Jeremy Warner's Outlook: Will it be third time lucky for EMI with Warner Music? You never know. It might just be

BAA: a question of how much leverage; Sky plugs into a broadband future
Click to follow
The Independent Online

When it comes to Warner Music, EMI is nothing if not persistent. In some guise or other, EMI's chairman, Eric Nicoli, has been trying to merge with Warner Music for more than six years, yet up until now, he's always been thwarted.

Tempting though it is liberally to sprinkle this piece with musical puns, I'll resist and instead confine myself to serious of analysis. This time, Mr Nicoli might actually succeed.

Back in 2000, a proposed merger of equals between the two foundered on regulatory objections. After a seemingly interminable investigation, the European Commission eventually demanded such a draconian set of remedies in terms of asset disposals that there was no point in doing the deal.

Three years later, with the music industry in apparent meltdown as a result of piracy and illegal downloads, Mr Nicoli returned for a second bite at the cherry after Time Warner put its music interests up for sale. Regulatory concerns scuppered him again, for Time Warner in the end preferred the certainty of a sale to private equity to the prospect of having to argue the toss before regulators once more.

Warner Music's private equity backers have since made a small fortune out of their purchase, which has been both refinanced and then later floated on the stock market. They've had most of the upside already, but there would plainly be more to come if the business could be crunched together with one of its international competitors. Analysts estimate the synergies at up to £100m.

Edgar Bronfman, Time Warner's chairman, was swift to reject EMI's $4bn May Day offer, but with a little bit more on the table, he might eventually be persuaded. He too has a long history of dalliance with EMI. He originally tried to buy the company when he was chief executive of the Bronfman family concern, Seagram. Spurned by EMI's then chairman, Sir Colin Southgate, he went and bought Polygram instead, which eventually, in the madness of the dot.com years, was folded into Vivendi. The original drinks business was sold off, and in the process of playing the media magnate game, Mr Bronfman very nearly squandered the family's inheritance.

The purchase of Warner Music has helped redeem his reputation as a money maker. For choice, he'd much prefer to reverse the tables and bid for EMI instead, but it is not clear his private equity shareholders would back him. They've already had a terrific run for their money and may well welcome the chance of an early exit.

Furthermore, they may not want to take the risk of another negotiation with regulators. The regulatory environment may be more accommodative than it was; the advent of digital downloads means that the music majors are not able to act as quite the monopolists they were. Yet no doubt some disposals will be required. Much better, from their point of view, to let EMI take on the regulatory risk.

EMI is the only credible trade buyer around - Sony and BMG have already merged - so Mr Nicoli will feel under no pressure to raise his bid immediately. Instead, he'll bide his time, and eventually, he'll probably succeed.

BAA: a question of how much leverage

It wasn't much of a defence, but so far we haven't had much of an offer either. Yesterday's formal defence document from BAA, owner of some of Britain's biggest airports, was as big a yawn as the bid itself from Grupo Ferrovial and its partners. An underwhelming offer, I guess, deserves an underwhelming response. Both sides seem at this stage to be keeping their powder dry. Yet if shareholders are banking on fireworks to come, they may have to think again.

Ferrovial yesterday repeated its previously stated position that it might be prepared to increase the 810p a share offer, but only "slightly" and in return for a recommendation and access to the books. Since the BAA board has already rejected an indicative offer from Goldman Sachs at 870p, it scarcely seems likely that the "slight" improvement on 810p a share being offered by Ferrovial is going to do the trick. Mike Clasper, the chief executive, is on record as saying the company is worth "way north" of what Ferrovial is bidding.

If Ferrovial is as good as its word, and is really not prepared to bid much more, is the game already as good as over? Perhaps not quite, for there is always the possibility of counter bids and, in any case, BAA is going to have to do something for its shareholders by way of capital return whether it likes it or not. The £9.5bn of capital spending over 10 years announced by BAA yesterday will take gearing at its peak to something over 100 per cent.

BAA would be hoisted on its own petard if it introduced the extreme level of debt leverage proposed by the Ferrovial consortium; the company believes it would be financially dangerous to have so much debt and, in all probability, unacceptable to the regulator, the Civil Aviation Authority. Yet there might be a half-way house, what Mr Clasper calls "a sweet spot", which would be attractive to the CAA because it would allow for a lower cost of capital, the benefit of which could eventually be passed on in lower landing charges, but would not be regarded as putting the investment programme in danger. Some extra leverage might be acceptable, but not too much.

In any case, the board would be unwise to believe it can get away with giving nothing back to shareholders at all. There's not a huge amount of goodwill for BAA in the City. The company is sometimes said to suffer from an arrogant sense of entitlement. If nothing else, the bid ought to galvanise management into a greater focus on delivering shareholder value.

The company is right to insist that too much leverage would be bad for Britain's airports. Look what happened to National Air Traffic Services, which essentially went bust post the terrorist atrocities of 11 September 2001 because of excessive levels of debt. But just as the London Stock Exchange was forced to give a little ground on leverage, while holding true to the argument that too much would damage users, so too will BAA.

Sky plugs into a broadband future

Faintly disappointing figures yesterday from BSkyB in terms of subscriber growth shouldn't be allowed to detract from the company's still excellent long-term prospects. These are set to receive a further boost later this year when Sky formally launches into the broadband market.

Local loop unbundling has given new entrants such as Sky the ability significantly to undercut the incumbents in the broadband market - British Telecom and NTL/Virgin.

Yet this is already a crowded market, with seemingly everyman and his dog seeking to "unbundle" BT exchanges with their own equipment. There's not enough space for all of them - quite literally as it happens, since many of the BT exchanges are not big enough to accommodate all the equipment that would-be competitors are looking to put into them.

Sky, which is already in one in three British households, looks certain to be one of the winners. Carphone Warehouse might be another. Through its retail chain, it has a ready, low-cost distribution channel too. Then there is the France Telecom-owned Wanadoo, soon to be rebranded Orange, also with an extensive retail presence and huge numbers of existing mobile subscribers to sell too.

More difficult is the position of companies such as the Cable & Wireless-owned Bulldog, which may be ahead of the game in terms of their place in the unbundling queue, but have to pay heavily for customer acquisition.

Bulldog's best hope might be to wholesale its broadband service to more customer-facing businesses in a better position to cross sell, such as the other mobile operators - O2, T-Mobile, 3, or even Vodafone. That was the strategy also adopted by Easynet. It proved difficult, and in the end it was easier just to sell the business outright to Sky. The same fate may await Bulldog, and other broadband pretenders with limited ability to cross sell.

j.warner@independent.co.uk

Comments