Warner May Say Yes to EMI This Time

For six years, two of the world’s largest music companies -- London’s EMI Group and New York-based Warner Music Group Corp. -- have circled each other in a tentative courtship.

Now, they may actually get hitched.

On Monday, EMI offered $4.2 billion for Warner Music, whose board rejected the proposal as “not in the best interests of our shareholders.”

This time, however, many insiders and analysts believe that, in the end, the cold feet will warm up. They are confident that price, timing and control issues can be worked out, and that the two companies would complement each other.

“EMI has worked hard to build its U.S. businesses without much success, and Warner has really cut back overseas, so there’s an opportunity to combine those strengths and still reduce overhead,” Pali Capital analyst Richard Greenfield said. “Getting bigger is better.”

One compelling reason is the $200 million to $300 million annual increase in cash flow a combined company could receive once overlapping bureaucracies and executives were done away with.

More girth would also give the companies more power to negotiate with artists and retailers. A combined EMI and Warner Music, a distant third and fourth in global sales now, would account for 26.4% of the song market, making it the world’s second-largest music seller behind Universal.

EMI and Warner nearly combined in 2000, but European regulators scuttled the deal over fears that the combination would be too large. EMI made a pass again at Warner Music in 2004, but Edgar Bronfman Jr. swooped in to buy the company from then-owner Time Warner Inc.

Still, many issues remain unresolved, with price the biggest one.

EMI’s offer was $28.50 a share, a scant 1.75% premium over Warner Music’s closing price Wednesday of $28 a share. Warner Music insiders with knowledge of the talks say controlling investors want closer to $32 to $35 a share, or $4.9 billion. An EMI executive familiar with the discussions hopes a deal might be struck closer to $30 a share, or $4.5 billion.

Warner Music’s debt is more than $2.2 billion, bringing the total acquisition cost to more than $6 billion at any price under discussion.

Finding that much cash might prove difficult for EMI, which as of September reported debt of about $2 billion. EMI sources said a combined company would probably sell the Warner or EMI music publishing businesses to pay down loans and appease regulators. The sale of such an asset could bring in more than $1 billion.

“We wouldn’t go into something like this without having the bankers on board,” an EMI insider said. “Getting the cash will not be an issue.”

In addition, sources at both companies say Warner Music’s private equity owners -- especially Thomas H. Lee Partners -- are insisting that EMI pay primarily in cash, rather than with shares of the combined company.

“The investor group has a lot of confidence in Edgar and his team,” said one person with knowledge of the negotiations who, like many sources, requested anonymity because talks were continuing. “They have less confidence in EMI’s executives. The private equity guys have no interest in EMI stock.”

Another topic under discussion is leadership. Executives at both firms say neither wants a merger of equals, pointing to the failed example of the 2004 marriage of the Sony and BMG music labels that resulted in power tussles and lost market share.

Others say that even if EMI took over, the company may not oust all of Warner’s top brass.

“This isn’t just about cost cutting,” an EMI executive said. “The EMI board is going to demand creativity, and there are very creative people at both companies. We want to buy and keep smart people.”

Some Warner Music insiders have speculated that Bronfman is loath to give up a position that has rehabilitated his stature on Wall Street after his ill-fated 2000 decision to sell his family’s Seagram Co. empire to France’s Vivendi in a stock swap. Vivendi nearly went bankrupt, destroying an estimated $3 billion of the Bronfman family’s wealth.

Some executives speculate that Bronfman may even mount a counteroffer to acquire EMI. But others say Bronfman, who stands to pocket more than $500 million from an acquisition, is content to walk away.

“Edgar is motivated by reputation,” a Warner insider said. “He bought Warner Music for $2.6 billion two years ago and already repaid the investors. Now he’s going to sell it for almost twice what he paid.”

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Fewer players

The record world had five major companies less than two years ago. If EMI buys Warner, that number will go to three.

Current share of new-release market in the U.S.*

Universal Music: 35.1%

Sony BMG: 25.8%

Warner Music: 17.2%

EMI: 9.2%

*Year to date as of April

Source: Nielsen SoundScan