How Citigroup Outfoxed Guy Hands In Its Takeover Of EMI

While press reports on Citigroup’s takeover of EMI are rife with phrases about how the bank “seized control” (New York Post) in a “surprise move” (Los Angeles Times) that apparently caught Terra Firma chairman Guy Hands off guard, those reports underplay what Billboard has learned really happened in the change of ownership.

While the move was initiated by Citigroup, the company needed to bring EMI Group CEO Roger Faxon on board with the plan. After four years of Terra Firma’s stewardship, Faxon was clearly fed up with all the press reports on EMI’s fate and the impact they’d had on EMI’s staff, so he was probably eager to help effect the changeover to Citigroup as soon as possible.

 While some press reports say Hands and Terra Firma were unaware that they were about to lose control sooner than anticipated, the Financial Times of London notes that the bank was able to seize control after concluding that the holding company had failed a solvency test. How did Citigroup know that before the end of EMI’s current fiscal quarter? Well for one, the company’s worth is less than the debt, but that’s been true for months.

 In order to move forward, it reached out to Faxon, whose cooperation was vital, not only because of his position as EMI Group CEO, but because of his roles in the other companies involved in Terra Firma’s ownership of EMI.

 EMI was controlled through two Terra Firma-created companies: Maltby Capital, which owns the EMI assets used as collateral for the Citigroup loans that helped Terra Firma pay for its acquisition of the major music company; and Maltby Investments, the special purpose vehile that borrowed 2.7 billion pounds from Citigroup to fund the 2007 EMI acquisition.

 Faxon is on the boards of both Maltby companies, but it’s likely his role on the Maltby Investments company is the one he exercised —  along with his position as EMI’s CEO — in aiding the sooner-than-expected ownership switchover. Faxon is the chairman of the board of Maltby Investments, which had only two board members when Maltby released its annual report in August 2010. The other board member for Maltby Investments was Ruth Prior, who had been a finance director at Terra Firma Capitol Partners but joined EMI Group as CFO in early December.

 In his role as chairman of the company that carried the debt — initially 2.7 billion pounds, now 3.4 billion — owed to Citigroup, Faxon undoubtedly had fiduciary responsibilities, which means that in certain circumstances he had to act in the best interest of the creditors, not Terra Firma.

 Furthermore, the situation itself practically dictated that Hands would have no say. “With the value of the business worth less than the 3.4 billion pounds of debt, Guy had no more economic interest in the business; Terra Firma’s investment had no value,” one high-level financial executive told Billboard about how Hands could have lost control to Citigroup — without knowing it until the deal was done. “It was between the company and Citi to resolve the issue.”

 The unfolding of the ownership switch was described in two sentences of the press release announcing the deal. It reported that following the appointment of Peter Spratt and Tony Lomas of PricewaterhouseCoopers as administrators to Maltby Investments, the administrators then sold Maltby and EMI to Citigroup. The FT report adds that it was “a pre-packaged administration, the largest on record.”

In the United States, such a move is often referred to as a “pre-pack” in financial parlance, which is short for pre-packaged Chapter 11. The music industry has seen this type of maneuver before, most recently in August 2009: Source Interlink, the parent of Alliance Entertainment, the largest U.S. one-stop, underwent a pre-packaged Chapter 11. It’s creditor — guess who? — Citigroup, assumed ownership of that company. Citigroup subsequently sold the one-stop to a pair of private equity firms.

But because EMI and Maltby are British companies, this pre-pack was done under that country’s legal system. So on Feb. 1, Citigroup and Faxon went to court in the U.K. to get the administrators and the pre-pack approved; and then the PwC administrators sold the company to the bank. That may have taken place in one day, but it’s more than a good bet that the pre-pack preparations were in the works for weeks before — with Guy Hands and Terra Firma unaware of the maneuvering.

So Faxon gave Citigroup two gifts. He helped engineer an earlier-than-expected assumption of EMI ownership before the company’s March 31 fiscal year-end, when it was expected to be in technical default on its loan covenant. And is there any doubt that the bank saw the earlier-than-expected move as a surprise payback to Terra Firma for the fraud lawsuit?

In return, Faxon and his team likely negotiated the pre-pack from a position of strength. As a result, he helped delivered EMI to a much better fiscal place, with its debt level reduced by two-thirds to 1.2 billion pounds, and he made sure the company had a 300 million poind position. The latter ingredient not only ensures that the company can fund its operations, but it adds an extra little bit of window-dressing for when Citigroup puts EMI on the block, as it’s certain to do. And as a bonus, he gets the Terra Firma monkey off of EMI’s back.

 What did Terra Firma get out of the deal? When all is said and done, it looks like Terra Firma paid a whopping 1.6 billion pounds to rent EMI for three and a half years.

Source: Billboard