Matthew Lynn

Can private equity halt EMI’s decline?

EMI is a giant of the music business and a symbol of British prowess in ‘creative industries’ — but has stumbled from disaster to disaster in recent years

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Amid the acres of coverage devoted to the 40th anniversary of Sergeant Pepper’s Lonely Hearts Club Band, the most celebrated record in pop history, one irony has been overlooked. The album was considered as ephemeral as any other when it came out, but has grown mightier and mightier; the company that made it, on the other hand, was rightly regarded as one of the giants of British industry back in 1967, but has never looked weaker than it does now.

Indeed, by the time the Sergeant celebrates his half-century — not to mention the palaver when he hits 64 — EMI may have shuffled into the history books, at least as far as being a public company is concerned. It has already agreed to a takeover bid from Guy Hands’s private equity firm Terra Firma. It may yet face a rival offer from Warner Music or other private equity bidders. Whatever happens, its days as a quoted entity look numbered.

Within this story there is a cautionary tale for the British economy. We pride ourselves on the idea that we may not make much stuff anymore but we still have a lead in ‘creative industries’ — and there is no corner of creativity in which the UK is more dominant than pop music. Yet Britain’s one major player in the recording business, EMI, has spent the last few years stumbling from one disaster to another. Maybe we’re not so good at this creative industries stuff after all.

Despite its illustrious history, EMI needed a long period of relative calm to rethink its business from top to bottom in the aftermath of the digital revolution. The City was never willing to give it that kind of space. Will private equity ownership be any better? This will be a fascinating test of the claim made by private equity bosses last week that they can nurture businesses through a period of change better than the public markets.

The past five years have been terrible ones for the music industry. Digital outlets and file-sharing have destroyed the old business model. New ways of making money out of music have been slow to emerge. There is little to suggest that EMI’s rivals have made a better fist of things: indeed most of them have been even slower. Likewise, plenty of other ‘old media’ companies, from news-paper publishers to commercial broadcasters, have made a worse hash of the transition to new media. Still, EMI has been through a tough decade, which has included a string of failed mergers. In the last financial year, it cut its revenue and profit forecasts twice. Finally, it reported a £287 million loss and a 13 per cent drop in sales, blamed on falling sales of CDs and widespread pirating.

And yet EMI is a company that once rode high on waves of cultural and technological change. Formed as The Gramophone Company in 1897, it has been around since the beginning of recorded sound. The great tenor Caruso was among its early stars. In the 1930s it merged with the British arm of Columbia to create Electric and Musical Industries, quickly shortened to EMI. Within its labs, it developed stereo and radar.

Most importantly, EMI effectively invented the modern pop business. Before any of its rivals, it recognised that this was a global industry, built around artists of stature. In 1955, it became the first international record label when it bought the Los Angeles-based Capital records, with a line-up that included Frank Sinatra and Nat King Cole. In the 1960s it pioneered album-oriented music, from The Beatles to Pink Floyd’s Dark Side of the Moon. It was the first record company to sell more LPs than singles. In truth, there was very little EMI didn’t know about getting ahead of the curve. When something new came along, it was the first to grab hold of it and the first to make money from it.

Then it got hit by the internet. The web posed three questions of EMI’s business. It liberated artists to find their own way to market. It created a new way of selling music. And it made it really easy to steal music as well. That last one was a threat. The first two were opportunities but the City didn’t seem to see it that way; it just saw the threat. ‘About ten years ago, I dubbed EMI “Every Mistake Imaginable”, and everything we have seen since then bears that out,’ said Lorna Tilbian, an analyst at Numis Securities.

In reality, it’s unfair to label EMI as a dinosaur. It started experimenting with the web as a way of selling music when most of us were still looking for the send button on our email. It was the first major recording company to make a whole album available for download. And it keeps up the pace: it has just become the first major label to make its catalogue available on iTunes without the software that limits the devices you can play it on or how often you can copy it. It has just done a deal to make its songs available on the hugely popular video site YouTube. In lots of ways it is among the most web-savvy of its peer group. Lily Allen, one of first genuine MySpace stars, is an EMI artist.

There have, however, been two major problems, both sadly reminiscent of the hurdles at which many other British industries have fallen. First, EMI has been focusing on deals. As far back as 2000, it agreed a merger with Warner Music which was spun as a response to the web. As it happened, the deal fell through — and EMI spent much of the next six years engaged in a fruitless attempt to get bigger, in the hope that it could rationalise, cut costs, and crawl its way back to profitability. It had another go at merging with Warner in 2003, then tried with Bertelsmann Music Group in 2004. But mergers were an irrelevance. When your whole business is being turned upside down, it doesn’t make any difference how big you are. Mergers just distract you from getting on with re-inventing your business.

Secondly, EMI hasn’t been radical enough — partly because its management is not sufficiently bold, but partly because the City won’t let it be. Music may well end up being free to the listener but paid for by sponsorship, publishing and advertising. EMI could have gone for a radical solution like that — but the hit on the share price would have been terrible. The board probably wouldn’t have survived.

Eric Nicoli, who became chairman in 1999 and is now chief executive, is a decent guy. He’s smart, and he’s passionate about the business. In his defence, the mooted mergers only consumed a few months out of the last seven years. If one of them had come off, the cost savings would have yielded enough to keep the City quiet while the management quietly turned the company upside down.

Will Terra Firma be any better? ‘Guy Hands couldn’t be much worse than the existing management,’ said one expert. ‘But although he won’t admit it, he’ll probably sell the recorded music division and leverage up the publishing unit. It will be just the same techniques the private equity firms have used with the local newspaper industry’ — where they have ignored the web and run the businesses for cash. That may be profitable, but it will probably be terminal for the industry.

That’s one view. The ‘black hat’ version of the future under private-equity ownership foresees Terra Firma managing EMI’s decline and squeezing it for cash — which no doubt means yet more Beatles re-releases — until it finally gets shut down. The ‘white hat’ version would like to see it freeing EMI from the pressure of twice-yearly results and constant dividend payments to get on with thinking about how the business should work in this decade and the next.

In its heyday, EMI stood apart from many of the problems that traditionally afflict British industry: an over-reliance on financial engineering, an obsession with mergers, and an agenda set by the City. In the end, it has succumbed to all of them. Whether private equity can do any better for it remains to be seen. If not, Britain’s creative economy may not be in such great shape as we like to think.