Firms Using Music Downloading And Streaming To Become More Profitable
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
One thing the internet has managed to quite successfully accomplish over the past ten years is to monetize the online music industry. In 2012, 52% of record company revenues domestically were actually digital. When compared with other online revenue streams, such as games, newspapers, books, and film, music revenue obtained digitally utterly swamped most other. The global percentage of revenue obtained digitally the last reported year, 2011, with 32% year over year growth, compared with averages of about three percent for books, newspaper and film combined. Globally, there were over 13 million digital music subscribers at year end.
In light of these sorts of trends in the computerization of recorded music, I wanted to take a look at some of the leading domestic based music download or streaming companies. The 800 pound gorilla in the room, in terms of downloads, is Amazon (NASDAQ: AMZN). Of course, the core of Amazon has been and will continue to be tangible books, records, and almost any other consumer item imaginable. But there is little reason to doubt Amazon when it decides to enter a new niche, as it has with music downloads.
The Amazon download system includes millions of titles, priced from $0.69, and entire compact discs, priced from $5. Amazon often bundles downloads upon selling a tangible music products. Amazon is thought of in the industry as the “economy brand” of the downloadable music world, which is quite consistent with this company over the past several years in general. It has been far more interested in growing revenue than in turning profits.
Amazon's earnings have advanced 30% annually the past five years. Its profits, which are being announced as I write this, are forecast for $0.29 per share, nearly a 30% drop from the same quarter last year. For a company selling as richly as Amazon is, I would like to see more than just revenue power. Amazon is not for me.
Hewlett-Packard (NYSE: HPQ) has made great strides toward downloadable music with high quality audio in its recently introduced 27 inch monitor with hip hop superstar Dr. Dre's Beats audio imbedded into it. The monitor is to be released near February 3, and was designed specifically, with upward angled speakers, to be a high quality music player. In addition, the company has introduced a new, highly affordable line of mid-grade laptops. Later in February, the company is to release its first “Chromebooks” with 14 inch monitors and price points below $400.
All of this is not necessarily going to save this sunken ship of a company. Neither, I believe, will its new Connected Music service, which was launched in November of 2012. This music download service will be bundled into many Hewlett Packard machines with no cost, short term use. But if Hewlett Packard is to thrive, it will do so by succeeding in its expansion of its enterprise business. However, even in that business there are deep pocketed, well established competitors such as IBM (IBM) and Oracle (ORCL).
Hewlett-Packard's fiscal 2012 ended October 31 on a decidedly downcast not due not only to the write off of the Autonomy investment, but sour ongoing earnings as well. It is unlikely there will be another multibillion dollar write off fiscal 2013, but ongoing earnings are not looking too bright. Wall Street is looking for first fiscal quarter of 2013 earnings of $0.71 per share, and I don't think that is going to happen. Upfront costs of new hardware, along with general economic malaise has me thinking any real earnings recovery will not occur until the second half of the year. As for consistently earning in the $7 billion to $10 billion per year range that it was last decade, I don't see that on the horizon at all. Hewlett Packard is not on my radar for an investment choice.
When it comes to streaming music, the best known domestic player in the industry is probably Pandora Media (NYSE: P). Pandora is unique in that is uses proprietary technology based on customer feedback to customize user “radio” stations. It was recently named by JPMorgan Chase (JPM) as that investment advisory division's top internet small cap pick for 2013. Despite this, Pandora has declared a profit in only one quarter since going public in June, 2011, and is not forecast to be profitable in fiscal 2013, which ended January 31, 2013, or in fiscal 2014. What Pandora does have is revenue growth. Fiscal 2013 revenues should be up about 55% from the previous year, and another 40% jump is likely next year. The bulk of those revenues come from advertising, as in the last reported quarter, the third fiscal quarter ending October 20, 2012, advertising accounted for $106.3 of the overall $120 million that was reported.
Trends for royalty payments by streaming companies are headed down, which of course bodes well for Pandora's long term prospects. Assuming revenue growth continuing aggressively out to mid-decade, this is a stock that has the potential to double or more over the next few years as it becomes sustainably profitable, but with no history as yet, Pandora is only suitable to investors who can afford to take risks.
Of course, in a field that is growing as rapidly as digital, downloadable music, there should be room for veterans. One such company is The Singing Machine Company (SMDM). This company has been around for 30 years and is best known for manufacturing children’s' karaoke machines. At the recent Las Vegas Consumer Electronics Show, the company introduced a new line of grown up “party machines” that stream 1,000's of songs from the internet and also act as wireless Bluetooth speakers. The products, sold at retailers such as Costco (COST), Target (TGT) and Toys R Us, are also sold online through Amazon and other websites.
The company’s debt ballooned to $5.7 million in fiscal 2011, but was able to reduce its debt down to $4.3 million in fiscal 2012. In fiscal 2012, the company posted nearly $600,000 in profit. Sales jumped 30% (due to the addition of new distribution channels (Target and BJ’s Wholesale Club). Expenses were stable, while margins improved slightly. The company reported a 90% sell through number, meaning that it sold 90 of every 100 shelved units. Online sales (Amazon.com and Walmart.com) rose significantly throughout 2012. On top of this, the company maxed out its warehouse capacity in 2012, especially during the holiday season. The company plans to reevaluate its systems processes to keep up with expected demand from the 2013 holiday season.
The company expects its debt will continue to decrease in 2013. I expect the company to show very strong numbers in its next earnings release. With this increased profitability, the company will have more cash available to pay down its debt. With well-established retail channels and new and exciting product, I am certain that in the quarters ahead The Singing Machine Company will generate enough cash to continue paying down its burdensome debt, paving the way for more consistent profitability. For those in a position to take substantial risk, The Singing Machine Company could well provide solid returns over the next few years if household incomes do not collapse.
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