Industry Woes Hit Vivendi’s Music Unit

The world’s premier music company, home to such stars as Eminem and Pavarotti, may be headed for the auction block--without a buyer in sight.

The sudden ouster of Vivendi Universal Chairman Jean-Marie Messier and the crash of the French media giant’s stock have led company insiders and Wall Street analysts to predict that the new management probably will try to shed some of its $30-billion debt by selling its Universal Music Group and other entertainment assets.

Had such an opportunity come four years ago, the world’s entertainment corporations would have been jockeying for a piece of the music property. Now, silence.

“For someone to step up and buy [Universal Music Group] right now, they’d have to believe that the music business in its current form has a strong future ahead of it,” said Michael B. Nathanson, an analyst with Sanford C. Bernstein & Co. “There is no one left who believes that.”

Plagued by surging piracy, plunging profit and rebellion among its artist ranks, Universal and other music corporations are struggling to sustain a way of doing business that, analysts said, is on the verge of imploding. Things are so bad that one of the biggest music firms, EMI Group, threatened this year to fire top executives who refused a 50% pay cut. Most acquiesced.

Studies show CD burning and Internet piracy have decimated sales of new hits and old catalog albums, shrinking international revenue by about 20% over the last three years. Despite their efforts, the labels have failed to develop a consumer-friendly digital delivery system for music that could hinder file-sharing bandits from stealing music. Industry figures show 2 of every 5 records sold today is an illegal copy.

Alarmed at the speed of the industry’s descent, the chiefs of the five largest music corporations convened an extraordinary emergency summit in New York two weeks ago to devise a strategy to fight piracy. They could not even agree on the design of an anti-piracy warning logo on CDs.

Music company stocks have been hit hard too, primarily because investors have come to distrust the inflated claims of “synergy” that have undergirded the spree of media company mergers.

A plan by Bertelsmann to harness the technology of outlawed Napster, the online file-sharing service, hit a sour note and is expected to be abandoned soon. Promises by AOL Time Warner Inc. to deliver music through its broadband cable lines have yet to materialize.

As for Vivendi Universal, Messier boasted that his company would lead a wireless revolution by delivering its music catalog digitally to consumer cell phones. That never happened because the technology didn’t work.

Then there is this: One federal agency has accused the industry of price fixing, another is reviewing antitrust allegations, and artists are alleging that their labels forced them to sign unfair contracts that cheat them out of royalty earnings.

“This is an industry in serious trouble,” said analyst Nathanson.

With the situation threatening to worsen, music corporations are scrambling to come up with some way to salvage the industry. One solution being debated at the top of the industry would transform the world’s largest labels into de facto management firms.

Companies including Sony Music Entertainment, Bertelsmann Music Group and Vivendi’s Def Jam Group are considering a contract system under which labels would become “partners” in all aspects of the careers of newly signed artists, including concert tours, advertising sponsorships and film and TV deals in the hopes of generating new streams of revenue. At the same time, the labels hope to offer artists shorter, less-risky contracts with fewer dollars on the front end but relatively bigger payoffs than they are currently offered should their records succeed.

Record executives believe that they are due a bigger chunk in return for the money they spend turning an unknown into a star who then goes on to make millions of dollars in movies and marketing deals, none of which is returned to the label’s coffers.

But such a restructuring of the business is certain to meet opposition in the ranks of artist representatives, who believe that the value of their clients should not revert to companies that simply release and market their music.

“Do I believe a new economic model has to emerge? Absolutely,” said artist manager Jim Guerinot, who represents Beck, No Doubt and the Offspring. “But not this one. It sounds desperate to me. These corporations hope to extract more from artists simply because CD sales are down. It won’t work.”

The fact that such extreme measures are even being considered today is surprising considering the industry’s standing just a decade ago.

Back then, Wall Street was bullish about the business. Consumers were in the midst of replenishing their music collections in the new CD format, providing a massive cash infusion to an industry that saw even more technological advances ahead--each carrying the potential for even greater riches. As a result, analysts began assigning huge values to record labels because they owned vaults of master recordings that could be repackaged and controlled by the world’s largest music companies.

Over the last 30 years, Sony Corp. bought Columbia Records. Warner Communications bought Atlantic. Bertelsmann bought Arista. PolyGram bought Island. MCA bought Geffen. Matsushita Electric Industrial Co. bought MCA. Seagram bought MCA from Matsushita and then acquired PolyGram.

Walt Disney Co. and other media companies also were angling for a piece of the business, sniffing around EMI, which at the time was being shopped around for about $12 billion. AOL Time Warner made a pass at EMI too. So did Bertelsmann.

But as the multibillion-dollar merger frenzy peaked, it was Vivendi that ended up buying Seagram, including its music business--the world’s most successful record corporation, which included Interscope and Def Jam labels. The company boasted a deep roster of executive talent and music stars, including Nelly, Shania Twain, Eminem, U2, Ashanti, Sting and Tupac Shakur.

Since then, the company has only gotten bigger and richer. Analysts value Universal Music Group at $12 billion. Last week, the company had six of the Top 10 records in the nation and accounted for more than 40% of all CD sales. That is why executives within Universal and other companies are so glum over the fact that only a dramatic drop in price may smoke out a buyer. Who wants to enter a business, they ask, that is on a grinding descent?

Publicly, however, the industry is working to put the best spin possible on the situation.

“All of these issues are challenges,” said Hilary Rosen, chairwoman of the Washington-based Recording Industry Assn. of America, which represents the nation’s five largest music corporations.

“But these challenges in no way diminish the very significant opportunities in the music business and the potential for growth over the long term.”