UK: THORN EMI'S FISSILE FUTURE. - The rationalisation of Thorn EMI into a two-pronged business - music and rental - is all but complete. Has the point been reached where a parting of the ways is inevitable?

by Dominic Midgley is a journalist with Today.
Last Updated: 31 Aug 2010

The rationalisation of Thorn EMI into a two-pronged business - music and rental - is all but complete. Has the point been reached where a parting of the ways is inevitable?

The Sir Colin Southgate who mounted the podium at this year's presentation of Thorn EMI's results was in every way more stylish than the Colin Southgate who took the company's helm in 1985. The latter was apt to appear in thick-rimmed spectacles and a square City suit. The former prefers contact lenses and a neat line in Italian tailoring. Among the cluster of lieutenants at his side, Jim Fifield, American chief of EMI Music, was equally up with the times - the exotic tie and trendy glasses confirming his conversion from corporation man to music-biz insider. Only rental boss Mike Metcalf and finance director Simon Duffy were taking a stand against the rock-and-roll culture. Both remained resolutely middle-of-the-road, Metcalf in dark blazer and grey slacks, Duffy in regulation suit and sombre tie.

So which (if either) of these two very different images is the truer reflection of Thorn EMI today? Is Britain's biggest leisure-cum-entertainment group debonair, fashionable, going places? Or is it commonsensical and reliable? And if it's going places, where is it going? Are its various pieces travelling in the same direction? Indeed, will Thorn EMI even exist a few years from now? The answer to the last question is 'Very likely not'.

For several years now the City has applauded as Southgate rationalised a rambling portfolio into a two-pronged business: a premium-rated music side, and a less profitable, but solid, rental operation. Yet it's clear that the rationalisation process still has some way to go. And if and when it's completed, what then? Even the company chairman does not deny that music and rental could reach a parting of the ways. Sceptics wonder about the pace at which existing obstacles to that possible demerger are being overcome. They are also doubtful about some of the directions in which the group is currently moving. They question the sustained heavy investment in the slow-growth rental sector, for example. And they point to earnings per share that are lower now than in 1988. Although, on that Tuesday last May, Southgate was able to report a 19% rise in pre-tax profits for the year to end-March (to £326.5 million, on a turnover slightly down at £4.3 billion), the doubters predominated in the market and the shares promptly lost 28p.

There's no argument, though, that Southgate has radically reshaped Thorn EMI already. He has disposed of more than 60 companies, with a combined turnover of £1.6 billion, since being pitchforked into the managing director's job nine years ago. He had gone on to the board on April Fool's Day 1984 - having joined the group as head of its IT division the previous year - and was promoted to MD exactly 12 months and two weeks later, when chairman Peter Laister went in a boardroom coup. Southgate denies any complicity in that event, incidentally. 'It wasn't me,' he declares with wide-eyed innocence. 'I was not involved - it was done by the non-executives.' The non-execs clearly knew Southgate as one who could be counted on to restore focus to Thorn's muddled vision. He had, as he acknowledges, 'the advantage of being financially independent' having done well from the sale to BOC of Software Sciences, the company he formed in 1970. And financial independence gave him the freedom to speak his mind. 'It so happened that a lot of the things that were going on I just didn't think Thorn could afford,' he recalls. These included 'esoteric' ideas about cable and software and satellite television. 'It's all very well, but where does the loot come from? When you have run your own business you are very conscious of these things.' Far from cultivating fresh fields, Southgate took an axe to the overgrown forest of activities that Thorn had planted earlier, or had acquired down the years. First to go was heating equipment, then EMI Cinemas, the TV manufacturer Ferguson, kitchen appliances company Kenwood, and Inmos in semiconductors. But as he thinned the portfolio he had simultaneously to strengthen the operations he had identified as core businesses for the future. Essentially these were two, of course: music and rental.

Both were in need of fresh faces. The first key hiring was a successor to Bhaskar Menon, the long-serving boss of EMI Music,when he retired in 1989. Southgate settled on Jim Fifield. After a 20-year career with the food and consumer products giant General Mills, Fifield had made a sharp impact on the entertainment sector in the US, taking CBS/Fox Video from start-up to a turnover of $150 million in only three years. To get his man, Southgate was prepared to make him the highest paid manager in the music business. (Fifield's salary package created headlines in June, when it was shown to have mushroomed to an incredible £13.5 million - more than 23 times Southgate's own stipend of £585,000. It's only fair to add, however, that nearly half the mammoth £8.9 million increase was a once-only payment connected with changes in Fifield's contract; also that the package included a performance-related bonus linked to music division targets.) Fifield's objective, from the beginning, was to take EMI (the initials henceforth denote the music division only) into the top three in the world of musical entertainment within five years. It then ranked 'a sleepy number five', with under 11% of the market. Fifield promised Southgate that, were he to fail, it would not be because of inaction: 'It would be because we were too aggressive in trying to make bold moves'. Within a year he had bought the US music publisher SBK for £165 million, taking the group to number one in the publishing sector. Next, in 1990, he acquired 50% of Chrysalis Records - the other half being added two years later. The big, nail-biting deal also came in 1992: the £510 million buy-up of Virgin Music. No one doubted there would be synergy in acquiring Virgin, but at what price would it give a net benefit to EMI? To pay more than half a billion pounds for a company with tangible assets of only £3 million is always a risky proposition.

