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this snippet of a Techcrunch story on The Orchard going private:
The Orchard has yet to file an annual report for last year, but for the first nine months of 2009,it has lost $17.5 million on revenues of $45.5 million.
The Orchard specializes in digital distribution. The fact that it cannot make any money is yet another nail in the coffin of the music industry. Perhaps under private ownership, it can transition to a different business model.
I like this because it encapsulates the journalistic narrative on the music industry perfectly: yet another nail in the coffin of the music industry
. Pretty much any story on music is shaped around that narrative, regardless of what the story is and regardless of the truth of the narrative.
In many ways (instruments, publishing, licensing) the music industry is doing better than ever. It is only the record industry that’s dying, just like the wax cylinder industry before it and the mass market for sheet music. _Recordings_ as a whole continue to drive a lot of transactions for third party products like jeans, cars and liquor, so there will continue to be money made. Managing recordings continues to be a hassle for consumers, and the business of making their problems go away isn’t becoming obsolete.
Journalists write whatever attracts readers. Readers love the narrative that the music industry is dying. That doesn’t mean it’s a true story, it just means that it’s dramatic and entertaining.
That also doesn’t mean The Orchard’s valuation isn’t really weak. Licensed distribution products don’t yet do a high volume of transactions — $45 million dollars is pretty lame considering how much music they represent. But I don’t know why their costs are so high.
Any thoughts on why The Orchard needed to spend $63 million to earn $46 million in the first nine months of 2009? Why is their business so expensive to run?
Hey Lucas
The reason is because their gross margin is only 20%. Very few businesses can operate with such low margin. 50% or more is typically required and 70% is ideal in order to obtain a valuation of over 5x revenue. They are valued at just 25% of annual rev because the GM is just 20%. It’s accounting 101.
All the best,
Ryan
Thanks for the insight, Ryan.
Is that a typical margin for a distributor? Any idea how their margin compares to IODA?
Actually, it’s not quite as bad as your numbers suggest – they didn’t “spend” $63 million in the first 9 months of 2009 (but it’s not great either)
They had gross revenues of $45.5. 80% of those revenues were really the revenues of their distributed labels/artists – so $33 million goes straight the the labels. This left them with a gross margin of $12 million – although in reality as a distributor this is really what you should think of as their revenues – the distribution income they generate. They had $15.7 million in operating expenses. So it cost them $15.7 million to run a business that generated $12 million in net revenues. So they are still losing $3 million on an operating basis.
On top of that – they took a $14 million goodwill write down related to the purchases of the Orchard and DMGI. This is a non-cash expense – a realization they overpaid for these assets when they purchased them.
If you look at the comparable #s for 2008, they generated $11.7 million of net revenues on $14 million of operation expenses – so they were still losing a couple of million on an operating basis.
Here’s the real problem. 2/3 of their revenue comes from iTunes and eMusic. So in reality for any indie label that is doing significant revenues it’s not that hard to a do a direct deal with those to accounts and save on they distribution fee. You might work with the Orchard for everyone else – but the volumes are a lot lower. They’ve set up a distribution that requires scale/volumes to generate profit – but in a world where 2 accounts represent 2/3 of the revenues – how much value are they really adding?
They had almost 1.5 million tracks in their catalog – so call that the equivalent of 150k albums. They generated $45 million in gross revenues in those 9 months. That works out to $300/album on average. Obviously, there’s large pieces of the catalog that aren’t selling at all. When you factor in the costs of licensing the content, getting it into their system, and accounting to artists/labels – they are probably losing money on a large percentage of the catalog they distribute.
Bottom line – you can’t base a distribution business on product that doesn’t turnover.
Please excuse me for not approving this right away. I didn’t realize that it was stuck in the queue.
More thoughts on to come when I have free time for blogging.