EMI On The Brink

The battle between EMI owner Terra Firma and its US bankers appear to have become so bloody that it’s hard to imagine the UK’s only remaining major record company will emerge unscathed.

British business analysts are divided on what will happen next, although they generally agree the relationship between Terra Firma chief Guy Hands and Citigroup has deteriorated to the degree that something needs to happen soon.

The latest test for EMI’s bank covenants came at the end of December and, whatever the figures say, the results are unlikely to damage the financial value of the company as much as the very public row it’s having with its bankers.

Healthy earnings from EMI’s music publishing arm mean it will easily meet its covenant test, but a separate test measuring earnings ratios in comparison to net debt figures could mean the recorded music business could fail without new money. The result of that test will be known later in the month.

Citigroup bankrolled Hands’ company for £2.6 billion of the £4.2 billion it paid for EMI in 2007, but a bearish economy and shrinking liquidity have created doubts over the music company’s ability to service the debt.

The loan from Citigroup includes certain requirements for the ratio of debt to earnings before interest, tax, depreciation, and amortization. The Wall Street Journal reckons EMI has failed three covenant tests since September and would have failed more if not for Terra Firma pumping in more cash.

Citigroup has tried to hive off some of its exposure to EMI but has denied that it intends to seize control and sell it off.
About 40 percent of Terra Firma’s funds under management are exposed to EMI, so its fortunes are critical to Hands’ entire operation.

He has said he would be prepared to pour in even more money, provided Citigroup is prepared to ease the debt burden.

The bank doesn’t appear interested in that sort of deal and pre-Christmas reports suggested it’s now looking for investors prepared to buy debt for equity.

Hands is also said to be looking for outside investors. A Reuters report said Terra Firma has approached “pension funds, insurance companies and foreign banks” amid fears EMI could default on interest repayments to Citigroup.

The WSJ said Hands asked J.P. Morgan Chase & Co. to see if it was possible to raise money on the junk-bond market to pay off part of the Citigroup loan.

Although Hands has improved EMI’s operating performance, largely due to cost-cutting, some acts have complained that he doesn’t understand the music business.

Radiohead, Paul McCartney and The Rolling Stones are among the artists to have left EMI labels.

The Guardian business writer Richard Wachman has warned that artists can walk if they don’t like what is happening. He said it could lead EMI to the media equivalent of a run on a bank.

Hands’ somewhat dramatic response to the increasing pressure on EMI has been to file a multimillion-dollar fraud suit in a New York court, claiming Terra Firma bought the music firm only because Citigroup knowingly gave it incorrect advice during the auction process.

Hands says Citigroup pressured him into offering 265 pence per share to ensure he’d top a rival bid, although the US investment bank was aware that all the other bidders already withdrew from the auction.

He also claims that Citigroup published financial research intended to force the company into collapse so the bank could take it over and sell it to rival music firm Warner Music Group.

The bank says the legal action is without merit and some commentators believe that taking on Citigroup may mean other banks will be more reluctant to deal with Hands in the future.

The waters were made even murkier by a Financial Times story saying “three people familiar with the negotiations” claim Terra Firma went on the attack only after Citigroup proposed a debt-for-equity swap that would have given it a majority stake.

The FT also said other sources close to the auction are challenging Hands’ version of events and the substance of the Terra Firma writ.

They say that Terra Firma was not the only remaining bidder, claiming Warner Music reps were still conducting due diligence in EMI’s London offices when the winning Terra Firma bid was made.

The louder the row between Terra Firma and Citigroup, the more potential investors may be tempted to hold back in the belief that there may be better bargains in a fire sale.