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Street cautious on Live Nation's $120 million Madonna deal

With its Madonna deal in place, Live Nation is discussing revolutionizing the music business. But Wall Street observers have doubts that the deal will pay off for the firm.

Until last week, the company used the following description of its business at the end of its news releases: "Live Nation is the world's largest live music company." Tuesday's release about the Madonna deal had a description signaling bigger ambitions: "Live Nation is the future of the music business."

The release also focused on bigger goals. "Live Nation's Artist Nation division redefines the music industry," and "Madonna joins forces with Live Nation in revolutionary global music partnership," it said.

The star also signaled that she is ready to change the challenged music business after deciding to leave longtime music label home Warner Music Group after her next album.

"The paradigm in the music business has shifted, and as an artist and a businesswoman, I have to move with that shift," Madonna said. "I've never wanted to think in a limited way, and with this new partnership, the possibilities are endless."

Live Nation president and CEO Michael Rapino even went so far as to say that "our partnership is a defining moment in music history" and that the music icon "has joined with us to create a new business model for our industry."

But Wall Street observers are not quite convinced that the big deal — whose financial terms were not fully detailed but which the Wall Street Journal estimated to be worth $120 million for Madonna over 10 years — will be profitable for Live Nation.

Morgan Joseph analyst David Kestenbaum in a report questioned the company's decision to spend so much on one deal, even if it is with the most successful female music artist ever.

"The economics of this deal could make it difficult for Live Nation to realize significant financial benefits since Madonna's tours generally carry lower margins relative to others and that we believe Madonna would have to average over 10 million copies per album to break even on any album advances," he said. "Also, her age (49) could limit touring appeal at the tail end of the agreement."

Nonetheless, Live Nation said it expects a "financially sound return" for Madonna and for shareholders.

In a conference call this week, executives didn't specify how big the company's return could be when pressured by analysts. But they said the Madonna arrangement will allow Live Nation to do a broader-than-usual range of business with a marquee artist — from recorded music and merchandise to media and film rights, as well as digital rights fan clubs/sites and sponsorships. This should boost its profitability beyond what one executive said is generally a blended margin of about 4%.

Still, some on Wall Street are cautious. Natixis Bleichroeder analyst Jeffrey Shelton said "the company will need to work hard" to make the deal work.

One key challenge Live Nation will have to work out is a way to "outsource" music production and distribution for Madonna, analysts said.

Kestenbaum said "a more prudent long-term strategy" for the firm would have been to spend the reported $120 million on deals with several artists to create a small record label of sorts.

But there also are some on the Street who expect Live Nation will indeed revolutionize music and walk away with a nice financial return on its Madonna deal as well.

"We believe the deal could be profitable for Live Nation," said JPMorgan analyst John Blackledge, estimating that it could capture "well over half of the reported costs of the deal through concert ticket sales, merchandise and ticket surcharges" alone. That is assuming similar audience sizes as on recent tours and similar ticket costs.

Goldman Sachs analyst Mark Wienkes also expects the Madonna deal to be accretive for Live Nation over its time frame.

"Live Nation already pays $1.5 billion to artists each year for a 4% margin business, so signing the most successful female artist of all time for about $12 million per year in a 10-year partnership to 'grow the pie' seems like an easy decision," he wrote.

Amid such mixed views, most investors seem like they might wait for first signs of proof that the Madonna deal will be worth its money.

Live Nation's stock closed down 2.8% on Wednesday at $20.84, about halfway between its 52-week low of $16.85 and its high of $25.63.

But Live Nation management sounded bullish in announcing the Madonna relationship, signaling similar if smaller deals are likely to follow.

Whether Wall Street and investors are fully convinced yet or not, Rapino said the ultimate goal is nothing short of creating "the next-generation music company."