Equity owner must decide whether to bail out 123-year-old music firm

Amid an exodus of artists and execs, the management team at EMI Group is making what many see as a final attempt to secure additional investment from private equity owners Terra Firma this month to stave off repossession by Citigroup.

The banking group loaned Terra Firma $3.8 billion to buy EMI in 2007, but despite massive cost cuts and a reorganization that is now generating improved profits, EMI was in breach of banking covenants in March and, according to insiders, will also breach covenants in June and September.

“If interest payments are being met but covenants are not, it is normal for the lender to renegotiate the loan conditions. However, Citigroup has remained silent on its intentions,” says one source familiar with EMI’s loan arrangements.

That relationship has been complicated by Terra Firma chairman Guy Hands’ December lawsuit charging the bankers with deliberately inflating the price for EMI by falsely claiming other parties were interested in a takeover at the time Terra Firma bought the music giant. Citigroup denies the allegations.

The case is expected to be heard in September, but it’s uncertain whether EMI will still exist as a stand-alone company by then. The music conglom has debts of about $4 billion and must persuade investors to put up $184.5 million by June if it is to avoid breaching its banking covenants.

Meanwhile, the storied company has been hit by a spate of unfavorable PR: Radiohead, the Rolling Stones and Paul McCartney severed decades-long relationships; a recent courtroom ruling in favor of Pink Floyd over royalties also brought a black eye; and while historic preservationists stepped in to save EMI-owned Abbey Road Studios from being sold to commercial developers, the episode’s fallout highlighted the company’s financial woes.

Last year, EMI posted an astonishing $2.5 billion loss because of impairment charges and escalating interest payments, wiping out improved operating profit of $460 million.

But while many observers indeed blame EMI’s financial woes on Terra Firma having paid too much ($6.5 billion) for the company, others believe the roots of the music major’s problems run deeper.

“Arguably it dates back to the de-merger of Thorn EMI,” says Brian Southall, a former EMI staffer and the author of the 2009 book “The Rise and Fall of EMI Records.” That severing of ties created a company quoted on the stock exchange whose sole business was music. Other music companies were part of larger entertainment conglomerates, but EMI’s share price could fallfor example, if the Japanese market experienced a poor quarter.

Mirroring the consensus in the music biz over the past decade, Southall contends EMI’s best option is a deal with Warner Music Group.

“When they first wanted to merge in 2000, the reasoning was that Warner was strong in the United States but not so hot internationally, while EMI was strong in the U.K. but weak in America. That’s still true today,” Southall says. “The two companies will eventually get together in some shape or form because it’s the only opportunity left for them.”

While Warner’s debts total only about $2 billion, the potential cost savings for both companies from a merger would be substantial.

Another former senior EMI exec says that the failed merger attempt in 2000 was operational suicide, arguing that because people knew EMI was up for sale, it became far more difficult for the company to hire quality executives.

More recently, EMI executive chairman Charles Allen decided to go back to the drawing board in formulating the company’s business plan after Elio Leoni-Sceti, the exec that Terra Firma had headhunted for the top position, left unexpectedly. Leoni-Sceti’s blueprint would have raised some $300 million. (Speculation was that a strategy to license the company’s catalog in America led to a boardroom rift that resulted in the exec’s exit.)

Despite the turmoil and uncertainty over EMI’s future, those dealing with the company say the new owners are making headway.

“EMI was a disaster, and Terra Firma has done a remarkable job in turning it around,” says Tim Clark of IE Music, which manages Robbie Williams, one of EMI’s biggest stars. “They have brought a lot of new thinking to marketing, and when it comes to what the digital age means for the business, I’d say that EMI is doing better than anyone else.”

Should Citigroup play hardball, however, it could bring down the curtain on 123 years of history encompassing such acts as Frank Sinatra, the Beatles and the Beach Boys.

That could mean a fire sale, with the bank especially eager to cash in on the jewel-in-the-crown music publishing division, estimated to be worth in excess of $2 billion.

Many think that would be folly.

“EMI has the longest established music publishing business, and it’s an absolute treasure trove of copyrights, including some of the greatest songs of all time,” says Steve Lewis, founder and CEO of publishers Stage Three Music.

EMI’s publishing roster includes R&B artists Beyonce, Usher, Alicia Keys and Rihanna; rappers Jay-Z, Kanye West and Ludacris; U.K. acts Amy Winehouse and Mark Ronson; art rockers Arcade Fire; crossover queen Norah Jones; and legacy acts Smokey Robinson, Queen, Bryan Ferry, Lou Reed, the Pretenders and Notorious B.I.G.

It’s unlikely regulators would sanction a sale to rival publishing giants such as Universal or Warner Chappel, but Sony ATV could be a credible contender, while cash-rich BMG is regarded as a favorite should EMI Music Publishing be sold off. Institutional investors could also be interested.

Some within EMI’s inner circle are optimistic that the financial threat is being dealt with.

“Senior management is very calm about the situation, and everyone is just getting on with doing the best job possible,” one insider tells Variety.

Others aren’t as sanguine, citing low morale among staff and frustration that experienced music people have been replaced by execs with little knowledge of the music industry.

That said, the company has been enjoying its best spell in years recently, thanks to chart successes by the likes of Lady Antebellum and Gorillaz. In fact, according to Nielsen SoundScan, for the week ending April 11, EMI had three of the top five selling LPs for the first time since April 2004, with a year-to-date overall album market share of 11.63%, up from 9.02% the year prior.

The recorded music division has stemmed its falling sales, and operating profit is expected to rise this year to $397 million from $246 million in 2009, thanks to continued cost cutting.

But the vultures are circling. Warner is reportedly talking to private equity group KKR about making a bid for EMI’s assets should Citigroup take control.

“It would be a huge loss to the music industry and culture in general if EMI was to disappear,” IE Music’s Clark says. “It has an extraordinary catalog, and while that might be relatively undervalued because of technology, once the value returns to the digital economy — which it undoubtedly will — then all of a sudden EMI will be a veritable gold mine.”

Still, EMI’s future lies in the hands of a lender that isn’t talking with the company’s owner, and which would lose no sleep over breaking the company up if that’s what’s best for its balance sheets. And that just makes it tougher for EMI to attract new acts looking to establish long-term ties.

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