MuseWire COLUMN: The history of Capitol-EMI in the late 1980s – early 1990s is one of constant turmoil and upheaval. Management devised, attempted to implement, and then discarded different strategies as it tried to respond to the dynamics and exigencies of a rapidly-changing market for the origination and delivery of recorded music.

A. Joe Smith Arrives

In a previous note I set forth the early history of Capitol’s management. Don Zimmermann had been president of the label since 1976. In August 1987 Bhaskar Menon, then head of EMI Music worldwide, fired him. To replace him, he hired Joe Smith, formerly head of Elektra Records.

Smith’s responsibilities quickly were expanded to running all of EMI Music North America. Smith hired David Berman, formerly with Warner Bros. Records, to replace Zimmermann. Later, in October 1989, Smith fired Berman and appointed Hale Milgrim, formerly with Elektra Records.

Smith fired Jim Mazza as head of EMI America Records (“EMIA”) and moved it to New York (for the early history of EMIA see this note). Shortly after his arrival Smith had hired Bruce Lundvall, formerly of CBS Records and Elektra Records, to start a new label in New York called Manhattan Records. Lundvall, however, quickly lost interest in running a pop label. Smith reorganized his responsibilities and put him in charge of the jazz label Blue Note Records. EMIA became EMI-Manhattan and then simply EMI-US. Smith then hired Sal Licata, formerly of RCA, to run it. EMI-US entered into a production arrangement with Orpheus Records for Freddie Jackson records, which was a significant contributor to its early sales.

B. Jim Fifield Arrives

In the meanwhile (as related at this note), Colin Southgate (then head of Thorn-EMI, EMI Music’s publicly-traded parent company) fired Menon in May 1988. Southgate replaced him with Jim Fifield, formerly of the snack food company General Mills. Fifield came from outside the record business. Southgate evidently believed Fifield’s more generic expertise as a corporate manager was more important than acquaintance with the industry’s unique conventions, customs and protocols.

After he arrived, Fifield quickly embarked on a series of acquisitions (compare – Menon only made one acquisition during his tenure, that of the troubled United Artists Records). Fifield had a mandate to “aggressively manage” the business and to “turn it around,” Haring, B. (1996), Off the Charts – Ruthless Days and Reckless Nights inside the Music Industry, p. 82. Fifield laid down several key management principles that were to govern acquisitions. “You look at the strength of a label’s catalog, you look at their existing artist roster, you look obviously at how many album those artists have on their contract. You look at the management of the company and whether they’re making good contribution to the business going forward. You look at what synergies you can put into the deal,” Haring, p. 81. Fifield then explained how one must assess the present discount value of a label’s cash flow over a period of (say) ten years, using whatever interest rate assumptions currently were fashionable, in order to establish a reasonable purchase price. Another critical factor is the caliber and quality of management, “Because the management has to continue to sign new acts that make years five through ten work out,” Haring, p. 97. Fifield’s subsequent history is one of deviating from, then abandoning, these sensible principles.

C. SBK Music Publishing – SBK Records

In January 1989 EMI bought the music publisher SBK Entertainment for a reported $337 million (“SBK” are the initials of its principals Swid-Bandier-Koppelman). Here is a copy of EMI’s prospectus for the acquisition. SBK had bought CBS Songs for a reported $125 million in 1986. Both EMI and Warner-Chappell (the other major music publisher, owned by the Warner Music Group) had been offered the deal, but turned it down, enabling SBK to turn a 250% profit on its investment in less than three years.

EMI’s music publishing had been lackluster prior to the SBK acquisition. In addition to publishing rights it had acquired from various artists over time, Capitol also owned the Glenwood Music, Beechwood Music and Morley Music catalogs. In 1970 Samuel Trust was head of music publishing. By 1973 Jay Lowy had replaced Trust. In 1976 EMI acquired the Screen Gems-Colgems catalog from Columbia Pictures Industries for a reported $23.5 million. Menon fired Lowy and replaced him with Lester Sill (who came with the acquisition). Menon fired Sill in April 1985. Sill went on to become head of Jobete Music. Menon replaced him with Fred Willms, an all-purpose executive within Menon’s inner circle. As part of the SBK acquisition, Koppelman and Bandier replaced Willms and became co-heads of EMI Music Publishing. By way of subsequent developments: in July 1997 EMI acquired half of the Jobete catalog from Berry Gordy, for a reported $132 million. In April 2003 it acquired another 30% from Gordy, for a reported $109.3 million. In April 2004 it acquired the remaining 20% for a reported $80 million. In July 1999 it acquired the Windswept Pacific catalog from the Japanese company Pony Canyon, for a reported $200 million. Bandier remained head of EMI Music Publishing until October 2006, when he left to join Sony Music to head their music publishing business, Sony/ATV Music. Eric Nicoli, then CEO of EMI Music, replaced him with Roger Faxon. In June 2010 Faxon was appointed as head of EMI Recorded Music (he also remained head of EMI Music Publishing).

