Sandy Brown

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Warner Music's Hitting a High Note

Sandy Brown

Edgar Bronfman Jr.'s Warner Music Group (WMG Quote), once derided as an awkward investment in a troubled industry, is starting to gather a little steam.

Bronfman's $2.6 billion buy of the Time Warner (TWX Quote) music division last year, along with a group of private-equity hard chargers, was written off as little more than a vanity play for a self-professed music fanatic cum media mogul. After all, the music industry has been hit by rampant piracy and declining retail sales, trends the industry has been unable to contain.

But the tables may be turning. Described as a noncore asset at Time Warner, Warner Music now looks like a play on a management group that saw the time was right to get into an industry in transition.

Warner Music Group shares have risen 20% since July and traded recently at $19, more than 10% above their admittedly reduced IPO price. Warner's recent decision to pass along a 13-cent quarterly dividend was greeted warmly, sending shares up 3% and overshadowing news that the company would take a $25 million fourth-quarter charge to merge its Java and Atlantic labels.

Part of the reason for the uptick may be what Bronfman has said recently regarding file-sharing, industry pricing and pay-for-content as it is distributed on newer platforms.

"We are really the arms suppliers to a significant series of wars going on," Bronfman said at a recent conference. He noted what he called the device wars, "as Sony (SNE Quote), Samsung and others come after Apple's (AAPL Quote) dominance in the device space," as well as content distribution wars among telcos, cable, broadcast and others. Plus, Bronfman said, there's "opportunity for penetration on existing platforms like mobile, where, despite drastic changes we've seen in digital, we have yet to sell a single song."

Though they still make up just 6% of all music sales, digital music purchases more than tripled in the first half of the year, according to estimates by the International Federation of the Phonographic Industry released earlier this week.

For starters, Bronfman would like to change the balance of what the music labels get paid for and what they give away. He says that 20 years ago the industry gave music to MTV and made that business successful, and that has more recently been the case where iPods are concerned. "We're selling our songs through iPods, but we don't have a share of iPods' revenue," he said. "We have to keep thinking about how to monetize our content for our shareholders where we've been creating value for so many other streams."

Bronfman expects to have agreements in place with Yahoo! (YHOO Quote), Microsoft's (MSFT Quote) MSN and Time Warner's AOL for music videos, and he expects to share in the revenue. That applies for ringtones and other content "across all channels," he said.

One such battle is likely to take place on the satellite front. Bronfman says the music industry essentially financed satellite radio's introduction and gave satellite radio a seven-year license at "vastly below market rates in order to allow that business model to occur. It has been six years, and it is now time for satellite radio to pay market rates for content," he said.

"There's no reason in the world, in my view, that satellite should have its content costs be one-tenth of what everyone else is paying, and have that specifically be on the back of the music industry," Bronfman added.

Naturally, piracy issues are still at the forefront of most discussions about the future of the industry. Bronfman says that he was very happy with the Grokster decision and that legitimate distribution will grow and grow, though the industry needs to remain vigilant.

Warner's resurgence comes as its former parent is in the crosshairs of investor Carl Icahn, who has taken to complaining that management isn't doing enough to rouse the media giant's torpid stock. His latest barrage against Dick Parsons and company, due as early as this week, is expected to hammer away on the terms of the Warner Music deal and the slow pace of transition at AOL.

Though Bronfman and his group have seemingly put Warner Music on the right track, some investors still think Time Warner made the right choice in bidding adieu to the music business.

"Music is not part of Time Warner's core," says Peter Jankovskis, director of research at OakBrook Investments, which owns some 100,000 shares in Time Warner. "Given ongoing problems with file-sharing and CD piracy abroad, it may prove to have been a smart move."

The challenge for Bronfman is to prove those problems aren't too big to overcome.