Guy Hands is the man with both the greatest name and the worst luck. Mr. Hands is head of the private equity firm Terra Firma Capital Partners, which owns massive stakes in several British companies. His most significant acquisition, however, is EMI Group, Ltd., the smallest of the Big Four record companies. It is also his albatross: Since acquiring EMI in 2007 for £4.2 billion (around $8 billion at that time), the music group has suffered continuous losses, exacerbated by several significant artists leaving the company after the acquisition. In the year ending March 2009, EMI had losses exceeding $2 billion and had only earned $1.75 billion.
Consequently, this year has been the nadir of EMI’s existence. In April, a distinct possibility arose that Hands would not be able to persuade his investors to inject enough capital in the company for it to pay off some immediate debt. Investors managed to save EMI in the 11th hour, staving off the possibility of the group (and Terra Firma) being forced into administration (the British equivalent of bankruptcy) by June 12. Attempting to save face, Hands sued American banking conglomerate Citigroup for fraud after it was revealed that EMI Group was overvalued at the time of its acquisition. However, on November 5, the American courts rejected his claim, and now Hands has lost 60-70% of his net worth after completely writing off EMI from his accounts.
While Hands and company intend to add more equity to EMI by March 2011, the writing is on the wall, and its ink is blood: the group that owns the labels of The Decemberists, Interpol, Lily Allen, and Coldplay is going to die.
What went wrong?
There are many reasons why EMI has fallen. However, much of it comes with irony: The group was as close to the forefront of the digital age as possible, having been the first company to partner with a streaming service and the first to offer DRM-free music. Furthermore, EMI had its ear to indie rock and managed to pick up several artists of such caliber as Art Brut, The Decemberists, Interpol, and Sigur Rós. They were even pioneers of the now industry-standard “360 deal,” which gives artists more assistance in day-to-day operations in return for a cut of all band revenue, including ticket sales. Still, EMI was in a bad position, sometimes of its own volition. Four reasons in particular stand out:
1. EMI did not adjust for file-sharing
Let us be realistic and pragmatic here, no matter what side of the file-sharing debate you are on: File-sharing cannibalized the music industry, upending its business model completely. Thanks to ignorant and shortsighted shareholders, labels have been incredibly slow to change their model and adjust to this new era, attempting to have the government subsidize them through draconian copyright laws. EMI has been the most liberal of the Big Four on this matter, having (as stated) been the first to go DRM-free, among other matters. However, file-sharing made the groups’ business model unsustainable. So while labels needed to become leaner businesses to maintain profit margins, EMI was still writing multi-million dollar contracts, including Robbie Williams’s incredible $157 million deal. These contracts would become the major burden EMI faced in recent years.
2. The acquisition did not go smoothly
When Terra Firma bought EMI in August 2007, Guy Hands announced drastic changes to the company, including cutting a third of its workforce, to cut back on losses. New management practices angered many artists, and a mass exodus ensued. Among the high-profile artists to leave were Radiohead (who had been with them since their debut EP in 1992) and The Rolling Stones. Pink Floyd also instigated a lawsuit over unpaid royalties with EMI. Meanwhile, losses continued to spiral.
3. EMI’s most lucrative property hates them (and the world)
We are of course talking about The Beatles. Apple Corps, the company that is run by surviving Beatles and the estates of John Lennon and George Harrison, has had at best a strained relationship with EMI in the years after the band’s breakup, including a lawsuit this decade over unpaid royalties. While EMI owns the copyright to The Beatles discography, Apple Corps has control over the distribution of their music. This conundrum, compounded with lawsuits leveled against Apple, Inc. (the creator of iTunes) and an unrealistic degree of distributive control that Apple Corps desired, has prevented EMI from distributing Beatles music and film on iTunes and other digital stores. While Apple Corps finally relented and allowed iTunes to sell their music starting last month, it has come too little, too late for EMI, who themselves may not be earning as much in royalties. To pour salt on wounds, Paul McCartney left EMI during the acquisition period for similar reasons as the artists above.
4. No media conglomerate backs EMI
This is really no fault of EMI’s, but EMI is one of two members of the Big Four that is not a subsidiary of a larger media conglomerate (the other being Warner Music Group). This degree of “independence” has a two-fold effect: One, EMI does not have a conglomerate that can effectively absorb its losses and still maintain optimal day-to-day operations. Two, EMI did not have a direct media platform for which to expand their artists’ outreach effectively, and thus could not turn their superstar acts (like Lily Allen and Coldplay) into brands like Sony and Universal can.
What happens now?
Three things can happen, all of which mean that EMI will drastically change. The first is to be bought out in whole by one of the other three music groups. The second is total liquidation of its assets, ending EMI’s existence outright. The third option would be a drastic restructuring similar to that of General Motors, re-emerging as a smaller group.
1. Merger or Acquisition
Why it’s likely: This is not the first time EMI has been in merger talks. In 2006, it took a gambit in buying out Warner Music Group, which WMG countered with its own buyout offer. Since troubles began with EMI after Terra Firma’s acquisition, rumors have floated in the industry of a merger between WMG and EMI, making them the second largest group (after Universal).
Why it’s unlikely: The recession has kept any possibilities of mergers and acquisitions on the backburner. Further, the only floated white knight candidate, Warner Music Group, has been in the red for nearly two years and is currently at junk bond status (meaning investors should avoid investing in the company). It certainly does not help matters that Warner Music Group has been far less welcoming of the digital era than EMI and may have a conflicting corporate culture. Sony and Vivendi (owner of Universal) probably have no interest in buying EMI completely and would instead buy certain record groups and labels only.
