Warner Music's Beat: Analyze This

Two bulls quietly cut estimates just before earnings.
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Something funny happened on the way to

Warner Music Group's

(WMG) - Get Report

fiscal first-quarter profit beat.

Two analysts with buy ratings on the stock quietly slashed their earnings estimates in the week leading up to Warner's

Tuesday morning report. The moves, which came as the analysts maintained their ratings and in one case actually raised their price targets on the stock, helped the music company to beat Wall Street's bottom-line target during an otherwise mixed quarter.

Warner made 46 cents a share for the quarter, beating the Thomson First Call consensus estimate by 6 cents. Meanwhile, revenue slipped 4% from a year ago to $1.04 billion, missing the seven-analyst consensus calling for $1.09 billion.

The last-minute estimate cuts came from Soleil Securities' Laura Martin and Deutsche Bank's Doug Mitchelson. Last month, Martin was expecting Warner to make 47 cents a share for the first quarter, while Mitchelson was targeting 42 cents, according to their published comments. Those estimates were in line with the Wall Street consensus, which at the time was 46 cents, according to Thomson data.

Deutsche Bank's Mitchelson was the first to make a stealthy EPS cut. On Feb. 6 he issued a report reiterating his buy rating and boosting his target price on Warner Music by $2 a share, to $24. At the end of the largely bullish report, he cuts his first-quarter earnings estimate nearly in half, to 22 cents from 42, explaining, "We are assuming margin contraction in the quarter given spending for launching albums for new artists, spending to rebuild Music Publishing now that a news management team is in place and an increase in FAS123 expense."

Three days later, Soleil's Martin made much the same move. She issued a report saying she rates the stock a buy, "based on stabilizing worldwide piracy rates, strong digital revenue growth, WMG's attractive market position, outstanding operating management, and strong cost-control focus." Without comment she simultaneously cut her EPS estimate to 28 cents from the previous 47 cents.

As a result of the two analysts' estimate cuts, the Thomson consensus dropped to 40 cents just ahead of the report from 46 cents previously and 49 cents around the end of 2005. So when Warner came up light on the revenue line, watchers were placated by a solid-looking performance compared with analysts' profit targets. Other analysts maintained their estimates right up to earnings week.

Reached for comment Wednesday, Martin says her firm was made aware of a $22 million charge on warrants and applied that to the EPS mix. Some analysts add back such charges and others do not, Martin says. Warner said it didn't offer any material information to analysts in the last two weeks.

Mitchelson attributes his change to a problem with internal systems, saying that the firm never published a model backing the original 42-cent estimate. "Somehow our system pushed it up," he says, pointing to a technical glitch. Deutsche Bank seeks to do business with Warner.

Martin adds that "most media companies don't trade on EPS, they trade on revenue. If our strategy was to lower EPS, obviously Doug and I didn't help -- the stock was down." Warner shares did decline more than 1% on Tuesday, closing at $20.43.

Warner, the former

Time Warner

(TWX)

unit that went public in 2005 after about a year in private hands, has performed well in the market of late, rising some 30% in the last three months after a rocky IPO. The company has staked its future to boosting sales of digital music, but Warner and its music-industry rivals continue to swim against a tide of sliding physical music sales.

On Wednesday, shares of Warner Music Group were up 16 cents to $20.69.