Portfolio: AID Partners and HMV Asia

Those who know HMV as a traditional music retailer will likely to feel increasingly disoriented as they explore the three-floor flagship store in Hong Kong's bustling commercial district of Causeway Bay.

The 45,000 square-foot space - designed to be a one-stop shop for music and entertainment - has a different theme on each floor. The first is filled with HMV's core entertainment products: movies, DVDs, CDs, books, magazines, and vinyl records. Move up one level and the focus shifts to lifestyle, with piles of Star Wars and Batman branded toys and other miscellanea, and then the top floor is all about food and beverage.

The café, bar and restaurant area, which opens for breakfast and closes at midnight, also features a stage for live music shows. Right next to the stage, there is a three-meter wide HMV trade mark oil painting that depicts a dog listening to a gramophone. This is Nipper, an enduring reminder of the past in a venue that aspires to a very different future.

I previously turned around Orange Sky Golden Harvest, so I thought I could turn around HMV as well. Both companies distribute movie and music products – the last mile of entertainment – Kelvin Wu

This thematic evolution is the work of Hong Kong-based AID Partners, which bought the Asia assets of HMV in January 2013. It wants to reposition the brand as more than just a place to shop DVDs and CDs; it is a place where people can come and spend the whole day, gorging themselves on media and entertainment.

"The idea is we want the younger generation to become our customers," says Kelvin Wu, chairman and CIO of AID Partners. "HMV is a place for entertainment and happiness. If we provide places for young people to hang out with their friends that will make them happy. We will also put in some DJ booths to give our customers a touch of live music. In this way we can differentiate ourselves from transitional retailers."

The party's over

The first HMV store was opened in Oxford Street, London in 1921 by UK-based Gramophone Company. In the old days, it was more of a diversified business, selling gramophones and other electronic goods. It wasn't until the early 1980s and the arrival of CDs that HMV narrowed its scope to focus solely on entertainment retail. Given that CDs could be produced for $0.13 apiece and sold for $18.00, the profits rolled in.

The launch of the DVD format in the late 1990s drove further growth. By the end of the decade, HMV operated more than 320 stores globally, with footholds in Australia, US, Japan, Hong Kong, Singapore and Germany. The first Hong Kong store opened in 1994 and Singapore followed three years later.

However, another technological breakthrough ultimately led to HMV's demise as a music retailer. The iPod, which arrived in 2002 as the world's first digital music device, triggered a series of challenges from which certain segments of the traditional music and movie industry have still to recover. Younger generations have moved seamlessly from physical to digital; CDs and DVDs have been replaced by online streaming.

According to the International Federation of the Phonographic Industry (IFPI), 39% of the music industry's revenues worldwide in 2015 came from physical format sales, down from 42% in 2014 and 46% in 2013. Meanwhile, the digital revenue contribution was 45% last year, up from 42% in 2014 and 40% in 2013.

HMV fought against the rising tide, acquiring other retail chains to boost scale and launching an e-commerce platform. But the nuances of brick-and-mortar retail worked against it.

"Physical entertainment is highly specialized. It involves unique, lengthy payment terms and a lot of consignment, concessions and returns. And it's a low margin. It's a bit like books. If you want to sell magazines, a publisher drops off 50 magazines and at the end of the month comes back and collects the magazines you haven't sold. It's very different from traditional retail business. I am always trying to move things in a more practical direction; more straightforward terms and higher margins," says Robert Esser, current CEO of HMV Asia.

In January 2013, the UK business went to administration. It was on the brink of bankruptcy when US-based Hilco Global agreed to acquire the debt of the UK, US and Canadian businesses. In March of that year, AID Partners acquired HMV's existing operations in Hong Kong and Singapore, plus the rights to develop the brand in in the mainland, Taiwan and Macau.

Wu declines to disclose the exact purchase amount, simply saying it was "a few millions of dollars." At that time, HMV had six stores in Hong Kong and two in Singapore, plus an e-commerce business in Hong Kong. The combined businesses posted an annual revenue of HK$300 million ($39 million), with music records sales accounting for 28% and visual products 41%. Non-music items, including electronics and video games, contributed 24%.

"First, HMV was only a small deal at that time but the brand had a lot of meaning to Hong Kong people. Second, it is an entertainment business, not just a pure retail company. If it was a convenience store, I wouldn't have been interested in buying it. Third, I previously turned around Orange Sky Golden Harvest, so I thought I could turn around HMV as well. Both companies distribute movie and music products - the last mile of entertainment," says Wu.

Orange Sky Golden Harvest - AID Partners financed an Orange Sky-led buyout of Golden Harvest in 2008, creating a business with interests in film production and theaters - is not Wu's only experience of the media and entertainment value chain. He also bought a stake in US-based studio Legendary Pictures, which was sold to China's Dalian Wanda earlier this year, and backed other media-related companies such as visual effects creator Prime Focus.

New direction

It was clear from the outset that HMV needed to be repositioned and its business diversified. The first iteration of this emerged in September 2014 with concept store HMVideal, located in Hong Kong's Lan Kwai Fong district. Covering two floors and 12,500 square feet, the store offered a comprehensive collection of books, magazine and vinyl records, as well as headphones and other entertainment-related products. It also featured a cafe, kid's playground and performance area.

