Summary:

Struggling UK entertainment retailer HMV (LSE: HMV) is giving equity worth 2.5 percent to its key suppliers – music and movie studios – to a…

Simon Fox, HMV CEO

Struggling UK entertainment retailer HMV (LSE: HMV) is giving equity worth 2.5 percent to its key suppliers – music and movie studios – to avoid breaching its banking covenants.

The move means music and movie companies have likely written off money owed for supply are now literally invested in saving one of their main sellers of content on plastic discs.

The retailer, led by CEO Simon *Fox*, had faced a test by banks against its borrowings this month, after seeing Christmas sales slip 8.1 percent from 2010.

But on Friday it told the City its banks had waived the test and had drawn up new targets for annual tests due in April and July because, HMV said, of “a change in the nature of HMV’s relationships with its key music and film suppliers, which includes the intended grant of warrants representing 2.5% of its equity to these suppliers”.

HMV’s announcement included a ringing endorsement from the largest music label, Universal, whose UK CEO David Joseph says: “HMV is a vital part of the UK music industry and we are delighted that the support of the film studios and music companies is helping to secure its future. We look forward to working closely with HMV in the years ahead.”

In other words, the music and movie studios have a big interest in ensuring HMV can continue to operate as a going concern, maintaining sales of physical entertainment media that are nevertheless falling industry-wide.

Even though HMV says the deal “will have a materially positive impact on the Group’s profitability and cash flow”, the announcement contained news that HMV Group has increased its forecast for 2011/12′s annual loss to £10 million.

HMV has debts of around £180 million. It thinks the new plan can shave off half of that within three years if current trading patterns continue.

But that logic seems predicated on no further decline in physical media sales, and industry indicators do not point in that direction.

HMV’s strategy to compensate for that reality is to sell entertainment-related hardware and gadgets in stores and to increase both digital and mail order content sales conducted through its website.

It is also considering selling its live music division, even though that is the one sector of the music industry many analysts think can maintain growth through the disc sales dip.

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