Private Equity Pursuing Music Giant EMI

Reuters reports that three American private equity firms, namely Fortress, Cerberus, and One Equity, are all interested in paying something in the vicinity of $6 billion for the British music group EMI. The entry of significant private equity dollars indicates a major shift from as recently as March, when EMI rejected a $4.2 billion bid from Warner Music.

EMI is one of the world's largest music companies but the industry has faced difficulties adjusting to the presence of digital distribution and the resulting ease of stealing its product. While Napster has been vanquished and reincarnated within just a few years as a legitimate distribution channel, the development of countless clones with technology designed to avoid legal challenges indicates the ultimate weakness of the business.

Downloading music illegally is getting easier all the time, and the potential to download higher value products like movies is increasing the returns to mounting this diminishing learning curve. The music industry's attempts at digital rights management, or DRM, have been a titanic failure. In addition to failing to prevent any reasonably dedicated teenager from getting a hold of music, the whole process has had the effect of creating an adversarial relationship with customers.

EMI has been underperforming its industry over the past few years and has actually lost money in the last quarter. Given the profitability of the rest of the industry, even as it struggles with change, this indicates EMI's management is not up to the task of answering the digital challenge.

All of this clearly begs the question: "Why is EMI suddenly worth so much money?" The better question is: "Why would private equity firms be willing to pay significantly more than music industry insiders for the company?" The answer seems to be that music industry insiders are focusing on the unique value proposition of the underlying business while private equity gurus are more concerned with the balance sheet.

The music business may not be what it once was, but significant revenues are a certainty for the foreseeable future. At the same time, the recent spate of private equity firms engaging in leveraged buyouts across numerous industries with widely different businesses and risk profiles seems to indicate that relative to the price of capital, most publicly traded companies are insufficiently leveraged. EMI is a giant business that has lost its way. The company is losing ground, but that actually makes it a more compelling takeover target.

By taking a company with essentially no debt and leveraging it to the maximum, the Americans plan to take value stored in the enterprise itself and cash out quickly. EMI is slowly sinking, but it isn't drowning. A quick turnaround could net substantial returns on resale in five years when the company has returned to profitability.

Experts know their area of expertise and not much more. Music industry insiders see a floundering giant, but private equity sees untapped potential. Only time will tell if the money that private equity can squeeze out of a leveraged buyout will outweigh the loses at EMI's main business.

Ford in Free-Fall

Reuters reports that Ford's April sales numbers fell 13 percent from a year ago. This might be easily dismissed as just the next chapter in the ongoing saga of Ford's difficulties, but the breakdown of the results yields some surprising results.

Ford's Expedition, a monster SUV, saw its sales rise 27%. And the Navigator, another leviathan, had sales that rose 13%. In contrast, the F-series pickup was down 12% and car sales were down over 23%. Clearly, Ford's car sales were hurt by the end of fleet sales to car rental companies that Ford decided weren't generating any profits.

Now, SUVs saw tremendous declines the last time gas prices went way up, and oil is heading back up again. But this time buyers aren't buying gas guzzlers without realizing the possibility of a tank of gas costing $100 is quite high. Rather, these affluent buyers don't seem to care. Given the social force of the global warming driven "carbon footprint" movement, it is all the more remarkable that consumers would choose to buy SUVs.

Detroit automakers in general are facing the music these days as Toyota has finally climbed past GM to become the world's number one automaker. But Ford seems to be suffering disproportionately. Chrysler's sales actually rose in April, albeit an anemic 2%.

Ford's saving grace up until now has been the strength of its F-series pickup. These trucks have been the best selling trucks in America for decades and their loyal buyers are among those most suspicious of foreign competition. But with sales on its flagship product falling 13%, the writing is now on the wall.

Something major needs to happen at Ford for a turnaround to work. Ford's management is hardly unaware of the problem. Ironically, Bill Ford was one of the early American proponents of environmentalism and his signature achievement was building one of the most environmentally conscious auto plants in the world. It's going to take more than incremental improvements in salesmanship and design to fix things.

Ford needs to completely re-brand itself around an innovative new design. Ford has admittedly been trying this for a while now, but the new designs really haven't caught on. Ford needs a sea change in leadership at the very top of the company to finally put all of its top talent on the products of the future. Ford finds itself in the awkward position of being a horse company competing against early auto companies. For a significant period, Ford is going to need to sell both horses and cars, but the company would be penny wise and pound foolish if it put any of its top people on its horse operations. Ford needs to put its top talent on the wave of the future, because if it doesn't the company may get put out to pasture.

Restructuring at Citigroup - 17000 jobs lost

The Globe and Mail reports that Citigroup may fire 5 percent of its workforce - about 17000 people. This is significantly less than earlier reports that warned of as many as 45000 jobs lost.

Citigroup is not exactly a money-losing business. Earnings per share have been steadily, if slowly, growing. The CEO Charles Prince is under pressure from Citigroup's largest shareholder, a Saudi prince, to match the performance of Bank of America and JPMorgan Chase & Co.

Citigroup plans to save about $2 billion per year after its restructuring, but it doesn't plan to rest on its laurels. The company just acquired Taiwan's Bank of Overseas Chinese for more than $400 million and is in talks to buy hedge fund Old Lane LP in order to expand their alternative-investments group. This profitable new area of business would include private equity and real estate.

Is this a sluggish, old money giant trying to slim its way to new economy success? Of course, but just because the strategy closely resembles a cliche doesn't mean it won't work. Citigroup can afford to pay a premium to hire the world's best management. The current leadership doesn't have a strong track record of recent success, but that actually makes immediate success easier to attain due to lower thresholds for growth rates.

Citigroup hasn't been a great investment for the last few years, and no matter how effective the restructuring turns out to be, the company probably won't lead the market higher in the next few years either. But Citigroup isn't going to even come close to losing money either. It can be difficult to leverage the stable, unsexy cash flows of the past into new revenue streams, but that's a whole lot easier than leveraging red ink into growth.