EMI turnaround plan hitting all the wrong notes

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The famous Rolling Stones single Time Is on My Side must make Guy Hands weep, for he has neither the Stones nor time.

The Stones bolted from EMI Group PLC shortly after the music company - the industry's fourth biggest - was bought by Mr. Hands's British private equity firm, Terra Firma Capital Partners, in 2007. As for time, Mr. Hands has until June 14. That's when EMI - home of the Beatles, Coldplay, Miles Davis and Katy Perry - must present a business plan to Terra Firma and its investors for long-term growth and profitability.

If the plan is approved, Mr. Hands might be able to persuade his investors to pump more equity into the debt-stuffed, profitless company. If they balk, EMI will go into default and almost certainly become a ward of its main creditor, Citigroup. Rival Warner Music, led by Edgar Bronfman Jr., is said to be watching EMI's spasms with something approaching rapture. Warner tried to buy EMI four years ago and may soon get a chance to buy it, as they say, for a song.

EMI's problems seem never-ending. This week, Elio Leoni-Sceti, the chief executive of EMI Music, the company's recorded music division, resigned after less than two years on the job. Whether he jumped or was pushed wasn't clear, but his departure came only two weeks after he made the cover of Management Today magazine. "I'm very dedicated to EMI," he said in the magazine interview.

He is to be replaced by Charles Allen, the former boss of ITV, Britain's main commercial broadcaster, who had been EMI Music's non-executive chairman. His new title is executive chairman.

On Thursday, EMI took another blow when Britain's High Court ordered it to stop selling downloads of Pink Floyd tracks individually rather than as part of the band's albums. Pink Floyd reportedly is considering jumping to another label, along with another EMI megastar, Queen. With the Stones and Radiohead already gone, the exodus looks like more than coincidence.

None of the big four music labels - Universal, Sony, Warner, EMI - has had an easy time in recent years. The business has been under attack by legal and illegal music sharing sites. Sales of CDs were in near free-fall (still are). The recession hit. Credit dried up, preventing sales and purchases of music labels.

The former Electric and Music Industries Ltd. was created in 1931, though one of its two predecessor companies, London's Gramophone, dates back to 1897. Its roster included an impressive array of stars, among them Elvis Presley, the Beach Boys, Stevie Wonder, Deep Purple, the Spice Girls, Madonna and Blur. By the early part of the last decade, EMI was in trouble. Its costs were out of control and most of its artists, financially speaking, were useless. By EMI's own count, the vast majority of the 14,000 artists on its roster produced no income - some 200 produced half of EMI's sales.

That didn't stop Mr. Hands, one of the private equity industry's most successful players. He likes big corporate names laid low by dim-bulb management or regulatory or structural problems, such as bloated costs.

Since 1994, Terra Firma's funds have invested €13-billion ($18.2-billion), mostly in Europe. Its high-profile purchases ranged from aircraft leasing company AWAS to Tank & Rast, the Germany highway service-station operator whose revival plan was simple: Make the toilets sparkling clean, and charge motorists a small fee to use them in exchange for coupons to be used for coffee and food.

EMI must have seemed like any other turnaround candidate to Terra Firma, which bought the company for £4.2-billion only months before the credit crunch hit. Citigroup provided £2.6-billion in loans.

The idea was to focus on the artists that earned money, ditch the no-hopers, find new artists with potential and "monetize the value of their work by opening up new income streams such as enhanced digital services and corporate sponsorships."

Things didn't work as planned. Some of the artists judged the turnaround plan as little more than a nasty cost-cutting exercise and left. Radiohead said Terra Firma was acting "like confused bulls in a China shop."

The private equity firm underestimated the rate of decline in EMI's traditional music business and found that its data collection and analysis systems were in terrible shape. The company had been shipping out millions more CDs than the market could absorb and had to take them back into inventory.

EMI's effort did produce some financial success. In its last financial year, to the end of March, 2009, the recorded music side reported operating profits of £163-million, triple the level before Mr. Leoni-Sceti arrived. Profit margins rose and worldwide market share climbed to 10.6 per cent from 9.7 per cent in the previous year. But pretax losses were a shocking £1.7-billion, including £1-billion of writedowns.

Most of EMI's equity has vaporized and the auditors of Maltby Capital, the Terra Firma company that bought EMI, expressed "significant doubt" about Maltby's ability to survive.

Keith Jopling, a music industry expert and director at London's Truth Consulting, said EMI's rising operating earnings show that the company was starting to get the idea that "music consumption can be monetized in a number of different ways." The new Gorillaz Plastic Beach: Experience Edition is a good example, he said: It comes with both a CD and DVD that provides online access to extra music, games and video.

Citigroup is apparently not impressed with the improved operating performance, and Mr. Hands is not impressed with Citigroup. He launched a legal dispute against the bank, alleging it misled Terra Firma into believing there were other bidders for EMI, pushing up the price. Citigroup denies it rigged the bidding process.

Citigroup has the power. Unless Terra Firma comes up with £120-million in fresh equity, and quickly, EMI will be in breach of its debt covenants and the U.S. bank could inherit the company. If it does, it might break it up or sell it, with Warner the obvious buyer.

What is certain is that the turnaround effort by Guy Hands has backfired. Some companies are not ripe for the classic private equity treatment - high debt, furious cost-cutting. EMI was one of them.