The most interesting bit to come out of Warner Music’s (WMG) Q3 earnings call: Some saber rattling about the music-based video games, primarily Activision’s Guitar Hero and Viacom’s Rock Band. The games, which allow players to download songs from the likes of Aerosmith and play along with their rock idols, are great, CEO Edgar Bronfman Jr. said. But he said that Warner’s seeing very little of the money that the games generated, and said that has to change. Paraphrased transcript from the call:
Games have enormous opportunity, and proves we have future business in non-traditional formats. But we have to be very careful that we do not allow an eco-system to occur where we do not get compensated properly. Like what happened with MTV, and now with Apple. And now [game developers] Activision and Harmonix [owned by Viacom] are in the same place. Amounts being paid to music industry for downloads, etc. “far too small”. Industry needs to participate much more fully. If that does not become the case, “we will not licence to those games.” Very small licence fee per song, plus additional revenue if artist involved. But royalties far below what true value is.
The gist of that is quite clear: We’ve seen two huge businesses (MTV, iPod/iTunes) built off the backs of our work over the last few decades, and we haven’t gotten much out of it. We don’t want that to happen again. What’s not clear: What WMG can do about it.
That’s because the game-makers are free to rerecord sound-alike songs for the games without Warner’s permission, and pay just a small publishing royalty. Would the actual songs be better? Sure, and they use those too, which do require sign-off from the labels. But while iTunes buyers expect to be able to purchase any track they want from the digital store, Rock Band and Guitar Hero are doing just fine by offering players a very small collection of tunes to play.
So while the game makers might be very excited to include, say, Warner artists Led Zeppelin in a future game, they can also live without them — they can always get the Who, or maybe even the Beatles. Hard to see where WMG will have the leverage working on their own to get more money out of the games business.
Quarterly results, earnings call coverage follow:
At first glance Edgar Bronfmans Jr.’s Warner Music Group (WMG) has handily beaten Wall Street’s low expectations for its Q3: Even allowing for the effect of the weak dollar, revenues trumped conensus, and the net EPS loss seems to have handily beaten expecations. This will feel particularly satisfying to the Warner guys after Goldman’s Ingrid Chung downgraded the company earlier in the week.
Call starting; refresh for latest: Lengthy disclaimer – nything we say now shouldn’t be held against us later.
Edgar: We’re doing better than a lousy business. Growing market share. As overall revenue shrinks, digital still growing. Shout-outs to Madonna and Frank Sinatra. [But Madonna’s headed to Live Nation, so don’t want to really play that up]. We like the new proposed European copyright laws. Digital growing nicely, but “ringtone revenue lagging expectations in U.S. and Europe.” [This is a recurring theme from WMG, and should be worrisome for Thumbplay and other mobile content players] But we sitill hope mobile will take off for us one day, and we’re beginning to see an actual business in full track over-the-air downloads.
Talking up propspects of “Access” business – also known as subscription business – from Nokia’s “Comes with Music” plan. DRM-free tracks at Amazon earlier this year, and newer deals recently: Wal-Mart, Napster, etc. [But no data on performance of DRM-free tracks. Until we hear differently, we’ll continue to believe that DRM-free tracks aren’t performing better than tracks with digital locks].
CFO: Now I’m going to repeat what’s in the earnings release. Please note that we had a bunch of one-time costs and benefits last year.
65% of total digital revenue in U.S. Online is primary driver. Mobile is small in U.S with flat ringtone sales.
“Comfortable with our balance sheet”. Discontinued dividend last quarter, “curtailed” M&A spending, and that looks to continue.
Organic revenue growth: Down 4% over last quarter and over last year, down 1% constant currency. We think this is pretty good given the state of the industry.
No guidance, per usual.
Q&A: Talk about the debt convenants. Debt to Ebitda ratio covenants are going to keep shrinking. How are you going to make those? Well, in part by reducing overall net debt (i.e. easier to shrink numerator than to increase the denominator). And you’re going to be growing cash balance? Yes, we will. We’ve doubled that in last six months.
