They wanna hold each other's hands

Music companies are hunting merger partners to save their profits, writes Heather Tomlinson. So who'll pair off and who'll sit out the slow dance?
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The Independent Online

Ego, glamour and a loose hold on the purse strings: all are common in the music business. But lavish spending and larger-than-life personalities may soon find themselves downsized because the industry is about to get smaller.

The five big music majors – Universal, BMG, Warner, Sony and the UK's own EMI – are suffering. Global music sales have slumped, hit by increased piracy as people download music from the internet, and profits have slipped down the charts. Meanwhile, demanding artists seek telephone number record deals and more control over what they produce, when they produce it and how it is used. Witness Robbie Williams' £80m deal with EMI (although it will be worth much less if his records flop) and Michael Jackson's bitter public spat with his record label, Sony (which followed similar rows between Sony and George Michael, and Warner and Prince). It is easy to see why the companies are singing the blues.

So the time is right for some of the players to merge, cut costs and so bolster themselves against the global music piracy – internet downloading or organised bootlegging – that is behind many of their traumas.

"There is a huge will to consolidate: everybody recognises there is a deal to be done in the industry," says one City analyst. "All the executives have worked at two or three of the majors over the years, and they can always be spotted having a drink at a social function. A deal needs to be done, but it's not going to be imminent. The industry is too focused on piracy and reducing the decline in sales."

However, the buzz of rumours over recent weeks indicates that the companies' appetites have turned to hunger.

Universal Music won't be one of the bidders, mainly because it is the largest of the majors and so would attract the most attention from competition regulators. That is despite its gruesome 19 per cent fall in sales in the first quarter of this year to €1.1bn (£774m). But Universal could be a bid target. Big media companies like News Corporation or Viacom have the ability to make a move. Even the computer firms Apple and Microsoft could be interested, so they can develop the potential of online music downloading. Last month it was said that Apple was preparing a bid for Universal, but this was denied by both parties. A more likely outcome is a computer group taking a minority stake in the music firm.

Given the sales slump, the music industry is likely to keep it in the family. The three most likely companies to end up in a union are EMI, Warner and BMG, but there is only room for two. The latest rumour is that Warner and BMG are in talks, leaving EMI the piggy in the middle. But previously the buzz was over EMI and either one of the others.

For all the speculation, however, none of the companies have much money. AOL Time Warner, the owner of Warner Music, is reviewing its assets as part of a debt-reduction strategy, so it is unlikely to want to splash out on a new division. "If it is going to buy BMG for cash in this climate, I don't think its shareholders would like it," says Mark Anselm, vice president at media corporate financier LongAcre Partners.

In fact it would be very happy to get a healthy offer for its music division, say analysts. But there are few people who are able to meet the expectations.

BMG, owned by private German company Bertelsmann, has just had to swallow the independent record label Zomba for $2.7bn (£1.7bn) in a deal that was pre-signed in 1991 and eventually done rather reluctantly, despite Zomba's successes with Britney Spears and Justin Timberlake. There are still reports that BMG is interested in taking a majority stake in AOL Time Warner, but with its hopes of flotation and its €2.7bn debt, it would probably make more sense if Bertelsmann sold BMG off.

Like its peers, EMI does not have much cash at its disposal. It has raised £123m net from the sale of its stake in HMV and is understood to be reviewing whether it could sell off its property, including Abbey Road studio, in a £200m deal. But to raise the sort of funds that would entice AOL or Bertelsmann to do a deal would be tough. It could issue its shares as payment, but the main desire of both these potential targets is for cash.

And as a seller, EMI's shareholders are also likely to be keener on money than paper in one of the larger media conglomerates. "Investors want a cash sum rather than something that gives them more exposure to the music industry," says one analyst.

But EMI has a card up its sleeve. A deal between Warner Music and BMG would attract the attention of tough American competition regulators, as they are both strong in the country. Industry veterans have not forgotten EMI's attempted merger with both parties a few years ago, both blocked by the European regulators and a huge distraction to management.

For EMI, which is strong in Europe, there is some hope that the European Commission could be more forgiving in the future. The regulator has been criticised for over-zealous application of competition law, and the deteriorating state of the industry could well be taken into account. "At some point, one hopes there will be some relaxation in regulation, but by then the music industry will have probably shrunk by a few percentage points," says Anthony de Larrinaga, media analyst at SG Securities.

But what the music companies want is what watchdogs are reluctant to give: a grip on the prices they can charge for the products. "The whole point of regulatory control is to stop pricing power, but if there is a merger without that power, it's just a short-term solution," adds Mr de Larrinaga.

However, there are interesting possibilities at one of the other operators, Sony. A big player in records, with artists like Jennifer Lopez on its books, the Japanese electronics giant is restructuring and has placed a new man in charge of the music business, Andrew Lack. His brief is to undertake a fundamental review of the business, from its manufacturing operations to the deals it strikes with artists. Could a few calls from across the Pacific Ocean or even over the Asian continent interest Sony in doing a deal?

Again, it is not cash rich but it is unlikely to be a keen seller given the overlaps between music, its video games and its Columbia Pictures film division.

So with all the four potential players, a deal would have to be an innovative proposition that could ease the fear of regulators, raise money from some quarters and also be a complementary fit between the prospective partners. "You have to get the right chemistry," says one City banker.

To provide funds, numerous private equity firms have been linked with the industry, particularly with EMI. But what they need for a deal – an undervalued company with a steady flow of cash to pay off big debts – is not present in music. The dramatic falls in revenues are also offputting.

However, if they were to look at the music companies' publishing businesses, which manage the back catalogues rather than trying to break hit singles in the charts, there could be more interest. That is particularly the case at EMI, the largest music publisher, where getting rid of most of these assets would both bring in cash and solve one of its major regulatory problems.

One of the simpler options, it would seem, is to do a straight merger, with either party holding on to around half their business. Warner Music's Roger Ames and BMG's Rolf Schmidt-Holtz are both thought to be considering this option.

But there is doubt that such a deal would really be easy. "With the egos and personalities involved, a merger would be very difficult," says Mr Anselm. "They would have to have one take over the other."

In this global game of musical chairs, someone is sure to be left standing in the corner. But who is far from clear.