analysis of warner music group
DESCRIPTION
1. Which are the strategic critical success factors of the company? Which are the main weaknesses of the actual strategic decisions (draw a SWOT analysis for this purpose). 2. Evaluation of the firm profitability according to the industry characteristics: explainment what ratios are more suitable for a company in this industry. Consider how to measure overall profitability, return on sales, and return on assets. What trends do you notice in profitability components for the firm over time (last two years)? 3. Is the firm efficient in its use of assets? Consider efficiency in terms of total asset turnover. How could you better investigate the total asset turnover? Which operational measures would you select? 4. Is the company likely to meet their debts as they come due? Consider ratios such as the current ratio, the quick ratio, and the debt-equity ratio. Also consider interest costs and the times interest earned ratio. 5. Consider the future prospects of the company and evaluate the risks they face. Does the company demonstrate a potential to increase its return on equity through operations? Why? 6. Are there any unusual or non-recurring items that need to be considered in your analysis? That is, are the earnings of high quality? Are the earnings persistent? 7. As a potential investor, is the company worth seeking further information about? What sort of information would you want? How do you evaluate the information available on the corporate website?TRANSCRIPT
Performance Measurement
Assignment 1
Analysis of Warner Music Group
Group 4
Alessia Bianchi (1381946), Valentina Chiarini (1573971), Claudia Klapproth (1574367), Federico Nardini (1343623), Andrea Padovani (1347780)
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
1. Critical Succes Factors: SWOT Analysis
Critical Success Factors
Group 4 2
Strengths
• Artist & Repertoire Section: able to attract, develop and retain main artists
• Highly diversified revenue base• Leader in downloading services,
like digital subscription services• Experienced, stable management
team
Opportunities
• More revenues in digital market• Expand the non-traditional recording
music business (e.g. fan clubs)• Enter to expanded-right deals: closer
relationships with artists• Agreements with major companies in
industry (Universal Group, EMI, Sony BMG) create entry barriers
Threats
• Decline of physical music industry• Digital piracy: loss in sales due to
illegal downloads • Highly competitive industry –
competing on artists• Downward pressure on prices due
to substitute goods and small number of online stores
Weaknesses
• Reliance on only one single company as the primary supplier (Cinram)
• Difficult to get additional financing due to substantial leverage
• Limited flexibility in operating business due to debt agreements
• Controlled by Current Investor Group
WeaknessesStrengths
Opportunities Threats
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
1. Critical Success Factors: Porter‘s Five Forces Analysis
Group 4 3
Critical Success Factors
• Highly competitive market: 4 majors competing on artists and customers (sales revenue)
• High entry barriers: market is dominated by 4 major players making it difficult to enter
• Illegal downloads• Blueray disc• Legal online access:
e.g. Youtube
• High bargaining power due to customer taste being key success factor
• Willingness to pay is decreasing due to downloading opportunities
• Artists: Bargaining power increases with popularity
• Cinram: High bargaining power as it is only supplier for manufacturing, packaging &physical distribution
Suppliers Customers
Rivalry
Substitutes
New Entrants
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
2. Profitability Analysis: Most Suitable Ratios
• Return on assets (ROA) is the most suitable profitability ratio in the music industry.
• Especially intangible assets are crucial for a firm operating in the music industry.
• Warner‘s strategy: the maximization of its music assets seeking to exploit the potential of previously unmonetized content
– in new channels (online physical retailers like Amazon and other digital sources)1,
– with new formats and product offerings (premium price album bundles, full track video and downloads on mobile phones etc.)2
• Assets in Warner‘s two core businesses as major revenue sources
– Recording Music• Long-term assets are exploited year after year – more profitable than new
releases in this industry.3
• Warner‘s strategy: creation of a specific division (Rhino) to acquire licensing rights from catalog artists to exploit long-term assets4
– Music Publishing• In the matter of intangible assets, royalties play a fundamental role, especially
the mechanical ones, way more profitable then the others because not affected by piracy.5
Profitability Analysis
Group 4 4
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
2. Profitability Analysis:Ratios
• ROE = Net Income/Sales x Sales/Assets x Assets/Equity = Net Income/Equity
– Because equity is negative, the ROE cannot be used to evaluate the profitability of the company.
– Given that the equity is negative, we already have an indication that the financial position of the company is problematic: There are more debts than assets. Dividends cannot be paid out to shareholders. If all assets were sold, shareholders would owe money instead of getting a return.
• ROA = EBIT/Sales x Sales/Total Assets = EBIT/Total Assets– ROA 2010: 90/3,779* = 0.024 = 2.4%– ROA 2009: 135/4,063* = 0.033 = 3.3 %– ROA 2008: 207/4,526* = 0.046 = 4.6 %
The return on assets ratio shows profitability in terms of how efficiently assets are managed to produce profits. The ratios seem rather small and, moreover, the ROA is declining in the past years, thus profitability is decreasing.