Progress on music royalty battle? No update. “Strong enforcement” legislation introduced in House, Senate. But some movement on royalty with radio broadcasters. It’s not likely to be an issue that this current session of Congress engages in. I.e – no government aid coming anytime soon.
How’s catalogue doing? And what’s up with video games – Guitar Hero, Rock Band, etc.? catalogue “continuing to perform well.” No dramatic change in mix from physical to digital. This is a good thing, since catalogue is so profitable. Physical retailers getting better at milking catalogue, too. Edgar on games: Enormous opportunity, and proves we have future busienss in non-traditional formats. But we have to be very careful that we do not allow an eco-system to occur where we do not get compensated properly. Like what happened with MTV, and now with Apple. And now [game developers] Activision and Harmonix [owned by Viacom] are in the same place. Amounts being paid to music industry for downloads, etc. “far too small”. Industry needs to participate much more fully. If that does not become the case, “we will not licence to those games.” Very small licence fee per song, plus additional revenue if artist involved. But royalties far below what true value is.
Trying to get head around access business/mobile business (like Nokia program). Big opportunity. Gets us into India, China, and at “very significant” margins. Model has yet to be introduced, has yet to be proven out, but “potentially very good news”. But we’ll have to see how that works.
We cutting back on physical distribution, increasing digital distribution (obviously). Now have “signifcant assets” redeployed.
On Sony/BMG deal: What do you think of $1.8 B valuation for that company? That was a private transaction. Still not sure what actual payments are, or what OIBDA is. But analysis that have been done and multiples are way too low (ie we think Rich Greenfield is wrong- Sony deal doesn’t devalue us).
Here’s Ingrid Chung! (WMG guys gritting their teeth): How is Amazon doing with MP3 store? “It’s early, but it’s encouraging” Amazon attacking a different customer base than Apple. So sales are incremental. [We’ve been hearing this from other music players, too]
What are chances that dividend is coming back? No direct answer. But we’re most interested in reducing net debt. So read between lines.
Recession affect on music sales? Don’t want to say we’re in recession. But whatever you call it, we think we ‘re in pretty good shape, especially as trend becomes moere digital. Don’t see material impact.
What about losing big artists to Live Nation (Madonna, NIckleback, etc) and the like? We didn’t keep those guys because the deals didn’t make sense. “We don’t pay retail.” That’s not going to change. We’ll do smart deals with up and coming artists. When it’s time to renew, if the price is too high, we’ll pass.
Revenue: $848 million ($795 million net of Forex), up 5% y/y, vs. $769 million consensus. Excluding Forex, a 1.1% decline, which by music business standards is good. Domestic revenue down 6.5%; International up 17.2% but 3.6% net of Forex.
EPS: Loss of 6 cents per share, an improvement over the 11-cent loss last year, and way better than consensus of 18-cent loss. Checking now to make sure we’re not missing one-time benefits.
Operating income: $51 Million, up 10.9% y/y; margin improved by 0.3%.
FCF: $93 million, up from $57 million a year ago. A healthy improvement and an important onegiven WMG’s debt covenant concerns.
Digital revenue: $166 million (about 20% of total revenue) up 39% y/y and 1% from Q2.
Recorded music: Revenue up 5.1%, down 1% net of currency benefits. Europe up, everywhere else down. U.S. digital recorded revenue now represents 31.7% of total us. recorded revenue. Operating income flat.
Publishing: Revenue up 7%, down 0.6% net of currency benefit. Flat domestically, up 11.1% internationally but down 1.1% after Forex. Digital contributions much smaller – just 6% of total revenue. This one is pretty straightforward: Decreases from CD sales just about equallying increases in performance revenue, sync rights (commercials, TV and movie licensing) and digital. Operating income down 16.7%, though.
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