September 30, 2009, NEW YORK–(BUSINESS WIRE)–According to Fitch Ratings, the music industry should be able to continue to navigate the digital transition within existing credit profiles. Digital content delivery has disrupted both advertising and entertainment companies over the past several years. For the music industry, the transition from physical to digital (including the affects of piracy), continues to be a challenge. However, given the competitive dynamics and cost structures for industry participants, Fitch does not expect material credit issues to arise during the industry's continued evolution toward legal internet distribution or from high profile musicians leaving major labels. Below is an excerpt from Fitch's 14-page credit analysis report on 'Warner Music Group' (rated 'BB-' with a Stable Rating Outlook). The report discusses key components of Fitch's ratings and outlook and includes a discussion on the future of the music industry.

Q: What is the impact of platforms such as MySpace, where independent artists can promote themselves? Has the industry lost its 'barriers to entry' competitive advantage?

While Fitch fully acknowledges the ease of digital distribution for independent bands, the resultant fragmentation makes the major labels' traditional marketing still very relevant, as they have the global infrastructure in place to reach radio, legitimate retail (physical and digital), and video outlets in a high-quality way to a targeted mass market. Fitch continues to believe that, regardless of how a band/musician is discovered, its No. 1 goal is still to be signed by a label – be it one of the four majors or an independent label. To that point, Fitch believes much of the music distributed independently on Internet sites is more likely to be a competitor to the independent labels (Matador, Sub Pop, etc.) and not the major labels like WMG. From an opportunistic standpoint, the legitimacy of social networking sites has provided additional inexpensive promotional opportunities for the major labels to offer streaming videos and other exclusive content of their artists.

Q: What is the impact of major established artists like Radiohead and Pearl Jam selling albums on their own without a major label?

Major artists have experimented with alternative distribution outlets over the last several years. These events, such as Radiohead 'selling' its new CD on its web site and Pearl Jam recording an album on their own and exclusively distributing in the U.S. through Target and iTunes, bring into question the long-term validity of the major labels' current market share. The Beatles pioneered such a move when they left Capital Records to form their own label (Apple Records) back in the 1960s. More recently, the Barenaked Ladies, Paul McCartney, and the Eagles left the major studios this decade. Fitch does not believe the departure of high-profile musicians from the labels is a major credit concern, as their ability to leave the label usually means they were successful and profitable while with the label and the label continues to retain all rights to the artists' catalog upon departure; moreover, established artists typically carry much lower margins, less lucrative terms, and therefore higher risk for the labels after their initial recording contract expires.

Importantly, Fitch believes there are a very limited number of artists that have the fan base to continue to be successful without a record label. Radiohead, Pearl Jam and Barenaked Ladies, without doubt, represent bands with loyal followings that would be maintained regardless of promotion and marketing plans. These bands can rely on their fans searching them out for new songs, concerts, and other events. Fitch believes the vast majority of revenue generated by the major labels comes from artists who rely more on the record labels for promotion. Of WMG's current roster of artists, Fitch believes that there are less than a dozen profitable U.S. artists that would be able to leave the label and maintain similar levels of popularity. Fitch believes Linkin Park and Metallica would be able to maintain their fan base without a label, while Nickelback and Green Day would likely be successful as well. We do not believe other major WMG sellers over the years, such as James Blunt, My Chemical Romance, Josh Groban, Sean Paul, Gnarls Barkley, Flo Rida, T.I., Rob Thomas, Jason Mraz, Kid Rock, and Daniel Powter, among many others, would be able to pursue a similarly successful career without a record label. While R.E.M. would be able to maintain its fan base, Fitch does not believe the band has been materially profitable for WMG this decade. Importantly, it still remains to be seen if any of these moves away from a record label can be successful over the long term. Various news reports have suggested that Radiohead's 'name your price' sale resulted in the majority of people taking the CD for free.

Q: Can the major labels really be successful in implementing 360-degree deals with artists?

Yes. Fitch expects that WMG and the other labels will continue to push these agreements with new artists and that the recording industry should have significant leverage regarding deal terms due to the oligopoly structure of the industry, combined with the virtually limitless supply of aspiring musicians. We believe that Madonna's eventual exit from the Warner labels represents a prudent move for WMG and that the goal for them should not be to sign Madonna to uneconomical terms, but to sign the 'next' Madonna to 360-degree agreements.

Q: What are some other opportunities to help grow and/or curb piracy?

Reaching an inflection point where digital growth exceeds physical erosion is the only way to stabilize the existing trend of negative net record sales. Fitch believes there are some things to be optimistic about in order to assist in reaching this inflection point (or offer ancillary revenues). These include the following:

Cell phone products: Fitch believes the seamlessness of over-the-air (OTA) purchases, which should become increasingly standard with the rollout of 3G and 4G phones, could provide additional demand on digital purchases. However, Fitch believes pricing will continue to be an issue with consumers as OTA downloads can be more expensive then computer downloads.

Internet fees: The labels are discussing a monthly fee as part of a consumer Internet service that would be for music. The biggest issue related to bundled monthly fees revolve around the consumers demand to own the song versus a monthly subscription where the consumer does not retain a library once the subscription is cancelled.

Regulating the Internet service providers (ISPs) to monitor piracy: This could remain an elusive goal; however, some progress has been made over the last year. France and the U.K., among other European countries, continue to look to the ISPs for assistance in curbing piracy. At the government's urging, six of Britain's biggest ISPs reached an accord that voluntarily binds them to a code of practice intended to reduce illicit file-sharing. Last year's ruling by the FCC to disallow Comcast from slowing downloads from file-sharing site BitTorrent seems to go in the opposite direction of the U.K. ruling. However, Fitch notes the recent statements by new FCC chairman Julius Genachowski that illegal activity on the Internet must be curbed when discussing net neutrality rules is a positive step forward.

Ad-based Web sites continue to exist; however, their long-term viability is questionable as they must pay royalties to the music company and to date have not been able to monetize their advertising space to sufficiently offset these fees. Web sites such as MySpace, YouTube, Imeem, Jango, LastFM, Pandora, and SpiralFrog, among many others, currently exist; it is unlikely, however, that new ones will surface, and more unlikely that these outlets will contribute materially to the music lab
els cash flows over the intermediate-term.

For additional information, please see Fitch's report on Warner Music Group dated Sept. 29, 2009 and available at 'www.fitchratings.com'.

Additional information is available at 'www.fitchratings.com'.

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Contacts

Fitch Ratings
Jamie Rizzo, CFA, +1-212-908-0548 (New York)
Mike Simonton, +1-312-368-3138 (Chicago)
Media Relations
Cindy Stoller, +1-212-908-0526 (New York)
cindy.stoller@fitchratings.com