There is an old saying among media investors that goes “the only people that make money in Hollywood are the actors and producers.” If you look at the record industry you could probably say the same thing.Now that the Warner Music Group acquisition has closed, Leo Blavatnik’s Access Industries has a lot of work to do turning the company around. Blavatnik is in a Catch 22 of sorts because much of the company’s (to be fair the entire industry too) demise is related to poor moves in response to consumer trends by executives that typically are overcompensated and lack innovative management skills needed to succeed in today’s economy. But then again, who else is going to run a record label where deals are struck in nightclubs and oversized egos often trump good decision making.
We think this story ends like the EMI saga – a lot of pain followed by another sale. In fact one senior label executive we spoke with about Warner’s chances said “the company is such a mess, the executives so impossible to manage or reform, this thing ends quickly and painfully.”
Deal Financing Still Leaves A Heavy Load To Lift
Access financed its acquisition with a combination of stock, cash, and debt. Specifically, Access used $1.1 Billion of cash and $1.1 Billion in new debt to pay out existing shareholders and refinance about $900 Million in existing debt. Warner had just under $2 Billion in debt on its books at the time of the acquisition so even with assumed slightly better rates on half of its debt we don’t think the company’s interest expense changes much.
The last full calendar year before the acquisition (2010) Warner spent $186 Million of its $70 Million in operating income so its debt load will still drive losses at the company unless operations are drastically and immediately turned around. Even looking at the more generous EBITDA measure of profitability doesn’t paint a very pretty picture – about half of it was put toward debt payments in 2010.
Industry Trends Working Against Them
Warner isn’t exactly riding a wave of prosperity in the music business. Through May 2011 the industry saw its first signs of growth since 2004 (yes, 7 years!). But after years of strong losses the growth achieved isn’t exactly something to cheer for. For example, the industry grew only 1.6% during that period while album sales continued its fall, decreasing 1.5%. catalogue titles appear to be driving the meager growth as catalogue titles grew 5.4% during the period while those titles older than 36 months grew 8.3% (current albums were down 7%).
What does this tell us?
Forget The Future Of Recorded Music And Focus On Libraries While Cutting Costs
We just don’t think recorded music is ever coming back. With new, smaller artists finding an increasing number of ways to finance and market their own careers while blockbuster artists want to get paid more and more the major labels are getting squeezed from all sides. We think the best a major label like Warner can do is to cut back on the number of new, smaller artists that are promoted, earn revenue from older catalogues from an increasing number of sources, and cut costs significantly.
Compensation The First Thing To Focus On
We think Warner should first look at compensation and corporate expenses. For example, corporate expenses at Warner dropped significantly in 2010 to $49 Million from $63 Million in 2009, but this is the same amount the company spent in 2007 ($50 Million) despite the fact that revenue at the company fell 12% from 2007 through 2010. We think there is clearly more room for chopping. Of course executives will have to live with smaller offices, lower compensation, and less luxuries like big expense accounts, drivers, and first class airfare. If you’ve ever spent much time with a senior record executive you will realise this is not going to happen without serious pushback.
Wow, These Are Some Seriously Nice Salaries!
We were left breathless when we found out how much senior management at Warner makes in cash salary and bonuses. In 2010 Chairman and CEO Edgar Bronfman Jr. was paid $5 Million in salary and bonuses, up from $3.1 Million in 2009. This after four straight years of heavy losses! CEO of Recorded Music (because no self respecting music exec can live without “CEO” in his/her title) was paid a mind-boggling $6.5 Million in 2010, up from $5 Million in 2009. This in a year when recorded revenue fell 7%! Michael Fleisher, Head of Strategy and Operations, was the only senior executive we could find that took a compensation decrease in 2010, to $1.9 Million from $3.2 Million in 2009.
As a point of comparison Warner’s parent company, Time Warner, paid its CEO $2 Million in 2010, up modestly from $1.75 Million in 2009. Did we mention that Time Warner grew its revenue and profits 4% and 26%, respectively in 2010?
Expect a lot of drama from this melting ice cube!
If you’re a Warner employee or former employee with something to add feel free to email us confidentially at [email protected]
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