27
Dec
16

Warner Music Group in the Digital Paradigm Shift

On December 8, Warner Music Group (WMG) released the annual report for the financial year 2016 ending on September 30, 2016 reporting the highest revenue of US$ 3.25bn since Access Industries has acquired WMG in 2011. WMG also reported its best profit performance – measured in operating income before depreciation and amortization (OIBDA) – of US$ 507m since 2006. For the first time after Access Industries’ takeover, WMG will pay a dividend of US$ 54m to its shareholders (WMG 2016: 110). Those key facts indicate a healthy business performance of the smallest music recording major company in the digitalised music industry. Thus, the following analysis highlights the causes for WMG’s economic recovery and the re-structuring of its business model.

 

Warner Music Group in the Digital Paradigm Shift

A short history of Warner Music Group in the digital era

In the same year, when WMG was acquired for US$ 2.6bn by The Investor Group led by Edgar J. Bronfman Jr. from the Time Warner conglomerate, Apple launched the iTunes download shop rewriting the rules of the recorded music business. The new owners of Warner Music Group immediately anticipated the shift from a record driven to a digital music business by selling CD and DVD manufacturing (WEA Manufacturing Inc. und die Warner Music Manufacturing Europe GmbH), packaging (Ivy Hill Corporation) and Giant Merchandising for US$ 1.1bn to Cinram. Only the sales and marketing operations of WEA Corp. remained a part of Warner Music Group (WMG 2005: 10). WMG continued its cost cutting strategy by selling Warner/Chappell’s subsidiary Warner Bros. Publications that conducted Warner’s sheet music business to Alfred Music Publishing in 2005 (WMG 2006: 50).

The divestments strengthened Warner’s financial structure and enabled investments in recorded music and music publishing companies. In 2004, WMG acquired a 30 percent interest in Maverick Records for US$ 17m, in which WMG already owned a 50 percent stake (WMG 2005: 104-105).[1] A year later, WMG bought a 50 percent stake in US rapper Sean Combs’ (aka Puff Daddy) Bad Boy Records for US$ 30m and made an investment of US $9 million to acquire a 15 percent interest in Irving Azoff’s Front Line Management (WMG 2005: 104-105). In May 2006, EMI proposed to buy WMG, but the bid of US$ 4.2bn was rejected by WMG’s owners.[2] A month later, WMG launched a counter-bid to buy EMI for US$ 4.6bn, but this time EMI’s key shareholders rejected the rival’s offer[3] and sold EMI a year later to the private equity company Terra Firma. When Warner’s strategy failed to merge with EMI to a recorded music major in the size of its competitors Universal Music Group and Sony-BMG, it continued to enlarge its music catalogues. In May 2006, WMG purchased Ryko Corporation for US$ 67.5m, including Rykodisc with a record catalogue of more than 1,000 titles (e.g. of Frank Zappa) and Ryko Distribution (WMG 2006: 104). In the same year WMG also acquired the remaining 20 percent interest in Maverick (ibid: 105) and a stake in the heavy metal recorded music company Ferret Music[4]. WMG continued its acquisitions’ strategy in 2007 by purchasing a 73.5 percent stake in the hard rock and heavy metal label Roadrunner Records (e.g. Nickelback and Slipknot) for US$ 65m (WMG 2007: 69). WMG paid further US$ 51 for the music production library Non-Stop Music, a video production company in the UK and a digital distribution company in Germany (Zebralution) (ibid: 10, 69). It also acquired an additional equity interest in Front Line Management for US$ 110m (WMG 2007: 69). The stake in Front Line Management was sold to Ticketmaster for US$ 123m a year later (WMG 2009: 100). In November 2007, WMG bought a 50 percent interest for US$ 50m in Frank Sinatra Enterprises that administers licenses for use of Frank Sinatra’s brand (ibid: 99).

