Music business stuck on downbeat note

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NEW YORK -- Shares of publicly traded music majors EMI Group Plc. and Warner Music Group hit new 52-week lows Wednesday after another EMI financial warning cited weakness in the U.S. recorded music business.

Despite solid ratings for the 49th annual Grammy Awards broadcast Sunday on CBS, music stocks have faced head winds in recent weeks as industry observers have cited weak releases and concerns over a potential slowing of digital music sales on top of declining physical sales.

WMG shares closed down 6.6% at $18.12 on Wednesday after going as low as $17.56 in intraday trading, setting a new 52-week low. Over the past year, the stock has traded as high as $31.

The EMI picture is similar. The London-listed stock finished down 12% at 210.75 pence ($4.13) on Wednesday after setting a new 52-week low of 201.75 pence ($3.96) during the day. It has traded as high as 314.00 pence ($6.16) during the past year.

EMI said Wednesday that it has revised its forecast for its recorded music division for the financial year ending March 31 to a year-over-year decline of about 15% assuming constant currency rates. Last month, the firm cut its overall revenue estimate for the year to a 6%-10% decline, already signaling that hopes for a strong second half thanks in part to releases from Robbie Williams, Norah Jones and Joss Stone have not fully turned into reality.

EMI now also expects fiscal-year profits to come in "significantly below current market expectations." The company cited as a culprit for its latest warning "the continued and accelerating deterioration in market conditions in North America," where year-to-date the physical music market as measured by SoundScan is down 20%.

Added EMI: "This unprecedented level of market decline has led to an exceptionally high level of product returns. Consequently, the net sell-through on EMI Music's current releases and catalogue has been lower than anticipated."

Wednesday's news followed a recent earnings disappointment from WMG, whose fiscal first-quarter figures came in below Wall Street expectations because of fewer releases and a sequential decline in digital music sales, which raised red flags for some analysts for the broader market.

"We were most surprised by the sequential decline in digital revenue, which we thought would have benefited from seasonality and secular tailwinds given the early stage of digital growth," Goldman Sachs analyst Anthony Noto said in a report Monday. "We now believe that our thesis, which assumed that higher-margin digital revenue could offset physical (music sale) declines ... only holds true in the presence of a strong content cycle."

Noto reduced his price target on WMG to $23 and kept his "neutral" rating on the stock.

Pali Research analyst Richard Greenfield on Wednesday lowered his WMG estimates for the second time in 10 days because of its own weak results, the EMI warning and "continued rapid declines in physical CD sales."

Concluded Greenfield: "While WMG is clearly better managed than EMI (where it appears there is complete internal turmoil), WMG is more exposed to the declining U.S. market with 40% of WMG's revenues coming from North America (compared to about 33% for EMI)."

As a result, he cut his price target on WMG by $2.50 to $16. The move comes on top of his rare "sell" rating on the stock.

Greenfield on Wednesday also cast doubts on overall digital music trends, saying his forecast for 40% digital growth in 2007 could turn out to be overly optimistic.

But not all Street observers are so bearish. Deutsche Bank analyst Doug Mitchelson last week reiterated his "buy" rating and $28 price target for WMG. He expects "a return to sequential growth" in digital sales in the current quarter "due to holiday seasonality with iPod and new Zune sales."
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