Music Firms Turn to Each Other to Survive

The music industry could soon shrink from five giants to three in a last-ditch effort to survive.

Sony Corp. and Bertelsmann formally announced plans Thursday to merge their recorded-music operations as rivals Time Warner Inc. and EMI Group continued efforts toward their own deal -- moves that would place the overwhelming majority of the world’s music catalogs into the hands of three players.

The consolidation would be unprecedented, but industry executives contend it is unavoidable.

Once a vibrant, cash-rich industry whose rapid growth fed a slate of media and entertainment powerhouses, the music business is drowning in red ink amid widespread piracy and plummeting sales. Losses have been so severe that industry executives say they face cutbacks that would effectively gut their enterprises.

Joining forces, they believe, gives them their best hope.

“The industry is in a storm, and I don’t see any signs of it clearing next quarter or even next year,” said Sony Music Chairman Andrew Lack. “The joint venture is a much better alternative than going forward on a stand-alone basis.”

Joining the industry’s No. 2, Sony Music, with the industry’s No. 5, Bertelsmann’s BMG, would generate an estimated $5 billion in annual sales and create a roster including such Sony artists as Beyonce Knowles and Bruce Springsteen and BMG’s Outkast, R. Kelly, the Strokes and Dave Matthews Band.

The prospective deal between Warner Music and EMI would put Warner’s Metallica and Madonna with EMI’s Coldplay and Rolling Stones.

The European Commission, which must approve such mergers and acquisitions, has cast a harsh eye on music industry tie-ups in recent years. Music executives have said they believe the case for consolidation has been strengthened by changes in the music marketplace, including the billions of songs that people now download for free every month from the Internet.

Strong opposition to that argument would be expected from Vivendi Universal’s Universal Music Group, the world’s largest recording operation, and from small independent labels that would contend that consolidation would reduce competition and harm consumers.

For the industry to shrink to three from five major players “can be very serious....It makes it that much easier for the companies to act in lock step and do what one another’s doing and raise prices,” said Eleanor Fox, an antitrust expert at New York University. “That certainly is a warning signal.”

The latest round of possible deal making marks a reversal for parent companies that once were desperate to break into the music business and made multibillion-dollar acquisitions over the last three decades.

That was before the widespread practices of “burning” CDs and Internet piracy destroyed sales of new hits and old catalog albums. Global industry revenue has shrunk by about 25% over the last three years.

One recent report estimated sales of pirated or counterfeit CDs at more than $4 billion a year. It is a crisis that labels have only begun to fight by backing consumer-friendly digital delivery systems for music that could hinder Internet bandits.

Record companies also have dropped in value because investors and industry executives have come to distrust the claims of “synergy” that formed the underpinning of a spree of media mergers, including America Online’s ill-fated union with Time Warner. Promises by media executives to harness online or wireless technology to sell music never came true.

Now the industry is preparing to argue that the marketplace is demanding a dramatic downsizing.

For Sony and Bertelsmann, marrying their record labels in a 50-50 partnership would reduce their exposure to the ill health of the industry. It also would create an unusual -- and some say unstable -- business structure without much precedent in the music business.

Though the two sides have agreed on the framework of the operation’s structure, it remains to be seen which of the forceful personalities in the upper ranks of both Sony and BMG would dominate day to day.

Sources say the two companies plan to form a governing board of six members, three from each firm. BMG Chairman Rolf Schmidt-Holtz would serve as chairman of the board, and Lack would become chief executive of the new venture.

The combined entity, to be called Sony BMG, would have about 25% of global music sales, placing it just behind Universal. If regulators approve the deal, sources say, the combined venture would expect to integrate operations and cut about $300 million in costs -- in part through layoffs and a reduction of artist rosters.

In the U.S., the world’s biggest music market, the new venture would claim about 28% of overall album sales, ranking it ahead of Universal, according to Nielsen SoundScan data.

The plan announced Thursday follows a months-long pursuit in which Lack, a veteran television executive hired to run Sony’s music division earlier this year, made numerous overtures to Schmidt-Holtz, who was engaged in exclusive talks to form a similar venture with Time Warner’s record label.

When those talks broke down, sources say, Lack and Schmidt-Holtz began intense negotiations.

In a nod to the regulatory uncertainty, Sony and Bertelsmann will merge only their labels -- the deal excludes their respective music-publishing divisions and CD distribution operations. European regulators signaled in previous merger attempts that too few companies controlling music publishing or physical distribution could cross the line into excessive consolidation.

With Sony and Bertelsmann seemingly en route to seeking regulatory approval, EMI is under pressure to step up its discussions to buy Time Warner’s recorded-music business. EMI has proposed purchasing the division for about $1 billion in cash and providing Time Warner with a 25% stake in the venture.

Time Warner has also discussed selling its music operation to businessman Edgar Bronfman Jr., vice chairman of Vivendi. Though that sale is not likely to raise concerns with regulators, it could deliver Warner a smaller payout.

Several experts said Thursday that it was unlikely -- but possible -- that regulators would allow two transactions at the same time. In 1998, the Federal Trade Commission moved to block two simultaneous merger proposals that would have combined four of the biggest firms in the drug distribution business, saying the pair of combined companies would control too much of the industry. But three years later, regulators approved two slightly different pairings.

Some artist representatives predicted the two deals would mean more trouble for aspiring artists. Simon Renshaw, co-head of the music division of artist management powerhouse the Firm, said with fewer labels, musicians could be pressured to sign contracts that give the companies a piece of their merchandise and sponsorship income, areas that have traditionally belonged solely to the artists.

“You’ll have the control of the development and marketing channels in the hands of four or possibly three people,” Renshaw said. “This is bad news for artists.”

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The Sony BMG deal

Each company would own a 50% share. No cash payments would be made. It would exclude the companies’ publishing and manufacturing operations.

Top executives

Sony: Andrew Lack

BMG: Rolf Schmidt-Holtz

Employees

Sony: 9,000

BMG: 5,100

Labels

Sony

Columbia, Epic, Sony Classical, Crescent Moon, Epic Records, Legacy Recordings

BMG

Zomba Music, Arista, RCA Music

The artists

Sony

Bruce Springsteen, Dixie Chicks, Jennifer Lopez, Beyonce Knowles and Celine Dion

BMG

Britney Spears, Elvis Presley, Dido, Dave Matthews Band, Christina Aguilera, Alicia Keys, Avril Lavigne

Other deals in the making:

EMI is trying to acquire Warner’s recorded music unit, but separately, U.S. media billionaire Haim Saban and former Seagram Chairman Edgar Bronfman Jr. also are exploring a bid for Warner Music.

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Sources: Bloomberg News and Times Research