In 2007, WMG also invested in the music streaming and music sharing site Imeem as well as in online retailer and music discovery site Lala.com. (WMG 2007: ii). However, the companies did not performed in the way than expected. Imeem, which was the first ad-supported music streaming service fully licenced by all major labels,[5] failed to secure sufficient funding by venture capitalists and got in serious financial troubles. WMG had to write off its entire US$ 16m investment in Imeem in 2009 (WMG 2009: 58). Subsequently Imeem was sold for not even US$ 1m to MySpace, which shut down the service after the acquisition.[6] Also in 2009, WMG had to write off US$ 11m of its investment in Lala.com (ibid). Lala.com was initially founded to trade used CDs, but shifted to a music locker service allowing registered users to upload their MP3 files for further streaming and sharing playlists. In December 2009, Apple purchased Lala.com for US$ 9m (WMG 2011: 72), but shut the service down half a year later.[7]

In 2010, WMG doubled the size of Warner/Chappell’s music production business by acquiring Groove Addicts Production Music Library in the US and Carlin Recorded Music Library in the UK for a combined sum of US$ 46m (WMG 2010: 101). Later in that year, Southside Independent Music Publishing was acquired by an earn-out worth US 6m (ibid: 181). WMG also bought the remaining stake in Roadrunner Records for US$ 21m (ibid: 100).

On July 20, 2011, the takeover of Warner Music Group by an affiliate of Access Industries was completed. Therefore, WMG had to buy back shares worth of US$ 1.278bn from the stock market to secure 100 percent equity ownership of WMG by Access (WMG 2012: 73). Backed by the new owner, WMG bid for those EMI labels, Universal Music Group had to sell according to the provisions made by the EU Commission. On July 1, 2013 the acquisition of the Parlophone Label Group (PLG) for £ 492m was completed (WMG 2014: 38). Thus, the historic Parlophone label, Chrysalis and Ensign labels as well as EMI and Virgin Classics, but also EMI’s recorded music operations in Belgium, Czech Republic, Denmark, France, Norway, Poland, Portugal, Slovakia, Spain and Sweden became part of WMG (WMG 2013: 3).

 

Figure 1: Major investment and divestment activities of Warner Music Group, 2003-2016

figure-1-major-investment-and-divestment-activities-of-warner-music-group-2003-2016Source: Warner Music Group annual reports, 2004-2016.

 

WMG’s investments and divestures reflect a shift from physical to digital by enlarging recorded and publishing music rights catalogues and selling pressing facilities and physical distribution networks. The new owners of WMG outlined a digital music strategy already in the 2005 annual report: “[W]e believe digital distribution will stimulate incremental catalog sales given the ability to offer enhanced presentation and searchability of our catalog.” (WMG 2005: 6). Whereas the digital strategy initially aimed at selling ringtones and music downloads, the focus shifted towards music streaming in 2010 by pointing at the growing relevance of YouTube and US music streaming service Pandora (WMG 2010: 3). In the 2012 annual report music streaming was explicitly mentioned as a “significant promise and opportunity for the music industry” (WMG 2012: 4).

 

Warner Music Group’s financial performance, 2001-2016

The financial figures perfectly reflect the shift from a physical to a digital recorded music business. For the first time in 2005, digital recorded music sales of US$ 137m were reported. Eleven years later digital sales have been increased more than tenfold to US$ 1.364m mainly driven by music streaming revenue.[8] Digital revenue has also significantly increased in Warner Music’s music publishing business – from US$ 20m in 2005 to US$ 141m in 2016. Thus, the revenue mix has diversified for the recorded as well as publishing business. Whereas digital sales accounted for 4.7 percent of the total recorded music revenue as well as the total publishing revenue in 2007, the digital share increased to 50 percent for recorded music in 2016 and 27 percent for publishing respectively.

The introduction of expanded rights deals with artists – so-called 360° deals – also improved WMG’s revenue performance. Thus, the income from artist services and especially concert promotion revenue have increased the overall recorded music revenue since 2012 (WMG 2016: 50). In the 2012 annual report the expanded rights deals are praised as one of the means to compensate for declines in physical sales: “We believe that additional revenue from these revenue streams will help to offset declines in physical revenue over time. As we have generally signed newer artists to these deals, increased expanded rights revenue from these deals is expected to come several years after these deals have been signed as the artists become more successful and are able to generate revenue other than from recorded music sales. (…) Revenue from our management business and revenue from sponsorship and touring under expanded-rights deals are all high margin, while merchandise revenue under expanded-rights deals and concert promotion revenue from our concert promotion businesses tend to be lower margin than our traditional revenue streams.” (WMG 2012: 51).

