The musical question: WMG in '08

With shares off 79% from 52-week high, Street is split

Outside of Movie Gallery, which is struggling for its financial life, no stock on The Hollywood Reporter Showbiz 50 index performed worse last year than Warner Music Group.

So is the last big music stock on Wall Street a buying opportunity at current levels, or is the music business so challenged that it can only sink lower?

Wall Street folks, who generally have been bearish on the music sector, have sent investors somewhat diverging messages early in the just-started year. But the mood has lightened compared with 2007 given the stock's decline during the past year to Friday's close of $5.12.

With WMG's stock now off 78.6% from its 52-week high of $23.92 and trading close to its 52-week low, the market doesn't attribute any real value to its recorded music business. And various analysts recommend buying shares on the cheap, or at least not selling those already purchased.

Merrill Lynch analyst Jessica Reif Cohen on Friday even upgraded WMG shares from "sell" to — no, not "neutral," but a straight "buy." She established a $6.50 price target on the stock, arguing that investors have oversold it by pushing it down 56% over the past three months alone.

"The sell-off has been overdone," she said in a report Friday. "While we remain bearish on the medium- to long-term outlook for the industry, strong sales from Josh Groban's 'Noel' and an improving release slate suggest more upside potential than downside risk."

Reif Cohen lauded Groban for selling more than 3.7 million copies of "Noel" in the holiday season quarter when it was released, which also made it by far the top-selling album in the U.S. for 2007.

And while WMG has few major releases in the current quarter, the second calendar quarter "slate looks much stronger with scheduled releases including Madonna, R.E.M., Alanis Morissette and Gnarls Barkley."

But WMG also continues to face detractors on the Street, led by Pali Research analyst Richard Greenfield, the only analyst to rate the company's shares a "sell," according to Yahoo Finance.

He recently listed numerous reasons for not owning shares of WMG. They were mainly based on concerns about the music business in general rather than WMG-specific shortcomings.

Among them was a disappointing fourth quarter for the music business on the whole, with digital and physical unit sales off a combined 12% compared with the same frame a year earlier. That's much heftier than the 2% drop experienced in 2006 compared with 2005.

Greenfield also said the floor space that stores will dedicate to CDs could again shrink dramatically this year because CD sales were down 15.5% in 2007 compared with a year earlier, according to Nielsen SoundScan, which like The Hollywood Reporter is part of The Nielsen Co.

Also weighing on the music industry are new and improved ways for pirates to obtain the product for nothing. Freemusiczilla.com, for example, allows users to download free music from social networking sites, including MySpace, according to the analyst.

"While everyone focuses on P2P networks, new forms of piracy are gaining traction and appear even harder to thwart," Greenfield argued.

"Consumers increasingly believe music is free," he said. "The major labels must embrace an ad-supported model for downloadable music — albeit we sense they have no desire to do this."

Greenfield even predicts that the music publishing business, which largely has been immune to many of the problems in the consumer music business, "will show its first cracks in 2008."

Reif Cohen, on the other hand, sees the music publishing business as one whose asset value will protect WMG from any further stock downside risk.

Should WMG shares not move up this year from their depressed levels, some on Wall Street are suggesting that the company's private equity owners led by chairman and CEO Edgar Bronfman Jr. could decide to take it private. In this scenario, the owners could ride out more music market challenges and bring WMG back to the public market in a few years, which also could allow some of the private equity firms to cash out of their stakes.

Street observers have argued that a going-private deal would allow WMG's owners to take the firm off the market at a relatively cheap price, while still offering investors a premium, which could push the stock up to at least the offered buyout price tag. After all, the company's market capitalization as of Friday's close stood at a mere $765.6 million, compared with the $2.6 billion for which it was purchased in 2004.

WMG officials declined comment on the likelihood of a buyout scenario.

What is clear is that few music companies have had much to celebrate, meaning that few investors have shed tears over today's lack of publicly traded industry players beyond WMG.

When Nielsen SoundScan recently unveiled its 2007 sales figures, there wasn't much for the music industry to be proud of, except for a 45% surge in the sale of digital tracks.

For WMG, however, the Nielsen SoundScan data showed positive momentum in the U.S., led by the top-selling "Noel."

Also, WMG boasted the greatest gain in total album market share of any major music company, up 2.2 percentage points to 20.3%.

A WMG spokeswoman also pointed out that, between WMG's Warner Bros. Records and Atlantic Records, the company is easily the biggest seller of albums and digital albums.

There are only two bigger music companies in the world, Universal Music Group and Sony BMG Music Entertainment. The former upped its market share by less than a percentage point to 31.9%, and the latter was down 2.4 percentage points to 25%.

EMI Group, the fourth-largest music company, also saw a decline in market share, to 9.4%.

But Greenfield argues that market share gains will be hard to sustain, given that they came in part through acquisitions and joint ventures. And, as earnings before interest, taxes, depreciation and amortization could fall this year, "it will be harder and harder for WMG to make acquisitions," he suggested.

Paul Bond reported from Los Angeles; Georg Szalai reported from New York.
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