'EMI Corporate Finance Essay\r'

'In this pays age, the consumer is using symphony content much than than ever forrader†whether that’s play appointing, podcasting, personalizing, sh atomic number 18, transfering or just simply enjoying it. The digital revolution has ca habituated a complete change to the culture, operations, and positioning of harmony companies everywhere. It hasn’t been easy, and we must certainly overcompensate to fight piracy in all its forms. only when there can be no dubiousness that with even greater commitment to innovation and a true focus on the consumer, digital distri scarceion is becoming the best thing that ever happened to the medical specialty byplay and the euphony fan.\r\nâ€Eric Nicoli, CEO, EMI Group1\r\nIn untimely alternate of 2007, Martin Stewart drove through the darkened streets of Kensington in westward London. As chief monetary officer (CFO) for spheric medical specialty giant EMI, Stewart already knew virtually of the give-a nd-take that would break at the order’s April 18 payment announcement. Annual underlying tax income for the comp all was down 16% to GBP 1.8 billion (British pounds). Earnings per partake in (EPS) had similarly dropped from 10.9 pence (p) in 2006 to âˆ36.3p in FY2007 ( monetary surgical incision). Those disappointing be were roughly in line with the counselor-at-law Stewart had given(p) investors in February. The performance reflected the global descent in unison labor revenues, as well as the extra ordinary monetary value of the restructuring program EMI was pursuing to line up its coronation priorities and focus its resources to achieve the best returns in the future. The earnings announcement would include an announcement of the dividend amount, which had non yet been determined. The board would meet soon to check up on EMI’s annual results,\r\nInternational Federation of Phonographic industriousness (IFPI), â€Å"IFPI: 07 digital Music Report,â € January 2007.\r\nThis case was written by Elizabeth W. Shumadine (MBA ’01), under the supervision of Professor Michael J. Schill, base on customary information. brothing was provided by the L. W lookere Matthews Fund for Finance case writing. Copyright © 2008 by the University of perfect(a)ia Darden cultivate Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to gross sales@dardenbusiness sire.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any delegacy†electronic, mechanical, photocopying, save, or otherwiseâ€with a appearance the permission of the Darden School Foundation. Rev. 2/09.\r\n.2 On an annual basis, EMI had consistently paid an 8p-per- grant dividend to ordinary shareowners since 2002 ( aim 1). Now in light of EMI’s late(a) performance, Stewart questioned whether EMI should continue to notice what would r epresent a feature GBP 63- meg annual dividend payment. Although omitting the dividend would preserve cash, Stewart appreciated the minus egress the decision might have on EMI’s share footing, which was underwayly at 227p. Stewart recognized that EMI go about considerable threat of a takeover. Although its board had tardily been able to successfully reject an unsolicited 260p-per-share nuclear fusion reaction declare from U.S. rival Warner Music, there remained considerable right(prenominal) interest in taking over EMI. It seemed that boosting EMI’s share price was imperative if EMI was to maintain its independence.\r\nEMI\r\nWith a storied history that included such name as the Beatles, the Beach Boys, Pink Floyd, and Duran Duran, it was non rugged to understand why EMI considered its current and historical catalog of songs and recordings among the best in the introduction. EMI, Warner Music Group, Sony BMG Music Entertainment, and ecumenical Music Grou p, collectively k like a shotn as â€Å"the majors,” henpecked the medicament persistence in the early twenty- premier century and accounted for more(prenominal) than two-thirds of the world’s record music and issue sales.3 uncover 2 contains a list of the global top-10 phonograph albums with their respective record labels for the eventually four course of instructions. Recorded music and music make were the two main revenue drivers for the music industry. EMI shared its organization into two corresponding theatrical roles. EMI Music, the recorded-music side, sought out creative persons it believed would be long-run commercial recording successes.