Digital music- making noise
We have been heartened by the ongoing operational progress at EMI Group (EMI) along with development activity in the all-important digital marketplace in the past year. The group's latest interim figures showed growth in both revenue and profits, while technical advances to enable further rapid growth of legitimate digital sales continue apace. We believe the substitution of digital for physical sales has now reached the point where industry wide sales growth will once more turn positive. Within this rapidly changing environment, EMI is well positioned to benefit.
| "The potential of digital music as demonstrated by current growth rates cannot be underestimated in our opinion." |
Since our last review in August, ongoing choppy trade has seen EMI breach trend-line support, previously identified in FAT95. However, the shares remain within the two year trading range bound by the August 2004 low of 187.5p and the February 2005 high of 288p. We are encouraged to see the correction low of 205.5p in October 2005 held above the psychologically important level of 200p as well as the prior significant low of August 2004 at 187.5p.
Six-month interim results released towards the end of 2005, revealed that operating margins rose by 0.6 to 9.4 percent, turnover by 5.8 percent to £925 million and pre-tax profits before amortisation and exceptionals by a healthy 9.0 percent. Both the Music and Publishing divisions performed well, contributing growth across nearly all regions where EMI operates. Digital music sales percentage of group turnover surged from 2.1 to 4.9 percent. We believe growth of these revenues in particular will be the single most important factor for EMI going forward.
EMI Music's strong performance was underpinned by the development of long-term career artists, commitment to local artists/content and maximising global potential. During the period, the group's market share of physical sales increased to 13.1 from 12.5 percent. Leading the way were top selling superstars such as Coldplay, Gorillaz and The Rolling Stones combined with promising new artists such as KT Tunstall and the Magic Numbers. The UK, North America, Continental Europe and Australasia regions all made solid contributions, with only Japan losing market share due to a soft local repertoire. A solid schedule of releases from the likes of Robbie Williams, Depeche Mode and the Beastie Boys should ensure that the group's strong first half will be continued into the full year.
The Music Publishing business has also pursued increased digital revenues. Mobile downloads such as ring-tones and ring-backs have thus far underpinned digital's 42.6 percent growth in sales. However, the strong stable of talented songwriters at EMI still generates the bulk of the group's revenue. Encouragingly, all revenue types (performance, synchronisation and mechanical) across all regions enjoyed growing revenues. As with the Music division, a strong second half schedule also bodes well for Publishing.
Musical taste is a very personal choice. While we have mentioned several individual artists and groups, clearly they may not be to everyone's liking, and their commercial success may not seem so readily apparent. However, accolades received by EMI's artists indicate to us widespread critical and popular success. Last year, EMI took home 33 'Grammys' and 10 MTV Europe 'gongs'. Similar success was experienced at the Country Music Association awards in the US. Domestically, EMI received 38 BRIT award nominations covering virtually every category. Obviously digital music is an exciting development for the industry, however content is also critical and these awards leave us confident EMI's core commodity is in excellent shape.
Keeping pace with changes in the technology and services that are driving digital sales growth is daunting, however EMI is also performing well in this arena. Significantly, Eric Nicoli, EMI chairman will be making the keynote speech at this year's MidemNet Music & Technology conference, the most important business event in the music industry. The market has moved swiftly on from bread and butter music downloads into exciting additional areas including mobile music development and music video downloads. Other Midem attendees such as Motorola, MTV and Real Networks attest to the convergence that is taking place with affects beyond just the music industry. Recent agreements with T-Mobile and Nokia demonstrate to us that EMI is taking a proactive leadership role in these changes.
| "We believe the substitution of digital for physical sales has now reached the point where industry wide sales growth will once more turn positive." |
The success of Apple's iTunes services has had a very positive impact on the industry, however record industry desires to modify pricing schedules has led to a potential problem. New York attorney general Eliot Spitzer is investigating allegations of price-fixing. Subpoenas have recently been issued to all major labels including EMI. We should note, the investigation is in very preliminary stages so the financial impact is difficult to gauge.
The potential of digital music as demonstrated by current growth rates cannot be underestimated in our opinion. This is reinforced by today's industry announcement that said digital music sales reached US$1.1 billion in 2005 (a threefold increase on 2004) with further significant growth expected this year. In addition to having a strong source of content and active engagement of technological developments, EMI have also benefited from successful legal action against Grokster in the US and Kazaa in Australia. This has allowed popular digital download services to grow while new platforms and products are evolving, which will enhance EMI's ability to monetise content in the future.
Although further gyrations within the trading range are likely in the near term, the overall picture remains positive. We anticipate support between 200p and 187.5p to underpin the shares prior to upward momentum being re-established. A clear and sustained break above resistance at the upper end of the trading range, at 288p, will see the market trading at the highest levels since May 2002. In our opinion this would indicate the potential for additional gains toward the 385-400p region. As such, EMI will remain firmly held in the Fat Prophets Portfolio.
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