As part of its acquisition of SBK, EMI also committed to establish a new SBK record label. Here is a copy of the SBK record label joint venture agreement. Koppelman became head of the new record label. He hired an accountant named Terri Santisi (who also had no previous record business experience) as his CFO for both EMI Music Publishing and SBK Records. Swid, who primarily was a financier, never was active in SBK operations.

The SBK record label nominally was set up as a joint venture, although as a practical matter most of the funding came from EMI. Here is how it was structured financially:

1. Capitol and SBK were 50% partners.

2. Capitol immediately contributed $5 million in initial paid-in capital and another $5 million shortly thereafter.

3. Shortly thereafter, Capitol contributed another $5 million and SBK contributed $5 million.

4. Shortly thereafter, Capitol again contributed another $5 million and SBK contributed $5 million. Total contributed: Capitol = $20 million, SBK = $10 million, for a total of $30 million.

5. At the end of five years, Capitol had the right to buy SBK’s half-interest pursuant to a mechanism where SBK proposed the price; Capitol had the right to accept or reject it; and, if Capitol rejected it, then SBK would have to buy Capitol’s half-interest for the same amount. This self-equilibrating procedure tends to promote financial realism in the initial valuation, because the party proposing the price doesn’t know if it will be a seller or a buyer.

SBK Records had out-of-the-box success with releases from Wilson Phillips and the white rapper Vanilla Ice. In view of this early success, and notwithstanding the five-year time frame, Capitol accelerated its right to buy out SBK’s portion of the joint venture, and did so in 1991 for a reported $26 million, plus the return of SBK’s initial $10 million investment (incorrectly reported by Haring, p. 118, as $5 million). The sell-buy mechanism of the original joint venture agreement was abandoned; SBK essentially was able to establish its own price. Capitol also committed to pay additional amounts, depending on the label’s sales and profitability. The value of this additional consideration was reported to be $100 million, Haring p. 118, although this figure is hard to believe in light of SBK’s actual sales and profits history. Almost inevitably, the early success of Wilson Philips and Vanilla Ice never was replicated.

Under any interpretation, it was a spectacular return for SBK. As I see it, SBK successfully accomplished what Mogull and Rubinstein had tried but failed to do with United Artists Records in the 1970s – buy it inexpensively, incur large (some might say, astronomical) marketing expenses to achieve high gross sales, then “flip” the label at an unrealistic valuation for an above-market price, before the true extent of the returns liability (arising out of the reported gross sales) materialized. Ironically, Artie Mogull, one of the United Artist Records principals, was a “consultant” to Koppelman in the transaction.

D. Chrysalis Records

Two months after buying SBK, Capitol-EMI bought 50% of Chrysalis Records from Chris Wright and Terry Ellis for a reported $79.1 million. EMI acquired the remaining 50% in 1991 for a reported $30 million. Chrysalis’ President in the U.S. was Mike Bone. Its CEO was Joe Kiener, a former tennis shoe executive who had worked for Adidas (another executive from outside the record business, with no discernible record company management skills or expertise). Kiener fired Bone in the summer of 1989 and replaced him with John Sykes, formerly of MTV and (for a brief while) an agent at Creative Artists Agency (“CAA”).

E. EMI Records Group

So by the summer of 1989, EMI had three record labels competing in New York: EMIA, SBK and Chrysalis. In April 1992, Koppelman and Santisi persuaded Fifield to let them consolidate EMIA, SBK and Chrysalis into a single label, the “EMI Records Group.” They fired Licata, Kiener and Sykes. Licata went on to head RED Distribution, a quasi-independent record distributor owned by Sony. Kiener went on to work for HarperCollins and then TV Guide. Sykes went onto become president of VH1, now owned by Viacom. Koppelman appointed Daniel Glass as president of the combined companies. Koppelman later fired Glass in September 1994 and appointed Davitt Sigerson.

