuses — of a few execs, but rarely affect the parent company’s stock.
A case in point: Two weeks after the TimeWarner/AOL announcement registered 8.7 on the Richter scale, the news that the Warner Music Group and EMI would be combined in a new 50/50 joint venture barely hit 2.9. The industry — and Wall Street — should adjust their seismometers, as this is a potentially revolutionary deal.
Back in the ’80s, when Warner Music could do no wrong, industry titans Mo Ostin, Ahmet Ertegun, Joe Smith and David Geffen had melded the Warner labels into a juggernaut with a domestic market share that frequently topped 30%.
In those days, music was by far Warner’s largest profit contributor, a status that continued well into the ’90s, even after the 1989 merger with Time Inc. The Warner Music Group remained, at least domestically, the unquestioned industry leader, with a U.S. market share consistently in the mid-20s for the first half of the ’90s. As recently as 1994, TW’s music arm accounted for $720 million, or a jazzy 40%, of the parent’s EBITDA. Last year, that figure was only $524 million, and that represented a slight improvement over the two prior years.
More ominously, its share of the domestic market had plunged to 13.7%. In the fastest-growing area, local repertoire overseas, Warner had never achieved a comparable standing and continued to struggle.
Only its mighty music publishing arm, Warner Chappell — the source of an estimated 30% of divisional profits and growing — kept earnings from looking still more anemic.
YEARS OF MANAGEMENT CHAOS throughout most of the ’90s had culminated in the 1995 appointment of WB’s Bob Daly and Terry Semel as co-chieftains of the Music Group, while they remained in charge of the studio.
For the next four years, this duumvirate dealt with the music division much the way Austro-Hungarian emperors regarded Serbia: a troublesome, dangerous province to be visited as infrequently as possible. Not surprisingly, morale plunged even faster than profits.
Was this an inevitable price to pay for transforming a culture that had regarded picking the next quarter’s release schedule as long-range planning? Surely, less maladroit corporate oversight could have preserved more of the baby, while still disposing of most of the bath water.
However, Jerry Levin was faced with more than just the need to rebuild the division’s esprit de corps and market share. He had to create a capability to deal with a little thing called the Internet, which quite simply threatened to make obsolete traditional methods of distributing music and indeed the very concept of a record label.
The music business had been based on seven-year contracts with artists — eat your hearts out, studio heads of production — and massive positive cash generation (imagine that, film division CFOs).
Now the very foundation of the industry, ironclad copyright protection, was under assault from Web sites offering digitally downloaded music via MP3 for — the Internet’s favorite word — free. (Parents of college-age kids, ask them about napster.com.)
Old music industry thinking would have called for circling the wagons in hopes that the deluge wouldn’t hit until the next management generation had taken over.
Levin and his team at TW saw a better way. Merge with — not acquire — U.K.-based EMI, the last stand-alone music major in the world, creating a joint venture that will be a worldwide colossus in recorded music and, especially, music publishing.
Just as Levin had concluded weeks earlier that having his shareholders own 45% of a merged AOL/TW was preferable to owning 100% of TimeWarner, he saw that having 50% of Warner/EMI was far more powerful than 100% of his current music division.
THE MUSIC INDUSTRY HISTORICALLY has been ignored by Wall Street, despite its importance and its many fiscally appealing characteristics.
However, at least one firm is out to right this oversight. Sanford C. Bernstein is a highly respected pure research firm untainted by the usual conflicts of interest that investment bankers face when opining on their existing or would-be clients.
Two of its analysts, Tom Wolzien and Michael Nathanson, cogently spell out, in just four pages, the strategic wisdom of this deal. They explain why the Warner/EMI combination had, overnight, turned them from consistent music industry bears to committed bulls — at least as regards TimeWarner and EMI, which will continue to trade in London as a holding company for EMI’s 50% interest in the joint venture.
This will produce something fairly unique for Wall Street, a pure music play to invest in. Nathanson noted the numerous short-term benefits of the deal. Warner’s greater domestic share is a perfect fit with EMI’s far stronger companies overseas. The two have compatible management teams.
Not inconsiderably, there would be perhaps $500 million in annual cost savings within a few years, allowing the new company to invest heavily in new artists without trashing the P&L.
But the Bernstein report focused, quite properly in my view, on the ways in which the deal would give Warner/EMI joint venture, per a conversation with Nathanson, “the largest seat at the table where the next generation of digital music products will be defined. The joint venture, as part of TW/AOL, will have the scale to assure that its interests are protected.”
In essence, putting the two music companies together is a junior version of the TW/AOL combo with the same potential to enable the respective partnerships to leapfrog the competition.
The corporate boys at 75 Rock may not have understood the sensitive psyches of the moguls of rock ‘n’ roll.
But, with this single stroke, they have snatched likely long-term victory in the dawning new music era from the jaws of near-certain decline.
(Roger Smith, a former Warner Bros. exec, now heads the Gotham consulting firm Roger Smith & Co.)