2. Total Liquidation
Why it’s likely: There are definitely profitable assets at EMI. Sony and Vivendi may take this situation to buy off Capitol Records Group or Virgin Records Group, the two core groups. Warner Music Group may buy Caroline Distribution at a bargain rate to solidify its hold on indie music distribution. Apple Corps may seek to buy The Beatles copyright and utilize the earnings to eventually regain complete control of their music by buying back the publishing rights from Michael Jackson’s estate. Other possible lucrative assets include EMI’s French and Japanese divisions, Parlophone Records, the legendary Abbey Road Studios, and the Christian Music Group. Total liquidation would certainly clear Guy Hands of the billions in debt he faces, help him save face, and recover lost net worth.
Why it’s unlikely: The sight of the label that launched The Beatles facing bankruptcy may invoke a backlash of sorts, rendering EMI “too big to fail.” The outcry invoked by the proposal that Abbey Road be sold off earlier this year as part of cost cutting makes this a very distinct possibility. Also, the other members of the Big Four may seek to garner public and political sympathy for the woes of the industry through EMI.
3. GM-style Restructuring
Why it’s likely: The other members of the Big Four could game on EMI’s wounded-dog status and still earn valuable assets in the process of restructuring. Furthermore, it is quite possible for EMI to scrap together Parlophone, Capitol, and a few other labels, and convert itself into a group whose size and structure would be similar to Beggars Group, weathering the mess outright.
Why it’s unlikely: EMI’s debt obligation is in the billions, including a defaulted $2.6 billion loan from Citigroup that may have instigated Hands’ lawsuit. There may be too few labels left to band together in the aftermath of any liquidation.
What happens next?
The question of EMI’s demise in its current form is not a matter of if, but when. Still, the potential downfall of one of the Big Four record companies will have a dramatic impact on the industry and could cause previously unthinkable events to occur. Here are some the likely scenarios to play out:
• Warner Music Group is next
As noted above, WMG has been in the red for nearly two years straight, and despite CEO Edgar Bronfman’s assurances to investors, it seems unlikely to change for the next two fiscal quarters. EMI’s collapse could trigger a cascade of investor uncertainty similar to the one that is at the center of the current crisis in Europe. Publicly traded WMG would be extremely vulnerable to this cascade, to the point that investors could very easily abandon the stock on grounds that it has become high-risk. Even if the board of directors were to re-shuffle, it would come too late for WMG, and it too would follow in the footsteps of EMI.
• The RIAA completely takes over copyright and internet law
For the surviving members of the RIAA (in particular, Sony and Universal), EMI’s collapse would yield two positives for them. The first is the potential fire sale of assets mentioned above. The second, however, affects everyone: The RIAA might be given the political ammunition necessary to completely rewrite the rules on copyright and internet traffic to reflect its draconian vision. While the RIAA has scored several victories on this front over the past decade, the feisty, spirited defense of the copyleft and supporters of file-sharing has kept it from achieving complete dominance.
The RIAA will likely craft a Dolchstoss, blaming the demise of EMI not on the recession and poor long-term decision-making, but errant “pirates” who “exploit” the “anarchic” nature of the internet to “steal” from “artists” and forcing thousands out of work. Given that the majority of the United States Government, including both houses of Congress and the Vice President, is all but in Big Content’s pocket one way or another, the destruction of EMI would make them cater to the RIAA’s every whim, especially when the RIAA bandies about the loss of several thousand workers from the workforce. This could mean laws that not only make the recent COICA look beneficial to pirates, but alter the function and roles of the internet so that piracy would be impossible. And neither the pithy yelps of Cory Doctorow and Richard Stallman nor the unpredictable wrath of Anonymous would be able to stop it.
• The industry becomes more polarized
While independent labels have been a significant force in the music industry after hardcore punk sparked a revival in the 1980s, their reach has been weak at best. EMI’s collapse would certainly change that, strengthening the indies enough to actually have an influence over the rest of the industry. In particular, large indie companies such as Beggars Group and TVT Records would have a much greater reach and access to a larger stable of artists, though they are unlikely to change their business practices. Sub Pop may even utilize the aftermath to split from Warner Music Group and return to its roots as a fully independent label. The indies’ influence will remain small, and the financial incentives of being on an indie label will remain minimal, but they will be much more versatile and their numbers will be greater, creating a sizable musical middle class. If EMI were to return as a larger form of Beggars Group, the indies would have a reach that is almost as large as the surviving members of the Big Four.
The two strongest majors, however, are likely to become even more corporate than before. Sony and Universal are the most conservative of the Big Four in terms of business practices, still relying heavily on a small stable of Top 40 artists with expansive creative and management teams handling every aspect of their careers. They may see EMI’s destruction as vindication that their business practices work (and, arguably, they’re right: both companies were in the black their last fiscal year) and solidify them. This, in turn, would lead to a smaller selection of pop stars dominating the Top 40 and an even more homogeneous sound than before.
EMI Group Ltd. may survive the following year, and maybe even the year after that. It’s unknown when the hammer will finally fall and seal the coffin. Yet what matters is that EMI is in that coffin to begin with and will certainly fall in the coming decade. That the most liberal of the Big Four will be the first to fall is ironic and disappointing in many ways. But it may just be the first wake-up call that the music industry as a whole must radically change, or follow EMI to self-immolation.