EMI rejected a $4.6bn (£2.5bn) cash bid from Warner Music yesterday, describing the offer as "wholly unacceptable", and disclosed that it had made an approach last week for its smaller US rival, worth the same amount.
Warner's bid - dubbed a "PacMan" defence after the computer game where one character turns around and eats its pursuer - leaves the music giants locked in a stand-off as they battle for control of what would become the world's second biggest record company with a 25 per cent market share.
Disagreements over the structure of the deal and which management team will take control of the enlarged company could yet scupper the merger, designed to create a stronger competitor to the current market leaders, Universal and Sony/BMG.
EMI described its increased $31-a-share bid, which represents a 44 per cent premium to Warner's share price before its initial approach in May, as "far superior" to its rival's revised alternative proposal which values EMI at 320p a share.
It is unclear whether EMI has the capacity or appetite to further raise its bid to convince Edgar Bronfman Jr, Warner Music's chief executive, and his backers to accept its advances. EMI's bid has been fully underwritten but is dependent on a share placing and the sale of assets.
Mr Bronfman and his private equity backers control about 75 per cent of Warner Music's shares, putting the US company in a strong negotiating position. As a result, Warner's management is considered to have more flexibility in raising its offer for EMI if it so desires. For its part, Warner has argued EMI's bid is dependent on an equity placing as well as the sale of its Warner/ Chappell music publishing business. Its cash bid for EMI is not subject to these conditions.
"It's a bit like a Mexican stand-off. It might be a case of who blinks first," said Anthony de Larrinaga, an analyst at SG Securities. The analyst said he would not be surprised if EMI comes under pressure to explain to its shareholders why it rejected the "generous" 320p bid, potentially leaving it vulnerable to a Warner takeover. "EMI could be thwarted by its own ambition," Mr de Larrinaga said.
Despite the rejection, EMI shares gained 8.4 per cent to 307.5p as a result of Warner's offer but remain shy of the bid price.
Analysts still believe a combination of the world's third and fourth largest music companies looks increasingly likely. The deal would see EMI's artists, including Coldplay, Joss Stone and Robbie Williams, come under the same umbrella as Warner's stars, including Madonna, Red Hot Chili Peppers and James Blunt.
Yet issues related to the structure of the deal and the management line-up of the enlarged company need to be resolved before a deal is agreed.
EMI has justified the deal by pointing to synergy benefits. Numis Securities estimates those benefits to be in the region of £160m. The broker said: "A merger between EMI and Warner would add very significant value, both in terms of cost synergies and increased scale."
EMI has been fighting to buy Warner for six years after a merger was blocked by regulators in 2000. In 2003, Time Warner auctioned its music business, but EMI lost out to Mr Bronfman.
Both companies operate in a tough music market, owing to illegal downloading and music piracy. Regulatory intervention looks less likely six years on, after a merger of the Sony and BMG music businesses was cleared. The enlarged company will also still trail the market leader Universal Music, owned by France's Vivendi.