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
Strengths Weaknesses
Weaknesses
Critical Success
Critical Success • Artist & Repertoire Section: able to
Factors
Factors attract, develop and retain main • Reliance on only one single company
artists as the primary supplier (Cinram)
Profitability Analysis • Highly diversified revenue base • Difficult to get additional financing
• Leader in downloading due to substantial leverage
Efficiency Analysis services, like digital subscription • Limited flexibility in operating
services business due to debt agreements
Liquidity & Solvency • Experienced, stable management • Controlled by Current Investor Group
Analysis team

Future ROE: Risks Opportunities

Opportunities
and Prospects
• More revenues in digital market
Unusal or Non- • Expand the non-traditional recording
Recurring Items music business (e.g. fan clubs)
• Enter to expanded-right deals: closer
relationships with artists
Potential Investment
• Agreements with major companies in
industry (Universal Group, EMI, Sony
BMG) create entry barriers
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

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 1. Critical Success Factors:
Porter‘s Five Forces Analysis
New Entrants
Critical Success
Critical Success • High entry barriers:
Factors
Factors market is dominated
by 4 major players
making it difficult to
Profitability Analysis enter
Suppliers Customers
Efficiency Analysis
• Artists: Bargaining
• High bargaining
power increases with Rivalry
Liquidity & Solvency power due to
popularity
Analysis • Highly competitive customer taste being
• Cinram: High
market: 4 majors key success factor
bargaining power as it
competing on artists • Willingness to pay is
Future ROE: Risks is only supplier for
and customers decreasing due to
and Prospects manufacturing, packa
(sales revenue) downloading
ging &physical
opportunities
distribution
Unusal or Non-
Recurring Items Substitutes
• Illegal downloads
Potential Investment • Blueray disc
• Legal online access:
e.g. Youtube

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 2. Profitability Analysis:
Most Suitable Ratios
• Return on assets (ROA) is the most suitable profitability
Critical Success ratio in the music industry.
Factors • Especially intangible assets are crucial for a firm operating
in the music industry.
Profitability • Warner‘s strategy: the maximization of its music assets
Profitability Analysis
Analysis seeking to exploit the potential of previously unmonetized
Efficiency Analysis content
– in new channels (online physical retailers like Amazon and other
digital sources)1,
Liquidity & Solvency
– with new formats and product offerings (premium price album
Analysis bundles, full track video and downloads on mobile phones etc.)2
• Assets in Warner‘s two core businesses as major revenue
Future ROE: Risks sources
and Prospects – Recording Music
• Long-term assets are exploited year after year – more profitable than
Unusal or Non- new releases in this industry.3
Recurring Items • Warner‘s strategy: creation of a specific division (Rhino) to acquire
licensing rights from catalog artists to exploit long-term assets4
– Music Publishing
Potential Investment • 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

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 2. Profitability Analysis:
Ratios
• ROE = Net Income/Sales x Sales/Assets x Assets/Equity = Net
Income/Equity
Critical Success
– Because equity is negative, the ROE cannot be used to evaluate the
Factors profitability of the company.
Profitability – Given that the equity is negative, we already have an indication that the
Profitability Analysis financial position of the company is problematic: There are more debts
Analysis than assets. Dividends cannot be paid out to shareholders. If all assets
were sold, shareholders would owe money instead of getting a return.
Efficiency Analysis
• ROA = EBIT/Sales x Sales/Total Assets = EBIT/Total Assets
Liquidity & Solvency – ROA 2010: 90/3,779* = 0.024 = 2.4%
Analysis – ROA 2009: 135/4,063* = 0.033 = 3.3 %
– ROA 2008: 207/4,526* = 0.046 = 4.6 %
Future ROE: Risks The return on assets ratio shows profitability in terms of how efficiently assets are
and Prospects managed to produce profits. The ratios seem rather small and, moreover, the ROA
is declining in the past years, thus profitability is decreasing.
Unusal or Non-
• ROS = EBIT/Sales
Recurring Items
– ROS 2010: 90/2,984* = 0.030 = 3.0%
– ROS 2009: 135/3,198* = 0.045 = 4.5 %
Potential Investment – 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

