20 Minutes That Changed an Industry

Thousands of miles away, in a remote desert at the end of the Earth, a secret rendezvous altered the future of the $40-billion music business.

On Sept. 22, top Time Warner Inc. executives picked the ancient Chinese city of Kashgar, one of the least accessible spots on the planet, to pitch the idea of merging the media giant’s beleaguered record division with Britain’s struggling EMI Music.

Sitting under the stars at a beer garden on the edge of the Tarim Basin oasis, Time Warner Chairman Gerald Levin listened as his company’s President Richard Parsons and music chief Roger Ames detailed their plan for the massive $20-billion merger--a deal that would create the world’s second-largest record company and shrink the number of major competitors from five to four.

It took Levin less than 20 minutes to make up his mind.

“The beer was good, the night was warm and Jerry was very enthusiastic about the deal,” recalled Parsons, who said

the three met in Kashgar, a detour during last fall’s Time Warner media tour of China. “To give you an idea of just how remote the spot was, our jet was the first international flight to touch down there in years. It was a very quick meeting. After Roger and I explained our thinking about the deal to Jerry, he just looked at us and said, ‘Let’s go for it!’ ”

Consummating the merger, however, was not easy. It required dozens of secret meetings in London and New York over the next four months. The deal was finally announced on Jan. 24--just two weeks after Time Warner unveiled its earth-shaking merger with America Online.

Assuming the pact is approved by antitrust regulators, the merger will create a powerhouse with an unparalleled publishing catalog and an artist roster that includes such stars as Madonna, D’Angelo, Metallica, Ice Cube and the Beatles.

The transaction puts Time Warner back on the music map in nearly 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 merger was the brainchild of Ames, who first called EMI in September even before he had signed his contract to take over as chairman of Warner Music Group. Ames, a Trinidad native who left PolyGram during the Seagram shake-up, was hired in May by Time Warner to help jump-start its stagnant international music arm. He was promoted on Sept. 1 to run the entire global music operation after the sudden exit of Time Warner co-chairmen Bob Daly and Terry Semel.

On Sept. 14, Ames phoned his longtime friend Ken Berry, head of EMI’s recording division, after reading that EMI might sign a joint manufacturing and distribution arrangement overseas with Seagram. Tracking Berry down at an EMI management conference on the Italian island of Sardinia, Ames proposed EMI do a similar deal with Time Warner instead.

The 15-minute phone call quickly escalated into a discussion about combining the two companies. It ended with Ames asking Berry to help him set up a meeting between their bosses, EMI Chairman Eric Nicoli and Time Warner’s Parsons.

“That call really instigated the whole thing,” said Berry, who had worked with Ames before and actually offered him a job at EMI before Ames joined Time Warner. “A number of factors were absolutely critical to this deal and Roger’s arrival at Time Warner was one of the biggest.”

As soon as Berry got off the phone he cornered Nicoli, who was also attending the conference in Sardinia. After hearing Time Warner’s proposal, Nicoli agreed to meet the executives for a confidential talk the next week.

On Sept. 21, Ames and Parsons took the corporate jet from New York to London to meet secretly with Nicoli and Berry. The group gathered in a Carlton Tower Hotel suite in London’s West End. After nearly two hours of kicking around various concepts about how to combine the two companies, they found their common ground.

Both sides quickly ruled out the idea of an acquisition. Time Warner had no interest in selling its music division and Ames and Parsons thought the $12-billion price tag Nicoli had in mind for EMI was far too hefty.

The solution was a merger. Both the Warner and EMI music groups have struggled in recent years and ranked fourth and fifth last fall in sales of music in the U.S., the world’s biggest market. EMI had long been dogged by rumors that it was ripe for takeover.

The combined operation was a different story. Together they would generate more than $1 billion in cash annually--not including the massive savings that could be reaped by consolidating some operations. Without talking about any specific numbers, Nicoli and Parsons shook hands.

“At that first meeting, we discussed the full range of options,” Nicoli said. “But we ultimately settled on the idea of a merger because it was the only one that would have no significant tax penalties and would allow them to consolidate. The meeting went fabulous.”

“It was a perfect matchup,” Berry said. “No ego, no bickering, no b.s. None of that ‘Our company’s better than your company’ crap. It was actually fun.”

