Computer Networking: Web triggers Wall Street retreat in music sector

Wall Street is taking record labels to task for lackluster Web sales, spiraling CD revenue and the defections of marquee acts, such as Madonna and Radiohead.

Nine Inch Nails' Trent Reznor

(Credit: Rob Sheridan)

Two analysts downgraded Warner Music Group last week, leading to a sharp drop in the company's stock price. One of the analysts, Richard Greenfield of Pali Research penned a gloomy report about why he thinks the sector is headed for even greater losses.

Greenfield wrote: "No matter how many people the RIAA sues, no matter how many times music executives point to the growth of digital music, we believe an increasing majority of worldwide consumers simply view recorded music as free."

Proof of this was provided last month by Radiohead fans. The British super group offered the digital version of In Rainbows, the band's latest album, for whatever fans wanted to pay. According to research firm, comScore, which conducted a study of the ground-breaking promotion, 62 percent of those that downloaded paid nothing.

To Greenfield, what's more disturbing is that Radiohead and a growing number of top acts perceive the Internet as an attractive alternative to record labels. Nine Inch Nails' front man Trent Reznor has indicated he plans to distribute his music online. Madonna announced last month she was leaving Warner Music for Live Nation, a music-promotion company.

"The paradigm in the music business has shifted," Madonna said in a statement announcing the switch. "For the first time in my career, the way that my music can reach my fans is unlimited."

Like Greenfield, Merrill Lynch analyst Jessica Cohen, downgraded Warner Music's stock from "neutral" to "sell." Both also lowered next year's earnings estimates for the company. Following the reports, Warner Music's stock hit a 52-week low ($8.78) on Friday. The company's shares, which were trading above $27 a year ago, closed Tuesday at $9.50.

What could be unsettling to those in the music business is that Warner Music was supposed to be faring better than the other three majors; Universal Music Group, Sony BMG and EMI, according to Greenfield. Earlier in the year, his view on the stock was slightly rosier.

"Over the past couple of years," Greenfield wrote in his report. "(Warner Music) has done an impressive job outperforming the industry weakness."

The main cause for concern continues to be spiraling CD sales. Download revenues are growing but not fast enough to ease the pain. Greenfield expects CD revenue to drop 22-percent in the 4th quarter of 2007. He said retailers, such as Wal-Mart, Target, and Best Buy are rapidly dedicating less floor space to the discs.

How bad off is the music industry?

Consider that the sector generated revenues of $14.3 billion in 2000, according to the Recording Industry Assoc. of America (RIAA). This year, it's expected to report revenue of $10.3 billion. Had sales growth only kept pace with the U.S. economy, it now would be worth $17 billion, Greenfield wrote.

This illustrates "how dramatically the music industry is continuing to under perform," Greenfield said in the report.

Greenfield urges music executives to embrace a new ad-supported business model, one that dramatically scales back the size of record companies and doesn't saddle songs with Digital Rights Management. He doubts this will happen anytime soon.

The industry is "not ready to endorse such a move at this point" Greenfield wrote. "Even if it was, the ...transition will be incredibly painful."

See Also