MUSIC TO WARNER’S EARS : Profit from Records Unit, the Industry Leader, Far Outstrips High-Profile Movie Division

In the auditorium at the New York headquarters of Time Inc. last week, a group of Wall Street financial analysts met with the three men who plan to run the largest media and entertainment conglomerate ever put together.

For about two hours, the analysts questioned Steven J. Ross, chairman of Warner Communications, Time Chairman J. Richard Munro and Time President Nicholas J. Nicholas Jr. about the proposed merger of their companies into Time Warner. Most of the questions focused on the likely impact of the deal on the magazine publishing, television, movie and video businesses.

“But Ross kept talking about the record business,” recalled one analyst present at the meeting. “He took the occasion to point with great pride to how well Warner’s record division was doing; he went on and on bragging about his record guys.”

Ross has reason to boast:

In each of the past two years, Warner’s recorded music division has earned more money than the higher-profile filmed entertainment division, posting pretax operating profits of $319 million in 1988 to the movie division’s $203 million. The record operations accounted for 52% of Warner’s revenue in 1987 and 45% in 1988.

“The record division is the engine of the whole company, and it’s a huge cash generator,” said Fred Anschel, an analyst for the New York investment firm of Dean Witter Reynolds.

Warner’s major record labels--Warner Bros., Elektra/Asylum, Atlantic and Geffen--currently dominate their competitors to an extent that is unprecedented in the history of the recording industry.

Last week’s issue of Billboard magazine offers dramatic evidence: Warner-owned or distributed record labels account for eight of the top 10 best-selling albums and tapes, 24 of the top 40, 44 of the top 100 and 75 of the top 200. Since the top 20 recordings account for the bulk of sales, for the moment, at least, it appears that Warner’s current share of record sales in the United States may exceed 50%.

“It’s amazing what’s happening, just amazing,” said RCA Records President Bob Buziak. “They’re gobbling up market share like Pac Man.”

Indeed, over the previous 15 years, Warner’s market share fluctuated between 20% and 25% in a perennial teeter-tottering fight with CBS Records for first place. However, since CBS was purchased by Sony Corp. for a record $2 billion in January, 1988, Warner has blown past its archrival. The company’s 1988 domestic record revenue of $1.05 billion nearly doubled those of CBS, which grossed about $650 million for the year, according to sources. Warner’s profit margins, too, are twice that of CBS, 16% to 8%.

Could Be Understated

Some experts say Warner’s record earnings are actually larger than what’s reflected in the company’s annual report.

“It could be close to $400 million (in operating profits) for 1988,” said Geffen Records Chairman David Geffen, citing the company’s “extremely conservative accounting practices” as the reason for the understatement.

“Warner has nothing capitalized,” Geffen said. “If they build a plant, they write it off immediately. When they record an album, the cost is written off that day, whereas other companies will amortize the cost.”

According to Lisbeth Barron, an analyst for McKinley Allsopp Securities in New York, Warner also maintains on its books a reserve for returned or unsold records that is “very, very high; nearly double what the actual returns are. And that helps understate their earnings.”

“This is definitely a division that hasn’t gotten the attention it deserves,” Barron said. “Revenues are soaring, and profit margins are skyrocketing. It’s probably more stable than the film division and certainly deserves equal billing and respect.”

The base of Warner’s success is a combined roster of more than 500 artists. “They have an incredible breadth of talent, from blues to jazz to country to rock,” Barron said.

The company also has what is generally considered to be the most talented and stable management team in the industry.

“The Warner labels are run by men who understand that the most important thing in this business is relationships, that you need to spend a certain amount of money to maintain those relationships,” Barron said. “(CBS President Laurence A.) Tisch didn’t get that. Steve Ross understands that better than anybody.”

Owns Other Labels

Ross built up Warner’s record operation by acquisitions. In 1969, his Kinney System, New York’s largest parking lot concern, took over the Warner Bros. and Atlantic record labels as part of its purchase of the financially troubled Warner Bros.-Seven Arts movie studio. Ross acquired Elektra Records in 1970 from its founder, Jac E. Holzman, who still works for Warner as the company’s chief technologist. Ross acquired Asylum Records in 1974 from its founder, David Geffen. Established in 1981, Geffen Records is 100% owned by Geffen and distributed by Warner in return for a 50% share of its profits, a deal that runs through the end of 1990.

In addition to the four major companies, Warner owns several smaller labels, including Sire, Reprise and Atco. The labels are distributed through two subsidiaries, WEA Distributing in the United States and London-based WEA International overseas. The U.S. subsidiary also distributes for independently owned Virgin Records and Island Records. With performers such as U2 (Island) and Steve Winwood (Virgin), the two labels contributed an estimated $100 million to Warner’s revenue in 1988. WEA International also handles the distribution of MCA Records outside the United States and Canada.

Warner’s music division operates the largest music publishing catalogue in the world, Warner Chappell Music, which holds the copyrights to nearly half a million songs. Warner also owns Ivey Hill, one of the largest manufacturers of record jackets and cassette labels in the United States.

By all accounts, Ross’ hands-off approach to managing his company’s various divisions has worked particularly well in the historically cyclical and unpredictable record business.

“It’s always been the philosophy of Warner corporate management to allow all decisions to be made at the division level,” said Joe Smith, the president of Capitol-EMI Music, who spent 23 years in the Warner organization, including a stint as chairman of Elektra/Asylum from 1976 to 1983.

Great Independence

“There is reporting on a periodic basis through the labels’ financial officers, and very expensive artist deals have to have some corporate clearance,” Smith said. “But other than that, there’s very little contact between the division heads and the corporate structure.”