Working with one of Virgin's top people, Ken Berry (newly appointed president of EMI Records Group International), Fifield produced a report detailing every operation of both companies in every territory where they were active. The potential advantages of the deal stood out in sharp relief. 'I could see how it would fit in just about every country in the world,' says Fifield. 'We had the facilities, we had the distribution centres and we had the worldwide network, we just didn't have enough quality product running through.' The same document became the blueprint for a strategy that was to cut Virgin's artist roster by 65%, streamline the A and R (artists and repertoire) and sales teams, and eliminate 1,000 jobs worldwide.

After the agreement was signed, Fifield told analysts that Virgin's profits would climb from £21 million in 1991 to £57 million in the first year with EMI, and to £80 million 12 months later. But the City soon began to lose confidence. The share price, which had at first soared to 888p, slumped below 700p. In the event, Fifield's projections were more than justified. Virgin returned a profit of £90 million in 1993/94 - £10 million up on the forecast.

Largely thanks to Virgin, which is market leader in the UK, EMI now owns 15% of the world market, and music accounts for 64% of the group's operating profits - compared to 27% in 1990. Without this strong contribution from Virgin, the music division's performance would still look pretty ordinary - operating profits (ex-Virgin) increased just 8.5% last year. Which causes some observers to question Fifield's credentials. 'He's brilliant at cutting costs,' acknowledges Steve Redmond, editor-in-chief of Music Business International magazine. 'But the real challenge for Fifield,' adds Redmond, 'is to generate organic growth.' It is a challenge of which Fifield is fully aware. With Berry installed as international supremo and Charles Koppelman - the K in SBK-running North American operations, he has time to think more about developing new opportunities for EMI. A self-confessed music fan (he played trombone in a dance band at high school), he makes a point of attending gigs as he flits around the globe. The name of the game in the music business, he recognises, is finding and signing-up tomorrow's stars. 'You just have to believe in your people, and give them an environment that makes them feel comfortable that you do believe in them,' he says. 'I guess the management principle I have to live with is patience ... The A and R department is a bit like a research centre. You hope it will come up with great new acts.' On the business development front, Fifield sees music TV as an important tool for stimulating CD and record sales. Thus EMI has teamed up with Warner Music, Sony, PolyGram and a local cable TV operator to establish an alternative music channel to MTV, in Europe's biggest national market, Germany. The joint venture, called Viva, will devote airtime principally to German artists, unlike MTV which tends to concentrate on English language performers. The same partners are considering a channel in North America to compete with MTV there. Fifield is keen to establish further partnerships to keep abreast of emerging technologies and to develop the CD-ROM market. But he sees no major acquisitions on the horizon.

Fifield's is unquestionably the fun side of Thorn EMI. On the other side of the house, Mike Metcalf (a former finance director transferred by Southgate into line management) has the unenviable task of injecting excitement into the rental division. In 1991, when Metcalf took over, its US arm was under threat from legislators while commercial problems were piling up in the UK. Radio Rentals constantly underperformed its main competitor Granada. And the branding policy that had created three separate chains - DER and Multibroadcast in addition to Radio Rentals - provided no useful market differentiation but added significantly to overheads. Moreover, the Rumbelows electrical retail chain could not compete with market leader Dixons and was making losses.

Metcalf spent his first year creating a single administration and distribution structure to serve the whole UK business. He then turned his attention to the High Street. Part of Radio Rentals' problem was that it made very little from the sale of ex-rental TV sets and videos. While Granada was bringing in an estimated £18 million a year by selling used TVs in its showrooms, Radio Rentals opted instead to sell through specialist warehouses. Analysts have calculated that the somersault on this policy could bring in an extra £20 million a year in the short term, although as rent-to-own expands in the UK the equipment available for resale will decline.

Next, Metcalf chopped DER and Multibroadcast, replacing them with two new chains, Fona and Crazy George's. The new outlets provide much more varied fare than traditional TV rental. Fona offers cash sales and a rent-to-own package called EasyOwn. Crazy George's is a more radical concept. It will allow customers, including those on low incomes, to obtain goods without any credit checks. To get that message across Metcalf researched names and opted for American-style razzmatazz. 'People think, "No, a UK company wouldn't do this for me, it wouldn't let me have new furniture or a new TV for a weekly payment and no credit check ..." So it had to have a US flavour.' The first store opened in Birmingham in April.

