EMI: Hands counts the cost of foray into music

By Martin Arnold and Andrew Edgecliffe-Johnson 11/5/10 Financial Times

Citigroup has won its courtroom battle with Guy Hands. But both sides are still facing painful losses on the £4.2bn buy-out of EMI and their fates remain locked together in a battle to decide the future of the British music group.

After a bruising legal fight that left both sides nursing blows to their reputations, people who know Mr Hands said it was too early to write off the maverick boss of private equity group Terra Firma

Investors in Terra Firma have warned Mr Hands will struggle to raise another buy-out fund. Now he has lost the case, it is likely to leave an even bigger stain on his reputation, especially as he argued the only reason he paid £4.2bn for EMI was that his banking adviser told him to, in spite of months of due diligence.

“I’m not sorry,” said Luke Johnson, a private equity executive. “You have to be grown up in private equity and know it’s a caveat emptor world. You do due diligence and back your judgment. Hindsight is not allowed. I think Mr Hands’s reputation is in tatters.”

The impact on EMI will become clearer over the next five months, as the next test of its ability to meet covenants in its £3bn of loans from Citigroup comes up at the end of March.

The music group has failed these regular tests for the past couple of years, but Mr Hands has been able to keep control by putting more of his investors’ money into the company as “equity cures”, allowing the extra cash to be counted as profits.

It seems unlikely investors will give Mr Hands more money in March, making it possible that the business will default on its debt and be taken over by its only creditor, Citigroup. If that happens, the bank is expected to seek a rapid sale of EMI, probably by splitting it into two parts: music publishing, with its valuable back catalogue of songs, and recorded music, the lossmaking business of producing new music.

How the deal went sour
..At the time Mr Hands won the bidding for EMI, Warner Music and three rival private equity firms were trying to pull their own bids together. In the end, none did, but interest from Warner and from the private equity community has not gone away.

Warner has had a representative sitting in the back of the court for most of the three-week trial, as courtroom 14B was turned into something akin to the data rooms that banks provide during auctions, with information about the company’s condition and rival estimates of its value for any would-be suitor to study.

Yet Mr Moulton, a specialist investor in distressed companies, predicted that a deal between Mr Hands and Citigroup to restructure its debt in return for an injection of cash from the private equity group, was still the most likely solution.

“It is not a cost-free, easy option for Citi to just grab the keys to EMI, which is why we have hardly ever seen that outcome in these situations,” said Mr Moulton.

The eight-person New York jury heard little of the turmoil at EMI since Mr Hands took control. It has seen a succession of chief executives and other senior managers, and deep cost-cutting.

EMI’s management now looks more stable under Roger Faxon, the former head of its music publishing division. But despite hits from artists including Lady Antebellum and Katy Perry, and successful exploitation of giants from its catalogue including The Beatles, EMI remains far smaller than Universal Music and Sony Music, the two largest recorded music groups.

A merger with Warner, which has been attempted unsuccessfully many times since 1999, remains the most likely solution in most industry members’ minds. But that remains conditional on Warner’s own balance sheet and on the ability of Mr Hands and Citigroup to agree a deal.

Selling off individual labels or the rights to distribute EMI’s acts in certain countries is another alternative.

There are more potential suitors for EMI’s larger music publishing business, whose rights to 1.3m songs and attractive cash flows were the main reason for the private equity interest from Terra Firma, Cerberus, Fortress and One Equity Partners three years ago and from Permira before that.

For Mr Hands, after losing what many considered his last-ditch attempt to turn the EMI deal around, the future looks grim.

One investor in Terra Firma said before the verdict: “If you asked whether I would give him any more money, then I expect the answer would be no.”

Mr Hands has had a deal blow up before, his buy-out of Le Méridien, the hotel chain, which was fatefully completed weeks before the September 11 terrorist attacks.

But investors say he committed the “cardinal sin” of overexposing himself to the EMI deal, which accounts for about 30 per cent of his last two funds.

“The amount of his funds he has put into the deal is an aggravating factor,” said one Terra Firma investor.

But few people are prepared to write off Mr Hands, even in private. One possibility for Mr Hands is to launch a different venture, in the mould of Mr Moulton, who quit Alchemy, the buy-out firm he founded, to raise £142m for his new turnround fund on the London Stock Exchange.

Mr Hands may end up losing £1.75bn of Terra Firma’s and its co-investors’ money on EMI, but he still has €2.4bn left to invest out of the €5.4bn Terra Firma Capital Partners III fund he raised in 2007.

He has shown he can still do deals and raise financing from banks even after he launched the lawsuit against Citigroup a year ago. Just last month, Bank of America Merrill Lynch advised Terra Firma and provided financing for its €670m acquisition of Rete Reinnovabile, Italy’s biggest solar power company.

It can take a long time to kill a private equity firm, because investors are locked into cast-iron commitments to provide it with long-term capital. Mr Hands will be counting on the industry’s high barriers to exit to help his recovery


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