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Music to their ears

AOL TW arm's union with BMG would bring lift

NEW YORK — The pending merger of Bertelsmann Music Group and Warner Music would prove music to the ears of AOL Time Warner shareholders.

The conglom stands to gain a big margin advantage through massive cost savings at its downtrodden music division if it can ultimately agree to terms — and appease regulators — for a tie-up with BMG.

According to research released by CIBC World Markets on Friday, Warner Music’s cash flow margins could double from 7% to more than 15% through hefty savings from the merger. Analyst Michael Gallant estimates that the two companies could expect cost savings of $460 million.

For AOL Time Warner shareholders that operating margin enhancement could equate to an extra $1.6 billion in additional net asset value.

Still on table

Deal to combine the world’s fourth- and fifth-largest music operations (BMG and Warner Music, respectively) is still the subject of ongoing negotiations between AOL Time Warner and BMG over valuation and control.

Accord is believed to create a 50-50 company that insiders said Warner Music chief Roger Ames is likely to run. But as Warner is 20% larger than BMG (based on 2002 sales), AOL Time Warner may be insisting on cash compensation from BMG.

The model for the deal is industry leader Universal Music Group, which despite continued top-line losses has managed to maintain a healthy 17% operating margin.

A combined Warner Music and BMG would have revenues of $5.7 billion. But the real advantage is on the cost side and the increased scale that may provide the merged entity more leverage in negotiations with technology providers and retailers.

Assuming the two sides agree on a management structure for the deal, the big sticking point remains getting the merger past European regulators.

Market runner-up

Both BMG and Warner Music note that their combination would make them second behind Universal Music Group in terms of U.S. and global record sales market share. BMG sources are confident that the European Commission will greenlight the deal despite past refusals of record company mergers as the union would not include either company’s music publishing divisions.

At the same time, the rumor mill is churning over whether ailing rival music conglom EMI may be trying to break up the party with its own $1 billion offer for Warner Music. Neither BMG nor Warner would comment on the speculation, saying only that the two companies remain under an exclusive negotiation pact until the end of August, which will likely be extended as negotiations continue.

Unconfirmed press reports had EMI chairman Eric Nicoli and recorded music head Alain Levy offering to pay $950 million for a 75% take in WMG’s recorded music business. But most analysts question how EMI –which has attempted to merge with both Warner Music and BMG in the past — could afford such a deal given its overleveraged balance sheet and falling market share.