\r\n all(prenominal) EMI record label commercializeed its artist’s recordings to the public and sold the releases through a variety of sell outlets. EMI’s extensive music catalog consisted of more than 3 one thousand million songs. Recorded-music division sales came from twain new and old recor dings with existing catalog albums constituting 30% to 35% of the division’s unit sales. shew 3 contains a list of EMI’s most successful recording artists in FY2007. EMI Music publish focused non on recordings and on the songs themselves. Generally, there were three categories of publishing-rights ownership in the music industry: the lyric’s author, the music’s composer, and the publisher who acquired the right to exploit the song. These publishing-rights owners were entitled to royalties whenever and even so their music was used. Music publishers categorized their revenue streams as mechanical royalties (sales of recorded 2\r\nIn the join Kingdom, companies typically declared dividends twice a year, first with the midyear results and second with the full-year results. Typically, EMI paid an meantime dividend of 2p per share and a final dividend of 6p per share. In entree, two EMI’s interim and final dividends were paid out to shareholders in the chase fiscal year. In November 2006, EMI’s board pull to paying the interim dividend of 2p per share following its 2007 fiscal midyear results with actual payment to shareholders expect in April 2007. both(prenominal) the 2p interim dividend and the recomm finish final dividend would be reflected in the 2008 financial statements. 3\r\nEMI included a fourth course of instruction of royalties labeled â€Å"other,” which included sales of sheet music and, increasingly, mobile ring tones and ring backs. Similar to the recorded-music division, the music-publishing division identified songwriters with commercial possible and signed them to long-term contracts. The division then assisted the songwriters in marketing their works to record companies and other media firms. EMI’s current publishing catalog encompassed more than 1 million musical compositions. Exhibit 3 includes a list of EMI’s most-successful songwriters in FY2007. EMI’s publish ing business generated onefourth of the union group revenue. Revenue in the publishing business was stable, and operating profits were positive.\r\nIn addition to seeking out and signing flourishing recording artists and songwriters to long-term agreements, both EMI divisions also set offed and deepen their individual catalogs and artist rosters by strategic transactions. ii key acquisitions for EMI’s recorded-music division were the 1955 acquisition of a leading the Statesn record label, Capitol Records, and the 1992 acquisition of Virgin Music Group, then the largest independent record label. unitedly the transactions added such key recording stars as Frank Sinatra, Nat King Cole, Janet Jackson, and the Rolling Stones. The music-publishing division also targeted existing publishing assets with large, proven commercial potential such as the purchase in various(a) stages of Motown founder Berry Gordy’s music catalog in 1997, 2003, and 2004.\r\nSince the caller- out’s founding in 1897, EMI’s impersonate had been that of â€Å"constantly seeking to expand their catalog, with the hits of to twenty-four hour period forming the classics of tomorrow.”4 Both divisions pursued the polish of having the top-selling artists and songwriters and the deepest, mostrecognized catalog assets. EMI welcomed technological innovations, which often drove increase music sales as consumers updated their music collections with the in vogue(p) music medium (e.g., replacing an LP or cassette with the homogeneous recording on squeeze disc). But the in vogue(p) technology, digital sound recording on the Internet, was different and revolutionary. Digital audio on the Internet demanded re withdrawing the business model of all the majors, including EMI.\r\nDigital Audio and the Music manufacturing\r\nDigital audio had been around since the advent of the compact disc (CD) in the early 1980s, but the nineties combination of digital audio, Inte rnet, and MP3 file format brought the music industry to a new crossroads. The MP3 format had close to the same sound quality as CDs, but its small file size allowed it to be soft downloaded from the Internet, stored on a computer hard drive, and transferred to a digital audio player, generally referred to as an MP3 player. Peer-to-peer file-sharing Internet services, most notably Napster, emerged in the late 1990s. graduation exercise acquirable in mid-1999, Napster facilitated the exchange of music files. The use of Napster’s file-sharing program exploded, and Napster claimed 20 million users by July 2000.\r\nEMI Group PLC annual report, 2007.\r\nNapster’s swift increase did not go unnoticed by the music industry. While the Recording assiduity Association of America (RIAA) was eventually successful in using the coquet system to force Napster to re affect copyrighted material, it did not stop peer-to-peer file sharing. New services were pronto developed to repla ce Napster. The International Federation of the Phonographic Industry (IFPI), an organization representing the recording industry worldwide, estimated that almost 20 billion songs were downloaded illegally in 2005.\r\nEMI was an early charge on the Internet in 1993. In 1999, EMI artist David Bowie’s album, hours…, was the first album by a major recording artist to be released for download from the Internet. None of the record labels were prepared, however, for how quickly peer-to-peer file sharing would change the dynamics of the music industry and force a seemingly permanent thorn in the music industry’s side. In the put forward of Napster’s demise, the music labels, including EMI, attempted various subscription services, but most failed for such basiss as cost, CDburning restrictions, and incompatibility with available MP3 players. Only in the spring of 2003, when Apple launched its user-friendly Web site, iTunes Music Store, did legitimate digital-a udio sales really take off in the United States, the world’s largest music market. Apple began to expand iTunes globally in 2004 and sold its one-billionth download in February 2006.