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?

1. 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)

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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.

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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