Sunday, February 7, 2010

Hit turns to miss as Hands sues Citigroup over EMI deal

Terra Firma's boss says he bought the now struggling music company for a 'fraudulently inflated' £4.2bn.

By Richard Northedge

The most played track on EMI's website last week was the American band Hockey's song, "Learn To Lose". Guy Hands, whose private-equity funds own the music company, has had to learn about losses quickly: EMI reported last week that it lost £1.7bn in the year to last March and may not survive unless investors subscribe more cash.

Lord Birt, the former BBC director-general who chairs EMI's parent company, admitted: "There is no certainty that such funds will be available."

If the peak of the dot-com boom was marked 10 years ago by AOL's disastrously overpriced US merger with Time Warner, then in Britain the summit of the stock market before the credit crunch was marked by Hands's takeover of EMI for £4.2bn in 2007.

EMI had a long and prestigious pedigree in recorded music – founded in 1897, pioneering discs over cylinders and recruiting the stars of the day. Sir Edward Elgar was an overture for soprano Nellie Melba and tenor Enrico Caruso, while the early Elvis was followed by the Beatles, Pink Floyd, Queen, the Spice Girls, Robbie Williams and, latterly, Katy Perry.

Yet revenues had been falling for five years when EMI and Time Warner eventually gave up a tortuous two-year takeover attempt in 2007 and Hands chose to gear up his Terra Firma funds for an audacious bid.

But now, after writing off 90 per cent of his investment, he is claiming fraud by Citigroup, the Wall Street bank that advised EMI. Hands claims he was rushed into an auction by the bank without time for due diligence or the chance to shop around for finance. He thus had to agree a £2.7bn loan with the bank that was selling the music company, he says.

A New York lawyer was given details of the claim on Thursday, with Hands saying: "Terra Firma has now discovered that in order to induce it to bid in a private-equity auction for EMI, Citigroup misrepresented fundamental facts about that auction, including misrepresenting that there was another bidder. Because of Citigroup's misrepresentations, Terra Firma paid a fraudulently inflated price."

He cited a subsequent note to investors in Warner Music by Citigroup's broking analysts that referred to EMI's problems and claims this is part of a campaign to undermine the UK company, possibly prior to the bank foreclosing on the debt, and selling the business to Warner.

The bank denies the claims and intends to defend the action, but such allegations make it harder for Hands to negotiate a refinancing of its debt that could make EMI viable again. Citigroup has agreed such deals with other troubled borrowers but shows no signs of reaching an agreement with this company.

Its loans are not expensive – the interest rate is 2.75 per cent above Libor, so the cost has fallen since the takeover – but the covenants are tested every three months to ensure the collateral covers the sum due, even though repayment is not until 2015. But with recession and the adverse consumer trend in recorded music, EMI's liabilities exceed the value of its assets.

Terra Firma had to inject an extra £16m capital, a year after completing the purchase, but three months later it put in another £13m, then a further £39m at the next test, and £37m three months after that. EMI scraped through December's test but directors do not think it will pass next month's assessment and are now asking investors to subscribe another £120m.

Those investors are spread around the world, but the largest number, providing about a quarter of the finance, are in the US, and include the pension funds of New York's fire department, police and teachers. With Lord Birt warning that yet more cash may be needed to satisfy Citigroup next year, some investors may decide to stop throwing good money after bad.

As if it didn't have enough problems, EMI also has a hole in its own pension fund of up to £200m that the regulator wants filled. Lord Birt admits: "These circumstances represent a material uncertainty that may cast significant doubt on the ability of the group to continue as a going concern."

Yet if it was not laden with debt, there is still a viable business within EMI despite its trading difficulties. Its operating profit – excluding losses on derivatives and currencies and goodwill write-downs – was £298m in the year to last March, according to figures filed last week. That covers Citigroup's £250m interest bill.

Besides artists such as Lily Allen and Coldplay, EMI makes almost half its money from music publishing. But the Rolling Stones and Radiohead left the label after Hands started cutting costs, and he must be careful not to lose further talent.

Hands doesn't come from a music background: He was a bond dealer at Goldman Sachs in London until he joined Nomura in 1994 to run its principal finance group; he then took Terra Firma independent in 2002, bringing in outside investors. His deals include buying and selling motorway service stations, railway wagons, pub portfolios, Odeon cinemas and former Army housing.

As he looked for ever-larger deals his name was associated with many public companies from Boots to Glaxo but he gained a reputation for losing interest as prices rose. He was likened to a bidder at a charity auction who makes the initial offer but drops out before the hammer falls. Many were thus surprised when he won EMI.

But the deal was completed in August 2007, just as the credit crunch struck. So even though Citigroup secured a sale – and £93m of fees, according to Hands – it was too late to syndicate the loan to other investors, leaving the bank with the whole £2.7bn. The debt would have junk-bond status if it had a credit rating.

A court date for the fraud claims has been set for October but Citigroup is arguing to have the case brought to London. Hands opposes such a move because it could land him with a large tax bill. Terra Firma is based in Guernsey, where he lives, and he told the court last week of its care in ensuring corporate decisions are made in the tax haven, rather than in the UK, to avoid Inland Revenue probing.

Preparing for a London court case and attending the hearings would make running his business difficult, he argued. His lawyer explains: "Hands made a personal decision to change his personal tax status from UK residence to Guernsey residence. Litigating this case in the UK would be inconvenient to him from a personal tax perspective."

Hands admits his own interest in music doesn't extend far beyond karaoke, but EMI's site will allow him to download The Bad Bankers' track "We Fucked You Up" – or The Jolly Bankers' "Tax Return". Either way, he should do it before Citigroup seizes control of the company

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