Is HMV in the ‘buggy whip’ business?
Posted on February 14, 2008 by Richard Beddard
Filed Under Companies |
With the invention of cars, the buggy whips used for driving horses became redundant. With the invention of downloads, the future’s bleak for music retailers, then.
While HMV (HMV) reported higher like-for-like sales last Christmas, it was only good news relative to what had gone before. Sales have barely risen over the last two or three years, and pre-tax profit margins have fallen by nearly two-thirds. Shareholders once earned 24p per share, but they earned just under 9p in 2007. The share price is around 124p. Three years ago, it was more like 270p.
This is a miserable situation, because I own shares in HMV. I bought HMV thinking it would go on growing but the question now is whether, one year into a three year recovery programme, the shares are cheap enough to warrant buying or, at least, worth holding in the expectation the price will improve with the company’s fortunes.
Maybe. HMV floated in 2002 and has reported five years of earnings, from which we can derive a five-year price earnings ratio. Five years was the minimum Benjamin Graham, the grandfather of value investing, recommended would-be analysts use in calculating a company’s PE. Any less, and a couple of good or bad years could mask a company’s real earning power.
HMV’s five year PE is under seven. For a company that is still profitable, with relatively low levels of debt, and recovery potential, that seems reasonable. It held its dividend at 7.4p in 2007 and confidently recommended the interim dividend of 1.8p in October, also the same level as 2006. The 6% dividend yield, and an unbroken sequence of director buys, seem to have ended the slide in the share price. For nearly a year, it’s moved sideways in a channel between about 95p and 135p.
Glancing through HMV’s annual reports, I’m not so sure. There are signs of recovery, but what of HMV’s long-term future?
When you buy shares in a company with a low price relative to the average of its previous five years earnings (or more), it’s because you believe that average is a reasonable measure of the company’s earning power. The company is suffering a temporary set back and, all other things being equal, it should go on and earn at least that much in the future. If it does, the price will follow the earnings back up.
But are all other things equal at HMV? Reading the 2002 and 2003 annual reports its obvious how much the business of retailing entertainment has changed, already. HMV believed ‘range authority‘ distinguished it from the competition. Supermarkets sold hits. If you wanted something more specialist, you had to go to a shop like HMV.
Since Simon Fox took over as chief executive in 2006, the words ‘range authority’ have disappeared from the company’s literature. Now it’s focusing on controlling costs, protecting store sales, and new Internet sites for Waterstone’s and HMV.
So what happened to range authority? Isn’t it important any more? Waterstone’s is half way through a three-year programme to reduce floor space by 10%. HMV is protecting store sales by devoting more space to products like games and technology (like iPods and mobile phones). Neither initiative seems likely to increase the number of titles or artists it stocks.
Yet music and DVDs account for 63% of sales, and books another 29%.
I think range authority is killing HMV. To understand this we need only look at Amazon, or iTunes, or even, dare I say it, Tesco.com. Thanks to the Internet. There’s very little music and very few books you can’t buy from these sites - any time.
HMV married longer, deeper shelves and bigger stockrooms to expert staff and efficient stock control, but on the Internet the customers market the music (or books, or films) when they rate it, recommend it, and review it. Customers who set up their own stores on Amazon even handle the stock. A major theme of Chris Anderson’s book, The Long Tail, is, thanks to cheap computer memory, the marginal cost of adding digital ’stock’ on a computer server is near zero. That means you can stock everything, however infrequently it sells.
HMV says the market for ‘physical music’ is expected to decline 13 % a year but I don’t suppose we’re listening to less music, we’re listening to downloads, legal and illegal.
In 2002, only 0.1% of world music sales were downloaded. Last year legal downloads accounted for 10% of the market. HMV’s confident prediction in its 2002 annual report that:
We firmly believe that the desire to own and collect music in a physical format remains undiminished.