That night, Parsons and Ames hooked up with a previous scheduled Time Warner corporate junket touring China. By the next evening, they were toasting Levin’s endorsement in the Kashgar beer garden. During that tour, Ames ran the proposal past several key members of the Time Warner board.

“I remember having to give this presentation in China to most of the board regarding our strategy on piracy,” Ames said. “Before I could get a word out, Ted Turner [vice chairman of Time Warner] started joking with me. He said, ‘Roger, the great thing about being as cold as you are right now is that the pirates have nothing of ours they want to pirate. I said, ‘Yeah, Ted, I guess that’s the upside.’ But he was right. We needed to make some big changes. And the board was pretty bullish about the EMI deal.”

By early October, teams of lawyers and advisors from both sides began meeting secretly in New York and London to structure a deal under which Warner Music and EMI would merge into a new company called Warner EMI Music, run as a joint effort by Ames and Berry. EMI would still be listed on the London stock exchange.

The new company would be a 50-50 partnership between Time Warner and EMI, each valued at approximately $10 billion. Time Warner would be required to 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.

On Oct. 16, Nicoli presented a rough draft of the proposal to the EMI board, which unanimously supported the concept with some reservations. Its directors wanted to protect the value of EMI shares.

“Passing control was a potential issue for EMI shareholders,” Nicoli said. “So we had to make sure we put in a shareholder agreement that would prevent value leakage and prevent abuse of the party with the technical minority, which was us.”

The deal nearly derailed several times throughout the fall over tax and control issues, but participants in the negotiations credit Parsons with finding solutions at each impasse. To him, this was the quickest--maybe the only--way to catapult Warner Music back to the top of the music business.

Suddenly, in October, Parsons had a second deal to worry about. Time Warner was flirting with the idea of merging with American Online after Levin got a surprise call from AOL chief Steve Case suggesting that the two firms join forces. As the AOL talks gained momentum, Parsons was also negotiating that novel arrangement.

Sworn to secrecy on the AOL deal, Parsons never breathed a word of it to anyone at EMI or Warner Music, including Ames, until Jan. 9--the night before the AOL merger was to be announced. AOL executives learned about the EMI discussions shortly before the AOL deal closed and enthusiastically embraced the possibility of gaining access to an even wider library of music for online exploitation.

On Nov. 16, Ames and Parsons discussed the EMI deal in detail with Time Warner’s board of directors, who gave it a preliminary thumbs-up. As the deal progressed, EMI continued to be the subject of takeover speculation in the media by such potential suitors as Bertelsmann.

“I got more paranoid and more excited the longer this thing dragged on,” Ames said. “I was certain it would leak and, if it did, we ran a real risk of letting some other company get a jump on us.”

By late December, the deal was all but done. Parsons called Nicoli on his Christmas ski trip in the Italian Alps several times. The two executives closed the pact on New Year’s Eve with an end-of-the-millennium telephone handshake.

On Jan. 9, Parsons phoned Nicoli, Berry and Ames to let them know Time Warner had negotiated a massive merger with AOL and planned to announce it the next day. All three executives were stunned.

“We didn’t have the first clue about AOL,” Nicoli said. “Confidentiality is important and they didn’t breach it in any way, which made them go up even higher in mine and Ken’s estimation. The fact is, the new relationship with AOL simply added power to the proposition for us.”

That morning, Nicoli and Parsons renegotiated several clauses in the pact with EMI to account for the AOL deal. The EMI board approved it unanimously. Levin and the Time Warner board approved the deal in a phone vote a beat later.

On Jan. 23, Parsons and Nicoli hammered out a few last-minute “short-strokes” of the deal over lunch at the One Aldwych Hotel in London’s Knightsbridge section.

That same afternoon, they drove to an office building in the center of London and closed the deal.

It was there, in a suite at the investment banking firm of Warburg Dillon Read, that the Warner/EMI contract was signed around 3 p.m. The merger was announced from the same room early the next morning.

“It was a long journey from that little beer garden in Kashgar to where we ended up,” Parsons said. “Throughout the whole thing, Roger kept asking me, ‘Are you guys going to bail on me?’ I told him, ‘Don’t worry, man. I got your back [covered].’ I knew we could put this thing together.”