UMG merger with EMI is on track, but at what cost?

Music for Screens: Summer 2012

Historic British record label EMI, which was just about shipwrecked in recent years, may be sailing toward calmer waters far away from a reckless buyout firm and a bank that repossessed it like a foreclosed house.

Record industry leader Universal Music Group is busy wrapping up a $1.9 billion acquisition of EMI’s recorded music biz and plans to invest several hundred million dollars to strengthen such key labels as Capitol Records (home of Katy Perry, Coldplay and Lady Antebellum) and break new talent. In order to reinvest in its potential new holdings, UMG hopes to raise cash from global asset sales, representing the one bright side of an onerous process: selling off assets so European regulators will approve the deal.

The divestitures, which could still be followed by a round of Stateside cuts depending upon U.S. regulators’ recommendations, had some wondering whether the entire deal would even make financial sense for the new owners. Historically speaking, the big record labels have often been guilty of chasing market share and paying less attention to actual revenues, but there are signs that UMG has a plan.

The merger “is not asset stripping,” says a person close to Universal. “We have cash coming in and we will put it right back in to rebuilding EMI.”

UMG chief Lucian Grainge will appoint an EMI CEO and “EMI will have its own P&L and the business will be run parallel to Universal’s,” he says. That’s likely reassuring to some industryites anxious that EMI was slowly becoming a catalog business.

They’ve had reason to worry. Over 50% of the label’s business is catalog vs. new music, compared with 20% to 30% at other majors. EMI’s investment in A&R, already a restrained £49 million (about $77 million) in 2008, plunged by more than half to about $30 million last year. Its artist roster shrank to 900 from 1,600, an unprecedented drop for a major music company.

EMI staff, estimated at about 2,000, is also rather spare, which means UMG may start hiring again when the deal is done and loose ends are settled.

There are quite a few of those. The European Commission has demanded wide-ranging divestitures, mostly in countries where Universal and EMI’s combined market share would top 40%. That’s the case in big territories like France and the U.K. and smaller ones like Norway and Poland, and it means giving up rights to top artists across a big chunk of Europe.

Universal has been working closely with regulators to get the numbers right and will submit a final blueprint in late August. It expects a greenlight soon after, a person familiar with the situation says, as the EC has set a Sept. 6 end to the process. The U.S. Federal Trade Commission is widely expected to give its thumbs up to the deal at about the same time.

Universal declined to comment and has not said publicly what it plans to offload. But it reportedly agreed to sell EMI’s Parlophone Records, U.K. home of Coldplay, Kylie Minogue and Gorillaz; as well as its Mute, Chrysalis and Ensign labels; EMI Classics, Virgin Classics and other assets in Belgium, Poland, Sweden and elsewhere — coming to about 60% of its European business. UMG would also divest its own catalog imprint Sanctuary Records.

The company made earlier concessions too, agreeing to sell global rights to a number of catalogs including songs by Robbie Williams and Ozzy Osbourne. EMI will keep the Beatles, Virgin Records and flagship EMI Records.

Of course, even once the UMG-EMI merger is finalized, the divvying up of divested assets could significantly alter the biz landscape even further. Speculation is rife that Universal apparently has several dozen buyers lined up already for EMI assets including such majors as Sony and BMG, indies like Daniel Miller’s U.K.-based Mute Records, and financial players like Ron Burkle and Ronald Perelman.

“Creatively, it would have been much better to keep EMI intact,” says one insider, but he adds that EMI was already a “decimated” company. Private equity group Terra Firma acquired it in leveraged buyout in 2007, loading the label with billions of dollars of debt in what media analyst Christopher Dixon called “one of the worst conceived LBOs in the history of the entertainment industry.” Citigroup swallowed it in 2011 after it defaulted on its loans and late last year broke the company in two and sold it.

A consortium led by Sony/ATV took EMI’s more valuable music publishing. “We knew going into it, it wouldn’t be easy,” says a person close to Universal, but the company never considered walking away from the deal as Time Warner did in 2005. Warner Music tried to buy EMI but backed off after European regulators slapped on too many conditions.

But so much has changed in the music business since 2005 that UMG execs, industry players and Wall Street alike expected an easier time this go-round, for a number of reasons. Physical music sales have plummeted and, as UMG itself has argued, big players need to get bigger to build scale in the digital space.

“It’s become very clear that with the rise of iTunes and the slowing of the CD model that the music industry was going to have to undergo some restructuring, a shift that would lead to natural consolidation,” Dixon says. “The problem is, regulators tend to be three steps behind the industry.”

Adds one insider: “Because of the changes in the music business we have become price takers instead of price makers. Apple has raised the price of songs once in nine years. … We get tenths of a cent for a stream. Walmart and Target are so powerful; if we raise (CD) prices they say ‘OK, we can replace your shelf space with cameras.’ And piracy is an old story. How do you compete with piracy? Not by raising your prices.”

What muscle EMI has left was on full display at the massive closing ceremony of the London Olympics earlier this month. The Spice Girls, Pet Shop Boys, Fatboy Slim and George Michael belted it out in what, one blogger joked, seemed like a reunion of 50% of the U.K. music industry.

U.K. regulators have been among the biggest opponents to a sale. “They’re saying, ‘Oh my God. Oh my God, it is part of the U.K.’s patrimony and we’re giving it to the French,’ ” says Michael McGuire of media research firm the Gartner Group. (Universal, HQ’ed in New York and Los Angeles, is owned by Vivendi.) But Universal might prove EMI’s savior. “Universal could have walked away too, but what effect would that have on EMI’s future? It may be the only class of investor that can care for the assets.”