Rent-to-own is a US retail innovation, and the £371 million acquisition of Rent-A-Center in 1987 made Thorn the biggest player in its country of origin, with a 24% market share. Organic growth, plus the further acquisition of Remco in 1992, has taken that share to 31%. It hasn't all been plain sailing, though. The share price was rocked last year by a Wall Street Journal article claiming that heavy-handed tactics had been employed to collect debts, and criticising the company's high interest charges. Thorn responded by commissioning a survey of more than 5,000 customers, past and present, which reported a satisfaction rating of 96%. Game to Thorn.

Overall, the rental division made an operating profit of £130 million last year. A UBS Global Research report suggests that the total could more than double in the next four years, with the slimmed-down UK business growing faster than the US. This will entail a step change compared with the recent past, however. Last year's profit increase was 13%, while turnover grew by less than 9%. But even if the most optimistic targets are met, one basic question remains. Music and rental are businesses with very different profiles. Compared to music, rental seems doomed to a modest rate of growth in both sales and profits. Its profit margins (still below 9%) lag far behind the music side. 'Our margins, in terms of ROS, are nowhere near where we believe we can get them in the long run,' says Metcalf. Together with a return on capital of around 20%, he adds, 'I think it makes a reasonable business'. Indeed, but return on capital is the biggest difference of all. Rental ties up more than twice as much money as music, and the return it earns is Lilliputian by comparison. So isn't a demerger the obvious answer?

The question has been asked repeatedly, and for a long time. Southgate points out that 'there's always strength in size - which is of help in raising money'. On the other hand, he concedes that 'There's little synergy between the two businesses, no swapping of data or whatever'. And he conspicuously refuses to reject the suggestion out of hand. 'It's on everyone's lips,' as he says, adding in true chairmanlike style that, when the time comes, 'we'll review (the situation) and do whatever is right for the business and the shareholders.' Those who follow UBS may already have made up their own minds about what's right. The analysts have estimated that the demerged music and rental businesses could have a combined market value of £6.5 billion - more than £2 billion up on the current level.

It's virtually certain that the logic of a demerger is universally accepted. The recent renaming of the rental business as Thorn Group - sharpening its distinction from EMI Music - looks expressly designed to facilitate a separation. But managers are adamant that the question must be approached step-by-step: that before serious consideration can be given to splitting the company, the remaining non-core activities must be sold off. 'Should I leave the defence division in the middle of EMI Music?' asks Southgate rhetorically. 'I don't think that would go down well with a lot of the artists.' The group disposed of 60% of its security business for £38 million at the end of May. In June, agreement in principle was reached with Thomson-CFS, for the French group to take over a couple of defence operations. But that still leaves more than half the defence division unsold, even though Southgate has been looking for a buyer since 1989. A year ago, negotiations with GEC went on for four weeks without result. Southgate was not inclined to give the companies away. He's a 'tough cookie', says a GEC executive, who 'would have his pound of flesh'.

For the present, then, the demerger remains a shimmering mirage. One development that might bring it into focus would be a bid. Observers speculate about EMI's attractions to a telecoms company or cable TV operator. 'The days of the hardware-driven market are over,' says Redmond. 'All the value these days is in the software, the music.' But Southgate insists there has been no flood of offers. He admits getting occasional calls from other software players looking for 'a premium-free take-over ... but not one single call from a telephone company'.

On the contrary, he reckons that, if anyone is going to be making calls, it will be him - with, very likely, a book publisher on the other end of the line. For he believes that book publishing and music are strongly synergistic. A publisher's reader, he suggests, is a bit like an A and R person. 'Everything from then on is exactly the same: the type of market, the consumer buy, the way you push, the return process, the risk management - it's no different.' Finance man Duffy confirms that raising the wind for such an acquisition should present no problem. Interest cover currently stands at 10 times, and he would be content to see this fall to three or four.

Many commentators, however, would be far less than content. All they really want to see are the last defence industry sale and the small print of the demerger terms. Everything else is a distraction. Indeed, that's the truth about Thorn EMI today. All his adroit axemanship has led Sir Colin Southgate to the cave of a dragon. It may be one that only he can slay.



Sales Operating

turnover profit

Music 1,760.5 246.1

Rental 1,511.6 130.2

HMV 403.9 6.1

TSE 407.7 (11.6)

Discont'd operations 208.4 11.7

Total 4,292.1 382.5


Sales Operating

turnover profit

UK 1,436.3 97.6

Rest of Europe 1,182.8 138.9

North America 1,257.8 96.8

Asia Pacific 302.2 41.5

Other 113.0 7.7

Total 4,292.1 382.5

Shareholders' funds £m): 735.1

Number of Employees: 41,400.

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