The Slings and Arrows of Industry Giants
Ever since private equity firm Terra Firma purchased the EMI Group in 2007, the label and publishing giant has been caught in a proverbial purgatory of sorts; too substantial and progressive to falter, yet too financially uncertain to move forward. Having finalized the acquisition on the eve of that year’s economic credit crunch, Terra Firma quickly found itself pulling rabbit ears out of its pants pockets in the face of a $3billion loan from its lender, Citibank. Terra Firma Chairman, Guy Hands, then filed a lawsuit with Citibank claiming that his loan officer, David Wormsley, had misrepresented the label and effectively duped him into purchasing the company. November 4th 2010 saw the conclusion of a four weeklong battle in the New York Supreme Court that favored Citibank. Guy Hands’s Terra Firma was made responsible for the full amount of EMI Group’s debt. Now, to stay in control of EMI, Guy Hands had to find the necessary funds to pay the debt—an improbable occurrence.
EMI and Citigroup
Following the New York Supreme Court’s decision, therefore, the transfer of EMI ownership had an air of inevitability. However, at the time of ruling, it was assumed by most that the transition would not take place until EMI’s March 31st, 2011 fiscal year-end, the time when Terra Firma was expected to default on its final loan payments. In an effort to expedite the process, and seize immediately control of the record label and publisher, Citibank asked for a solvency test that it expected EMI to fail. It did. As a result, Guy Hands and Terra Firma were removed early from the company and lost any stake they had in it. Research by Private Equity News would put Guy Hand’s Terra Firma’s loss at $2.7 billlion—perhaps the largest ever in the history of private equity.
The acquisition improved the position of the label. Time was bought back from the March 31st, 2011 deadline (Citigroup took effective control on February 1st). In addition, the purchase reduced the debt level of the record label by more than 65%. Through a debt-for-equity swap, Citigroup was able to recapitalize EMI, reducing its debts from $5.5billion to just $1.9billion. “We have gone from a company that is vastly overleveraged to having one of the strongest balance sheets in the music industry,” says Roger Faxon, CEO of the EMI Group. “This gives us strength to move forward … We have plenty of headroom in our loan covenants and lots of liquidity.” While restructured balance sheets have a notable affect on EMI, they are also equally attractive to Citibank- who will use them as a selling point for potential investors as they begin the process of selling off the EMI assets, which include its valuable publishing catalog. “It’s pretty clear that Citigroup will not sell CDs… It’s not a comfortable place for a music business to sit,” Faxon says; he adds that “in due course, we of course are going to get sold; but it will be an orderly and profitable process.”
A Potential WMG Merger
The prospect of a merger between EMI and Warner Music Group has been on the radar since before Terra Firma snatched the company in 2007. Now that EMI is effectively back on the market, it is up to Warner’s capital investors –Thomas H. Lee Partners, Bain Capital, and Providence Equity Partners- to decide whether or not to make another bet on the music industry. Despite the fact that Goldman-Sachs was recently hired on to seek out potential buyers for WMG assets, label executives still maintain vocal interest in placing a bid for EMI when the opportunity arrives.
One of the constraints that Warner has is European and US regulators. But given these economic times, and the current status of the music industry, it is possible that government oversight might be relaxed to stimulate the economy. The expectation that “regulators need to play the role of facilitator and help the industry make money rather than fending off a monopoly” is reasonable, and is widely held by investors today such as Anil Narang, a partner at MKM Capital Advisors that discussed the Warner-EMI merger in Billboard Magazine.
The consolidation of EMI and WMG would have a significant impact on the music industry—and not just the recording industry. EMI Publishing, for instance, already holds a commanding lead in overall market share at 18.1%. The addition of Warner/Chappell’s 12.7% share would afford the new company control over more than a third of the industry’s total publishing assets. Moreover, the consolidation of both company’s artist rosters, executive staff, and financial assets would create a very favorable competitive position in regards to the other two majors.
The role of BMG
Another player interested in EMI and Warner is the German Bertlessmann Music Group (BMG). Their interest, however, is focused exclusively on acquiring publishing assets, not record labels. Because of this, they may be at a disadvantage against a package-deal offer for both.
The saga of BMG is worth telling. Its recorded music business joined forces with Sony Music in 2004, creating at the time the largest global record company with a 21.5% market share. BMG then ran into liquidity problems that were unrelated to its music operations. It decided to start selling off assets in 2007, when it sold back to Sony its 50% stake in Sony BMG for $1.5billion. BMG’s separate publishing arm, not part of the Sony-BMG merger, was also auctioned off to Universal Music Group for $2.6billion.
However, by 2009 Bertelsmann re-opened shop. It began focusing exclusively on music publishing, and entered into a joint venture with private equity firm Kohlberg Kravis Roberts & Co. (KKR). Under the leadership of its new CEO Hartwig Masuch, BMG is by far the fastest growing publishing company in the industry. In the past 18 months, the company has embarked on an acquisition spree, picking up the likes of Crosstown Songs America, Stage Three Music, Cherry Lane Music Publishing, Evergreen Copyrights and Chrysalis. As of Q3’10, BMG is the 6th largest music publisher in America, as measured by the Harry Fox Agency.
Bertelsmann is currently one of the front-runners going after the publishing assets of both EMI and WMG. With a 5.2% market share in Q3’10, acquisition of the EMI catalogue could vault BMG to a controlling share of around 23%. BMG’s CEO is on record for saying that BMG is “not interested in buying a major label, [and that] they have a scalable infrastrucure [as a publisher only]”. He does not rule out, however, a future interest in controlling master recording rights to extend the reach of BMG services—which is where EMI and Warner’s recorded businesses will come in.
By Evan kramer