Time May Be Right for Music Mergers

And then there were four?

Record executives are increasingly convinced that a merger of the music labels owned by AOL Time Warner Inc. and Bertelsmann would win approval from regulators who frowned on similar deals two years ago, according to people familiar with the matter.

A combination of the labels would shrink the number of global record distributors from the current five, providing new muscle and cost-saving opportunity for some players in an ailing music industry -- while potentially threatening others. But the executives believe that recent legal rulings and the industry’s weak condition would bolster their cause in persuading regulators, particularly in Europe, to greenlight a deal.

“The climate has definitely improved since last time around,” said one source close to the AOL-Bertelsmann discussions. This person added: “We also recognize that the merger-approval process is unpredictable and lends itself to political opportunism.”

Driven largely by plunging CD sales, executives with every major music operation except Sony Corp.’s are known to be flirting with merger or sale possibilities. The talks between AOL’s Warner Music Group and Bertelsmann’s BMG have focused on a pairing that would give their parent companies stakes in a joint operation.

“The current environment improves the potential for getting a merger approved in the music industry,” said attorney Perry Johnson, a former director of the Federal Trade Commission’s competition bureau who has worked for several entertainment clients.

Record companies have met resistance from regulators repeatedly since 1998, when Seagram Co.’s acquisition of PolyGram sailed through and created industry leader Universal Music Group, with $6 billion in annual sales.

Plans to combine Bertelsmann’s music unit and EMI Group collapsed two years ago under the weight of European regulatory concerns. The year before that, European antitrust concerns unraveled a proposed deal between Warner and EMI.

The demise of those deals solidified the architecture of the global music economy, in which Universal comfortably outpaces its closest rival, Sony Music Entertainment, which has about $5 billion in annual sales.

Analysts say a Warner-BMG combination would create a second powerhouse with sales in the $6-billion range and a diverse roster joining such Warner stars as Madonna and Matchbox Twenty with BMG’s Carlos Santana and Christina Aguilera.

The talks could fall apart. Vital issues, such as each company’s valuation and a division of duties between Warner Chairman Roger Ames and BMG Chief Executive Rolf Schmidt-Holtz, have yet to be worked out.

Rolling the dice on an expensive antitrust review isn’t likely to be done lightly: EMI reported that its nine-month pursuit of the Warner deal in 2000 cost more than $60 million.

But executives involved in the latest talks say they believe the regulatory hurdles that scotched past deals appear to have crumbled. In the two recent merger attempts, for example, European Commission competition officials raised objections under the theory of “collective dominance,” which holds that companies will act like monopolies when two or more of them start to take over a market.

A European court last year overturned the commission’s decision to block a union of two travel companies based on the legal theory, dealing a rare defeat for top regulator Mario Monti. The ruling didn’t question the legal principle but forced regulators to stick to more specific standards for rejecting future deals.

As a result, record executives say Monti may have a tougher time proving harm to consumers if the number of global music conglomerates shrinks from five to four.

In the U.S., executives and some outside experts say they believe the Bush administration has installed regulators at the Justice Department and the Federal Trade Commission who are more likely to look favorably on a merger.

Executives also say they are emboldened by the notion that some concerns that wrecked past plans wouldn’t apply.

For example, critics of the Warner-EMI deal had warned that AOL would tower over rivals in the sale of music online -- a prediction that collapsed with the emergence of vast online pirate networks.

Now, Warner and BMG, or any other two companies pushing for a merger, probably would argue that the major labels have licensed big catalogs of songs to several independent companies, such as Apple Computer Inc.’s music download service and RealNetworks Inc.’s Listen.com.

What’s more, the companies increasingly believe they could argue that rampant digital piracy makes it impossible for even a monopolistic company to dominate music distribution or jack up CD prices.

In addition, regulators worried over the effect of a Warner-EMI deal on the music-publishing business because the deal would have joined the two largest players in that industry. But people involved in the discussions say Warner and BMG probably would exclude their music-publishing operations from any proposed joint venture.

But others warn that the regulatory climate still could turn stormy.

Critics might use a merger review to open a wider debate on song lyrics, music industry business practices or other potentially controversial issues.

And executives at competing entertainment firms are expected to line up against such a deal.

One potential rival expressed doubts that the online black market would be counted as a competitive factor or that European regulators were prepared to abandon earlier concerns.

“I don’t think this is a slam-dunk at all,” the rival said.

A shifting marketplace, he noted, “doesn’t mean they’re going to just let anything through.”

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(BEGIN TEXT OF INFOBOX)

Come together, over sales

Executives at the major record labels continue to flirt with merger possibilities after earlier attempts failed.

The players

Warner Music Group

2002 sales: $4.2 billion

Part of AOL Time Warner, Warner Music Group is composed of music publishing and record companies, including Atlantic Group, Elektra Entertainment Group, Rhino Entertainment and Warner Bros. Records. Warner Music International includes a roster of more than 1,000 artists and operates in more than 70 countries through various subsidiaries.

January 2000: Time Warner announces plans to acquire control of music business from EMI. The new company would be called Warner EMI Music with an estimated $20-billion value in a deal described as a ‘50-50 joint venture structure.’

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BMG

2002 sales: $3.2 billion

BMG is a division of media giant Bertelsmann. In 1979-80, Bertelsmann expanded into the U.S. market by purchasing Arista Records and Bantam Books. In 1986, it acquired the RCA label. BMG formed in 1987 by combining the company’s global music businesses, including Arista and RCA. BMG completed the $2.74-billion acquisition of record label Zomba Music Group in 2002.

Los Angeles Times

**

EMI Group

2002* sales: $3.3 billion

EMI Group has more than 70 labels and more than 1,500 artists. In 1955, EMI bought Los Angeles-based Capitol Records. In 1992, it acquired Virgin Records for $960 million, and in 2002, it acquired Mute, a European independent record company for $33.5 million.

Pearl Records

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The courtships and failures

October 2000: Time Warner calls off planned EMI deal, clearing the way for its AOL merger.

November 2000: EMI says it is receptive to a BMG proposal to merge.

January 2001: European Union opens antitrust probe to determine whether major music distributors artificially inflate CD prices.

May 2001: EMI and BMG scrap plans to merge music operations in the face of EU regulatory hurdles.

May 2003: Warner Music Group talks with BMG, and proponents say such a consolidation could result in cost savings. A deal would put their labels in a jointly owned venture.

*Fiscal year ended March 31.

Researched by Times librarian Cary Schneider

Sources: Company reports, Times research