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 really happened in the change of ownership.
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 implement a solvency test before the end of EMI's current fiscal year on March 31? It had to reach out to the directors of one of the Terra Firma companies involved in the ownership of EMI, Maltby Investments Ltd.
EMI was controlled through three Terra Firma-created companies, Maltby Capital, Maltby Investments Ltd. (where the 2.7 billion pound loan used to pay for EMI resided), and Maltby Acquisitions Ltd., where the EMI assets sat and which were used as collateral for the Citigroup loans.
While the Maltby Capital Board had seven directors, five of whom are employees of Terra Firma, the Maltby Investment Board has two directors, one of whom is EMI CEO Roger Faxon. 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.
Citigroup reached out to Faxon and Prior in their roles as the only directors of Maltby Investments and asked if there was a balance sheet insolvency/technical default, and the directors had to conclude there was, says a source familiar with the situation.
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 called the loan, and Faxon and Prior appointed the administrators. Then the pre-pack was recorded in the British court system, where the administrators were approved. 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. Indeed, Faxon and his management team were making contingency plans in anticipation of such a move.
So through their roles as directors, Faxon and Prior made two decisions that worked in Citigroup's favor. It could 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 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 Faxon's favor,the move delivered EMI to a much better fiscal place, with its debt level reduced by two-thirds to 1.2 billion pounds, with a 300 million pound cash 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, Faxon gets the Terra Firma monkey off of EMI's back.
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 for the changeover to Citigroup to occur as soon as possible.
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