After a continuous decrease of total revenue by 20.9 percent from 2006 to 2012, growing digital sales (especially in the streaming segment), expanded rights deals and the purchase of EMI’s Parlophone Label Group in 2013 the revenue performance improved. The revenue increased by 16.8 percent from 2012 to 2016 almost compensating for the prior revenue decline.

 

Figure 2: WMG’ revenue performance, 2001-2016

figure-2-wmg-revenue-performance-2001-2016Source: Warner Music Group annual reports, 2005-2016.

 

Figure 3: WMG’s recorded music revenue and music publishing revenue, 2005-2016

figure-3-wmgs-recorded-music-revenue-and-music-publishing-revenue-2005-2016Source: Warner Music Group annual reports, 2005-2016.

 

Figure 4: WMG’s recorded music revenue and music publishing revenue shares, 2007 and 2016

figure-4-wmgs-recorded-music-revenue-and-music-publishing-revenue-shares-2007-and-2016Source: Warner Music Group annual reports, 2007 and 2017.

 

When the Investor Group acquired Warner Music Group from AOL Time Warner, the music segment was deep in red figures. WMG reported a negative operating income of -766m in 2001, -1.5bn in 2002 and -1.2bn in 2003. The AOL Time Warner annual report of 2002 ascribed the loss to impairments of goodwill (US$ 646m) due to the failed merger of AOL with Time Warner in 2000 as well as to a reduction of brand and trademark value in the music segment (US$ 853m). The new owners, however, attributed the impairment of goodwill and other intangible assets of US$ 1.0bn in 2003 and 2004 to “(…) declines in the valuation of music-related businesses due largely to the industry-wide effects of piracy and were recorded in November 2003.” (WMG 2005: 43). Whatsoever caused the high impairments of goodwill, the operating income recovered after selling the manufacturing facilities and physical distribution networks. In 2005, the operating income was positive after years of losses and remained in the profit zone in the following years. The 2006 annual report states: “The restructuring plan included the consolidation of our Elektra Records and Atlantic Records labels, rationalization of our global network, dropping approximately 30% of our artist roster and an approximately 20% reduction in our global workforce.” (WMG 2006: 3).

 

Figure 5: WMG’s profit performance (operating income), 2001-2016

figure-5-wmgs-profit-performance-operating-income-2001-2016Source: Warner Music Group annual reports, 2005-2016.

 

The cost structure also improved by shifting from physical to digital as the 2012 annual report pointed out: “Due to the absence of certain costs associated with physical products, such as manufacturing, distribution, inventory and returns, we continue to experience higher margins on our digital product offerings than our physical product offerings.” (WMG 2012: 3). The profit margins, therefore, increased with the ongoing digitization of the music business.

 

Figure 6: Revenues and total cost of WMG, 2001-2016

figure-6-revenues-and-total-cost-of-wmg-2001-2016Source: Warner Music Group annual reports, 2005-2016.

 

Although the acquisitions of recorded music labels and music publishers worsened the cost structure again, the rise of music streaming increased the profits. Despite the purchase of the Parlophone Label Group (PLG), WMG reported the highest ordinary income before depreciations and amortizations (OIBDA) for 2016 since ten years.

A closer look at the cost performance of the WMG unveils decreasing artist & repertoire expenses in the recorded music segment as well as overall selling and marketing expenses by 31 percent from 2005 to 2011.

 

Figure 7: The cost of revenue in the recorded music segment, 2005-2016

figure-7-the-cost-of-revenue-in-the-recorded-music-segment-2005-2016Source: Warner Music Group annual reports, 2005-2016.

 

Figure 8: The overall selling, general and administrative costs, 2005-2016

figure-8-the-overall-selling-general-and-administrative-costs-2005-2016Source: Warner Music Group annual reports, 2005-2016.

