Warner to Form Giant Music Firm With EMI

Less than two weeks after announcing its world-shaking merger with America Online, Time Warner Inc. has negotiated a $20-billion deal that would give the entertainment juggernaut control of British music giant EMI Group, home to the Beatles and Rolling Stones, sources said.

The deal, expected to be announced Monday in London, would merge Time Warner’s music division with EMI to create the world’s second-largest music conglomerate. It would instantly transform the landscape of the global record business by shrinking the number of major competitors from five to four.

The timing of the transaction, following Time Warner’s Jan. 10 proposal to merge with America Online, underscores the importance of music as the most immediately valuable entertainment asset on the Internet, where record companies hope to boost profits by delivering their products directly to computer users at home.

The proposed merger, which has been a closely held secret during months of negotiations, is likely to draw criticism from those who believe that fewer competitors in the global music market will diminish diversity. But the deal also may accelerate online access to music for consumers around the world.

Time Warner, already the largest entertainment company in the world, has driven the vast consolidation of the entertainment industry over the last decade with its voracious deal-making.

In music, the company’s Atlantic, Elektra and Burbank-based Warner Bros. Records labels release CDs by such stars as Metallica, Jewel, REM, Kid Rock and the Red Hot Chili Peppers. Adding EMI to its roster will give Time Warner access to artists on the Virgin, Priority and Hollywood-based Capitol labels, including the Beastie Boys, Van Morrison, Massive Attack, Blur, Master P and Frank Sinatra.

Time Warner and EMI declined to comment, but sources said the deal was the brainchild of recently installed Warner Music Group Chairman Roger Ames, who has told executives at both companies that he intends to run the combined operation as a partnership with his longtime friend Ken Berry, the current head of EMI’s music division.

Negotiations for the merger began in August, even before talks started between Time Warner and AOL, when Ames first approached Berry about the possibility of joining forces, sources said. Time Warner President Richard Parsons and Chairman Gerald Levin quickly threw their support behind Ames’ plan for the merger. AOL executives, including Chief Executive Steve Case, were informed as the EMI discussions progressed and enthusiastically endorsed the possibility of gaining access to an even wider library of music for online exploitation, sources said.

On Saturday, Ames and Parsons flew from New York to EMI’s London headquarters to hammer out last-minute details of the pact with Berry and EMI Group Chairman Eric Nicoli, sources said. The deal is not yet signed, and there is still a remote possibility that it could unravel today, sources said.

Under the agreement, the Warner Music Group and EMI Group would merge in a new company called Warner EMI Music and be listed on the London Stock Exchange. The company would be a 50-50 partnership between Time Warner and EMI shareholders. But Time Warner would pay EMI a control premium of a pound per share (more than $1 billion total) in exchange for the right to appoint a majority of the combined company’s board of directors. Under the plan, the board for the combined company would consist of 11 members: six from Time Warner, including Parsons, and five from EMI, including Nicoli.

Regulators’ Approval Needed

The proposed deal would have to be approved by government regulators, and one area of the merger might be particularly troubling for antitrust authorities. Warner and EMI own the world’s top two music publishing companies and the combination would place more than a third of the music publishing market under one roof.

Warner EMI would emerge as a global powerhouse, selling one out of every four albums in the United States and accounting for more than 20% of all music sold around the world. The move would put Time Warner--which over the past decade has fallen from first to fourth place in domestic market share--back on the map in every territory around the world, nipping at the heels of Seagram Co., which became the industry leader in 1998 after acquiring PolyGram for $10.4 billion.

The music industry is still recovering from the Seagram/PolyGram consolidation, in which hundreds of recording acts and thousands of employees lost their jobs. Seagram was able to slash $300 million in costs annually by restructuring dozens of its business operations, but has been accused of destroying the unique multicultural vision that helped turn PolyGram into the international leader.

