Warner Music’s Chart-Toppers Open Window of Opportunity

Warner Music Group is having a bittersweet moment.

The record giant, knocked from its place at the top of the U.S. market by corporate turmoil in the mid-1990s, pulled off a stunner last week: It captured six of the top 20 spots on the nation’s pop chart with hits from such acts as hip-hop’s Fabolous and Lil’ Kim.

But the performance may have come just in time for more turmoil.

Debt-laden AOL Time Warner Inc. is considering a plan to sell some of the music company’s operations piecemeal as part of a scramble to raise cash, according to company executives. That means the hits pumping out of Warner’s labels may serve to raise the price AOL would fetch by dumping at least some of them.

Warner Music chief Roger Ames declined to comment, and an AOL Time Warner spokesman also declined to comment.

Privately, some Warner Music executives pointed to last week’s series of chart-toppers as the still-delicate, and possibly endangered, fruit of Ames’ effort to revitalize the operation since taking charge in 1999.

“We’re in such a fragile place,” an executive said. “It’s taken patience, and getting the right structure, and all of a sudden all of his hard work is about to be completely swept away with a possible sale to EMI, or a breakup of the company. It’s amazingly ironic.”

AOL executives recently dismissed a pitch from British rival EMI Group to buy all or part of the Warner music operation, and several company insiders said the New York media giant is unlikely to divest the entire division.

Fred Davis, a prominent music attorney, said AOL corporate executives “have to be a little patient. Over the long term, selling the entire music division would be a faulty plan.” Davis, whose Warner clients include Staind and Missy Elliott, said the long-term prognosis for the music business “is very strong.”

But the company is exploring the possible sale of Warner Music’s CD-manufacturing arm, a move that could bring in an estimated $1 billion. And music industry observers continue to insist that nothing can be ruled out in the parent company’s push to lessen its $27 billion in debt -- including ditching the music division.

“You can run AOL Time Warner without the music business,” said Tom Wolzien, an analyst at Sanford C. Bernstein & Co. “If you’re looking for something to sell, it’s a logical thing to consider.”

Selling off the labels would be tough at a time when most major record operations are looking for buyers and finding none. One of the more complex notions making the rounds in music circles has EMI -- whose debt was downgraded to junk status last week -- purchasing a stake in Warner and financing the deal with the sale of Warner’s music-publishing operation. Warner insiders, however, said last week that they considered that sort of deal unlikely.

Meanwhile, the buzz at Warner over the last few days has been more about record sales than asset sales. While still trailing Universal Music Group, Sony Music Entertainment and BMG in sales of new releases, the firm, in a generally weak season, suddenly showed it could still pop to the top of the charts.

Warner’s Elektra label scored the biggest with Fabolous, whose album sold 185,000 copies and grabbed the No. 3 spot, according to Nielsen SoundScan data, followed by Atlantic’s Lil’ Kim at No. 5, Kid Rock at No. 8 and Sean Paul at No. 13.

On the Warner Bros. label, opera phenom Josh Groban also joined the company’s hit parade at No. 19. And upcoming albums from Linkin Park, Metallica and P.O.D. point toward continued strength for a company that has lacked the kind of sales power Eminem brought to Universal and Celine Dion brought to Sony.

Ames, a former Polygram music executive, was recruited by Time Warner to revive the record operation, which had lagged for years after a corporate bloodbath during which a dozen key music executives left for jobs at Universal and elsewhere.

The music unit also suffered a blow when former Time Warner Chairman Gerald Levin, bowing to political pressure in 1995, unloaded its interest in Interscope Records, home to controversial but hot-selling rap stars such as Tupac Shakur and Snoop Dogg. That move resulted in a massive erosion in profit and damaged the company’s credibility in creative circles.

Shortly after taking over, Ames tried to engineer a merger with EMI’s music operation. European regulators scotched the deal, which would have created the world’s biggest record company.

Warner later undertook deep cutbacks, restructuring the WEA Inc. manufacturing arm, which AOL is now putting on the auction block. Ames also made key management moves at flagship Warner Bros. Records and Atlantic Records, and also pushed to bolster the label’s hip-hop roster.

Thanks largely to the cost-cutting, Warner Music reported 2002 earnings before interest, taxes, depreciation and amortization, or EBITDA, of $482 million -- a 15% increase in the face of the worst U.S. sales slump in at least a decade. EBITDA is a common measure of financial health in the media business.

To be sure, the division still remains a long way from its heyday: Warner Music reported $595 million in EBITDA in 1995.

Since then, Warner’s share of new-album sales in the U.S., a key measure of a record company’s hit-making power, has plunged from an industry-leading 23% to 15% now, ranking the company fourth among the five major record conglomerates, according to Nielsen SoundScan data. If sales of older catalog albums are included, Warner ranks second in the U.S., with total market share of 17.3%.

If AOL were to sell its manufacturing arm, executives say the effect on operations would be fairly minimal, although having it in-house makes it easier to rush out additional copies of a hot CD when record stores’ supplies run low. The division’s bottom line, however, probably would take a hit: The boom in DVD manufacturing, which is handled by the record operation, accounted for as much as 20% of the music division’s earnings last year, according to analysts.

Mostly, however, a piecemeal sale would almost certainly take its toll on the psychology of an operation that is only now beginning to feel, once again, like a winner. In the words of one Warner Music executive: “Now we’re on the way up, and this is becoming a distraction. It’s a shame.”