 

Conclusions

The analysis of Warner Music Group (WMG) unveils a paradigmatic shift in the recorded music business model from physical to digital music sales. WMG sold its manufacturing facilities and physical distribution channels so improve its cost structure by focusing on the acquisition of recorded music and publishing catalogues. WMG has also cut A&R costs and traditional selling and marketing costs by a third. At the same time WMG benefitted from the booming music streaming licensing its vast music catalogues to digital music service providers in exchange for a certain controlling stake in music streaming services such as Spotify. Thus, WMG has regained control in the distribution of (digital) music. Further, WMG does not rely anymore on the traditional business model on investing in a broad portfolio of unproven artists hoping to recoup the investments by the success of a few of them. Nowadays WMG only signs artists if they have proven their market value by successful releases backed by a considerable fan-base. WMG has – to a certain degree – outsourced the risk of A&R failures to the crowd.

It seems that nothing has changed in the recorded music industry. We have three well-known major music companies that control the production, distribution and marketing of music. A closer look unveils, however, a totally different business model. The WMG of the year 2000 is a very different company than the WMG of the year 2016. It is not just owned by a global investment funds (Access Industries), but was rebuilt from a company manufacturing and selling CDs to a conglomerate of music catalogues that are licensed to digital music service providers. To put it in a nutshell: WMG is a large and globally acting licensing agency for recorded music and publishing rights.

 

Sources

AOL Time Warner, 2002, Annual Report of AOL Time Warner Inc. for the fiscal year ended December 31, 2002.

Warner Music Group (WMG), 2005, Annual Report of Warner Music Group for the fiscal year ended September 30, 2005.

Warner Music Group (WMG), 2006, Annual Report of Warner Music Group for the fiscal year ended September 30, 2006.

Warner Music Group (WMG), 2007, Annual Report of Warner Music Group for the fiscal year ended September 30, 2007.

Warner Music Group (WMG), 2008, Annual Report of Warner Music Group for the fiscal year ended September 30, 2008.

Warner Music Group (WMG), 2009, Annual Report of Warner Music Group for the fiscal year ended September 30, 2009.

Warner Music Group (WMG), 2010, Annual Report of Warner Music Group for the fiscal year ended September 30, 2010.

Warner Music Group (WMG), 2011, Annual Report of Warner Music Group for the fiscal year ended September 30, 2011.

Warner Music Group (WMG), 2012, Annual Report of Warner Music Group for the fiscal year ended September 30, 2012.

Warner Music Group (WMG), 2013, Annual Report of Warner Music Group for the fiscal year ended September 30, 2013.

Warner Music Group (WMG), 2014, Annual Report of Warner Music Group for the fiscal year ended September 30, 2014.

Warner Music Group (WMG), 2015, Annual Report of Warner Music Group for the fiscal year ended September 30, 2015.

Warner Music Group (WMG), 2016, Annual Report of Warner Music Group for the fiscal year ended September 30, 2016.

 

Endnotes

[1] Maverick Records initially was a joint venture between pop superstar Madonna, her then manager Frederick DeMann, entertainment lawyer Veronica “Ronnie” Dashev and WMG’s former parent company Time Warner. In 1999, Frederick DeMann was bought out by Madonna’s new manager Guy Oseary. In March 2004, Madonna and her business partners filed lawsuit against WMG and Time Warner claiming mismanagement, which WMG answered with a countersuit. In June 2004, the lawsuits were settled by the purchase of Madonna’s and Dashev’s shares in Maverick to WMG, which resulted in the increase of WMG’s stake in Maverick to 80 percent (see Los Angeles Times, “Madonna to Sell Stake in Label to Warner Music”, June 15, 2004).

[2] BBC News, “Warner Music throws out EMI bid”, May 3, 2006.

[3] BBC News, “EMI rejects Warner takeover bid”, June 28, 2006.

[4] WMG press release: “Independent Label Group (ILG) Announces Partnership With Ferret Music”, August 7, 2006.

[5] Wired, “Imeem Signs Deal with Universal. Now Streams All Four Major Labels for Free”, December 10, 2007.

[6] Wired, “MySpace Music Acquired Shuttered Imeem Music Service”, August 12, 2009.

[7] Techcrunch, “Apple To Shut Down Lala On May 31”, April 29, 2010.

[8] Music Business Worldwide, “Streaming drives Warner Music’s biggest annual revenues in 8 years”, December 8, 2016.

 

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