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Warner Music hits sour note in IPO

May 2005

Warner Music hits sour note in IPO

By Steve Gelsi  

Shortly after Warner Music Group (WMG) CEO Edgar Bronfman Jr. rang the opening bell, accompanied by power chords from Led Zeppelin guitarist Jimmy Page, the stock dropped. Shares opened at $15.75 a share and recently changed hands at $16.24 for a drop of 4.5% below its $17 offering price.

While the deal managed to get done despite rockiness in the IPO market, Warner Music faces a five-year industry slump in music sales and questions over whether it can profit from digital distribution of music, observers said.

While investors have been embracing digital music technology makers such as Apple (AAPL), it could take more time for the record industry to draw acclaim on Wall Street, said media consultant Ken Marlin.

Marlin, who pointed out that a key case from content swapping site Grokster awaits a Supreme Court decision, sees a long-term win for Warner Music.

"The technology that allows for file sharing and the downloading of individual music is going to go forward and the content players are best positioned to capitalize on it," he said. "Warner Music has great artists and a great library. It will bode well for them."

Blue notes

Signs of a slack debut came as the company cut the IPO price from the original range of $22 to $24 each.

To stoke interest in the deal, insiders shifted 5.4 million shares of the IPO from their pockets into the company's coffers.

The move appeared aimed at addressing criticism that the deal amounted to a big payout for Bronfman and his private-equity partners that carved out the firm from Time Warner (TWX) last year.

The IPO raised $554 million by offering a total of 32.6 million shares, with Goldman Sachs (GS) and Morgan Stanley (MWD) heading up the underwriting group.

At $17, the IPO puts Warner Music's market value at $2.4 billion, or a 26% cut from its originally proposed $3.3 billion valuation.

By going public, Warner Music is offering Wall Street a half-billion dollar bet on whether it can profit from the growing wave of digital music distribution.

Even with the price cut, Warner Music is one of the bigger IPOs seen so far this year and ranks as the biggest from an entertainment and leisure firm since Las Vegas Sands (LVS) kicked off in December.

The overall IPO market has been uncertain of late, with deals typically facing price cuts as buyers maintain control.

Digital music distribution

One of the largest recording companies in the world, Warner Music Group ranks third in terms of U.S. market share behind Sony (SNE) and Universal Music Group (V).

To woo investors, Warner Music is touting itself as better-positioned to profit from sales of digitally distributed music to iPods and other portable devices.

Warner Music said industry data on the company from SoundScan show higher market share in sales of digital music downloads than many of its competitors.

The company also said it's "highly focused" on supporting existing and new online music services in the U.S. and abroad, working with "legitimate" online music stores such as iTunes, the service operated by Apple Computer as well as Napster Inc. (NAPS) and others.

Moreover, Warner Music's working to "influence the evolution of new mobile phone services and formats and simplifying the clearance of all of our content for digital distribution."

In its analysis of the company's $2.5 billion debt, Standard & Poor's lauded Warner Music for its "healthy cash balances, good cash flow and borrowing ability."

S&P said it's mulling a ratings boost if the company shows "more clarity about the music industry's prospects for defeating online piracy and restoring sustainable revenue growth."

Renaissance Capital concluded in its IPO of the Week column that the "jury is still out on whether it can make its transition to a digital-content company a Grammy-worthy performance." See full story.

Warner Music reported fourth-quarter net income of $36 million on revenue of $1.09 billion, compared with a loss of $1.15 billion in the year-ago period. Revenue declined 8%.

Carved out last year from Time Warner (TWX) in a $2.6 billion acquisition led by Seagrams heir Bronfman, the music giant sells a huge variety of popular music -- from The Eagles to Sean "P. Diddy" Combs.

At the time of the sale, Time Warner was seen as ridding itself of a noncore asset and in the process, exiting an industry saddled with sharply declining profits and an uncertain future.

No other major music companies have gone public in recent years, but the media-entertainment industry last year chalked up a successful IPO from DreamWorks Animation (DWA), producer of the "Shrek" movies among others. The IPO debuted at $28 per share last fall and is now trading above $36 a share.

Bronfman teamed up with Thomas H. Lee, Bain Capital and Providence Equity Partners to buy the firm.

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