At Warner Music, cuts go deep
The folks at Warner Music Group Corp. are doing more than cutting records these days. They’re also cutting jobs.
In the year since Warner Music Chief Executive Edgar Bronfman Jr. and his fellow investors bought the once-venerated company, they have eliminated 1,600 positions, pared wages, slashed investments in new artists, shut offices and quadrupled employees’ health insurance premiums.
The reason: They’ve been getting the company ready for Wall Street. On Friday, Warner filed papers to raise as much as $750 million through an initial public offering of stock, ending months of speculation about the company’s future.
The cost-cutting campaign appears to have improved Warner Music’s bottom line, at least in the short term. Net income for the three months ended Dec. 31 rose to $36 million, contrasted with a loss of $1.1 billion for the same period a year earlier, the company reported.
The New York-based company -- which consists of the Atlantic, Elektra and Warner Bros. labels as well as Warner/Chappell publishing -- also predicted that a sweeping restructuring plan would yield $250 million in annual savings.
But at what cost?
Some analysts and music industry insiders caution that Bronfman and his co-investors -- chiefly Thomas H. Lee Partners, the second-biggest leveraged buyout firm in the world -- may be cutting too close to the bone.
“They do run the risk of jeopardizing the future,” said Tom Taulli, co-founder of CurrentOfferings.com, an IPO research firm in Newport Beach. “That may not matter if you’re investing for the short term, but if you’re looking out three or four years, it’s something to think about.”
More broadly, the impending Warner Music IPO is being touted by some as a referendum on the viability of the music industry.
Though a successful IPO wouldn’t by itself improve the fundamentals of the industry -- music companies have seen their margins eroded by technology, piracy and changing consumer habits -- it would signify a vote of confidence from Wall Street.
“The view of the people taking the company public is that this is an industry two-thirds of the way through its transition, and on the other end it’s a growth industry again,” said Henry Ellenbogen, media analyst at T. Rowe Price Group Inc. in Baltimore. “The results of the IPO will be a statement by U.S. investors on the future of the music industry.”
Representatives for Bronfman and Warner Music Group declined to comment. Thomas H. Lee, whose company is not only an owner but also has been hired to spearhead the restructuring, did not return calls.
After an IPO, Warner Music Group would be the only publicly traded pure-play music company based in the United States. The industry’s three other giants -- Sony/BMG, Vivendi Universal and EMI Group -- are headquartered overseas. The Warner Music talent roster includes rock band Green Day (which won a Grammy Award this year), ballad singer Josh Groban and rap diva Missy Elliott. Its catalog also is bursting with big names from the 1960s, ‘70s and ‘80s, including Led Zeppelin, Fleetwood Mac and Madonna.
In the documents filed Friday, Warner Music said it would use the IPO proceeds to pay down part of its $2.5-billion debt load and for general corporate purposes. Bronfman and his fellow investors have moved quickly to recoup their original outlay. In October, $350 million in “excess cash” was distributed to the group, which also includes Bain Capital and Providence Equity Partners. The investors also were paid the lion’s share of proceeds from $700 million in debt offerings floated in December. That prompted credit rating firm Standard & Poor’s to lower Warner’s outlook to “negative” from “stable” because it rewarded management at the expense of the company’s balance sheet.
Even Warner Music’s admirers in the investment community say that’s a problem.
“As a public investor, you would much rather see management and the private equity investors continue to have skin in the game,” said Ellenbogen, the Baltimore analyst.
Warner Music also is spending handsomely on salaries for its top executives. Bronfman earned $6.3 million in salary and bonuses last year. Lyor Cohen, the former head of Universal’s Island Def Jam group, snagged $8.3 million, including signing and restructuring bonuses and restricted stock awards. The company’s top five players reaped $23.2 million in 2004.
In addition, the investor group collected $75 million in transaction fees. The group is guaranteed $40 million more in fees over the next four years.
These sizable payments come at a time when cuts throughout the company have removed not just flab but muscle, according to some music industry insiders.
Investment in talent has dwindled in recent months, and artist representatives privately complain that the company has been slow in paying royalties and has failed to keep stores stocked with CDs in towns where Warner acts are on tour.
Some artists have cried foul. Chart-topping singer Kid Rock, who records for Warner’s Atlantic arm, cut ties last month with the corporation’s publishing arm, saying he was looking to partner with a company “more interested in music than IPOs.”
