Record Industry Is Suddenly a Smash Hit : Fueled by Boom in Compact Discs, Firms’ Fortunes Have Soared

When Laurence A. Tisch became the largest shareholder in CBS Inc. in October, 1985, the company valued its CBS Records Group at about $500 million. For the past several months, Tisch--now president and chief executive of the company--and the rest of the CBS board have debated whether to sell the record division to Sony Corp. for a reported $2 billion.

What a difference a couple of years have made in the record business. Fueled by booming sales of compact discs, which carry higher prices and healthier profit margins than cassettes or LPs, the U.S. record industry is currently enjoying the headiest days in its history. CBS Records is expected to report 1987 pretax profits of as much as $200 million, up from $22 million just five years ago.

It’s not just industry leader CBS; nearly every major label is reporting record or near-record profits. According to Mark Riely, an analyst for the new York investment firm of Eberstadt Fleming, “the devaluation of the dollar in relation to European currencies has made earnings of international record companies stated in U.S. dollars much higher. Most of the artist royalty payments of CBS or Warner are lower because Madonna and Michael Jackson get paid in U.S. dollars. All this boosts profits.”

With those profits has come a dramatic increase in the perceived value of the companies. Last week, for example, N. V. Philips of Holland announced that it plans to sell 20% of its Polygram Records division in a stock offering that could raise as much as $270 million, which would set a market value on the whole company of $1.35 billion. Just three years ago, Polygram was considering quitting the U.S. record market, and the whole company was on the sales block for less than $100 million.

“There’s no doubt about it, the record business is very sexy and glamorous to the financial community these days,” said Geffen Records Chairman David Geffen. “Until recently, it was inconceivable that anyone would offer $2 billion for a record company, or that someone might turn that offer down. Now people are finally seeing the hidden worth of these companies.

“Right now you have two record companies--CBS and Warner--that are making more money than any TV network, more than any movie studio, and with less risk than any other entertainment business,” Geffen said.

That’s why, experts say, record companies are becoming the prime acquisition target in the entertainment business. The problem is there are only five record companies with their own international distribution systems, and all are already owned by large entertainment conglomerates--CBS, Warner, Polygram, Bertelsmann (formerly RCA) and Capitol Industries-EMI. MCA, the smallest of the so-called Big Six U.S. record distributors, does not distribute its own product overseas.

According to Capitol Records President Joe Smith, “the various players who could benefit from having a record company--either a movie company or a hardware manufacturer like Sony--when they think about starting one, they realize it can’t be done. You can’t build another CBS or Warner or Polygram.”

(In fact, the last successful entry into U.S. record distribution was Polygram in 1969, and the company reportedly sustained losses of nearly $300 million before its recent turnaround.) “You cannot go out and buy an artist roster,” Smith said. “Even if you went to Bruce Springsteen and offered him $100 million an album, he wouldn’t be available for five years.”

Comparison to Real Estate

As a result, buying a record company is “like (buying) Beverly Hills real estate,” Smith said. “The agent says, ‘This is what the property is really worth, but they won’t sell it to you at that price, so this is what you’ll have to pay.’ ”

It remains to be seen how much Sony is willing to pay to acquire CBS Records. CBS’ statement following its board meeting Wednesday left open the possibility that it may yet sell the record division to the Japanese firm at an even higher price.

That prospect disturbs most record industry executives, who see Sony’s bid as a back-door way of introducing its dreaded digital audio tape technology, or DAT, into the U.S. market.

Fearing that the near-perfect recording quality of DAT will undermine the recent success of the compact disc and result in millions of dollars in losses from home taping and counterfeiting, the major record companies have been fighting the introduction of DAT by, among other things, refusing to license their music for use on DAT cassettes.

CBS Records has been at the forefront of opposition to DAT.

However, a Sony-owned CBS Records could be expected to quickly license all of CBS’ music for DAT use, eventually forcing the other companies to follow suit.

“If Sony doesn’t buy CBS, DAT may never come in,” Geffen said. “Who would buy the machine if they can’t buy the software?” Still, Geffen admitted, “there’s a price at which any record company can be bought.”

If Sony pays that price, the entire landscape of the record business could be altered.

Other companies, fearing the impact of DAT and seeing the high valuations placed on their record operations, could decide to take the money and run.