HAVING established a haven for rock artists, Sanctuary Music Group, one of Britain’s best-known and hitherto most successful music companies, will this week mount a fight to restore its financial health.

The company, whose clients include Elton John, Guns ’n’ Roses and Beyoncé, is tomorrow holding a board meeting to discuss options, including an emergency rights issue and an acceleration of efforts to find an external investor or buyer.

The heat is on because the City believes Sanctuary is struggling to avoid breaching its banking covenants.

Conor O’Shea, media analyst at Teather & Greenwood, said last week: “We estimate that unless conditions materially improve, the group risks breaching two of its main four banking covenants.”

Sanctuary’s founders, old university chums Andy Taylor and Rod Smallwood, are more used to being stock-market darlings than ugly ducklings.

The company, founded in 1976, took its sales to just £13m by the end of 1998. Since then its turnover has soared, hitting £220m in the year to the end of 2004.

But nine days ago its share price crashed following a profit warning, its second this year. Two weeks earlier the company had claimed it was in talks that could lead to a takeover offer, thought to be from either a competitor such as Warner Music Group or a private- equity firm.

After the profit warning on June 17, Sanctuary’s shares fell 30% from 43p to 29¾p. On Friday they closed at 20½p amid fears that the group will struggle to restabilise its bruised balance sheet.

On Tuesday, when Sanctuary releases its interim results, the company is expected to say that discussions with potential suitors are ongoing but that no firm offer has been received.

Executive chairman Taylor will say the board has already identified areas in which it can slash millions of pounds from the company's cost base. A sale of the firm’s book-publishing division is one option under consideration.

But analysts and investors are sceptical. O’Shea said: “I cannot see the business surviving in its current form. What is really surprising is that things have deteriorated at a time when the music industry is showing steady signs of improvement.”

Investor confidence in Sanctuary has been steadily waning for months. The company’s unique structure — it is not just a traditional record label but also manages artists, acts as a promoter and handles merchandise sales — has attracted clients but has also created a complex financial structure.

The company’s rapid growth has been fuelled by an aggressive acquisition policy in which Sanctuary has snapped up clients, including £16m spent on Elton John’s management company in April. The series of purchases has been funded using £30m of debt it tapped from Highbridge, a specialist house.

The head of equities at one of the City’s biggest institutions said: “Sanctuary is simply not of investable quality.”

And the firm could face a fresh headache if negotiations with Morrissey, one of its biggest clients, lead to him leaving the group’s record label. Sanctuary declined to comment.

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