• ROS = EBIT/Sales– ROS 2010: 90/2,984* = 0.030 = 3.0%– ROS 2009: 135/3,198* = 0.045 = 4.5 %– ROS 2008: 207/3,506* = 0.06 = 6.0 %
The return on sales ratio indicates a low profitability of sales, declining over time. The profitability of sales will be further investigated by looking at the composition of sales revenue in the following slide.
Profitability Analysis
Group 4 5
*Figures: million dollars
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
2. Profitability Analysis: Sales Revenues
• Total sales revenues are largely
affected by the decline in sales of
physical/mechanical content, due to
a declining demand for phyiscal
products in the industry
• Reasons are piracy but also a shift
in demand from physical to digital
content
• Thus, sales from digital content are
increasing.
• No significant change in revenue
from licensing
• Performance sales are only
decreasing due to timing of cash
collections and Warner‘s decision not
to renew low marging deals in this
business area
% of Total Sales 2010
Change2010 vs. 2009
Change 2009 vs. 2008
Total Sales 100% -7% -9%
Recorded Music Total 82% -7% -9%Physical and other 51% -15% -14%Digital 24% 9% 10%Licensing 7% -2% -3%Music Publishing 18% -4% -7%Mechanical 6% -8% -15%Performance 7% -8% -7%Synchronization 3% 5% -2%Digital 2% 9% 35%Other 3% -15% -38%
Decrease in total sales has negative effect on profitability (ROA and ROS) and efficiency in use of assets (asset turnover)
Group 4 6
Profitability Analysis
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
3. Efficiency Analysis:Asset Turnover
ROA = EBIT/Sales x Sales/Total Assets
• Total asset turnover:
Sales/Total Assets 2,984/3,779* = 0.79
As part of the ROA, asset turnover is measuring the firm‘s efficiency in using its assets: for every dollar in assets, Warner is selling $ 0.79 worth of products. This ratio seems rather small, equivalent to the overall result of the ROA.
• Inventory asset turnover:
Sales/Inventories 2,984/37* = 80.65
Inventory turnover, as part of the total asset turnover, is not a problematic measure for Warner, on the contrary, Warner is handling its inventories efficiently.
However, looking at the balance sheet, it is obvious that the assets that are affecting total asset turnover to be low are the goodwill and the intangible assets.Group 4 7
Efficiency Analysis
*Figures: million dollars
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
3. Efficiency Analysis:Main Operational Assets
• Goodwill– In 2010, goodwill was accrued primarily due to the acquisition of
Roadrunner Music Group, a touring company, and a production music company.1
– These investments are necessary in order for Warner to pursue its expanded-rights deals strategy: building closer relationships with recording artists and diversify revenue streams such as merchandising, fan clubs, sponsoring, and touring.
• Intangible Assets– Are comprised of the record music catalog, music publishing
copyrights, artist contracts, trademarks and other intangible assets.2
– These assets are the most valuable assets for the company3, but they do not seem to be used efficiently.
– The company searches to exploit the assets through a variety of distribution channels, formats and products in order to generate revenue
– A major reason why these assets are currently not being used efficiently is the decrease in revenues accounted from the selling of physical products such as CDs (see slide 6)
– However, non financial performance measures for intangible assets, we can conclude that Warner is performing very well in terms of number and quality of artists
Group 4 8
The amount of assets is necessary in this industry, especially in terms of intangible assets. The decreasing sales in terms of
physical products affect asset turnover negatively. Sales need to be increased to make asset use more efficiently.
Efficiency Analysis
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
4. Liquidity Analysis: Ability to Pay Short-Term Debt
• Current Ratio = Short-Term Assets/Short Term Liabilities– Current Ratio 2010: 1,129/1,721* = 0.656– Ratio is less than one, thus firm is not in a good
position, because its ability to repay liabilities in the short run is poor. (benchmark: should not be lower than 1, but above 2)
• Quick Ratio = Short-Term Assets – Inventories – Prepaid expenses) / Short-Term Liabilities– Quick Ratio 2010: (1,129 – 37 – 143) / 1, 721* = 0.551– Taking into account only the most liquid assets: The
result is far from 1 (benchmark value), so short-term liabilities exceed short-term liquid assets, entailing a high amount of debt for the firm and a low capacity to repay it.
Group 4 9
Liquidity Analysis
The firm’s ability to repay its short term debt is very low.
*Figures: million dollars
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
4. Solvency Analysis: Ability to Pay Long-Term Debt• Debt-Equity Ratio = Total Liabilites/Equity
– Debt Equity Ratio 2010: 3, 990 / (-211)* = -18. 91– Benchmark: should be positive and as low as possible. However,
the ratio is negative indicating that the firm´s net worth is negative, meaning that its debt is not matched by its ability to cover it. If all assets were sold now, investors would be left with debt.
– The result was expected due to the fact that liabilities exceed assets and thus equity is negative.
• Time Interest Earned Ratio = EBIT/Interest Expenses
– Time Interest Earned Ratio 2010: 90 / (-190)* = -0.474– The ratio suggests that the company is not able to repay interest
in the medium and long run.
