The music industry has never really recovered from the revenue slumps that came with mass online piracy, and probably never will. One private equity player, which invested in EMI Music and took it private with debt from Citigroup, has learned that lesson much to its financial disadvantage, as the bank used the debt to take over 100% of shares, and then processed a debt for equity swap to clean up its balance sheet and handed it some £300 million in cash to run the business.
While Citigroup made EMI issue a release to put a positive spin on the deal, it will mean the loss of something over $1billion for Terra Firma, the UK private equity group which invested in EMI back in 2007, as it loses all of its holding in the business.
EMI was one of the top four global music companies and was in merger talks with Warner Music when the private equity deal emerged. Everyone thought that Guy Hands, the leader of the Terra Firma deal, would break up EMI and go in for a quick turnaround, shopping it off to the highest bidder, but instead he tried to run it as a going concern. The problem was the amount of debt he took on to fund the deal, that and a continuing deterioration of the music business.
Previous attempts to sell EMI into one of the two largest music companies, Sony BMG and Universal Music Group met with insurmountable regulatory hurdles, so Warner was always the only likely merger deal.
Terra Firma formed a company called Maltby as the acquisition company and that has now gone into administration
In its last public quarters EMI had revenues of £1.75 billion down from £2.01 billion the previous year, with an operating profit of just £150 million and although the company has gone on to sign new bands and its statement claims that the management has improved revenues, it is has not been enough to service the £3.4 billion of debt the company had. The debt for equity swap will see debt fall to just £1.2 billion
During the Maltby management period debt continued to spiral and in May last year Terra Firma managed to find a further $156 million in financing to meet its loan repayments to Citigroup. We said at the time that this was likely to give it only a year of breathing space.
Citigroup will now have the same problem that Hands had, to find a sensible exit for the business and will have to trade it at a profit before it can either reliably merge it with Warner Music (if it still wants it) or take it public. A statement from the company said that EMI now has the financial flexibility to invest in its strategy for growth.
PriceWaterhouseCoopers were installed as administrators at Maltby Investments Limited and they sold EMI and its immediate holding company Maltby Acquisitions Limited to Citi.
Roger Faxon, EMI’s chief executive, said: ‘The recapitalization of EMI by Citi is an extremely positive step for the company. It has given us one of the most robust balance sheets in the industry with a modest level of debt and substantial liquidity. With that solid footing, we are confident in our ability to drive our business forward. We have already made great progress in meeting the challenges facing our industry. The closer alliance between our two operating divisions is already delivering impressive results on behalf of the creative talent we are privileged to represent. We have a clear vision for the future, a strong and committed management team, and now the right capital and financial structure in place to deliver successful outcomes for artists and songwriters.’
But EMI has always struggled in the modern age and despite the fact that it was the first company to concede the MP3 battle and drop proprietary online formats and DRM for online music, that was too little, too late. In our opinion the music industry was getting increasingly fat, forcing people to buy albums when they wanted singles, and sticking with outmoded formats and this caused piracy, and then it decided to sue it customer base ‘en masse.’ It more or less got what it deserved, and some would argue that the social networks are in a better position to become the record labels of the future and that genuine record labels are almost defunct.
The smart money remains on an eventual merger with Warner, partly paid for by sales of the music publishing to one of the market leaders. Expect more red ink around EMI before that happens.