Bertelsmann's Time of Trials

Can CEO Thomas Middelhoff manage in a downturn?

Before he became an e-commerce freak, Bertelsmann CEO Thomas Middelhoff was as bricks-and-mortar as they come. Back in the 1980s, he put himself on the fast track by turning around a Bertelsmann printing operation in Berlin. Workers at the plant even gave him a traditional printer's baptism, feeding him prodigious quantities of beer through a funnel.

That turnaround experience could come in handy again, given the challenges suddenly facing the German media conglomerate. The BMG Entertainment division may be lucky to break even, and a bid to acquire music company EMI Group PLC has collapsed because of antitrust problems. Magazine ad sales are heading down fast. Meanwhile, Middelhoff's bold experiment to make Napster Inc. the industry standard in online music distribution is looking more and more like a long shot. And in a sign of e-tailing's struggles, Bertelsmann announced May 15 that it is rolling its online book-and-music operation into its traditional book clubs.

Not all is woe. Closely held Bertelsmann is still expected to beat last year's profit of $590 million, thanks in part to one-time gains such as the sale of shares in America Online Inc. Profit from the book and television businesses will also improve. "The situation has gotten more difficult than it was six or nine months ago," concedes Klaus Eierhoff, a member of Bertelsmann's board of management. But he adds: "I have a very good feeling about overall profit." Still, in a career marked by triumph and accolades, Middelhoff, 48, must now show he can manage a downturn. Bertelsmann "has a lot to prove," warns UBS Warburg media analyst Richard Jones.

Take the magazine business. In the first four months of the year, ad pages are down 39% at Fast Company, the U.S. business magazine Bertelsmann bought last year for $342 million. The company says it partially offset the decline with higher rates. At small-business magazine Inc., revenue fell 31% through April, to $21.7 million, according to Publishers Information Bureau. Along with startup costs for new publications and Internet investments, the drop in advertising means magazines aren't expected to contribute as much to Bertelsmann's earnings as last year. Then, the Gruner + Jahr magazine division added $330 million before taxes and interest.

The biggest fix-it job is Bertelsmann Music Group. The studio, whose acts include Whitney Houston, the Dave Matthews Band, and Outkast, earned $200 million last fiscal year before interest, taxes, and amortization--a 4.7% return on sales. And that was a banner year for albums, when Bertelsmann artists such as Carlos Santana won 24 Grammies. Now, after a year of management turmoil, BMG faces a dearth of hot new recordings. In addition, profit was hit by costly severance agreements with BMG Entertainment Chief Michael Dornemann and other executives who quit. Bertelsmann won't confirm German press reports that BMG will report a loss, but any profits will be skimpy.

Middelhoff's Internet strategy also looks frayed. His alliance with Napster helped jolt the rest of the music industry out of its complacency toward the Net. But the odds are lengthening that Bertelsmann can turn Napster from an Internet Robin Hood into a law-abiding online music merchant: Resistance from other record companies is just too strong. Bertelsmann still plans to relaunch Napster as a subscription-based music site as early as July. So far, though, it lacks rights to songs from most other studios and can't offer a comprehensive catalog.

Other Net startups have turned sour. Shares in Berlin-based consultant Pixelpark, 60%-owned by Bertelsmann, have plunged 90% from their high. The firm, which helps corporations develop a Web presence, is laying off 20% of its worldwide staff.

What else could go wrong? Well, a mob could try to break into one of your offices--which is more or less what happened outside Paris. On May 12, guards firing tear gas held back demonstrators who tried to disrupt production of Loft Story, a program where men and women are locked in a studio for 10 weeks, their every move broadcast to millions of viewers. Bertelsmann's RTL Group owns a minority stake in the French company that broadcasts Loft Story. That was enough for critics to paint the show as a German-financed assault on French culture.

A FAT WAR CHEST. Can Middelhoff beat back the challenges? He has a knack for making the best of a bad situation. When America Online Inc. merged last year with Time Warner Inc., Bertelsmann had little choice but to unwind its alliance with AOL. It looked like a setback. But Bertelsmann is picking up more than $7 billion from its 5% stake in AOL and 50% stake in AOL Europe. That's given him a powerful war chest for acquisitions. Moreover, Middelhoff used the opportunity to reassess his Net strategy, focusing on selling CDs, books, and magazines online. That helped him avoid the worst of the dot-com shakeout.

That's not to say selling books online is a slam-dunk. Bertelsmann's decision to combine its book and CD site with its book and music clubs looks like a surrender to But it could pay off. Bertelsmann is using Web sites to lure 30% of new book-club members in the U.S. And the clubs are winning back their price advantage as and others trim discounts. "The overall vision is a strong one and will pay off eventually," says Mark Mulligan, an analyst at Jupiter Media Metrix Inc. in London.

For all his talk of the Internet, Middelhoff has never neglected traditional businesses. His two biggest deals were the acquisition of book publisher Random House Inc. in 1998 and acquiring control this year of RTL Group, Europe's biggest broadcaster. Now, Middelhoff is planning a "business excellence program" that will require all businesses to match or beat the performance of their best competitors. The aim is to prepare Bertelsmann for a stock exchange listing as soon as 2003.

Even with its problems, Bertelsmann is a long way from being in financial trouble. The company, based in the north German city of Gütersloh, is nearly debt free, and is sitting on $13 billion in cash that can bankroll deals--especially now, when assets are cheap. "We at Random House take a contracyclical approach to investing," says Peter W. Olson, CEO of Bertelsmann's Random House book unit. BMG, for example, is talking to smaller, independent music labels. Speculation focuses on Hamburg-based Edel Music Group, Europe's biggest indie.

There are also indications that the worst is over in some Bertelsmann trouble zones. BMG CEO Rolf Schmidt-Holtz predicts music profit will rise again in the next fiscal year as management stabilizes and the division releases albums by stars like Christina Aguilera and Toni Braxton. BMG may also cut costs by combining back-office operations with another music company. "The strategy is very simple," says Schmidt-Holtz. "Keep moving forward." Simple, but sometimes hard to do.

By Jack Ewing in Frankfurt

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