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Back in January, 2001, you could almost hear the music industry smirking over Bertelsmann's decision to put Rolf Schmidt-Holtz in charge of BMG Entertainment, the media giant's music division. Schmidt-Holtz had managed magazines and TV networks for Bertelsmann but had zero music experience. Plus the division had deep troubles -- not just external factors like CD piracy and file-sharing but management turmoil and vast cost overruns. Making matters worse for the smallest of the Big Five music outfits was the ill-fated decision by Bertelsmann headquarters in Gutersloh, Germany, to align itself with file-sharing pioneer Napster. Nobody gave Schmidt-Holtz a chance.
These days, Napster is dead and buried. But as the music industry looks ahead to the Grammy awards on Feb. 23 at Madison Square Garden in New York, the 54-year-old Schmidt-Holtz has plenty to smile about, having engineered a turnaround at BMG. With Arista and RCA among its big labels, BMG has become a bright spot in an industry full of gloom.
STAR STABLE. All the record companies, including BMG, are still struggling to find a viable model to compete with the proliferation of free music on the Net. Still, even though CD sales declined for a second straight year in 2002, BMG has streamlined operations, smoothed management tensions, and is riding high on a string of hit albums that include Avril Lavigne's Let Go, Elvis Presley's Elvis 30 #1 Hits, Pink's M!ssundaztood, and Santana's Shaman.
BMG, which doesn't disclose financials, turned what several sources estimate to have been 2001's operating loss of $360 million into an operating profit of more than $125 million in 2002 on revenues of about $3 billion. It garnered 71 Grammy nominations, second only to the industry's biggest outfit, Universal Music Group. And after watching its market share evaporate in recent years, BMG's U.S. share inched up in 2002, from 14.71% to 14.79%, according to Nielsen SoundScan. "Two years ago, we were a natural-born victim -- the slowest zebra in the herd," says Schmidt-Holtz. "Today, we are the lion looking down on the herd."
BMG is feeling so rejuvenated that it's taking a serious look at possible acquisitions, three years after pulling out of a proposed merger with EMI when regulators signaled their concerns. Now, BMG and EMI are talking again, each having sensed that the industry's woes might make regulators look more favorably upon a marriage. Publicly held EMI -- the only one of the majors not part of a larger media company -- has struggled with earnings. Its share price is down more than 50% in the past year, to about $2.
"WE HAVE MOMENTUM." "Given the ever-declining fundamentals and despite the music majors' attempts at 'self-help,' 2003 will be the year of further music consolidation with EMI at the center," predicts Michael Nathanson, a music industry analyst with Sanford Bernstein & Co. A combined BMG-EMI would have a 23% market share in the U.S., second only to Universal. When pressed about whether he would pursue London-based EMI, Schmidt-Holtz says: "We have momentum now, and that's always important."
Much of the credit for BMG's new success, industry analysts say, goes to Schmidt-Holtz. But he was also deft enough to hire Chief Operating Officer Michael Smellie, a 49-year-old Australian music veteran who was running BMG's Asian operation when Schmidt-Holtz tapped him in the spring of 2001 to help engineer the turnaround. Based in large part on the job Schmidt-Holtz has done at BMG, he appears to be on the short list to run Bertelsmann's RTL broadcasting arm. Smellie would then be elevated to CEO of entertainment if Schmidt-Holtz moves on, many
speculate.
"Michael Smellie understands that you have to consider the wants and needs of fans and artists against the balance sheet," says an executive at a competing music company. "He's the right guy in this climate." Together, Schmidt-Holtz and Smellie have fashioned an enterprise that could serve as a model for other bloated music outfits. Indeed, in January, Sony replaced music division CEO Tommy Mottola with NBC President Andy Lack, another exec with no music experience.
PAST THEIR PRIME? BMG has cut more than 1,500 jobs, reduced the number of departments from 100 to 15, and removed a layer of bureaucracy by eliminating regional divisions. It has been choosy about the talent it signs, too. When EMI last year jettisoned Mariah Carey by buying out her contract for $28 million, BMG took a pass. She eventually landed at Universal's Island Def Jam Music Group, which agreed to shell out $20 million to start a new label for her.
The biggest challenge for BMG appears to be consolidating operations. First in line is integrating Zomba Music Group, in which BMG held a partial stake for 11 years. Last summer, Zomba founder Clive Calder exercised an option to sell his entire company to BMG. The $2.7 billion price tag was seen as an unwelcome expense at BMG, the concern being that Zomba's top acts -- artists like Britney Spears, Justin Timberlake, and the Backstreet Boys -- were waning in popularity. But Calder had proven himself to be a talented hit maker, and keeping him at the company was seen as crucial. Schmidt-Holtz says Calder is now acting as a consultant to the entertainment division.
Plus, BMG in November bought the 50% stake in Clive Davis' J Records that it didn't own. Davis, who was forced from his longtime label, Arista, in 2000 to make room for Antonio "L.A." Reed, had great success in 2001 at upstart J, most notably with Grammy award winner Alicia Keys. The 69-year-old Davis, who is considered to be one of the last great music men in the industry and was responsible for the careers of Janis Joplin, Bruce Springsteen, Santana, and Whitney Houston, will oversee BMG's RCA Music Group, which will include J Records. He'll report directly to Schmidt-Holtz.
UNTAPPED MARKET. Despite the recent good news, BMG execs aren't deluding themselves about the issues facing the industry -- even those beyond piracy. "It's so much easier these days for an artist to be wildly overexposed so quickly," says Smellie. "And there's not enough great songwriting. We can cut out the bureaucracy. But we also need to form an insular ring around our key creative people."
Rather than go to court and fight tooth-and-nail with file-sharers, both Smellie and Schmidt-Holtz see a vast, untapped market online, and they applaud music retailers' plans to sell songs on the Net. "We've lost a lot of time to these illegal services, but the solution isn't always taking them to court," says Schmidt-Holtz. "The retailers really understand the consumers. This is a positive."
And how important will a couple of Grammy wins be on Feb. 23? Schmidt-Holtz says they would help boost BMG's morale and could goose sales. But what's important, he adds, "is the next artist, breaking that next act." Spoken like a true lion.
By Tom Lowry in New York Edited by Douglas Harbrecht
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