Warner Music Out of Tune

The recorded music business has been getting beaten up for the last decade or so, starting with the original release of Napster in the late 1990s. Music industry executives decided that they’d rather fight than switch, so the industry has filed lawsuits either to kill file sharing web sites or to intimidate consumers.

It’s hard to imagine what would have happened if the companies had tried to figure out a way to live in the new digital world, but it’s easy to see the result of this strategy. Warner Music Group Corp. (NYSE: WMG) reported fourth fiscal quarter and full-year results today that missed already low estimates. Warner reported a quarterly EPS loss of -$0.31 on revenue of $752 million. Analysts had been expecting an EPS loss of -$0.13 on revenue of $740 million. The music division of Sony Corp. (NYSE: SNE) reported its second quarter results last month, posting a drop of nearly -11% in revenue and more than -6% in operating income.

Warner increased its digital sales by 7.1% to $197 million, but the loss of CD sales more than wiped out that gain. Digital sales grew more than 10% sequentially, and contributed more than 26% of Warner’s total revenue for the quarter. Full-year revenue was down -6.7% from 2009, again reflecting the change from physical CDs to digital downloads.

The company’s long-term debt totals nearly $2 billion and it holds less than $500 million in cash and equivalents. But that’s not stopping Warner from considering a buyout of EMI Group Ltd., currently owned by private equity company Terra Firma Capital Partners Ltd. Terra Firma paid $6.5 billion for EMI in 2007.

According to Britain’s The Observer, Warner is expected to offer $750 million for EMI’s recorded music division. Terra Firma is not interested in splitting up the company, but Citigroup, Inc. (NYSE: C) might force the sale. The bank lent Terra Firma about $4.5 billion to purchase EMI.

Terra Firma’s crown jewel is its music publishing arm, which holds the rights to music by the Beatles and Pink Floyd, among others. That division is estimated to be worth about $2 billion. All told, EMI’s value has been halved in just three years.

If Warner can do a deal with Terra Firma, it might be able to compete better with Sony and with Universal, a part of NBC Universal which is owned by General Electric Co. (NYSE: GE), but currently about to be sold to Comcast Corp. (NASDAQ: CMCSA).

Still, like every big music company, Warner needs to come up with a way to recover the sales it lost by fighting digital downloads. That hasn’t been easy and it’s not going to get any easier.

Warner stock is down about -8.5% in early trading this morning.

Paul Ausick