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 2. Profitability Analysis:
Sales Revenues
% of Change Change • Total sales revenues are largely
Critical Success Total 2010 2009 affected by the decline in sales of
Factors Sales vs. vs. physical/mechanical content, due
2010 2009 2008 to a declining demand for phyiscal
Profitability Total Sales 100% -7% -9%
Profitability Analysis products in the industry
Analysis
Recorded Music • Reasons are piracy but also a
Efficiency Analysis Total 82% -7% -9% shift in demand from physical to
Physical and digital content
Liquidity & Solvency other 51% -15% -14%
Analysis • Thus, sales from digital content
Digital 24% 9% 10%
are increasing.
Future ROE: Risks Licensing 7% -2% -3%
• No significant change in revenue
and Prospects Music
from licensing
Publishing 18% -4% -7%
Unusal or Non- Mechanical 6% -8% -15% • Performance sales are only
Recurring Items decreasing due to timing of cash
Performance 7% -8% -7%
collections and Warner‘s decision
Synchronization 3% 5% -2% not to renew low marging deals in
Potential Investment
Digital 2% 9% 35% this business area
Other 3% -15% -38%
Decrease in total sales has negative effect on profitability (ROA
and ROS) and efficiency in use of assets (asset turnover)
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 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 As part of the ROA, asset turnover is measuring the firm‘s efficiency in
Efficiency Analysis using its assets: for every dollar in assets, Warner is selling $ 0.79 worth
Analysis of products. This ratio seems rather small, equivalent to the overall
Liquidity & Solvency result of the ROA.
Analysis
• Inventory asset turnover:
Future ROE: Risks Sales/Inventories 2,984/37* = 80.65
and Prospects
Inventory turnover, as part of the total asset turnover, is not a
Unusal or Non- problematic measure for Warner, on the contrary, Warner is handling its
Recurring Items inventories efficiently.
However, looking at the balance sheet, it is obvious that the assets that
Potential Investment are affecting total asset turnover to be low are the goodwill and the
intangible assets.

*Figures: million dollars

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 3. Efficiency Analysis:
Main Operational Assets
• Goodwill
Critical Success – In 2010, goodwill was accrued primarily due to the acquisition of
Factors Roadrunner Music Group, a touring company, and a production
music company.1
– These investments are necessary in order for Warner to pursue its
Profitability Analysis expanded-rights deals strategy: building closer relationships with
recording artists and diversify revenue streams such as
Efficiency merchandising, fan clubs, sponsoring, and touring.
Efficiency Analysis
Analysis • Intangible Assets
Liquidity & Solvency – Are comprised of the record music catalog, music publishing
Analysis copyrights, artist contracts, trademarks and other intangible assets.2
– These assets are the most valuable assets for the company3, but
Future ROE: Risks they do not seem to be used efficiently.
and Prospects – The company searches to exploit the assets through a variety of
distribution channels, formats and products in order to generate
revenue
Unusal or Non- – A major reason why these assets are currently not being used
Recurring Items efficiently is the decrease in revenues accounted from the selling of
physical products such as CDs (see slide 6)
Potential Investment – 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
Group 4 asset turnover negatively. Sales need 8
to be increased to make asset use more efficiently.
 4. Liquidity Analysis:
Ability to Pay Short-Term Debt
• Current Ratio = Short-Term Assets/Short Term
Critical Success Liabilities
Factors – Current Ratio 2010: 1,129/1,721* = 0.656
Profitability Analysis – Ratio is less than one, thus firm is not in a good
position, because its ability to repay liabilities in the
Efficiency Analysis short run is poor. (benchmark: should not be lower
than 1, but above 2)
Liquidity
Liquidity & Solvency
Analysis
Analysis • Quick Ratio = Short-Term Assets – Inventories
Future ROE: Risks
– Prepaid expenses) / Short-Term Liabilities
and Prospects – Quick Ratio 2010: (1,129 – 37 – 143) / 1, 721* =
0.551
Unusal or Non- – Taking into account only the most liquid assets: The
Recurring Items result is far from 1 (benchmark value), so short-term
liabilities exceed short-term liquid assets, entailing a
Potential Investment 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.
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 4. Solvency Analysis:
Ability to Pay Long-Term Debt
• Debt-Equity Ratio = Total Liabilites/Equity
Critical Success – Debt Equity Ratio 2010: 3, 990 / (-211)* = -18. 91
Factors – Benchmark: should be positive and as low as possible.
However, the ratio is negative indicating that the firm´s net
Profitability Analysis worth is negative, meaning that its debt is not matched by
its ability to cover it. If all assets were sold now, investors
Efficiency Analysis would be left with debt.
– The result was expected due to the fact that liabilities
Solvency
Liquidity & Solvency exceed assets and thus equity is negative.
Analysis
Analysis
• Time Interest Earned Ratio = EBIT/Interest
Future ROE: Risks Expenses
and Prospects
– Time Interest Earned Ratio 2010: 90 / (-190)* = -0.474
Unusal or Non- – The ratio suggests that the company is not able to repay
Recurring Items interest in the medium and long run.

