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Analysis of Warner Music Group
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Analysis of Warner Music Group

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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?

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    Analysis of Warner Music Group Analysis of Warner Music Group Presentation 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)
    • 1. Critical Succes Factors: SWOT Analysis Strengths Critical Success Critical Success Factors Factors Profitability Analysis Efficiency Analysis Liquidity & Solvency Analysis Future ROE: Risks and Prospects Unusal or NonRecurring Items Potential Investment 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 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 Group 4 Weaknesses 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 Threats 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 2
    • 1. Critical Success Factors: Porter‘s Five Forces Analysis New Entrants Critical Success Critical Success Factors Factors • High entry barriers: market is dominated by 4 major players making it difficult to enter Profitability Analysis Efficiency Analysis Liquidity & Solvency Analysis Future ROE: Risks and Prospects Unusal or NonRecurring Items Potential Investment Suppliers • Artists: Bargaining power increases with popularity • Cinram: High bargaining power as it is only supplier for manufacturing, packa ging &physical distribution Customers Rivalry • Highly competitive market: 4 majors competing on artists and customers (sales revenue) • High bargaining power due to customer taste being key success factor • Willingness to pay is decreasing due to downloading opportunities Substitutes • Illegal downloads • Blueray disc • Legal online access: e.g. Youtube Group 4 3
    • 2. Profitability Analysis: Most Suitable Ratios • Critical Success Factors • Profitability Analysis • Profitability Analysis Efficiency Analysis – Liquidity & Solvency Analysis Future ROE: Risks and Prospects 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 • Unusal or NonRecurring Items Potential Investment • – 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 Group 4 4
    • 2. Profitability Analysis: Ratios • Critical Success Factors – – Profitability Profitability Analysis Analysis Efficiency Analysis Liquidity & Solvency Analysis Future ROE: Risks and Prospects Unusal or NonRecurring Items Potential Investment 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. *Figures: million dollars Group 4 5
    • 2. Profitability Analysis: Sales Revenues Critical Success Factors Profitability Analysis Profitability Analysis Efficiency Analysis Liquidity & Solvency Analysis Future ROE: Risks and Prospects Unusal or NonRecurring Items Potential Investment Total Sales Recorded Music Total Physical and other Digital Licensing Music Publishing Mechanical Performance Synchronization Digital Other % of Change Change • Total sales revenues are largely Total 2010 2009 affected by the decline in sales of Sales vs. vs. physical/mechanical content, due 2010 2009 2008 to a declining demand for phyiscal 100% -7% -9% products in the industry 82% -7% -9% 51% 24% 7% -15% 9% -2% -14% 10% -3% 18% 6% 7% 3% 2% 3% -4% -8% -8% 5% 9% -15% -7% -15% -7% -2% 35% -38% • 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 Decrease in total sales has negative effect on profitability (ROA and ROS) and efficiency in use of assets (asset turnover) Group 4 6
    • 3. Efficiency Analysis: Asset Turnover ROA = EBIT/Sales x Sales/Total Assets Critical Success Factors • Total asset turnover: Sales/Total Assets 2,984/3,779* = 0.79 Profitability Analysis Efficiency Analysis Efficiency Analysis Liquidity & Solvency Analysis Future ROE: Risks and Prospects Unusal or NonRecurring Items Potential Investment 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. *Figures: million dollars Group 4 7
    • 3. Efficiency Analysis: Main Operational Assets • – Critical Success Factors – Profitability Analysis Efficiency Analysis Efficiency Analysis Liquidity & Solvency Analysis 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 – – Future ROE: Risks and Prospects – Unusal or NonRecurring Items – Potential Investment – 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 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 8 Group 4 to be increased to make asset use more efficiently.
    • 4. Liquidity Analysis: Ability to Pay Short-Term Debt Critical Success Factors Profitability Analysis Efficiency Analysis Liquidity Liquidity & Solvency Analysis Analysis Future ROE: Risks and Prospects Unusal or NonRecurring Items Potential Investment • 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. *Figures: million dollars The firm’s ability to repay its short term debt is very low. Group 4 9
    • 4. Solvency Analysis: Ability to Pay Long-Term Debt • Debt-Equity Ratio = Total Liabilites/Equity Critical Success Factors Profitability Analysis Efficiency Analysis Solvency Liquidity & Solvency Analysis Analysis Future ROE: Risks and Prospects Unusal or NonRecurring Items Potential Investment – 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. The firm’s ability to repay its long-term debt is very low. In the following slide, the effect of the interest expenses will be shown, thus the effect of the large amount of debt. *Figures: million dollars Group 4 10
    • 4. Solvency Analysis: Interest Expenses Critical Success Factors Interest Year EBIT* Expenses EBT 250 200 207 180 27 150 2009 135 195 -60 100 2010 Profitability Analysis 2008 90 190 -100 50 Efficiency Analysis 0 -50 Solvency Liquidity & Solvency Analysis Analysis 2008 2009 2010 -100 -150 Future ROE: Risks and Prospects Unusal or NonRecurring Items Potential Investment 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 Warner’s last gains were in 2008, since then the company is increasingly making losses. Group 4 *Figures: million dollars 11
    • 5. Future ROE: Possibilities to Increase Critical Success Factors Profitability Analysis Efficiency Analysis Liquidity & Solvency Analysis Future ROE: Risks Future ROE and Prospects Unusal or NonRecurring Items Potential Investment (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
    • 5. Future ROE: Prospects and Risks Critical Success Factors Profitability Analysis Efficiency Analysis Liquidity & Solvency Analysis Future ROE: Risks Future ROE and Prospects Unusal or NonRecurring Items Potential Investment Prospects • 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 Risks     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. Group 4 13
    • 6. Unusual or Non-Recurring Items • Critical Success Factors • Profitability Analysis • Efficiency Analysis • Liquidity & Solvency Analysis • Future ROE: Risks and Prospects • Unusal or NonUnusual/NonRecurring Items RecurringItems Potential Investment 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. 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. Group 4 *Figures: million dollars 14
    • 7. Potential Investment • Critical Success Factors Profitability Analysis 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): • • Efficiency Analysis Liquidity & Solvency Analysis Equity1 Future ROE: Risks and Prospects 100 Unusal or NonRecurring Items -100 0 2006 2007 2008 2009 -200 2010 Equity is steadily declining by large amounts over the years -300 Potential Investment 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. Group 4 15