Sources also said Warner Music sharply reduced its artists-and-repertoire budget last year for new songwriters and unknown acts -- the inexpensive contracts that nurture young talent and help keep hits flowing into the pipeline. Moreover, the company has virtually ended its talent scouting in foreign territories, knowledgeable sources said.
In the music business, a company’s value is derived primarily from the strength of its published compositions and hit recordings. Hit songs make money by generating immediate profit at the time of their release and by becoming staples in a company’s catalog -- music that can be repackaged and resold to each new generation of consumers.
Sources say the cuts have been notable for their lack of sensitivity. Many senior Warner executives, for example, learned from news releases that they were losing their jobs.
A year ago, Bronfman dispatched Warner’s head of human resources to fire top managers and employees in Manhattan, Chicago and Los Angeles. Not long afterward, sources said, the human resources chief was reviewing an invoice from a headhunter that disclosed the name of his successor. That’s how he learned that he was being fired too.
Some analysts see the belt-tightening as overdue.
“The process ... isn’t pretty, but let’s face it, these companies tend to be bloated and inefficient,” said Larry Haverty, who helps run a media investment portfolio at Gabelli Asset Management Inc. in Rye, N.Y. As the music business becomes “less physical and more digital,” he added, it makes sense to employ fewer workers.
Warner’s share of current album sales in the U.S. music market has fallen to 13% from 23% in 1995, according to Nielsen SoundScan. Warner has fallen to third place from first among the world’s four biggest recording giants in sales of current albums in the U.S. Internationally, the company ranks last in most markets.
Once the dominant and most respected operation in the record business, Warner Music already had endured a decade of talent and staff cutbacks and falling sales when, last March, Bronfman and the consortium of private investors bought it from Time Warner Inc. for $2.6 billion.
The erosion had begun during the mid-1990s after a lengthy corporate blood bath forced the exit of nearly a dozen top executives. The corporation plunged deeper after the merger of its parent company, Time Warner, with America Online Inc. Then came the arrival of the free-downloading service Napster in 1999, which music companies say caused industry sales to plunge nearly 20%.
That provided an opening for Bronfman, who was eager to get back into the music business even though his previous venture had drawn mixed reviews. Universal Music Group, a corporation he built in the late 1990s by combining MCA Records and PolyGram, is now valued at less than a third of the $15 billion that his family and other Seagram Co. stockholders spent to acquire the two labels separately.
Bronfman’s defenders say the company’s slide in value had more to do with the technological shift that shook up the industry than with mismanagement.
Last year the timing was right to negotiate a good price for Warner Music. The $2.6 billion that Bronfman and his consortium paid was about half what the company had been valued at a decade ago.
In recent months, timing has been on their side again: Favorable currency swings have helped offset a slump in sales that has resulted in fewer platinum albums. The company reported a profit in the first quarter of its new fiscal year, despite an 8% drop in revenue.
Last month Bronfman resumed spending, buying a 50% stake in rap mogul Sean “P. Diddy” Combs’ Bad Boy Entertainment for $30 million. The company saw the acquisition as a way to bolster the label’s appeal in the hip-hop genre -- and among Wall Street investors.
“It’s not like they are just cutting, cutting, cutting,” said Sabur Moini, senior high-yield strategist at Payden & Rygel, a Los Angeles investment firm that bought Warner Music bonds in mid-2004. “They’re looking to grow the business. They’re not pillaging the company and moving on.”
Music industry insiders, however, were surprised by the Bad Boy purchase. Just three years ago, Combs tried to sell Bad Boy for $100 million but attracted no bidders. The Bad Boy catalog is anchored by just three Notorious B.I.G. albums, and Combs himself is now more active in the fashion world (he has his own clothing line, Sean John) than in the music arena.
Moini said that in the wake of deep cuts, Warner Music could rely at least for a while on selling and reselling classic albums in its catalog such as Fleetwood Mac’s “Rumours” and Prince’s “Purple Rain.”
“Those royalties tend to be a steady-Eddie business,” he said. “It smoothes out volatility.”
Haverty, the New York investment fund manager, speculated that within a few years, downloads and ring-tone sales could make up 20% of Warner’s revenue.
Still, the profit-making opportunity for music companies on the Internet remains in question. Some industry executives are skeptical that any serious money can be made in that arena. Bullish analysts think that the potential is great. According to one trade group, payment-generating downloads topped 200 million songs worldwide in 2004, up tenfold from 2003.
But at the same time, illegal downloads have not declined.
“No question the Internet is here to stay and will make it difficult for traditional players,” said Taulli, the Newport Beach analyst.