Anatomy of a deal | Working in harmony: Universal's purchase of EMI
13 December 2013 | By Becky Waller-Davies
26 May 2014
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21 July 2014
Universal took a massive risk when it bid for EMI, with few believing it would get competition clearance. But with SJ Berwin’s help the punt paid off
On 11 November 2011, lawyers at SJ Berwin (now King & Wood Mallesons SJ Berwin) succeeded in engineering the £1.2bn purchase of EMI by its client Universal.
Similar deals had been mooted in the past but were blocked by competition authorities. Rival Warner tried to purchase EMI in 2000 but abandoned the deal, while Sony’s purchase of BMG, which took the number of major music labels from five to four, took four years to gain competition clearance following the initial acquisition in 2004.
But this time the circumstances surrounding the deal were different. The music industry was – and still is – in the midst of intense change and global players such as EMI and Universal were vulnerable.
“Our arguments to the European Commission were about the nature of competition,” says competition associate Michael Reiss. “Even though at first sight it looks like four big majors going to three, we explained that competition had changed a lot since those earlier cases. The main issues were the massive decline in sales and the digital direction of music.”
Physical sales of music have plummeted over the past decade. Although digital sales and legitimate streaming via services such as Spotify have increased, they have not filled the gap. Instead, that gap has been filled by illegal downloads.
“You are very much looking at a declining market,” Reiss confirms. “Music piracy was the main driver of the declining market. Some figures estimated that at the time music piracy accounted for 90 per cent of downloads.
“If record companies are trying to sell exactly the same tracks for a price and you could get them for free, that is a massive competitive constraint. It obviously puts a lot of pressure on Universal and others to reduce their prices.”
Music piracy was not the only reason for the decline in sales and revenue, however. The digital takeover of the music industry has changed the way people listen to music. Before digital music, consumers were left with no choice but to buy a whole album of songs, whether online or in a store.
Now, streaming services have made it easier for an entire generation to cherry pick the songs they want to listen to and then, if they do choose to purchase songs via legal means, buy only the ones they particularly like.
Competition authorities such as the European Commission concern themselves with ensuring that mergers do not harm consumers, for example by increasing prices or restricting opportunities for innovation.
Although both Universal and EMI were big players in the industry, this argument could not be said to apply to them due to the continuing fall in sales.
Another major shift in the music industry was that buyer power had undergone a huge transformation. Before Amazon and iTunes became the main purveyors of legally bought music, HMV and similar high street stores were the record companies’ main route to market.
By 2011, this situation was unrecognisable.
“They are just so powerful,” Reiss says of iTunes and Amazon. “Music is not that important to them, but it is obviously very important to our client. iTunes makes more money from hardware and uses music just to drive sales of hardware and Amazon sells so many different types of product, and often uses music as a loss-leader. They are very, very powerful customers so they can constrain any attempt by record labels to put up prices.”
HMV, meanwhile, added an interesting dimension to the market. Record companies such as Universal did not want HMV to go out of business for two reasons.
One was that it represented a route to market for their product. The second was that if HMV were to go out of business, companies such as iTunes and Amazon would be even more powerful than before, and more able to constrain the record companies.
The UK market that SJ Berwin’s competition team had to navigate was complex. But EMI and Universal were global companies.
This meant that SJ Berwin had to make equivalent arguments for every European country and work with local lawyers in the US, Canada, Brazil, Australia, New Zealand and Japan.
Work on the deal began when EMI was put up for sale by its owner Citigroup in mid-2011. Universal was keen to secure the company, as was rival Warner.
“EMI was essentially taken off Terra Firma’s hands by Citigroup and the entire market knew it would be up for sale pretty quickly,” says Universal vice president of legal and business affairs Alex Doherty. “It was something we were thinking about and when the process started we got involved pretty quickly.”
Bidders were not just competing on price but also on who would take the antitrust risk, deciding whether it would be the seller or the buyer that would suffer the consequences if the deal was blocked.
“It is hard to say for sure, but we think one of the reasons that Universal won the bid was not just the purchase price but because it was prepared, perhaps unexpectedly in the eyes of other bidders, to take that risk,” says Reiss.
If Universal had purchased EMI and then been refused competition clearance, it would have been forced to sell on all or most of it under pressure.
This would have led to a poor sale price and the costs associated with the initial purchase and subsequent sale would have been borne by the company. It was essential that SJ Berwin was able to gain competition clearance.
The main opposition
Following the November 2011 purchase, work began to ensure that Universal’s sale did not derail, despite its competitors’ best efforts.
“In Warner’s eyes no doubt, it was quite surprising that we would take the risk. That may be the reason why we managed to secure the assets and also why Warner could be seen as a jilted bride – because it had very much hoped to buy EMI,” Reiss says. “It missed out and it vigorously opposed Universal’s acquisition of EMI, whether that was in the form of PR or more rigorous legal submissions to competition authorities around the world.”
Other parties that opposed the deal included indie record label association Impala, which took the same strategy as Warner, mobilising PR teams and making submissions to competition authorities.
“Impala was one of the strongest opponents,” Reiss says. “The indies are much stronger nowadays. With digital platforms it is much easier to sell your music. You don’t necessarily need to have a big infrastructure to do that.”
The increased strength of indie record labels was an important argument for the Universal/EMI deal to be allowed to continue.