Surely there was nothing about SBK’s performance as a record company that compelled this result. From August 1989 to March 1990, SBK had net sales of $15.8 million, compared to $23.4 million for Chrysalis and $69.6 million for EMI-US (in the case of EMI-US, this is its full-year FY 1990 sales from April 1989 to March 1990). SBK’s results aren’t bad, especially considering it was a brand-new start-up label. In FY 1991 (from April 1990 to March 1991), SBK’s net sales soared to $100.3 million, compared to $50.7 for Chrysalis and $63.6 for EMI-US. But by FY 1992 (from April 1991 to March 1992), SBK’s net sales had fallen to $17.7 million, compared to $20.4 million for Chrysalis and $59.7 million for EMI-US. SBK’s dramatic decline in net sales in FY 1992 primarily was due to returns from product shipped during FY 1991.

The most likely explanation for this outcome in my view is that Koppelman and Santisi needed cover for SBK’s poor FY 1992 results and its less-than-stellar going-forward prospects. Although SBK’s net sales recovered somewhat for FY 1993 to $36.3 million, it still was outpaced by Chrysalis ($47.1 million) and EMI U.S. ($42 million). Notwithstanding, Koppelman and Santisi had corporate momentum arising out of EMI’s acquisition of SBK Entertainment, and gradually but pervasively came to dominate the company.

Why did this happen? Fifield (I believe) was mesmerized by Koppelman’s undoubted style and flair, which is why he acquiesced in this scheme and deviated from his own management principles governing acquisitions, set forth above. Fifield’s going-forward calculations regarding the estimated value of a label’s turnover and the ability of a management team to originate and exploit new artists, collapse completely when the label is shut down. There is no more management team or on-going entrepreneurial value. Whatever catalog there is just becomes a collection of old masters, floating in and out of circulation, in response to consumer demand.

At the time, catalog was thought to have substantial value for re-release as CDs. Now, however, with file-sharing technologies and the widespread availability of used CDs through outlets like Amazon, most old masters aren’t even worth a penny (plus $2.99 shipping cost). In his book The Long Tail – Why the Future of Business is Selling Less of More (2006), the author Chris Anderson hypothesized that intellectual property rights (such as recorded music) always will retain some residual value. This is completely false. The value of most intellectual property rights is zero, because their product life cycle expires quickly and is not susceptible to being extended. They are ephemeral, transient, and as perishable as a load of cantaloupes on a Bakersfield train siding. While of course there are exceptions for well-recognized artists everyone can identify, record companies safely could revert entire catalogs of old masters back to the artists who originally recorded them, because there is no consumer demand for them, and there never will be. They safely can be extirpated from the historical canon of intellectual property rights. The record company can’t efficiently exploit them. Not even the original artists could efficiently exploit them. They actually are a liability. The record company typically has incurred large, unrecoupable advances and recording costs, which should be written off. Management has to think about them, somehow account for their worth, and pretend they have value if they ever decide to sell them. “Capitol Records owns a million masters,” I was told on my arrival at the company, as if I was supposed to be in awe at this figure. I venture to guess that fewer than 1% of them have any value today.

The magnitude of Fifield’s error was close to $750 million. Here is how I calculate this amount. EMI’s initial investment in EMIA was $43.9 million; its initial investment in SBK Records was $56 million; and its initial investment in Chrysalis Records was $109.1 million, for a total of $209 million. In the case of SBK one also would have to add the reported buy-out figure, as high as $100 million (as per Haring, op. cit.). None of these labels ever were profitable, resulting in additional operating losses not susceptible to precise calculation. I suspect SBK’s operating losses were at least equal to the amount of its total net sales, or around $170.1 million. I suspect the same is true for Chrysalis (around $141.7 million) and EMI-US, at least after it moved to New York in 1989 ($235 million). Milgrim was reported to have lost at least $10 million of Capitol’s money on a deal with M.C. Hammer, “Bust It Productions.” In a widely-disseminated memo dated October 31, 1991, Peter Paterno, then head of Disney’s Hollywood Records, cited sources claiming Capitol had lost an estimated $90 to $105 million during Milgrim’s tenure alone (though Capitol’s back catalog, such as the Beatles, always has been profitable).

Put another way, if these numbers are even remotely accurate, Fifield’s failure to adhere to his initial business plan cost EMI close to three quarters of a billion dollars. After the formation of EMI-US, EMI’s accumulated investment in EMIA (including the cost of the United Artists acquisition) vanished. EMI’s investment in Chrysalis vanished. EMI’s investment in the SBK joint venture record label vanished. All of the palaver about originating commercially demanded artists, and then supporting them with an expert management team, simply was rhetoric. These were real costs in the hundreds of millions of dollars that had nothing to do with abstract business school principles. At the time he made these acquisitions (and others), Fifield was quoted as saying, “the jury’s still out on every acquisition that’s made,” because the requisite ten-year holding frame had not yet elapsed, Haring, p. 97. This rationale no longer pertains when the label disappears, because the jury has come in, and it has voted “guilty.” Haring at p. 83 quotes an unnamed executive: “The biggest problem with Capitol-EMI was that they did not allow their own management teams to grow.”