“We are given a completely free hand,” said Elektra/Asylum Chairman Bob Krasnow. “We run an enterprise that’s based on other people’s creativity, and our charge is to make judgments on what appeals to us. We all have our own unique vision, and our companies always reflect that uniqueness.”

Although Krasnow said Warner corporate management is “absolutely invisible” in the daily running of his company, he cited the company’s vast international distribution system as a big factor in Elektra/Asylum’s success. “We live in a world where distribution is most important,” he said. “There’s our distribution system, and then there’s everyone else.”

Warner’s distribution system is the muscle behind the company’s success. “It’s awesome what they can do,” said RCA’s Buziak. “With their huge branch and field operations marketing to retailers, they can take a young act with no radio air play and sell over 200,000 albums.”

The men who run the Warner record companies come from the same mold--independent and entrepreneurial, with a strong affinity for the quirky, creative side of the business. “It’s a very artist-friendly group,” said one competitor.

Krasnow, 54, is the newest member of the team, having worked for Warner since 1975. Before that he founded two record companies--Loma in 1964, under the auspices of Warner Bros. Records, and Blue Thumb Records in 1968, which he sold in 1974. He took over the then-faltering Elektra/Asylum in 1983 and quickly turned it into one of the most successful labels in the industry. Elektra/Asylum has more than doubled its revenue in the past two years, to about $170 million last year from $80 million in 1986.

Pioneer in Business

Elektra/Asylum’s recent track record for discovering and launching such eclectic new artists as Anita Baker, Tracy Chapman and the Gipsy Kings has earned Krasnow a reputation as “the best ears in the business.”

Ahmet Ertegun, 64, has been at the helm of Atlantic Records since he founded the company in 1947. The son of a former Turkish ambassador to France, England and the United States, he is regarded as one of a handful of true pioneers in the record business, having helped launch the recording careers of Ray Charles, the Drifters, Bobby Darin, Aretha Franklin, Buffalo Springfield, Led Zeppelin and Cream.

After weathering some lean years in the early 1980s, Atlantic has caught fire recently, increasing its revenue to nearly $200 million in 1988 from about $140 million in 1986.

Mo Ostin, 62, has been the chief executive of the flagship Warner Bros. Records since 1970. More than any other Warner executive, he is credited with engineering the corporation’s emergence as a worldwide distribution power.

Publicity-shy in the extreme, he rarely grants interviews to the press, and his company biography hasn’t been updated since 1973. An accountant by training and distinctly conservative in style, he is nonetheless revered in the rock artist community. Among the more flamboyant performers Ostin has signed are the Mothers of Invention, Jimi Hendrix, the Fugs, Alice Cooper and Jethro Tull. Under Ostin, Warner Bros. has remained consistently profitable, even during the industry’s bad years. Since 1986, the company’s revenue has risen from about $270 million a year to nearly $350 million.

David Geffen, 45, is perhaps the most independent-minded of all the Warner label heads, a stance no doubt encouraged by a personal fortune of $240 million, as estimated by Forbes magazine. Considered one of the savviest players in all of show business, his David Geffen Co. also produces movies (“Risky Business,” “Beetlejuice”) and Broadway plays (“Dreamgirls,” “Cats”).

Century of Experience

Since 1981, Geffen Records has grown from three employees to more than 100. Revenue has increased to about $100 million in 1988 from $40 million in 1986. The company currently has three albums in the top 10.

All together, the four label chiefs have logged nearly 100 years of experience in the Warner organization, a stunning statistic in the notoriously itinerant record business. “It’s a credit to Steve Ross’ genius that he’s managed to keep these people for so long,” said Geffen. “People don’t leave Warner to go elsewhere; there’s no step up from here.”

Overseeing the activities of these four headstrong executives--as well as 8,000 other record division employees worldwide, is Robert Morgado, 37, a corporate executive vice president whose three years as head of the records group coincides with the division’s dramatic growth.

“Morgado deserves more credit than he’ll ever get publicly because his style is so low-key compared to the others,” said a colleague.

“We do have personalities out there,” Morgado said. “My job is to keep creating the environment in which they can perform.

“You have to encourage the spirit of independence, but the bottom line is, you can’t let chance totally guide the outcome,” he said. “You have to create a collective whole. The pieces have to add together, the investments and attitudes have to mesh, and you have to have a corporate strategy that makes sense.

“I’m not involved in the day-to-day acquisition of talent--that’s their job. The day-to-day acquisition of companies, that’s my job, creating values and assets.”

For example, Morgado directed the 1987 purchase of Chappell music for a reported $250 million. Merged with Warner Music’s already huge song catalogue, “we have an asset that has since doubled in value to nearly $1 billion,” he said. Warner also recently purchased Teldec, a West German record company specializing in classical music, an area in which Warner traditionally has had very little business. However, Morgado predicts that “by this time next year we will have 15% of the classical market.”

Lately, Morgado has been focusing his attention on the international market, where the music division earns about half of its $2 billion in annual revenue.

“The success you’re seeing in this country is being replicated overseas in even more dramatic form,” Morgado said. “Three years ago, we were the No. 3 or No. 4 company overseas. Now, except for Japan, we are at the moment the No. 1 company.”

WARNER REVENUE

Industry estimates of labels’ revenue in millions of dollars. Elektra/Asylum 1986: 80 1987: 110 1988: 170 Geffen 1986: 40 1987: 85 1988: 100 Warner Bros. 1986: 270 1987: 320 1988: 330 Atlantic 1986: 140 1987: 145 1988: 200