Big Money Music Finance

Once upon a time, music companies could afford to spend a great deal of money on artist production and development through the revenue generated by the sale of recorded music. Other companies were rewarded indirectly.

Much has changed. In 1998, global recorded music sales were worth $38.6 billion.  But by 2008, worldwide sales had fallen to $18.4 billion; by 2010, they were down catastrophically to $15.9 billion. During the collapse of music sales, digital music revenues (from downloads and mobile purchases) have done little to offset overall losses. Digital music, it is true, now moves one out of every three dollars spent on recorded product—and yet it is not enough. It is no wonder that in the wake of large-scale industry layoffs, investors fear to tread in a trade they feel is agonizing. Analysts, like Forrester Research, expect the turmoil to last at least until 2013.

Pandora

The current rumor that the capital markets are in the midst of a new tech bubble has directed some renewed attention on music companies seeking to go public through an initial public offering (“IPO”). But that focus has come with questions and criticism. The reduction of recorded music revenue also affects ancillary music companies, and poses a question about the trustworthiness of any valuation. A good case in point today is Pandora. Pandora is an Internet radio company that functions as an automated music recommendation service, streaming licensed music to its online viewers for free. Pandora executives claim that there is value beyond their current financial statements, and that investors need to consider the company’s long-term customer base and market share to establish true value (for the detail of Pandora’s IPO, see our article on pp.  ).

The first concern with Pandora’s business model is that they pay licensing royalties every time a user streams music on Internet radio. Royalty expenses have accounted for 50% of the company’s revenue. Meanwhile, investors remain skeptical as to whether Pandora can negotiate a better deal on its royalty fees. Pandora’s arrears to the ailing record companies, to whom these licenses are paid, the financial malaise of the record companies, and the requirements of its new investors do not seem to provide the company with room for maneuvering.

A second issue relates to Pandora’s only revenue — its advertisements. Advertising rates tend to be cheaper on mobile devices (according to a study by research firm Insight Express, they also provide a better return on investment than traditional Internet ad dollars), and as customers shift to using Pandora’s services on their phones, the company could see a reduction in advertising money.

The third concern is competition. Companies such Apple, Google, Amazon and other tech giants are in a much better financial position to operate a similar business model and compete for Pandora’s market.

History is no Help

It seems investors will remain skeptical too about Spotify, the European ad-based streaming service now apparently seeking its own IPO. Market memory is not in short supply. Between 1995 and 2000, Internet company stock prices shot up, defying traditional financial analysis. Equity values increased despite any correlation to company growth.

A good example is Musicmaker.com, a provider of customized CD compilations.  It went public on July 7, 1999, at $14 a share, and the company saw a remarkable 71% price increase on their stock during the first day of trading. This despite a net loss of $4.65 million on revenue in 1998; investors were betting to the bubble. By January of 2001, Musicmaker.com pulled the plug on their website and began liquidating assets.

Launch Media, another online music website, also went public in April of 1999. At the initial asking price of $22, Launch Media was valued at $75 million. Less than two years later Yahoo purchased the company for $12 million,  at 16 per cent of its initial market capitalization.

The failure of music companies in the capital markets is tied, ultimately, to poor profits. Entertainment and media companies spend a lot of money on promotion and marketing—a black hole. Valley Media, which went public in 1999, exemplified this.  As the country’s leading music and video wholesaler at the time, their IPO raised $56 million to be put towards company expansion. Despite generating nearly $900 million in revenue that year, the company did not generate profit and filed for bankruptcy in 2001.

 

No Relief in Sight

Capital markets are difficult to access at the best of times and are becoming more so for music companies today. Insiders understood that Pandora sought money from the IPO to pay for its losses rather than to pursue an immediate growth strategy.  Yet investors gave it the benefit of the doubt. How long can this last? If the music industry and its strategists fail to come up with a sustainable business model that can entice customers to pay for product and make a profit, the likelihood of fresh infusions of cash from private savings will become even rarer.

Elliot Weiss

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Comments

7 Replies to “Big Money Music Finance”

  1. Tommy George says:

    Its obvious the business model will need to make changes. They’ll need to decrease operating expenses. Target their audience, and add value for those that want to own the product. They’ll need to break down their operation into segments, with a dedicated purpose. I think there will only be two segments. Those that want to own , and those that want to listen. For those that want to own , they’ll want stories, interviews, and collectible interests. Those that want to listen, they’ll want convenience with a price to match. The industry will need to deal more in subscriptions for those that only listen. For those that want to own, quality of product and trends will set the pace. Theft is here to stay, deal with and you can beat it.

  2. Hopefully, the opportunity that has arisen is for artists to truly focus on creating art that speaks to them personally, that allows them to cultivate a loyal and engaged fan base, and to focus on creating work that their fan base will respond to rather than having to market to the masses through commercial appeal. There may be fewer superstar musicians that can arise from the disruption, but there will be more artists that can retain their control.

    On the tech side, I think startups like AudioSocket that allow artists to monetize their copyrights through Synch licensing are the kinds of startups we will see arising, that have real cash flow, that are providing unique value and platforms to the industry, and that will ultimately win the day.

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