Although of course it is a matter of opinion, I believe that the decline and eventual fall of EMI Records in the U.S. began with Koppelman and Santisi. While the record business always has been cutthroat, they introduced a culture of entitlement, self-aggrandizement and corporate nihilism. Not only was this previously unknown at EMI; it was formidable even in comparison to EMI’s most rapacious competitors.

F. Goodbye to Joe

In January 1993 Fifield fired Smith as head of music in North America and appointed Koppelman in his place. Smith told me he saw this coming as far back as EMI’s acquisition of SBK Entertainment. In fact, he told me he was surprised he’d been able to hang on, for as long as he had. Koppelman fired Milgrim in May 1993 as Capitol’s president, and appointed Gary Gersh, formerly of Geffen Records, to replace him.

Smith’s management style could not have been more opposed to Koppelman’s. Smith was an intuitive, visceral, old-school executive in the style of Steve Ross, head of Warner Communications. He objected to “the corporatization of the music business” which has “sucked out a lot of the adventure, a lot of the charm, a lot of [its] distinctive nature, Haring, p. 21.

Koppelman, on the other hand, has been is portrayed as conniving and self-interested. From Haring, op. cit.: he was “the most disliked mogul in the music industry,” p. 24. He “spent money lavishly, to the point where profit hardly seemed to matter.” Rather, what was important was the “impression of success,” p. 25. He allegedly charged personal expenses to recoupable artist accounts, and encouraged artists to record songs where he owned the copyrights, p. 61. SBK “took full advantage of the loopholes in the retail system, purchasing items on its own acts in key stores that would then report tremendous activity to Billboard’s charts and local radio stations,” p. 110, and paid payola to radio station disc jockeys for record reporting, p. 113. Koppelman had poor artistic judgment, signing “expensive flops” with no hope of recouping, such as Smokey Robinson, Francesca Beghe and Russ Irwin, p. 115. In fact, SBK “would put out a record of fart sounds if they knew they could sell eight million copies of it,” p. 117. Even Koppelman’s partner Swid is quoted as saying, “it’s possible for someone like him to do $80 million [in turnover] and not earn any money,” p. 103. “In many ways, SBK Records became the record industry equivalent of a Ponzi scheme.” Its approach was to “build up the company to enormous heights, give the impression of success, however fleeting, pump up the sales volume, and damn the costs. So what if long-term value isn’t there?”, p. 104. EMI Records Group – the successor to SBK – did no better. Artists such as Jon Secada and Joshua Kadison were “costly and high-profile failures. Down the hatch went Slaughter and Jesus Jones, to be followed by albums by Sinead O’Connor, Queensryche, Billy Idol, and Pat Benatar,” p. 139. Even the old SBK “magic acts,” such as Wilson Phillips “couldn’t be revived,” p. 140. Even considering the generally polemical tone of Mr. Haring’s book, these are serious allegations.

I remember well a group meeting with Koppelman at the Beverly Hills Hotel, shortly after the start-up of the SBK label, to announce its initial line-up. He was smoking a fat cigar. The audience comprised primarily record company middle-management; the people Koppelman was going to have to rely on to market, promote and distribute his records. “I now have all the money I could possibly want,” he said. “Now that I’ve secured my financial future, I have time to play around with a record company.” There were audible gasps at the candor and forthrightness of Koppelman’s remarks.

Copr. David Kronemyer

All of this being so, I am a big admirer of Koppelman, because it is a testament to his adroit political maneuvering that he was able to engineer these results. Figure 5 depicts Capitol-EMI’s North American net sales attributable to its proprietary (owned) labels during the period 1980 – 1993. The Zimmermann-Menon regime is shown for 1980 – 1987. Net sales during this period meandered from $150.9 million/year (in 1980) to $188.3 million/year (in 1987). The Smith-Koppelman regime is shown for 1988 – 1993. Net sales skyrocketed from $218.4 million (in 1988) to $584.5 million (in 1993). Much of this increase is attributable to Fifield-driven acquisitions, as set forth in this note.

Next: the arrival of Virgin Records.

Article is Copr. © 2010 by David Kronemyer – all rights reserved.