BMG BACK ON TRACK

After years of management turmoil and financial setbacks, Bertelsmann Music Group seems to be on the right path to repairing its struggling music operations.

In a story Sunday in the Los Angeles Times, music writer Chuck Philips outlines the company’s attempts at getting back in the game after years of turmoil, and the possibility of parent Bertelsmann getting out of music altogether.

According to the article, fixing Bertelsmann's music business has taken a lot of effort. For the fiscal year ended in June, BMG's $3.2 billion in sales marked a 12% drop from two years earlier. Company sources said political infighting and other mistakes made under BMG’s previous management cost the company about $400 million in operating losses in fiscal 2001.

As part of a management shakeup, Bertie chief Thomas Middelhoff forced out BMG's top two executives, Michael Dornemann and Strauss Zelnick, whom the corporation now blames for most of the music unit's financial and morale problems. Fifteen months ago, Middelhoff installed Rolf Schmidt-Holtz, a former TV executive, as BMG's music chief. Since then Schmidt-Holtz has announced 1,500 layoffs worldwide after discovering, among other things, that BMG's North American music division had not posted a profit since it was launched in 1997.

With the help of some hit records and cost cutting, BMG says it broke even in the last six months of 2001 and expects to turn a $100 million-plus operating profit for 2002, the paper said.

"We're finally starting to see signs of life after a long, disastrous turn of events," Schmidt-Holtz told the Times. "When I arrived, what I found was a company in shambles. A financial mess. A political nightmare. We had lost all credibility with our artists and our labels. We had lost the backing of our own shareholders. Nobody believed in BMG. And why? All because of ego and arrogance on the part of BMG managers. Corporate arrogance nearly killed this company."

BMG blames Dornemann and Zelnick for infuriating the artistic community after driving Clive Davis from power at Arista. Dornemann and Zelnick also locked horns with Zomba Group record chief Clive Calder, head of BMG's other top creative engine.

Bertelsmann fired its management team, but was forced to enter an expensive, face-saving joint venture to keep Davis that cost BMG more than $100 million in start-up costs for the J label and permitted him to raid Arista of dozens of top executives and artists, including Alicia Keys. It also means Bertelsmann reaps only 50% of the profit from J, including Keys' hit album.

Dornemann and Zelnick squandered hundreds of millions of dollars, sources say, on a variety of misguided ventures, according to an internal company audit of BMG commissioned by Bertelsmann.

"Quite simply, all of this political infighting robbed [BMG] of its credibility," COO Michael Smellie told the Times. "It hurt us. There's no point in pretending it didn't. The creative values of the company were severely eroded. It's a hard thing to turn a company around after devastation like this."

A big chunk of BMG's losses stems from an estimated $60 million in severance packages for Dornemann, Zelnick and other former executives, including former BMG tech guru Kevin Conroy, according to company sources. That's more than half of the additional $100million paid in exit packages for the 1,500 employees who are losing their jobs during the restructuring of BMG's corporate operation.

The company also was forced to write off more than $40 million in Internet investments, direct-marketing schemes and other botched ventures launched by Zelnick and Conroy with Dornemann's approval. BMG racked up an additional $40 million in losses for its German division after management problems there and a significant downturn in the music market.

But BMG's biggest financial hit stemmed from the Arista fiasco, in which the company ate nearly $100million in write-offs and lost revenue last year. By the time Davis left the label, the clever entrepreneur had emptied the talent pipeline at Arista. When new Arista President Antonio "L.A." Reid arrived, there was little product to release, no artists in the studio and few executives left to run the label. The result: BMG's hottest creative engine released only a few records during the first six months of 2001, which cost the company an estimated $50 million in sales. In addition, sources say Reid spent about $25 million hiring a staff, signing acts and renegotiating several key deals to pacify top artists, including Whitney Houston, who were upset about Davis' departure. Reid also racked up about $25 million in write-offs as he cleaned house at Arista, cutting ties with a variety of acts and executives before starting over.

This does not account for the $100 million BMG previously paid to Reid and his partner to buy the second half of their Atlanta-based LaFace label—a move by Zelnick to lure him to New York to replace Davis at Arista.

Schmidt-Holtz said he had no idea that BMG was in such bad shape when he agreed to take over. Neither did the company's executive committee until last March, when he shared the results of an internal audit that detailed BMG's financial state.

Schmidt-Holtz and Smellie implemented a massive overhaul designed to save Bertelsmann nearly $200 million by the end of 2001. The pair significantly slashed BMG's artist roster and orchestrated its exit from music deals in small markets such as Turkey and the Scandinavian nations. They also cut acts in the U.S., shut down RCA's urban division and dumped several money-losing joint-venture labels.

BMG is negotiating an end to its joint venture with Bad Boy founder Sean "P. Diddy" Combs, who it will pay more than $30 million to leave. The Bad Boy label reportedly is losing $25 million a year.