HMVideal has now closed but will reopen in a new location, while one of the six Hong Kong retail outlets and both of the Singapore locations have been shuttered. AID Partners will leverage its LP relationships to secure land; its backers include a leading Hong Kong real estate developer. After the flagship premises in Causeway Bay opened in December 2015, multiple mall operators offered to host new stores in return for a cut of monthly turnover rather than a flat rental fee.

In terms of products, the flagship store now stocks 113 different brands of headphones and speakers, up 40% year-on-year, and it is also making a big commitment to vinyl, holding about 15,000 new and used records. Customers are able to buy, sell and trade, while HMV has also appointed merchandisers to purchase used vinyl from Japan or the US. Despite accounting for just 2% of global industry revenue, vinyl record sales increased 54% last year; HMV's sales rose almost three-fold in 2015.

"As a part of our whole business, it's still quite small, but the growth is very promising. The great thing about vinyl records is that they're genuine music. Your ears can perceive the presence of things which are missing in a computer file," says Esser, who joined the company in March 2015. "There is also a promising growth market for turntables and vinyl accessories."

Although technology is disrupting retail, he believes consumers still want to physically engage with products that resonate with them. Various online retailers are now adding brick-and-mortar outlets to capture customers offline; Amazon opened its first store in Seattle last year, after 20 years as an online-only operator.

AID Partners is also seeking strategic partners for HMV in order to broaden the brand's content pipeline. Two months ago, it sold an 18.37% stake in HMV to Japan's World Innovation Laboratories (WiL), a Silcom Valley-based venture fund.

"HMV plans to expand into mainland China, where the entertainment business is booming. It wants to have more content and it wants to source this content from Japan. We have great contacts within Japanese corporations and the IT industry, which will help," says Gen Isayama, co-founder of WiL. "In addition, all of our Japanese LPs are very keen on increasing their presence in China. So there are a lot of strategic synergies in working with HMV because it has local shops."

A few weeks after announcing the WiL deal, HMV formed an alliance with Hong Kong GEM-board listed China 3D Digital Entertainment through a backdoor listing. China 3D bought the remaining 81.63% interest in HMV for HK$408.1 million ($52.6 million) and issued shares to AID Partners in return, making the PE firm controlling shareholder in the listed entity. China 3D is now called HMV Digital China Group.

"The way to win this game is how you differentiate yourself. It's not as simple as putting a café into a bookstore, or a restaurant into a barber shop. You have to offer something different in terms of user experience, services and content," says Wu. "That's why we want to work with China 3D on the content side. Content isn't just putting out a DVD, we're talking about live music contents - singers performing in HMV. That's unique content and China 3D can help."

China 3D operates in several segments of the media industry, spanning film production and distribution, cinema operations and Hong Kong artist management. Last year, it signed a long-term agreement with Baidu-controlled iQiyi that has seen the Chinese online video streaming platform will commit 40% of the budget for 8-12 films produced each year by China 3D. IQiyi will take charge of promotion and online distribution in mainland China, and HMV will be the priority distributor in Hong Kong.

Further synergies are expected to come through the company's movie theater business - China 3D has four theaters in the mainland, with two more to open this summer - and its artist management operation.

As part of a gradual integration with HMV online and offline, China 3D plans to open an HMV store in each cinema, while its artists will hold live webchats with fans through the HMV online platform and media campaigns for their movies will be held in the flagship store in Causeway Bay. China 3D is one of the distributors for "Olympus Has Fallen" and its sequel "London Has Fallen" due out this year, and activities for fans have been organized at HMV.

"Most media companies don't have this kind of vertical integration. After we merge with HMV, we will be the most integrated company and we can make use of all of our resources," says Stephen Shiu, chairman of China 3D.

A sustainable model

Although China 3D has already built presence in mainland China, the expansion of HMV outlets in the mainland is still at its early stage. The biggest hurdle is government censorship. All media retailers are required to obtain special licenses and HMV is currently negotiating with regulators to establish a presence in Shanghai where it will sell a limited range of products.

The company will also expand into other parts of Asia, with Singapore and Thailand on the provisional agenda. However, with HMV having just posted its first increase in revenue in 11 years - the total was not disclosed, but in 2014 revenue came to HK$43.7 million and there was a net loss of HK$24.1 million - for now the focus is on improving existing services. The Causeway Bay store is a laboratory to experiment with an integrated entertainment business model.

"We need to get our offerings right, because there is a variety of things that we can do," says Esser. "Right now the Causeway Bay store has all that in it - physical entertainment products, food and beverage, lifestyle products. But how do we take that and put it into a shop that's only 6,000 square feet in a mall? I don't know the answer yet. That's something we're working on."

Initial feedback has been positive as evidenced by the number of repeat customers, but the priority remains promotion in order to imprint the new brand identity in the minds of a wider audience. "If you stop 20 people on the street, what they're going to tell you is, ‘It's a music and movie store,'" Esser adds. "How many of them will know there is a bar inside? Very few. We are taking the brand on a journey."

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• Topics
• Greater China
• Consumer
• Buyouts
• Southeast Asia
• AID Partners
• Hong Kong (China)