\r\nAccording to the IFPI, there were 500 legitimate on-line music services in more than 40 countries by the beginning of 2007, with $2 billion in digital music sales in 2006. scorn the hook of legally downloaded music, the global music market act to shrink due to the rapid ebb in physiologic sales. Nielsen SoundScan noted that total album units sold (excluding digital- drag equivalents) declined almost 25% from 2000 to 2006.5 IFPI optimistically predicted that digital sales would compensate for the decrease in physiological sales in 2006, yet in early 2007, IFPI admitted that this â€Å"holy grail” had not yet occurred, with 2006 boilersuit music sales estimated to have declined by 3%.6 IFPI now hoped digital sales would overtake the decline in physical sales in 2007.\r\n impute Suis se’s Global Music Industry Forecasts corporal this view with a relatively flat music market in 2007 and minor egress of 1.1% to 1.5% in 2008 and 2009.7 The Credit Suisse analyst also noted that the music industry’s operating margins were expected to rise as digital sales became more material and related production and distribution costs declined.8 Lehman Brothers was more conservative, assuming a flat market for the nigh few years and commenting that the continued weakness in early 2007 implied that the â€Å"market could remain tough for the contiguous couple of years.”9 Many in the industry feared that consumers’ ability to unbundle their music purchases†to purchase two or three favorite songs from an album on-line versus the wide-cut album at a physical sell storeâ€would put negative pressure on music sales for the foreseeable future. A adopt Stearns research report noted:\r\nWhile music consumption, in terms of listening time, is incre asing as the iPod and other portable devices have become mass-market products, the industry has still not found a way of monetizing this consumption. Instead, growing piracy and the unbundling of the album, combined with the growing office of big retailers in the physical and iTunes in the digital worlds, have left the industry in a funk. There is no immediate solution that we are aware of on the horizon and in our view, visibility on sales remains poor.10\r\nRecent Developments at EMI\r\nThe last few years had been incredibly difficult, peculiarly within EMI’s recordedmusic division, where revenues had declined 27% from GBP 2,282 million in 2001 to GBP 1,660 million in 2006. (Exhibits 4 and 5 show EMI’s financial statements through FY2007.) Fortunately, downloadable digital audio did not have a similar unhealthful effect on the publishing division. EMI’s publishing sales were a small buffer for the company’s performance and hovered in a closemouthed range of GBP 420 million to GBP 391 million during that period. CEO Eric Nicoli’s address at the July 2006 annual general collision indicated good things were in store for EMI in both the short term and the long term. Nicoli stressed EMI’s exciting upcoming release schedules, growth in digital sales, and success with restructuring send offs. EMI’s digital sales were growing and represented an increasingly large character of total revenues. In 2004, EMI generated group digital revenues of GBP 15 million, which represented just less than 1% of total group revenues. By 2006, EMI had grown the digital revenue to GBP 112 million, which represented 5.4% of total group revenues.\r\nThe expected 2007 digital sales for EMI were close to 10% of group revenues. tending(p) the positive candidates for its 2007 fiscal year, financial analysts had expected EMI’s recorded-music division to see positive sales growth during the year. EMI’s surprising negative e arnings guidance on January 12 quickly changed its outlook. EMI disclosed that the music industry and EMI’s second half of the year releases had underperformed its expectations. While the publishing division was on track to achieve its goals, EMI’s recorded-music division revenues were now expected to decline 6% to 10% from one year ago. The market and investor community reacted swiftly to the news.\r\nWith trading hoi polloi nearly 10 times the previous day’s volume, EMI’s market capitalization ended up down more than 7%. EMI barely shocked the investment community with another profit warning just one month ulterior. On February 14, the company announced that the recorded-music division’s FY2007 revenues would truly decrease by about 15% year-over-year. EMI based its new dismal forecast on turn market conditions in North America, where SoundScan had calculated that the physical music market had declined 20% in 2007. The investment community p unished EMI more severely later this second surprise profit warning, and EMI’s telephone line price dropped another 12%. British publisher The day-after-day Telegraph reported shareholders were increasingly dissatisfy with performance surprises.