In the following slide, the effect of the interest expenses will be shown, thus the effect of the large amount of debt.
Group 4 10
Solvency Analysis
The firm’s ability to repay its long-term debt is very low.
*Figures: million dollars
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
4. Solvency Analysis: Interest Expenses
Group 4 11
Solvency Analysis
Warner’s last gains were in 2008, since then the company is increasingly making losses.
Year EBIT*Interest Expenses EBT
2008 207 180 27
2009 135 195 -60
2010 90 190 -100
2008 2009 2010
-150
-100
-50
0
50
100
150
200
250
EBIT Interest Expenses
EBT
• EBIT is steadily declining due to declining sales revenues• Interest expenses are stable, but very high due to the large
amount of debt ($ 3,990 million in 2010)• Due to this, EBT is declining and therefore also net income
*Figures: million dollars
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
5. Future ROE:Possibilities to Increase
(1) Net Income/EBT: Net income and EBT are both negative due to high interest expenses. No EBT is kept in the company. EBIT is not high enough to cover Interest expenses due to a decrease in sales .
(2) EBT/EBIT: Effect of interest: interest expenses are so high, that no EBT is retained by the company, the company is making losses.
(3) EBIT/Sales: ROS is declining due to decline in sales that is also affecting EBIT
(4) Sales/Assets: Assets efficiency is likely to stay low if sales continue to decline, as current intangible assets are being kept.
(5) Total Assets/Common Equity: Effect on leverage: negative ratio due to negative equity. Accumulating new assets will be difficult as there is a large amount of debt.
ROE = Net Income/Equity
ROE is possible to be increased by changing: Net Income: should be increased to be positive and large
Increasing sales – since market is decreasing, sales cannot increase by focusing on the physical sales. By increasing digital sales, overall sales can be increased
Cost savings – Warner is determining contracts with artists of low revenue and focuses on smaller number of high quality artists. Moreover, shift from physical to digital products will entail cost reduction.
Decreasing debt – debt has to be paid back in order to decrease interest expenses. This can only be done if sales increase to then pay back debt.
Equity: should be increased to be positive by repaying the company’s debt
Group 4 12
Future ROE
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
5. Future ROE:Prospects and Risks
Group 4 13
Future ROE
Prospects Risks
• Push sales of digital content by focusing on that sector which is increasing
• Costs savings- Focus on few but popular
artists instead of investing in new emerging artists
- Push digital sales which are less costly than physical sales
• Combat piracy- If Warner‘s strategy to
combat piracy pays off, sales could be improved
Decline of music industry continues
Downward pressure on prices
Failing to identify new artists due to attempt to save cost
Debt agreements contain restrictions that limit its flexibility in operating business
Overall, it will be difficult for Warner to increase the ROE due to the market characteristics and its currently financial
position with a lot of pressure due to difficulty to repay debt.
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
6. Unusual or Non-Recurring Items
• There are no unusual or non-recurring items in 2010 that need to be included in the analysis.
• There are no discontinued operations are shown in Warner’s income statement for the year 2010 (the company only discontinued their Bulldog operations in 2008 losing $21 million1)
• Thus, earnings are persistent and of high quality. The company does not rely on unusual items to make earnings.
• However, since Warner is afflicted by a big amount of debt (and in consequence by a big amount of passive interest), its income statement results in a net loss.
• Quailty of Earnings are high, but not high enough to cover the interest expenses resulting from the large amount of debt.
• Quality of Earnings Ratio = Cash Flow from Operating Activities / Net Income
– Quality of Earnings Ratio = -12 / -143* = 0.0832
– Ratio cannot be used due to the fact that both cash flow from operating activities as well as net income are negative.
Group 4 14
Unusual/Non-Recurring Items
Earnings are persistent and regular (but decreasing due to decreasing sales). Due to high interest expenses and the resulting loss, quality of earnings cannot be calculated.
*Figures: million dollars
Critical Success Factors
Profitability Analysis
Efficiency Analysis
Liquidity & Solvency Analysis
Future ROE: Risks and Prospects
Unusal or Non-Recurring Items
Potential Investment
7. Potential Investment
• Based on the analysis, regarding the ROE and ROA and the overall trend of the industry, Warner Music Group is not a company potential investors are likely to invest in.
• This is not necessarily due a poor management but rather due to the problems that the music industry is facing in general (e.g. piracy).
• As already mentioned, the company‘s equity is negative, which is a warning sign for potential investors. With the negative equity, Warner is not able to pay its shareholders dividends and if all assets were sold, shareholders would not receive any compensation for the investment. The equity is even worsening over the past years (last year equity was positive was in 2006):
Group 4 15
Potential Investment
• However, if there was still a potential investor interested in investing in the Warner Music Group, the most necessary information for him to be found would be the share prices and possibilities to invest
• In the investor relations section of the company‘s website, potential investors find all necessary information in a well structured way.
2006 2007 2008 2009 2010
-300
-200
-100
0
100
Equity1
Equity is steadily declining by large
amounts over the years