Wednesday, May 11, 2005

Linkin Park and the Warner Music Group IPO

Linkin Park and the Warner Music Group IPO
Originally uploaded by Tommy Perkins.

A week ago, as Warner Music readied itself for its much-anticipated public offering, the beleaguered major label was broadsided by one of its top-grossing acts, rap metal band Linkin Park, who threatened to bolt the label.

Chief among the band’s gripes were that the label was not effectively marketing the band, which claims sales of 35 million records and 10% of Warner’s total sales in the past five years. Warner disputes that percentage, but the indisputable takeaway is that Linkin Park has been a major breadwinner for the label.

Warner expected the IPO to bring in $750 million, of which it would allocate $574 million to debt and $7 million to general operations. Unfortunately, Warner only managed to raise $554 million today, with the share price cut to from the planned range of $22-$24 down to $17.

According to Reuters, “a source familiar with the discussions said the public spat was a ploy by the band’s managers, The Firm, to renegotiate their contract and extract a $60 million advance ahead of the IPO. The source said the band also asked for 50 percent of profits.”

A May 2 press release from Linkin Park and The Firm, states: “The new owners of the Warner Music Group will be reaping a windfall of $1.4 billion from their $2.6 billion purchase a mere 18 months ago if their planned IPO moves forward. Linkin Park, their biggest act, will get nothing.”

Well, unless Linkin Park got stock options as part of its contract, I’m not sure why they would have a claim on the proceeds of an IPO. The band’s statement presumes that the reader believes bands are awarded their budgets based on past, rather than expected, performance. And if that resonates with their fans, as I suspect it does, then good for them, although the implication is less than genuine.

The release goes on to quote music industry attorney Peter Paterno, who represents artists such as Dr. Dre, Pearl Jam and Warner Music’s Metallica:

“The (WMG) guys who are running this thing are looking at it pretty cynically. It's becoming more and more apparent that this is nothing more than a financial play for the investors. It's not about the music or the employees; it's about a return for private equity investors. It's kind of astounding when you sit back and look at the audacity.”

It’s hard for me to read this statement without thinking, “Duh.” The only thing about this that’s astounding to me is the naiveté being feigned by Paterno and Linkin Park. Of course this was a financial play. Private equity firms don’t buy companies so that they can hold them in their portfolios indefinitely and any lawyer or manager knows that. PE firms flip companies to make money for their investors, who, as often as not, are pension funds.

But, in fairness, this turned out to be an essentially riskless play for Bronfman and a team that included Thomas H. Lee Partners, Bain Capital and Providence Equity Partners, who paid Time Warner $2.6 billion for the unit. According to today’s Wall Street Journal (subscription required)”

“Because the IPO raised less than the $574 million the company had promised in its SEC filings to allocate to debt reduction, the company is expected to reduce slightly a special dividend it plans to issue to its original investor group. Even before the IPO, though, the investors had been repaid the entire $1.25 billion [for the equity] they put up for the acquisition, thanks to an earlier series of dividends and other maneuvers.”

I know my MBA is showing here, so indulge me a bit further before we move on to what happened in today’s IPO. The ugly corporate realities of signing a major label have only been around for, oh, the lifetime of Linkin Park’s oldest fan. Signing with a major has long been known to be a deal with the devil and, in this case, it was a deal with a devil that had previously done a deal with another devil. I’m sure Linkin Park had its pick of independent labels to sign with, but it wanted a big bonus and a big marketing budget, so it landed with a major.

Now that the band has reaped the benefits of said label’s infrastructure, it has decided that it can go the way of Phish and the Grateful Dead, by, according to its press release, “relying more on touring, merchandising and endorsements, rather than leaving their future in the hands of a weakened WMG.”

The band notes that “new Fiona Apple music was released on the Internet for free and for years, bands like the Grateful Dead and Phish have performed new material live and let fans tape for free.”

Well, good luck to ‘em. Linkin Park obviously is more optimistic about its prospects than Warner is, so we’ll see who’s right.

Meanwhile, back on Wall Street, where’s Scott Reeves asks, “If the smart money wants out, do you want in?”

Reeves isn’t talking about Linkin Park (indeed, he never mentions the band’s dispute); he’s referring to the backers who cashing in on a company who’s year-over-year sales are down 9%.

While Warner Chairman and CEO Edgar Bronfman Jr. predicted in 2000 that worldwide music sales would almost triple to $100 billion, instead they’ve fallen to a fraction of that year’s $38 billion figure.

Reeves implies that online piracy will continue to dampen Warner’s sales. That may be true, but the fact that none of the IPO’s proceeds will fund continuing operations hardly inspires optimism in Warner’s pipeline of new releases.

Regardless of what anyone thinks was wrong with this deal, it was clear that Wall Street shares Reeves’ pessimism. Shares were down 76 cents, or 4.5%, to $16.24 in afternoon trading Wednesday on the New York Stock Exchange.