Seems naive now. My 11 year-old-son, who plays in a band and who only loves football more than music, watches YouTube and listens to a Zen (it’s an MP3 player). His generation could be the first that never buys physical copies of music. In five or ten year’s time, the same might be said of the other HMV staples: films, books and games. They can all be digitised.
Going back to the five-year PE ratio. The average of the previous five years earnings are supposed to be indicative of a company’s future earning power over, say, the next five years. But the entertainment business is changing so fast, I’m not sure HMV’s record is relevant. If it recovers, it will be a different business selling different things through different channels.
So, although it’s cheap, it doesn’t look like a value stock to me. Value stocks aren’t speculative. They are shares in dependable businesses that other investors have forgotten. That way all the company has to do is keep trading. The risk, that it might not recover, is small and the reward, that the price will rise when it does, is both likely and large.
HMV may recover. But it could be, in the words of Charlie Munger, a ‘buggy whip’ business:
When technology moves as fast as it does in a civilization like ours, you get a phenomenon which I call competitive destruction. You know, you have the finest buggy whip factory and all of a sudden in comes this little horseless carriage. And before too many years go by, your buggy whip business is dead. You either get into a different business or you’re dead - you’re destroyed. It happens again and again and again.
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14 Responses to “Is HMV in the ‘buggy whip’ business?”
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Which part of the music business is still worth being in? what and where is it? Should HMV go there?
Hi Julian, it’s a good question. And what, I imagine, Simon Fox and co think they are doing i.e. investing in its websites and downloads in its stores. I’m just cagey because:
1. It’s behind the competition (If you read HMV’s 2002 annual report it was already experimenting with websites and kiosks in its stores - it doesn’t seem to have progressed much)
2. Downloading is different business to traditional retailing. It’s a technology business. HMV’s expertise is in stock control, managing suppliers etc.
That doesn’t mean it’s doomed. In fact in the short-term the company’s bouncing back. I just can’t see where it’s going say five years ahead - and that’s the kind of time-frame investors (as opposed to speculators) should be thinking about.
For me the strengths of the brand are that people love music and games. The weakness is that it is not clear whether consumers like them enough to pay for a conventional retailer’s balance sheet. If they don’t and the brand wants to stay meeting that demand it muct either a) add a tremendous amount of value to the experience generated through the balance sheet (shops, inventory selection, staff, location) or get rid of the balance sheet (pure online channel).
I don’t think, given as you have noted, HMV’s late attendance in the game, that option two is a goer. It must therefore configure the balance sheet around the customer. It is trying with new concept stores, etc. But a more radical solution is required to do with its brand and how that can make a shop more than a shop, like Apple can, which has the most profitable retail space on the planet.
Julian
Yes, I have to confess I haven’t seen an Apple Store or one of HMV’s concept stores (there’s one in Tunbridge Wells apparently).
I suppose the difference between Apple and HMV though is iPhones aren’t commodities - while music seems to be. Even artists are giving it away for exposure.
iPhones may not be (yet) but phones in general are, mp3 players are, laptops are, headphones are, speakers are and so is customer service. This is what actually comes out of an Apple shop. But people love it, and will pay a premium to get it.
Why? Music is assumed to be free by large portions of the public, but that is because they have been trained by Apple that they shouldn’t somehow maintain a valuable relationship with an artist / album or song they show focus on filling up an ipod with over 40,000 files. That size of collection was inconceivable 10 years ago. The downside is that volume has triumphed over quality. But these cycles always rebel and the rish, edited selection will come back into vogue.
It’s simply a matter of emotional framing for the purpose of business. Apple have been very good at this and also at off-loading their waste on to other stages in the value chain, such that people love music and resent the music industry yet love Apple, whose products accelerate the effects of commoditisation. Retailers must engage with the audience and find a win/win such that people want them to succeed.
I’m inclined to think that win/win doesn’t involve a shop! Which takes us back to the web sites. And the problem there is does an editorial selection have much value when algorithms (a la Google) and the wisdom of crowds (e.g. Last.fm/bloggers etc.) can do the job for us? It’s an issue that affects journalists too (gulp).