“There are all sorts of services out there that aggregate music from different indies and might sell them collectively to retailers, whether through digital or physical copies,” Reiss continues. “It’s easier for indies to sign artists and sell their music. We used the example of Adele. She was one of the top-selling stars at the time the sale was going through and was signed to an indie who had managed to launch a global superstar.”
Competition clearance was forthcoming in September 2012. However, the clearance was given with certain restrictions.
“The clearance was conditional on certain divestments being made,” SJ Berwin corporate partner Will Holder explains. “Some of the assets were from EMI and also a handful of assets that Universal already owned. It ended up being nine different sales that were subject to a timetable set down by the European Commission.”
SJ Berwin’s corporate team had four months to sell the nine different businesses.
Associate Richard Davies was first aware of the Universal deal as a trainee, when it was making its way through competition clearance. He qualified into the commercial department in September 2012 and went into a briefing on the deal on his first morning back in the office after NQ leave.
“The commercial team had already been working on the deal for a month or so and I immediately realised it was going to be a very busy period,” he says. “At that stage it was the auction process for the divestments.”
Divestments were auctioned off to bidders, subject once more to competition clearance.
The principal divestment was Parlophone group, which was purchased by Warner. The creation of Parlophone was effectively the creation of a new label with UK and various European operations. Other smaller divestments, such as the Now That’s What I Call Music division, were also made, but these were self-contained units and relatively simple to transfer to new owners.
By contrast, Parlophone was completely integrated with EMI and so needed to be separated from the main business to be sold.
“It had to be separated out and that was everything from its IT systems to its contractual arrangements and archives of recording tapes,” says Davies. “There was the period between exchanging contracts in February and completing in July which involved separating out the building and moving people who wouldn’t be working in the EMI building.”
Associate Matthew Pearson, a trainee at the time of the deal, says: “A lot of the other divestments were already formed and quite distinct but we had to create the Parlophone divestment so that is what a lot of our efforts went into.”
Davies adds: “It was quite a difficult process. On normal corporate deals it is usually quite straightforward but with this there were so many documents, tens of thousands of them, everything from David Guetta’s recording contract to licensing agreements with iTunes and Amazon.
“We had to make sure that certain artists could still use the record labels they wanted on their next albums.”
Managing the data room holding the documents became a job in itself. “It ended up being a pretty bespoke job,” Holder recalls. “One of the big issues was confidentiality of information because you had trade or strategic buyers as well as private equity buyers.
“You invariably need to be concerned about, for example, a Coldplay contract or a Pink Floyd contract. There were multiple data rooms to deal with redacted and un-redacted versions of documents.”
Aside from documentation governing the internal licensing of the labels, the SJ Berwin team also had to ensure that external licensing agreements were transferred from EMI to Universal and Warner.
“The main focus of the work I was doing was on digital licensing,” Davies says. “The EMI repertoire was available through iTunes and Spotify and that was being split.
“Some would be retained by Universal and some would be sold to Warner. There was a whole process around ensuring that those agreements would stay in place and they would still be able to distribute across the world and platforms differed. For example, we were dealing with the equivalent of iTunes in China.”
Divestments aside, Universal retained about two thirds of EMI, getting a good price for its sale of Parlophone to Warner, and keeping artists such as Emeli Sandé, Katy Perry and The Beatles on its books.
It finished the year with a combined turnover of $2.2bn and an exclusive agreement with professional controversialist and profit-maker Miley Cyrus, surely making 2013 a year that’s indelibly etched into Universal history.
Sponsor’s comment: Michael Reiss, competition associate, King & Wood Mallesons SJ Berwin
The Universal/EMI transaction brought together individuals from across the firm. There was every level of seniority from paralegals, trainees, associates and partners all the way up to the managing partner (a leading corporate lawyer) and senior partner (a leading competition lawyer).
Various departments were engaged including corporate, competition, employment, tax, commercial, intellectual property, litigation and real estate. Lawyers from different offices were part of the team, including in the UK, Germany, France and Spain.
Trainees played a central role in the whole project with significant day-to-day client contact, whether in set-piece drafting meetings or smaller scale consultations on specific issues. In corporate, trainees gained experience of due diligence, running virtual data rooms and drafting transaction documents. In competition, trainees were involved in preparing submissions to be made to the European Commission in Brussels, as well as researching key developments in the music sector and legal issues. One competition trainee was charged with supervising about 40 paralegals as part of an exercise to review and disclose a mass of documents to the Brussels regulator.
There were moments of high drama. Take the drafting sessions between Universal and Citigroup (on the purchase of EMI) and Universal and Warner (on the sale of Parlophone) where principals, lawyers, bankers and accountants negotiated dozens of interlocking agreements in a bid to overcome commercial and legal obstacles to a deal. Take the merger remedies discussions with the European Commission where the future home of some of the world’s greatest artists was as stake. Take the challenge of dissecting the EMI record company into a retained business and a divested Parlophone business and the question of which side of the line all the artists, employees, customer agreements, supply agreements, recording studios, IT systems and even musical memorabilia such as posters would fall. Trainees were at the heart of the action in each case.
This was a transaction – or, more accurately, a series of transactions – in which, if an issue could crop up, then it probably did. It has generated a raft of experiences and precedents, which all participants, junior and senior alike, will keep with them for the rest of their careers.