Warner Music Shines in Digital Sales

Warner Music Group said Friday that it lost money in its fiscal second quarter, but the company beat Wall Street expectations and showed substantial growth in digital music sales.

The results bolster the company’s case that it is worth more than the $4.2 billion it turned down this week from suitor EMI Group.

New York-based Warner, the world’s fourth-largest music company, said it lost $7 million in the three months ended in March, contrasted with a $4-million profit a year earlier, when it had a one-time gain from the sale of some assets.

Warner reported increased sales of CDs and digital recordings, with overall revenue rising 4% to $796 million. The company’s top-selling artists include singers James Blunt, Madonna and Tim McGraw.

Warner’s strongest growth was in digital sales, which increased to $90 million during the quarter, or 11% of total revenue.

“Digital growth is finally offsetting declines in the industry’s physical sales,” said Laura Martin, an analyst at research firm Soleil-Media Metrics. “Everyone has been waiting for a signal that the online market has fully arrived. This might be it.”

Warner did sound a sour note by reporting a 16% decline to $129 million in publishing revenue -- the royalties for songs used in films, video games and commercials.

But overall, analysts were impressed.

“The good story here is that they increased both physical and digital revenues,” said Bishop Cheen, an analyst at Wachovia Securities, which owns some of Warner’s bonds. “People will pay for good albums, and Warner had some exceptional releases last quarter.”

The company’s loss of 5 cents a share was cheered by Wall Street, which on average had expected a loss of 16 cents a share, according to a consensus estimate compiled by Thomson Financial. Warner’s stock rose 66 cents to $29.40 on Friday.

The better-than-expected results come at a delicate time for Warner. Company directors Tuesday rejected the $28.50-a-share offer from London-based EMI.

Since then, Wall Street has been rife with rumors that EMI will raise its bid, or that Warner may make a counteroffer.

Warner’s strong numbers indicate that EMI may have to substantially increase its offer, probably to at least $30 a share, some analysts said. Some of Warner’s largest owners -- private equity investors and Chairman Edgar Bronfman Jr. -- have indicated that they are hoping to sell at $32 to $35 a share, or as much as $5.2 billion.

But Bronfman has said the company’s board is under no pressure to make a deal, telling a New York audience Thursday that “consolidation for consolidation’s sake doesn’t make a lot of sense.”

EMI has tried to merge with or acquire Warner twice before in the last six years.

Analyst Cheen cautioned that EMI executives needed to watch what they spend.

“If EMI pays too much for Warner, they are going to have a really hard time getting high returns on their investment,” Cheen said.

Observers have said that a combined company could achieve a $200-million to $300-million increase in cash flow by shedding unnecessary positions and combining departments. But Warner already fired more than 1,000 employees after the Bronfman-led group purchased the company for $2.6 billion in 2004. EMI also has been cutting costs for years.

“It’s supposed to be ‘buy low, sell high,’ ” Cheen said. “Not ‘buy high and pray that you can find a whole bunch of people to fire after the companies have already been firing people for years.’ ”

EMI will release fiscal-year results this month.

EMI said last week that it expected to report an almost 4% increase in revenue and a 12% gain in pretax earnings.

A Citigroup analyst estimated EMI’s full-year sales at about $3.7 billion.