Obviously there will be room for lots of models, but that means less room for each one doesn’t it?
And that comes back to my original thoughts about HMV as an investment. I’m not saying it’s doomed. Just that it’s difficult to see it returning to its former levels of profitability, or being the same sized business even.
Another viewpoint about HMV is that it has a large network of dedicated music shops and bookstores which its competitors do not have. If they utilise this asset like a warehouse then they cannot possibly compete with the likes of Amazon.
I know I like to wander into an HMV or Waterstones. There are advantages to shops (e.g. browsing the merchandise, no postage and packing, helpful advice, immediately available, easier returns - although HMV’s returns policy sucks, impulse buys, the potential to offer cool ‘in-store’ services). If the customer can be convinced that the deal they are getting is nearly as cheap as anything online, then they will probably buy the product there and then.
I also notice that on-line prices are starting to significantly converge now and it is actually quite hard, and fairly boring, trying to save an extra 50p on a purchase.
I also think it would be a sad future to only be able to download music and videos from the internet in the future. I hope HMV can make their business model work and take some wind out of the online stores.
Hi Robin,
This is, I think, why it’s quite dangerous to rely on personal experience. No doubt part of my scepticism about HMV is that I’m almost completely beholden to Amazon. I buy a lot of books and films and music too - all from Amazon. And I sell it through them too. I think of Amazon as a kind of library where you don’t have to give back the book or CD unless you want to! The problem is how to stop that personal experience from unduly influencing your investment decisions.
I walk into HMV occasionally - mostly to see how my investment is doing
And when I do I see rows and rows of CDs (and books if its Waterstones) but out of context. I can’t see the reviews, ‘what other people have bought’ etc. So for me the whole industry is shifting.
That’s why I almost always fall back on the numbers. I see considerable uncertainty about HMV’s business whereas (and I haven’t done the research yet) take SCS upholstory. It’s long-term PE is 2 compared to HMV’s 7. Now, on the face of it, SCS’s woes are worse. It’s barely making a profit this year and it’s not paying a dividend. I suppose sofas being more expensive than CDs, people are more likely to hold off on buying them in a downturn. But long-term I don’t imagine we’re going to stop sitting on sofas and SCS has no debt (I think - not checked) so if it can last a few bad years it could at some point be an outstanding bargain.
I’ve posted this in the links on the right but it speaks volumes about the music industry. It’s the Kaiser Chiefs talking at the Brits last night. Some quotes:
Chief 1: ” I think it’s just like natural selection - if record companies are clever enough to survive, they’ll survive. If they keep going the way they’re going, they won’t.”
Chief 2: “Things are going wrong aren’t they? In a way I feel privileged I’ve seen it being ballsed up so much. We lived and survived through a time when record companies couldn’t make the right decision to save their lives.”
Hi Richard,
Do not worry, I agree with your analysis
To use a value term, I see the stores which HMV owns as its ‘economic moat’. However, right now they are a liability and not an asset.
It is a shame because, with the right information available in store, I would be a much more active buyer. However, right now, if I see anything I like, I make a mental note of it and go back home. Sometimes I can be bothered to look it up online, sometimes I get it out the library, and sometimes I just move on
Thanks Robin (though dissent is allowed :-)).
I like the way you and Julian above describe the situation. Seeing its stores as liabilities and not assets and doubting that customers are prepared to spend enough on music and film to pay for a traditional retailer’s balance sheet pretty much sum it up.
As a final footnote to this issue, I went into my local HMV this weekend and I was thinking about what kind of ‘user experience’ I was getting … it really sucked!
Needless to say, I did not buy anything (even though I have a £16 voucher from a refund from a few months ago).
I would definitely say they are a business in trouble - HMV are now resorting to pretty desperate tactics to attract new customers: http://getcloserbeta.blogspot.com/2008/02/getclosercom-how-hmv-are-spamming-you.html
The funny part of all of this is that now we have peak OIL coming, buggy whip sales might actually recover.