The music business has to brace itself for more declines this year, Merrill Lynch analyst Jessica Reif Cohen warned in a research report.

Overall, the "music market appears headed in (the) wrong direction," she said Thursday, estimating that global music sales fell 2%-3% in 2006.

"The slow start to 2007 (U.S. down 10% year-to-date) suggests another down year is likely," Reif Cohen said. "With digital growth naturally decelerating over time and the decline in physical sales accelerating, an imminent return to growth for the industry no longer appears likely."

Together with her European colleague Julien Roch, Reif Cohen estimates that music retail sales will decline 3% -- globally and in the U.S. -- in 2007. "This is a significant deterioration from our previous forecast of 2% growth both in the U.S. and globally, but may still be optimistic given the weak state of the market," she said. "Sales have declined in nearly all the major markets year-to-date, with the decline in the U.S. particularly precipitous."

Resuming coverage of Warner Music Group with a "neutral" rating Thursday, Reif Cohen said "the outlook for 2007 appears difficult given a weak start to the year, continued market weakness and more challenging comparisons."

Overall, she said she does not find WMG's valuation "to be attractive at these levels and continue to prefer entertainment names with a clearer growth outlook and/or company specific catalysts."

Nonetheless, Reif Cohen said music shares should get support from likely continued merger talk. "The worse the fundamentals, the more likely a merger with EMI becomes," she said.

However, the analyst also said she is "skeptical that there will be meaningful growth in fiscal-year 2008" for WMG.

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