Middelhoff plans to make it second time lucky

Bookham freefall; Pension headache

We've been here before. Way back in the mid-1990s, Bertelsmann, the German media group, approached EMI to talk about a merger of their respective music interests. The talks only became known about because a British journalist happened to be sitting in Bertelsmann's reception when who should walk out of the chief executive's office but Sir Colin Southgate, then chairman of EMI. Gutersloh, the village in north-west Germany where Bertelsmann has its global headquarters, is not the sort of place Sir Colin would chose for a holiday. "What are you doing here, Sir Colin?" the journalist asked. "Ummm...", came the embarrassed reply.

We've been here before. Way back in the mid-1990s, Bertelsmann, the German media group, approached EMI to talk about a merger of their respective music interests. The talks only became known about because a British journalist happened to be sitting in Bertelsmann's reception when who should walk out of the chief executive's office but Sir Colin Southgate, then chairman of EMI. Gutersloh, the village in north-west Germany where Bertelsmann has its global headquarters, is not the sort of place Sir Colin would chose for a holiday. "What are you doing here, Sir Colin?" the journalist asked. "Ummm...", came the embarrassed reply.

In the end, the talks came to nothing. Sir Colin took the view that the deal as proposed would be both unacceptable to the competition authorities and to his own shareholders. The competition authorities, he thought, would baulk at a merger that would enable EMI and Bertelsmann to leapfrog rivals to become the largest music company in the world, while the City would find it difficult to stomach a merger that would put Bertelsmann, a privately owned business steeped in the teutonic traditions of German corporate life, firmly in the driving seat.

The world has moved on a bit since then, but fundamentally Sir Colin's reservations would still seem to hold good. On the rebound from Time Warner, it is only too tempting for EMI to run crying into the arms of Bertelsmann, but is Bertelsmann really any more likely to be a workable relationship? There are plenty of reasons for believing not. The competition difficulties facing a Bertelsmann/EMI combination are probably not as great as the alternative Time Warner proposal, but they are still formidable. Very substantial disposals would be a certainty.

Furthermore, to satisfy the European Commission's concerns about "collective dominance" - the number of music majors coming down from five to four - the disposals would have to be to someone outside the other majors capable of creating a new fifth force. Bertelsmann claims to have thought through these problems and is confident it can come up with a package acceptable to the Commission. Now where have we heard that one before?

But even if the competition difficulties are surmountable, what of shareholder value? One of the big drawbacks of the Time Warner deal was that it was not a merger as such. Tax complications prevented a clean transaction that would have given Time Warner a 50 per cent interest in EMI's equity in return for its music interests. Instead, a more complicated route was chosen which gave EMI a 50 per cent interest in a combined music company managerially controlled by Time Warner. This was never a satisfactory outcome but EMI ploughed ahead none the less.

What Bertelsmann might be prepared to agree is a straight equity swop deal, so that the German company ends up with, say, 40 per cent of EMI. The disposals would allow some cash back to shareholders as well. The trouble is that a dominant minority shareholding of this sort amounts to control. EMI would in essence become a publicly quoted offshoot of Bertelsmann. It is not clear this would be in anyone's interests except Bertelsmann's. So Mr Middelhoff, any chance of a straight, unconditional cash offer? OK, only asking.

Bookham freefall

Bookham Technology makes devices that route, fragment, monitor and amplify light through fibre-optic, as opposed to copper wire, telecoms and data networks. It has always been seen as one of the ultimate New Economy companies and last month it exploited the resilience of its share price to the tech-stock downturn by launching a secondary share offering, raising about £120m. Coming just six months after Bookham raised £200m with its London flotation, this always looked an opportunistic move. As if to confirm the sell signal, 3i, Bookham's lead investor, and Andrew Rickman, the chief executive, cashed in £190m of stock as well. The shares have been falling ever since.

No New Economy stock, however advanced its technology, is immune to the business cycle and right now, that cycle is coming home with a vengeance among the over-extended telecoms companies that are the ultimate end-users of Bookham's technology.

Since Bookham completed its fundraising, a profits warning from Nortel Networks, the builder of fibre optics networks that is behind 56 per cent of Bookham's sales, emphatically confirmed that the market for such devices is seeing a sharp slowdown in its growth, which analysts now reckon will continue until 2002.

The Nortel wake-up call was reinforced by a conference call to analysts - conveniently coinciding the Chancellor's pre-Budget statement - that threw up concerns over an abundance of Bookham's microchip stocks. In a clarifying statement yesterday, Bookham insisted that inventories were rising only in line with demand, but it has none the less surprised investors that there were any stocks at all given the appetite there was meant to be for Bookham technology.

To be fair on Bookham, managing the supply chain in semiconductors is a lot harder than for most businesses. Demand is, after all, growing rapidly: waiting for orders before going into production is not an option. Bookham must invest capital upfront, build the product, and hope that the scale of demand meets forecasts. Even so, for Bookham shareholders, the return to reality is proving a painful one.

Pension headache

It is easy to forget, but the state retirement pension still rests on the contributory principle. A new report from the Government Actuary acts as a sharp reminder of the underlying economic truth that pay-as-you-go pension commitments will always end up being paid for by the active workforce.

The Actuary's calculations are intended to make the point that restoring the earnings link on the state pension would be financially as well as politically unfeasible in the long run. Within two or three decades there would need to be an increase of about 8 per cent in national insurance contributions, compared to no change if the Government sticks with the present inflation link.

The report adds that the National Insurance Fund will in any case require a top-up, either by an explicit increase in national insurance contributions or from general taxation, by 2009/10, because of the above-inflation increase in pensions announced in the Chancellor's pre-Budget report.

If the demographic trends were better, and the ratio of pensioners to workers not rising, a more generous universal pay-as-you-go scheme would be affordable. But since they are not, Gordon Brown is opting to concentrate state resources, funded from the contributions of those still in work, on the neediest pensioners.

It is hard to quarrel with the principle. The original purpose of National Insurance - that pensioners would draw payments in relation to what they paid in as workers - has long since vanished. Increased means testing of state pension benefits further reduces the meaning of National Insurance as a separate form of taxation. Integration of the income tax and national insurance systems looks more and more inevitable.

Mr Brown has already gone some way towards merging the two, but the survival of the upper earnings limit on national insurance - no insurance is paid after the first £29,000 of income - sticks out like a sore thumb. The Chancellor will almost certainly continue to chip away at this anomaly, but he risks another electoral rebellion if he moves too swiftly.

* outlook@independent.co.uk