Song remains the same for EMI and Warner

As Eric Nicoli, EMI’s chairman, this week made his approach for Warner Music, he could take comfort that the target owns an appropriate soundtrack for the on-off talks between the UK and US music majors – “We Belong Together” by Mariah Carey.

Although Warner has rejected the cash and shares approach worth $28.50 per share, the idea of a tie-up between the world’s third and fourth music groups is seen as almost inevitable across the industry.

They have circled each other for years, with previous agreements near in 2000 and 2003. More recently, shares in both companies have been lifted by hopes that the – on paper – well-suited partners would join the boom in mergers and acquisitions on both sides of the Atlantic.

In the month to May 2, EMI shares outperformed the FTSE All Share by about 11 per cent, leaving it valued at £2.33bn ($4.26bn). Warner Music beat the S&P 500 by 17.7 per cent over the same period, raising its value to $4.05bn.

And markets have begun to price in the big prize of any merger – possible savings of anywhere between $150m and $370m from combining the two groups and their operations worldwide.

Simon Baker, analyst at SG securities, says: “Indisputably, both EMI and Warner share prices are already factoring in a degree of merger benefits.”

For analysts, the rationale for any deal is about cost-cutting.

Faced with pricing pressures from large retailers and the challenge to traditional revenues from new rival distributors of music on the internet and mobile devices, record labels have been sharpening their axes.

Artist rosters have been pruned, middle management has been shed and some offices closed. Digital platforms have been expanded.

But few think the process has gone far enough.

In a typical view of the situation, Nick Bell, analyst at Bear Stearns, says: “I think this is overwhelmingly a cost-driven story. If this deal is going to be earnings-accretive to EMI shareholders, it looks like there would need to be about $300m in cost savings across the merged group.”

Although a combined EMI-Warner would leapfrog into second place globally in terms of music recording share, behind Universal, the merger benefits to its future growth prospects are less clear.

One music analyst, who spoke on condition of anonymity, says: “It is not clear that there are huge top line benefits from a merger. Certainly there hasn’t been at Sony BMG …maybe it helps in negotiations with retailers.”

Mr Baker of SG adds: “This is a people-based industry where the impact of being a global leader can in itself attract talent, whether it is artists or executives.

“In terms of additional pricing power, even if it means the merged group is simply able to match the efficiencies of the Universals of the world, that is important.

“Even getting back to a neutral footing is better than the current under-exposure and the weaker pricing power which is otherwise the future for the second-rank companies in the music business.”

However, major stumbling blocks have also been identified. On the music publishing side, the two groups have a large combined share and might need to dispose of assets.

Any deal between the two would also create a clash of music industry personalities. There have been reports in the past that relations between Mr Bronfman and Alain Levy, head of EMI Music, are cool.

Meanwhile, Roger Ames, who left Warner Music after Mr Bronfman took over, is now a consultant at EMI.

It is not clear, either, who would run the merged group.

Perhaps, more seriously, the relative recent strength of Warner in digital sales and in the US market had led some to believe that Warner could bid for EMI rather than vice versa.

Mr Baker adds: “The fact that EMI was first to knock on Warner’s door should only be seen as EMI being a step closer to becoming the dominant player. Yet the fact that Warner Music seems to have rejected it without even taking EMI to the negotiating table would clearly suggest there is an irreconcilable element in the deal structure.”

With that in mind, both companies have publicly stated that they do not believe a merger of equals would work.

If anything, the recent fight between Sony and Bertelsman executives for control of their Sony BMG joint venture has only hardened those views.

And whoever ends up in charge will still face immense strategic challenges.

Lorna Tilbian, an analyst at Numis, says: “The question is, even if you replace your analogue revenues with digital revenues, what is going to happen to the margin?

“What you are seeing is the unbundling of tracks, so that instead of buying a whole album, people are downloading two or three tracks. It is the impact that has going forward that is the question.”