Record Label Shake Ups, Sales Make For A Tumultuous Year In The Music Industry
Record Label Shake Ups, Sales Make For A Tumultuous Year In The Music Industry

Warner Music Group posted relatively upbeat results for its second fiscal quarter on Tuesday, less than a week after the company agreed to be acquired by Access Industries for $3.3 billion.

The results were a glimpse into the reasons why Access would want to buy a company some may consider a poor investment in a doomed industry. When its release schedule is strong and it does not put a great deal of its cash toward investments in other companies and copyrights, Warner can put together decent revenue and free cash flow.

In the quarter ending March 31, revenue was strong compared to its two previous fiscal second quarters (and even stronger when you consider the decline in the industry's revenue over that same time period). Revenue was up 2% to $682 million from $666 million in the prior-year and $668 million two years prior. Its $220 million of digital revenue, now over 32% of the total revenue, was up 9% from the prior-year quarter and up 18% from the previous quarter.

Both segments posted upticks in revenue. Recorded music revenue was $550 million, up from $538 million, while music publishing income ticked upward to $137 million from $134 million. U.S. recorded music revenue was basically flat at $254 million compared to $253 million in the prior-year quarter. U.S. music publishing revenue grew to $61 million from $54 million in the same time periods.

Warner is a company that regularly posts losses and has amassed sizeable losses since being acquired from Time Warner in 2004. It definitely posts an accounting loss. In the latest quarter alone, Warner had depreciation and amortization expense of $66 million -- $55 million of that related to intangible assets (in other words, the copyrights it has acquired).

So what does Access see in Warner? Certainly not the net profit or loss as reported under Generally Accepted Accounting Principles, a requirement of publicly traded companies. Warner's value is more apparent if you remove depreciation and amortization and take a closer look at the company's operating performance. In the first half of Warner's fiscal year, operating income before depreciation and amortization (OIBDA) was $214 million, down from $245 million in the prior-year period.

At the end of the day, investors care about how much cash a company can spin off. And in a good quarter, Warner can indeed generate cash. In the latest quarter, Warner had free cash flow of $46 million. But its free cash flow over the last six months was -$133 million - which includes $103 million used for investments.

Of course, who knows exactly what the future will hold? Recorded music and publishing revenues have fallen in recent years. In the same quarters in 2006, 2007 and 2008, Warner posted revenue of $796 million, $784 million and $989 million. It was regularly turning a profit back then - and it was still paying a dividend, too.

But given Warner's revenue and ability to generate a fair amount of free cash, and considering the valuable music assets it owns, $3.3 billion appears to be a fair price that reflects the realities and trends of the industry. It may seem a bit high to some equity analysts, but it's certainly nothing like Terra Firma's overpriced acquisition of EMI just four years ago.