\r\n superstar shareholder allegedly said, â€Å"I think [Nicoli]’s a dead duck. [EMI] is now very vulnerable to a [takeover] bid, and Nicoli is not in any position to defend anything. I think the finance director [Martin Stewart] has also been tainted because it suggests they did not get to the bottom of the numbers.” EMI analyst Redwan Ahmed of Oriel Securities also decried EMI oversight’s juvenile news: â€Å"It’s disastrous … they give themselves a big 6% to 10% range and a month later say it’s 15%. They have missed all credibility. I also think the dividend is pass to get slashed to about 5p.”11 Exhibit 6 contains information on EMI’s shareholder profile.\r\nAs its f iscal year came to a close, EMI’s internal reports indicated that its February 14 forecast was close to the mark. The recorded-music division’s revenue was down, and profits were negative. The publishing-division revenue was essentially flat, and its division’s margin better as a result of a smaller cost base. The company expected underlying group earnings before interest, taxes, depreciation, and amortization (EBITDA), before exceptional items, to be GBP 174 million, which exceeded analysts’ estimates. Digital revenue had grown by 59% and would represent 10% of revenue. EMI way planned to make a joint announcement with Apple in the next few days that it was sacking to be the first major music company to offer its digital catalog free from digital-rights management and with improved sound quality. The new format would sell at a 30% premium. EMI management expected this move would drive increased digital sales.\r\nManagement was cheerful with the progr ess of the restructuring program announced with the January profit warning. The plan was being implemented quicker than expected and, accordingly, more cost nest egg would be realized in FY2008. The program was going to cost closer to GBP cxxv million, as opposed to the GBP 150 million previously announced. Upon completion, the program was expected to remove GBP 110 million from EMI’s annual cost base, with the majority of savings coming from the recorded-music division. The plan reduced layers in the management structure and encouraged the recorded-music and publishing divisions to work more closely together for revenue and cost synergies.12 One headline-worthy change in the reorganization was the surprise removal of the recorded-music division head, Alain Levy, and Nicoli taking direct responsibility for the division.\r\nThe Dividend decision\r\nSince the board had already declared an interim dividend of 2p per share in November 2006, the question was whether to maintai n the past payout aim by recommending that an additional 6p final EMI dividend be paid. Considering EMI’s struggling financial situation, there was good reason to question the wisdom of paying a dividend. Exhibit 7 provides a forecast of the cash go effects of maintaining the dividend, based on market-based forecasts of 11\r\nAlistair Osborne, â€Å"Nicoli ‘a dead duck’ as EMI issues new warning,” Daily Telegraph, February 16, 2007. Restructuring efforts over the previous three years had collectively saved the company GBP 180 million every year; however, the result was a one-time implementation cost of GBP ccc million.\r\nOmitting the dividend, however, was likely to send a message that management had lost confidence, potentially accelerating the ongoing stock price declineâ€the last thing EMI needed to do.13 (Exhibit 9 depicts trends in the EMI share price from may 2000 to May 2006.) Many believed that music industry economics were on the verge of turning the corner. A decision to maintain the historical 8p dividend would emphasize management’s expectation of business improvement despite the disappointing recent financial news. Forecasts for global economic growth continued to be strong (Exhibit 10), and reimbursements to shareholders through dividends and repurchases were on the upswing among media peers (Exhibit 11). As Stewart navigated his way home, the radio played another hit from a well-known EMI artist. Despite the current difficulties, Stewart was convince there was still a lot going for EMI.\r\nHistorically, there was strong evidence of significant negative stock-price reactions to dividend cancellations (see Balasingham Balachandran, John Cadle, and Michael Theobald, â€Å"Interim Dividend Cuts and Omissions in the U.K.,” European pecuniary Management 2:1 (March 1996), 23â€38, for a study using only British firms, and Roni Michaely, Richard Thaler, and Kent Womack, â€Å" toll Reactions to Divid end Initiations and Omissions: Overreaction of Drift?” Journal of Finance, 50, 2 (June 1995), 573â€608, for a larger study using U.S. firms. Both academics and practitioners vigorously debated the blow of dividend policy. In fact, Nobel laureate economists had argued that dividend policy should maintain precise relevance to investors. Exhibit 8 contains a abstract of Modigliani and Miller arguments.\r\n'