Terra Firma Sues Citi over EMI Takeover

It was around midnight and British financier Guy Hands was on the phone again with "the Worm," his long-time dealmaker at Citigroup Inc. (C), David Wormsley.

The next morning, May 21, 2007, Hands's private equity firm, Terra Firma Capital Partners Ltd., bid 4 billion pounds ($6.5 billion) for EMI Group Plc, the London-based record producer whose pedigree runs from the Beatles to Beyonce. EMI's managers, advised by Wormsley, accepted the offer the same day.

Two years later, the purchase has turned sour and personal for both men, with Hands saying in a lawsuit against Citigroup that Wormsley "misrepresented" the facts to rush him into a deal that cost his firm "billions" of dollars. The suit and a separate arbitration claim filed this week by the Abu Dhabi Investment Authority against Citigroup are signs that investors who made big bets during the boom are turning to the courts to recoup losses.

"There will be more similar lawsuits" to Hands's, British venture capitalist Jon Moulton, who's known Wormsley and Hands for years, said in a telephone interview. "Back then money was deployed on very flimsy information. There were very clear conflicts of interest. People were just anxious to be in the deals."

Hands's complaint, filed in New York on Dec. 11, sheds light on private equity firms' takeovers during the boom that ended in 2007, and the conflicts of the banks that both advised buyers and earned fees from arranging loans to finance acquisitions. The firms have announced $70 billion of acquisitions this year, about a tenth of the $664 billion of deals they led in the peak of 2007, according to data compiled by Bloomberg. Hands's suit against Citigroup doesn't name Wormsley as a defendant.

Long History TogetherHands, 50, and Wormsley, a year younger, worked together on deals ranging from Terra Firma's acquisition of United Cinemas International in 2004 to the purchase and later sale of German highway services chain Autobahn Tank & Rast Holding GmbH.

An Oxford graduate who spent 12 years at Goldman Sachs Group Inc., Hands—6-feet with blond curly hair—started Terra Firma in 2002, after leaving Nomura Holdings Inc.'s private equity unit. Four months after buying EMI, he called bankers "dogs" as debt funding for acquisitions dried up.

Wormsley described Hands as "very quirky," in an e-mail disclosed in the complaint. Wormsley went to Cambridge University and worked for Schroders Plc, which later became Schroders Salomon Smith Barney and part of Citigroup. With brown hair usually slicked back, he is today chairman of U.K. banking and broking. He's advised Spain's Grupo Ferrovial SA on its $27.4 billion acquisition of BAA Plc, the owner of London's Heathrow Airport. His fellow bankers and London newspapers including The Times have nicknamed him "the Worm."

Failed AuctionExcluding EMI, Citigroup earned more than 136 million pounds of fees from about 20 transactions with Hands's companies from 2000 to 2007, the private equity firm said in the lawsuit.

Now Hands is accusing Wormsley of misrepresenting the facts to him in the final hours before Terra Firma made its bid to protect his bank's 92.5 million pounds in fees and his own reputation from a failed auction. Wormsley and Citigroup deny they did anything wrong.

"I absolutely refute Terra Firma's assertion that I misrepresented the situation," Wormsley said in a statement. Hands declined to comment through his spokesman, Andrew Dowler.

EMI, whose artists have included Frank Sinatra, Thelonious Monk, Snoop Dogg and Alicia Keys, was the most high-profile deal of Hands's career: He bet almost a third of his 5.4 billion-euro ($7.7 billion) fund on the 110-year-old, money-losing company. Hands has more than 50 million euros of his own money invested in the fund.

Free MusicHands has struggled to return EMI to profit as teenagers turned to file-sharing Web sites that let them download songs for free, destroying profits throughout the record industry.

London-based Terra Firma has written off half of its 1.5 billion-pound investment, a person familiar with the situation said in March. Citigroup never found investors willing to take the 2.5 billion-pound debt it provided for EMI off its balance sheet after credit markets froze following the deal.

"Nobody placed a gun on Guy Hands's head to force him to do the deal," said Claire Enders, chief executive officer of Enders Analysis Ltd., a London-based music and entertainment industry research firm. "He badly wanted to do it, which intrigued everybody in the music industry, and Citigroup decided to back him up. Unfortunately for both of them, EMI was the last moment of the bubble. Both of them got duped."

Cost CuttingHands quickly ran into resistance from artists as he moved to curb costs at EMI. The record company cut 1,500 jobs, about a third of its workforce. Bands such as the Rolling Stones and Radiohead quit.

Hands's cost-cutting helped to boost EMI's cash flow to 190 million pounds in the year through March 2009 from a loss of 144 million pounds the year Terra Firma bought the company, according to the complaint. That's not enough for Hands.

"EMI's potential, however, is being constrained by its debt," Terra Firma said in the suit.

Hands is seeking to reduce those borrowings. Last month, Terra Firma offered to inject 1 billion pounds in EMI in exchange for a similar reduction in the debt. Citigroup rejected the proposal because it doesn't want to write off 40 percent of its loan, according to people familiar with the matter, who declined to be identified.

The lawsuit is "inseparable from the commercial relationship" between Hands and Citigroup, Moulton said in an interview. "It's possible it's part of some sort of tactical game," he said.

Warner MusicIn the lawsuit, Hands depicts Citigroup as a bank with conflicting interests, conspiring to protect its fees as an adviser and a lender. He also alleges Citigroup has sought to wrest control of EMI and sell it to a competitor, Warner Music Group Corp., the world's third-largest record company.

Hands says that Wormsley misled him that May weekend by saying another investment firm, New York-based Cerberus Capital Management LP, was bidding for EMI when Wormsley knew it wouldn't make an offer. Wormsley told Hands he had to pay more than 262 pence a share to win EMI, according to the suit.

"Because of Citi's misrepresentations, Terra Firma paid a fraudulent inflated price for EMI," Terra Firma said in the lawsuit. "Indeed, had Terra Firma known about Citi's misrepresentations, Terra Firma would not have bid."

Peter Duda, a spokesman for Cerberus, declined to comment.

'A Sophisticated Man'"The idea that bankers can manipulate their clients like little girls and tell them what to do is absurd," said Roy Smith, a former Goldman Sachs partner who now teaches finance at New York University. "Hands is a sophisticated man. Nobody is going to feel sympathy unless he's got evidence of fraud, which I doubt he has."

Following Terra Firma's 265 pence-a-share offer, EMI's stock rose to more than 270 pence amid speculation Warner would make a counterbid. Warner, which had held merger talks with EMI for a year, considered a bid for EMI until July 17, 2007, when it said it wouldn't make an offer.

"This suit is without merit, and neither Citi nor any of its bankers have done anything wrong here," Citigroup said in an e-mailed statement. Citigroup also denied the claims made by Abu Dhabi Investment Authority, which accused the lender on Dec. 16 of "fraudulent misrepresentations" as it tries to abort an agreement to buy $7.5 billion of the bank's stock.

"I am surprised that more of the investors haven't said you didn't give me good advice, I want my money back," Ralph Silva, a London-based strategist at Silva Research Network, said. "A lot of promises were made about the risks of investments. Looking back investors were completely misled."

By providing loans to fund the EMI acquisition, Citigroup became a partner with Terra Firma and shared the risks of the transaction with the private equity firm, Smith said.

"Why would you want to manipulate yourself?" he said. "Citigroup probably had bigger paper losses than Guy Hands on its EMI loans."

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