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Bertelsmann's Slimmer Profile Generates Thinner Profits

Bertelsmann Chief Executive Gunter Thielen points out that the second half of the year is traditionally more profitable for media companies. He'd better hope so. Bertelsmann's first-half earnings report released Sept. 6 showed how tough it has been for the Gütersloh, Germany-based media giant to get back on a growth track after several years of cost-cutting and asset sales.

The company, whose holdings include book publisher Random House and European TV powerhouse RTL Group, reported nearly flat net income of $434 million, even as sales rose 14.5%, to $11.7 billion. Bertelsmann, which isn't publicly traded, didn't break out results for the second quarter, but based on previously released first-quarter figures its second quarter net income fell 12%, to $319 million. Bertelsmann attributed the flat earnings to a one-time tax effect the previous year.

But perhaps spectacular growth isn't really Thielen's biggest priority. On the same day, Bertelsmann announced a deal to sell its music publishing business to Paris-based Vivendi Universal for $2.1 billion. The proceeds will go to pay down Bertelsmann's debt, which ballooned when the company opted earlier this year to buy out a minority shareholder rather than face the unpalatable prospect of being dragged into a public stock listing.

A LOWER PROFILE. It was only the latest in a series of divestitures that have slimmed down the former high-flyer from its 2001 peak of $24.3 billion in revenues to $22.9 last year. At the turn of the century, Bertelsmann stood in the upper ranks of global media giants such as Time-Warner (TWX) and Walt Disney Co.(DIS). A string of aggressive acquisitions by Thielen's predecessors, including former CEO Thomas Middelhof, had catapulted the 170-year-old company—which started out selling bibles in rural Germany—into a media star.

But the ambitious Middelhof was ousted in 2002 by members of the Mohn family, which controls Bertelsmann, and Thielen took his place. The new CEO has backed off from glamorous dealmaking in favor of a lower profile and return to basics, such as book and magazine publishing (see 3/18/05, "Bertelsmann's Creed: Inner Growth").

If there was any good news in the first-half results, it was that Bertelsmann is continuing a slow revenue recovery from its low point of $21.5 billion in 2003. Sales are up this year, in part due to select acquisitions such as a German car-magazine publisher, as well as increased demand for Bertelsmann's Arvato unit, which provides outsourcing services such as billing for e-commerce retailers or even mobile-phone repair (see, 10/31/05, "Arvato Is Printing Money").

UNLOADING ELVIS. Nevertheless, the results show the price the company paid earlier this year to avoid going public. In May, family shareholders led by Liz Mohn, wife of Bertelsmann's postwar patriarch Reinhard Mohn, had to decide whether to buy back 25% in the company owned by Brussels-based holding company GBL. If they hadn't, GBL had the right to list the stake on the stock exchange.

Bertelsmann chose to buy back the stake for $5.8 billion. The decision preserved the company's independence but sent debt skyrocketing. As a result, investment will be "restrained" through 2007, Bertelsmann says, as the company pays down debt of $11.2 billion, more than double what it was a year ago.

Getting out of hock undoubtedly prompted the Sept. 6 sale of BMG Music Publishing, which markets music rights and includes in its catalog artists ranging from Elvis Presley to the Backstreet Boys to Coldplay. But Bertelsmann is pulling in its horns elsewhere, too. Last year, for instance, it withdrew from the U.S. magazine market.

"Thielen has said he wanted to dismantle to pay down debt and make a leaner and more tightly focused group," says Mark Mulligan, vice-president Europe at Jupiter Research in London. "By definition, that's going to change the global footprint." Still, Mulligan notes, "Not being in music publishing doesn't prevent them from being in music."

POSITIVE DEVELOPMENTS. No one denies the company's operating performance in the first half left something to be desired. Among Bertelsmann's units, only RTL was able to translate an increase in sales into an increase in profit. RTL's operating profit rose 27% to $603 million for the half. The Sony BMG Music Entertainment joint venture, in which Bertelsmann holds 50%, saw operating profit plunge almost to zero—$2.6 million, to be precise.

Of course, all the music majors have struggled to cope with music piracy and the shift to digital distribution. But even Bertelsmann's Arvato unit, which has been a star performer, saw operating profit slip 4%, to $123 million, even as sales rose 17.5%. Profit at Random House and the Gruner + Jahr magazine unit was flat. The Direct Group book clubs unit, which hasn't generated significant profits for years, managed to emerge from a loss last year of $14 million. But the $17 million operating profit represented a margin of just 1% on sales of $1.6 billion.

Thielen can to look forward to some positive news in the coming year. Sony BMG could see better profits thanks to the release of major new albums, such as Christina Aguilera's Back to Basics, which hit No. 1 on the Billboard charts soon after its release in August. "We expect Sony BMG to significantly improve performance in the next six months," Chief Financial Officer Thomas Rabe told analysts in a conference call.

But RTL's ad revenue could also sag in the second half, after the first half benefited from the football World Cup. "Back to basics" also describes Thielen's strategy. But it has yet to go platinum.

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