Potential Investment 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
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 4. Solvency Analysis:
Interest Expenses
Interest 250
Critical Success Year EBIT* Expenses EBT 200
Factors 2008 207 180 27 150

Profitability Analysis 2009 135 195 -60 100

2010 90 190 -100 50

Efficiency Analysis
0
2008 2009 2010
Solvency
Liquidity & Solvency -50

Analysis
Analysis -100

-150
Future ROE: Risks
EBIT Interest Expenses EBT
and Prospects
• EBIT is steadily declining due to declining sales revenues
Unusal or Non- • Interest expenses are stable, but very high due to the large
Recurring Items
amount of debt ($ 3,990 million in 2010)
Potential Investment • 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 (1) Net Income/EBT: Net income and EBT are both negative due to high interest
Factors expenses. No EBT is kept in the company. EBIT is not high enough to cover Interest
expenses due to a decrease in sales .
Profitability Analysis (2) EBT/EBIT: Effect of interest: interest expenses are so high, that no EBT is retained
by the company, the company is making losses.
Efficiency Analysis (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
Liquidity & Solvency current intangible assets are being kept.
Analysis (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.
Future ROE: Risks ROE = Net Income/Equity
Future
and ROE
Prospects ROE is possible to be increased by changing:
 Net Income: should be increased to be positive and large
Unusal or Non-  Increasing sales – since market is decreasing, sales cannot increase by
focusing on the physical sales. By increasing digital sales, overall sales can be
Recurring Items
increased
 Cost savings – Warner is determining contracts with artists of low revenue
Potential Investment 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
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 5. Future ROE:
Prospects and Risks
Critical Success Prospects Risks
Factors
• Push sales of digital content by  Decline of music industry
Profitability Analysis focusing on that sector which is continues
increasing  Downward pressure on
Efficiency Analysis • Costs savings prices
Focus on few but popular  Failing to identify new artists
Liquidity & Solvency artists instead of investing in
Analysis due to attempt to save cost
new emerging artists
Push digital sales which are  Debt agreements contain
Future ROE: Risks restrictions that limit its
Future
and ROE
Prospects less costly than physical
sales flexibility in operating
• Combat piracy business
Unusal or Non-
Recurring Items If Warner‘s strategy to
combat piracy pays off, sales
Potential Investment could be improved

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.
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 6. Unusual or
Non-Recurring Items
• There are no unusual or non-recurring items in 2010 that need to
be included in the analysis.
Critical Success
Factors • 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)
Profitability Analysis • Thus, earnings are persistent and of high quality. The company
does not rely on unusual items to make earnings.
Efficiency Analysis • However, since Warner is afflicted by a big amount of debt (and in
consequence by a big amount of passive interest), its income
Liquidity & Solvency statement results in a net loss.
Analysis • Quailty of Earnings are high, but not high enough to cover the
interest expenses resulting from the large amount of debt.
Future ROE: Risks
and Prospects • Quality of Earnings Ratio = Cash Flow from Operating
Activities / Net Income
Unusual/Non-
Unusal or Non- – Quality of Earnings Ratio = -12 / -143* = 0.0832
Recurring Items
Recurring Items – Ratio cannot be used due to the fact that both cash flow from
operating activities as well as net income are negative.
Potential Investment
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
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 7. Potential Investment
• Based on the analysis, regarding the ROE and ROA and the overall trend of
Critical Success the industry, Warner Music Group is not a company potential investors are
likely to invest in.
Factors
• This is not necessarily due a poor management but rather due to the problems
Profitability Analysis that the music industry is facing in general (e.g. piracy).
• As already mentioned, the company‘s equity is negative, which is a warning
Efficiency Analysis 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
Liquidity & Solvency
over the past years (last year equity was positive was in 2006):
Analysis
Equity1
Future ROE: Risks 100
and Prospects 0 Equity is steadily
-100
2006 2007 2008 2009 2010 declining by large
Unusal or Non- amounts over the years
Recurring Items -200

-300
Potential Investment
Potential • However, if there was still a potential investor interested in investing in the
Investment 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.
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