Smart Money Gets Dumb

Sep 21 2008

Wow– who could imagine a time when the music industry felt more secure than the banking business? And yet, EMI Records winds up outliving Lehman Bros. and Warner Chappell outlasts Merrill Lynch. While no one would declare the record biz to be a healthy, thriving industry, it is now obvious that things could be worse. Thank goodness we didn’t have many financial whiz kids in music– it may be the only thing that saved us.

As the term “investment expert” now enters the realm of oxymorons like “military intelligence” or “government ethics”, it is clear that a lot of those financial whiz kids were not as smart as they appeared. Interestingly, that’s true not only in fields like real estate, mortgage lending, derivatives, etc. Their results in music publishing haven’t been so impressive either…

As I’ve mentioned several times in this blog, music publishing recently became a favorite target of the investment community– as money men looking for new place to park their millions began to gravitate toward what they saw as the goldmine of the music industry. Convinced that they could make a fortune by buying up publishing companies and catalogues, investment companies and hedge funds went on a purchasing spree over the last five years– buying up publishers like Bicycle, Windswept, and Bug, and backing new acquisition-oriented publishing entities like Evergreen, Primary Wave, and many others.

Not surprisingly, there were a lot of theories floating around behind this investment-backed shopping expedition. Some made sense– primarily the idea that established music publishing catalogues, unlike record labels, were reasonably predictable income streams that could be counted on as a moderately secure long-term investments. Some of the theories made some sense– that the music industry was undervalued and that surely the industry would someday figure out again how to monetize the value of music, or that growth in China, Latin America, and Eastern Europe would eventually force those countries to tighten up on piracy– although those theories have yet to be proven.

But some of the theories fueling this new investment made no sense at all. Many of these “new” publishers were convinced that better collection and a bigger effort in the Film and TV department would allow them to greatly increase earnings, justifying purchase prices far beyond what any experienced publisher would pay. Catalogues that would have been purchased for 8-10 times their annual earnings a decade ago, were suddenly being snapped up for 14 or 16 times earnings. As most music business veterans shook their hands in wonder, the investment community assured the sellers of the catalogues, who were often songwriters or their heirs, that the new companies were in the game for the “long-run”, not just out to make a quick buck.

It will surprise no one then that most of these companies are now, openly or not so openly, up for sale. The bankruptcy of Lehman has already put one of the companies on the block, and it’s clear that almost all of these new “publishers” are now actively looking for someone to bail them out of the music business. Most likely, the people that will do the bailing are the music business weasels who sold to them in the first place– buying the catalogues back for half of what they sold them for 2 years ago.

What can we learn from this?

1. Music publishing is indeed a good investment– but ONLY for the long-term. If you’re looking to purchase music catalogues, particularly proven, time-tested ones, you can expect over ten years to earn a relatively predictable return. But you cannot expect to earn that return every year. Over a shorter time-span, there will be wild swings in earnings, based on collection issues, sync placements (or the lack thereof), currency issues, and pure dumb luck.

2. No music publishing company hits the ground running. If you’re starting a music-publishing venture today, you can’t expect to see money tomorrow. As I mentioned in a recent blog, there is generally a 3-4 year lag between a hit record today, and when the money actually arrives in the publisher’s pocket. That’s not such a big problem for a well-established company, with a catalogue that’s been earning money for decades. But for a new start-up, it virtually guarantees three or four very lean years in the beginning.

3. If you’re venturing into the music business for the first time, do it with people who have been successful in the music business before, and really know about music. Having met with a few of the investment guys as they embarked on their foray into the music biz, it was hard not to be impressed. They were smart, confident, and could actually add numbers in their head (and have them add up correctly, which almost no music weasel can manage). The only problem was that they had little or no knowledge of contemporary music; no gut instinct for what was happening with contemporary audiences, and almost no interest in the creative element of music publishing. What they learned was that this is an art, not a science. Most old-school music types don’t seem too smart– but neither does a shark.

In the end, it appears that music-publishing business will soon be handed back to old-fashioned music publishers. For all their faults, that might not be such a bad thing.