Warner Music sale would only be an opening act

April 15, 2011

By Jeffrey Goldfarb
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A sale of Warner Music would only be the opening act in the record industry’s latest tragic rock opera. The company behind Bruno Mars and Metallica has attracted a surprising number of suitors. But that’s primarily because the headliner waits in the wings. The show investors really want to see is a Warner combination with EMI Group.

The less glamorous music publishing side still sets the tempo for any deal. This income stream from songs played on the radio or performed live has been steady for Warner, with the division’s operating profit before depreciation and amortization declining a mere 6 percent between the fiscal years ended Sept. 30, 2008, and 2010. The recording side, which includes the Atlantic and Warner labels, has suffered far worse over the same span, with these earnings tumbling nearly a third.

Potential buyers like Ron Burkle and Len Blavatnik may have reason for optimism about the business of discovering and developing rock stars. Industry executives expect the increasing use of smartphones to help reinvigorate the legal consumption of music. Digital services like Pandora and the development of cloud-based song libraries also are creating new enthusiasm.

But everyone is really just eager for the duet that has been a decade in the making. The first of many attempts to merge Warner and EMI occurred in 2000, when European watchdogs shot down the idea. But the business has changed substantially and Warner’s next owner will most probably try again to unite the company with the industry’s over-leveraged number four player seized earlier this year from buyout baron Guy Hands by its lender, Citigroup.

Not only could the best executives and musical acts be cherry-picked from the two firms, but nearly the whole merged recording-unit operation could be run with just one side’s cost base.

The last time these two tangoed, back in 2006, annual savings were estimated at some $300 million. Assuming that still holds true, the estimated $2.3 billion present value of these synergies would go a long way toward paying for any deal. Warner and EMI are each worth about $3 billion and selling one of the two publishing businesses to sidestep regulatory questions would probably fetch at least $2 billion. Despite the industry’s many sour notes, investors still have room to make sweet music.

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