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Rating Action:

Moody's downgrades EMI Group's ratings to Ba2

20 Oct 2006
Moody's downgrades EMI Group's ratings to Ba2

Approximately GBP 911 million of long-term debt affected

London, 20 October 2006 -- Moody's Investors Service said today that it had downgraded EMI Group plc's (EMI) senior debt and guaranteed debt ratings to Ba2 (from Ba1). At the same time Moody's assigned a Ba2 Corporate Family Rating to EMI. The downgrade is based on Moody's expectation that EMI's debt protection measurements will not improve near-term to a level commensurate with the Ba1 rating category. The rating outlook is now stable.

Despite a visible improvement in operating performance during the 2005/6 financial year EMI's cash-flow based measures of indebtedness have remained relatively weak with Adj. RCF/Adj. Net Debt at 8.3% while free cash flow (after capital expenditures and dividends) was negative as it has been in four out of the last five years. While Moody's believes that EMI's second half release schedule will help to compensate for a weak first half performance (reported revenues -5%) during the company's 2006/7 financial year, it will be challenging for EMI to show meaningfully improved revenue and profits for the year against the backdrop of a still struggling global market for recorded music. Current year operating cash flows will also be held back by significant restructuring spending (~GPP 60 million) although Moody's acknowledges that EMI has completed compensatory property sales to fund these outflows. In addition, the company is, in Moody's opinion likely to use any financial flexibility gained over the medium term to consider add-on acquisitions (music publishing catalogues, smaller recorded music labels) given that acquisition activity has been very muted over the last couple of years.

The Ba2 rating continues to recognize EMI's position as a global player in the oligopolistic recorded music industry as well as the company's leading world-wide position in music publishing with a more stable revenue base compared to recorded music. EMI Music Publishing is currently the world's largest music publisher, but is likely to cede its top place to Universal Music once Universal's acquisition of Bertelsmann Music Group's music publishing business (announced in September 2006) becomes effective. The rating further acknowledges the significant restructuring steps EMI has been taking over the last few years to lower the company's cost base, including the outsourcing of manufacturing in the US, Europe and Japan and the tight management of the artist roster. Current year cost savings are expected to save GBP 30 million on a run-rate basis from 2007/8 onwards. In addition, EMI's performance in music publishing remains relatively resilient with mechanical revenues directly related to recorded music sales representing no more than 45% (in 2005/6) of EMI's music publishing revenues.

The Ba2 rating and a stable outlook assume that EMI can (i) translate its strong release schedule into revenue and profit growth for the second half of 2005/6 (ii) deliver consolidated revenue growth thereafter and (iii) achieve cost reductions as forecast. Failure to deliver these objectives, near-term debt-financed acquisitions or failure to move the ratio of Adj. RCF/Adj. Net Debt towards 10% over time could result in ratings pressure. The possible business combination between EMI and Warner Music Group adds an element of uncertainty to the outlook over time. While any such combination would have significant cost saving potential, the financing of a potential transaction and who would be in the role of acquirer remain unclear. However, merger talks have ceased for the time being as the EU reconsiders the competitive implications of the merger between Sony Music and Bertelsmann Music Group following the annulment of the initial approval for this transaction by the European Court of First Instance. If after the review process the Sony BMG merger were to be re-approved Moody's believes that a resumption of the talks between EMI and Warner would likely follow.

Moody's notes that the operating environment for recorded music remains difficult. The global recorded music markets have been shrinking since 2001 and total global music sales (on a trade values basis) fell by a further 4% during the first calendar half of 2006 (after -1.9 % in 2005) despite continuing strong digital sales. Moody's believes that the fall for the first half of 2006 is aggravated by the phasing of release schedules with a further increasing bias towards releases during the second half of the calendar year. Nevertheless it will remain challenging for the industry to reverse first half trends and achieve overall growth for the calendar year. Notwithstanding the relative success of both the industry's legitimate download products and concerted legal action, download and physical music piracy remain a constricting factor for the global recorded music industry. In addition, the very success of the legitimate download product also means that EMI and the industry as a whole will have to carefully manage the retail channel as the continuing move towards digital distribution is likely to take a toll on specialist retailers.

Ratings affected are :

EMI Group plc

- CFR of Ba2 assigned

- 8.25% GBP bonds due 2008

- 8.625% notes due 2013

Capitol Records Inc. (gtd. by EMI Group plc)

- 8.375% guaranteed notes due 2009

EMI Group plc, one of the world's leading music recording and publishing companies is headquartered in London, England.

London
David G. Staples
Managing Director
Corporate Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

London
Christian Rauch
Senior Vice President
Corporate Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

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