Terra Firma has filed a slightly batshit lawsuit against Citigroup, in which the poor sheeplike Guy Hands claims he only bid for EMI because Citi’s David Wormsley told him he ought to.
There’s another part of the lawsuit, though, which hasn’t got quite as much attention: Hands claims that Citi put out a research report in September the publication of which had all manner of nefarious undertones:
While nominally labeled an analyst report regarding the publicly traded stock of Warner, the core of the Citi Report was a broadside attack on Terra Firma, its investment in EMI, and its reputation. Citi launched the attack in order to create marketplace uncertainty about EMI’s ability to operate as a going concern, thereby damaging EMI’s currentand prospective business relationships and profitability, and undermining Terra Firma’s ability tomanage EMI successfully.
In other words, Citi’s objective in publishing the Citi Report was to undermine EMI’s performance, causing the business to fail the quarterly covenant test and thereby allowCiti to wrest control of EMI from Terra Firma.
Wow, a research report can do all that?
Citi was kind enough to send me a copy of the report, although they refuse to let me post it here so that you can see for yourself what it does and doesn’t contain.
It’s true that the report talks a lot about “EMI’s banks” without ever disclosing that in fact there’s only one bank involved — Citi. One would think that given the authorship of the report, that would be a pretty obvious disclosure to make, but at the same time the identity of EMI’s banker was already known to anybody following the EMI saga.
But I see no “broadside attack on Terra Firma” in the report. Instead, it’s all based on the fact — and it is a fact — that Terra Firma is asking Citi to write down the principal amount owed, in return for Terra Firma injecting hundreds of millions of dollars of new money into EMI. Writes analyst Jason Bazinet:
The key question for the banks is do they accept Terra’s offer to lower debt, wait for the industry to turn- around, or do they push EMI into insolvency?
The point here is that any bank can be expected to act in its own best interest. Terra Firma is offering one option: a write-down of principal, along with an increased chance of repayment after new money is invested into the company. But any such option carries an implicit ultimatum: if you don’t write down your loan, Terra Firma is saying, then we won’t inject any more money, and EMI will be forced into bankruptcy.
Bazinet’s report basically just looks at what happens in that latter case. When a company declares bankruptcy, it essentially gets taken over by its creditors. In this case, the creditor is Citi, which — as the Terra Firma lawsuit explains at length — has long been advising both EMI and Warner Brothers with an eye to merging the two companies. But even putting to one side the existence of Citi’s M&A advisory practice, the obvious Plan A for any creditor faced with Terra Firma’s ultimatum is to seize the company and sell it to Warner. If the proceeds of such an action mean that the bank gets its original loan back in full, there’s no reason to go along with Terra Firma’s plan and write down the loan.
Bazinet’s analysis indeed comes to the conclusion that if EMI were to declare bankruptcy, “the banks will likely recoup their initial investment in the firm, increasing the possibility of an EMI insolvency”. If Citi’s lending arm were to come to the same conclusion, then the chances of them taking Terra Firma up on its offer would be slim indeed.
But it’s a very, very long way from that simple argument to this kind of conspiracy theory:
Artists who are considering signing contracts with EMI are less likely to do so as a result of the Citi Report, and more likely to sign instead with either Warner or one of the other major music labels…
The purpose behind Citi’s smear campaign is to force these artists and counterparties to refuse to do business with EMI, thereby undermining EMI’ s ability to generate revenue and, hence, to meet the financial covenants in the Financing Agreements.
Somehow I doubt that a band on the verge of being signed by EMI will (a) find the Citi report; (b) read and understand it; and (c) decide that the risk of EMI merging with Warner brothers means that they’d be better off not signing with EMI at all. The worst-case scenario would be that the band in question might ask for some kind of change-of-control clause, saying that if EMI merges with another label, the band has the right to renegotiate its contract. Call it a Poison PiL. (Any such agreement, of course, would only strengthen Terra Firma’s bargaining position with its bank.)
More generally, Hands is leveling an extremely serious accusation against Citi generally and Bazinet in particular — that Citi’s research arm is happy to do the bidding of its investment bankers, and that Chinese walls at the company are either low or nonexistent. Remember that we’re talking about the former employer of Jack Grubman here: Citi, more than most banks, knows the dangers of using research for ulterior motives.
My feeling is that Bazinet is simply collateral damage in the war between Citi and Terra Firma. Hands threw the accusation against Bazinet into the lawsuit not because he particularly thought it would stand up in court, but rather because he wanted to come out guns-blazing for strategic reasons. If Citi doesn’t accept his ultimatum now, it might still be able to sell EMI to Warner, but it will also have a major lawsuit to contend with, which will cost it significant amounts in management time, legal fees, and general public image. Hands doesn’t want to win this lawsuit: he wants to drop it, in return for an agreement by Citi to write down its loan. It’s a high-risk play, because the suit makes him look a bit stupid. But that’s obviously a price he’s willing to pay.
(Many thanks to Peter Kafka for setting me off on this trail.)