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BRUSSELS (Reuters) - EU regulators have told Universal Music Group that its plans to buy an EMI unit will significantly impede competition, signaling a possible veto unless it offers major concessions, three people familiar with the matter said on Tuesday.
The European Commission, which has been examining the $1.9 billion deal since February, has given Universal until July 3 to reply to concerns set out in a 194-page statement of objections sent last month.
Vivendi-owned Universal's stars include Lady Gaga, Rihanna and U2 while EMI's recorded music catalogues include The Beatles and Katy Perry. The combined company would be almost twice the size of its nearest rival in Europe.
The EU watchdog expressed strong concerns about the deal, saying it was incompatible with the EU's internal market and would completely change the interaction between supply and demand in the music industry, said one of the sources who has seen the document.
The Commission also rejected Universal's arguments that the threat from piracy and the bargaining clout exerted by customers such as Apple's iTunes, Amazon and other online music services would limit its power, the source said.
The document suggested that "Universal will have to significantly reduce its market share," the source added.
The company could offer to sell catalogues or offer improved licensing deals to rivals to reassure regulators.
Universal and EMI hold a combined market share just below 40 percent of digital music distributed by iTunes and Spotify in Europe, making it the biggest single source.
Critics say the merged company could control the future of digital media by withholding content from distributors. The Commission has set a September 6 deadline for a decision.
Universal declined to comment on the details but said it was preparing a response to the Commission's statement "which will address the concerns outlined in this procedural document".
"We will continue to work closely with the Commission and look forward to securing regulatory clearance," it said in a brief statement.
Universal had always expected a close inspection of the deal after the Commission was embarrassment over another takeover battle within the industry. The Commission had approved the 2004 merger of Sony and Bertelsmann's BMG when a group of independent record labels forced Europe's second higher court to block the deal. EU regulators eventually approved that deal in 2007.
The Universal-EMI tie-up was further complicated last week when the head of Vivendi suddenly quit, throwing into question whether the new management team would support such a big deal.
However, Universal Chief Executive Lucian Grainge emailed staff in recent days to reassure them that the current chairman of the supervisory board, Jean-Rene Fourtou, remained a supporter of the division.
"Mr Fourtou is committed to Universal's strategic ambitions, which include our evolving services to artists and determination to help digital music grow further for our business partners and consumers. He is also fully supportive and inspired by our planned acquisition of EMI Recorded Music," the email said.
EMI seller Citigroup Inc took over the British record label after its previous owner, buyout firm Terra Firma, defaulted on loans owed to the investment bank.
The U.S. Federal Trade Commission is also examining the deal.
The EU executive in February blocked the merger of Deutsche Boerse and NYSE Euronext after the exchanges failed to offer major concessions to offset worries about its near-monopoly in the worldwide market for European derivatives.
Reporting by Foo Yun Chee; Additional reporting by Kate Holton in London; Editing by Rex Merrifield and Mark Potter