EMI, the crown jewel of the British media business, has been the on-and-off subject of takeover speculation for the past four years with a long list of potential suitors, including Seagram, News Corp., Walt Disney Co. and Bertelsmann, which was reported to be still interested as late as last week.

Analysts said that EMI would cost nearly $12 billion based on its current market value, including debt and a premium. Many prospective buyers considered that to be too steep a price tag.

But by using its existing music assets, Time Warner has cut a deal to spend just slightly more than $1 billion to get control of EMI. The combined assets of Warner EMI would total $20 billion. And the merger would provide Warner EMI Music with hundreds of millions of dollars in savings by allowing the combined company to integrate business operations and restructure the struggling Warner Bros. and Capitol labels, which have been performing poorly in recent years.

Sources said Ames, a Trinidad native who left PolyGram during the Seagram shake-up, may restructure Warner EMI in the image of his former employer, dividing the world into five equal territories, instead of elevating the status of its U.S. division over its international arm.

The merger is expected to take about a year to complete.

Both the Warner and EMI music groups have struggled in recent years and now rank fourth and fifth in sales of music in the U.S., the world’s biggest market.

Once the dominant and most respected operation in the record business, Warner has seen its credibility dwindle and its share of album sales in the U.S. music market shrink to 15.7%, from 22.4% in 1995, according to SoundScan, which tracks sales.

Warner’s decline followed several years of turmoil that gutted management and shattered morale. EMI has also had difficulty building its business in the U.S. and has gone through a series of management shake-ups.

Even though Warner and EMI account for only 15.7% and 9.5% of the U.S. music market, respectively, the merged entity will trail Seagram’s Universal Music Group in this country by just one percentage point.

The combined operation would generate more than $1 billion in cash annually, sources said. Last year, Time Warner’s music operation generated $522 million in cash, while EMI’s cash flow was about $550 million.

That doesn’t account for the potential edge that Warner EMI will gain when the AOL merger is complete. AOL is by far the strongest brand name on the Internet, with more than 20 million subscribers.

Warner EMI Music’s affiliation with AOL is almost certain to hasten the decline of the traditional retail system as the firm seeks to create an electronic distribution model of the future. Time Warner’s Levin has said he believes “the digital download is the most efficient delivery for music.”

Music executives believe that digital distribution of music will revolutionize the industry by dramatically cutting manufacturing and shipping costs associated with delivery of audio recordings to retail outlets. It also will slash millions of dollars spent annually trying to convince retailers to place products in prime spots in stores.

Downloading Music From the Internet

In the future, music fans no longer will have to visit retail stores to purchase recordings, but will be able to download their music directly from the Internet. Most computer owners, however, currently access the Internet through telephone modems, which take more than an hour to download a typical record album. In the next few years, analysts expect many computer owners to upgrade to cable or faster phone connections, which allow consumers to download albums in minutes.

Warner EMI Music will also be able to exploit its vast music publishing catalog on the Internet by collecting license fees for copyrighted songs it owns.

For years, there have been rumors that Microsoft was weighing a purchase of EMI’s lucrative song catalog.

Under the terms of the Warner EMI deal, Ames, 50, will be chief executive officer and Berry, 47, chief operating officer of the new company, sources said.

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Time Warner, EMI Deal

Time Warner has negotiated a $20- billion deal with British music giant EMI Group. The deal, expected to be announced Monday, would create the second-largest music conglomerate.

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Warner Music Group

Artists: Matchbox20, Brandy, Madonna, Jewel, Alanis Morissette, Eric Clapton, Goo Goo Dolls. Labels include: Warner Bros. Records, Atlantic, Elektra, Rhino

Chairman and CEO: Roger Ames

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EMI Group

Artists: Garth Brooks, Smashing Pumpkins, Ice Cube, Spice Girls

Labels include: Capitol Records, Virgin, Priority

Chairman and CEO: Eric Nicoli

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Top four music companies if merger goes through:

* Universal

* Warner EMI

* Sony

* Bertelsmann

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