EMI hopes they can make music together

Determined not to be left behind in the desperate march to achieve scale in a dive-bombing music industry, U.K.-based music producer and distributor EMI confirmed Monday that it has entered non-exclusive talks to buy Warner Music Group.

Company’s last-ditch campaign, after months of not-so-subtle hints of its interest in WMG’s recorded music division, reportedly includes $1 billion cash plus a 25% stake in an enlarged EMI (worth an estimated $600 million). The combined companies would generate sales of around $5.8 billion but could leave EMI dangerously overleveraged, say analysts. However, the alternative — being No. 4 in global music market share with limited costs left to cut — may be far worse.

EMI is jostling for a prime position at the auction after Warner’s exclusive merger talks with Bertelsmann Music Group ended a week ago, purportedly after the German conglom balked at ceding control, upping its cash contribution to the 50/50 merger. Companies say talks between BMG and WMG continue and that EMI’s talks are at a “very preliminary” stage.

Seeking concessions?

In fact, sources speculate that TW has opened the door to alternative bids in an effort to get concessions out of Bertelsmann, which infuriated Warner execs earlier this year by backing out on a preliminary deal to acquire Time Warner’s book biz. Indeed, banking sources suggest there is a lot of politics undermining a final deal between Bertelsmann and AOL Time Warner, despite broad agreement between the respective record company execs.

EMI’s talent roster includes Robbie Williams, Kylie Minogue and Coldplay, but its profit margins from North America are under pressure as marketing costs rise in a tight marketplace. WMG, while it has a robust 17% of the U.S. market, is said to be struggling with 5% operating margins. The combined companies would be looking to cut some $300 million in annual costs.

EMI has secured financial backing from U.S. private equity firm Blackstone but would prefer to raise more of the financing in the form of debt from a syndicate of banks including the Royal Bank of Scotland and Citicorp. EMI, the world’s third largest music group, has a market value of $1.9 billion.

The decision to make a formal offer comes a week after EMI announced its intention to offer x300 million ($339 million) in 10-year senior notes, having already raised $243 million in convertible bonds.

Trouble from cartel cops

But EMI and Warner, which were rebuffed at the altar by European regulators three years ago, may have a tougher time getting past the cartel cops than a WMG-BMG merger. That’s because EMI has a larger share of the European market. Combined, EMI and Warner would claim a 30% market share regionwide (and up to 40% in some territories), compared with only 21% between WMG and BMG.

For EMI, buying Warner Music is a desperate measure to use scale to shore up an ailing business. A Warner-BMG combination would leave EMI a distant fourth in an industry dependent on cost-cutting to offset steadily declining CD sales, especially in the U.S. BMG, EMI and Warner Music each have between 11% and 12% of the global recorded music market, behind industry leader Universal Music, with 26%.

Ratings agency Standard & Poor’s on Monday placed EMI on CreditWatch with negative implications, based on “uncertainty over the capital structure of any potential transaction between EMI and AOL Time Warner.” EMI already carries a hefty £900 million ($1.48 million) in net debt.

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