EMI Corporate Finance Essay

In this Internet age, the consumer is exploitation euphony content more(prenominal) than ever before whether thats playlisting, podcasting, personalizing, sharing, downloading or sightly simply enjoying it. The digital revolution has caused a complete change to the culture, operations, and posture of practice of medicine companies everywhere. It hasnt been easy, and we must certainly continue to fight plagiarization in any its forms. But thither can be no doubt that with even greater commitment to innovation and a unfeigned focus on the consumer, digital distribution is be feeler the outperform amour that ever happened to the medication commercial enterprise and the music fan.Eric Nicoli, CEO, EMI Group1In first bombardment of 2007, Martin Stewart drove through and through the darkened streets of Kensington in West London. As foreman financial forwardicer (CFO) for global music giant EMI, Stewart already k virgin near of the intelligence learning that would break at the comp any(prenominal)s April 18 wages announcement. Annual underlying revenue for the company was down 16% to GBP 1.8 meg (British pounds). Earnings per piece of land (EPS) had also dropped from 10.9 pence (p) in 2006 to 36.3p in FY2007 ( financial year). Those disappointing numbers pool were roughly in line with the guidance Stewart had given investors in February. The carrying out reflected the global decline in music sedulousness revenues, as swell up as the extraordinary hail of the restructuring course EMI was pursuing to realign its enthronement priorities and focus its resources to achieve the best returns in the future. The earnings announcement would accommodate an announcement of the dividend amount, which had non yet been determined. The board would meet soon to look back EMIs annual results,International Federation of Phonographic Industry (IFPI), IFPI 07 Digital practice of medicine Report, January 2007.This case was written by Elizabeth W. Shumadin e (MBA 01), under the supervision of Professor Michael J. Schill, ground on public information. Funding was provided by the L. White Matthews Fund for pay case writing. Copyright 2008 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, shine an e-mail to gross gross salesdardenbusiness issue.com. No part of this publication may be reproduced, rememberingd in a retrieval system, used in a spread ragtime, or transmitted in any form or by any means electronic, mechanical, photocopying, ushering, or otherwisewithout the permission of the Darden School Foundation. Rev. 2/09..2 On an annual basis, EMI had consistently remunerative an 8p-per-sh atomic number 18 dividend to ordinary shareholders since 2002 ( register 1). Now in discharge of EMIs modern performance, Stewart questioned whether EMI should continue to maintain what would represent a unite GBP 63- one million million annual dividend payment. Although omi tting the dividend would preserve cash, Stewart appreciated the negative effect the decision magnate have on EMIs share price, which was actually at 227p. Stewart recognise that EMI faced consider qualified threat of a takeover. Although its board had recently been able to victoryfully reject an unsolicited 260p-per-share merger maintain from U.S. rival Warner Music, thither remained considerable outside interest in pickingsover EMI. It seemed that boosting EMIs share price was imperative if EMI was to maintain its independence.EMIWith a storied fib that include such names as the Beatles, the Beach Boys, Pink Floyd, and Duran Duran, it was non difficult to understand why EMI considered its current and historical catalogue of songs and recordings among the best in the world. EMI, Warner Music Group, Sony BMG Music Entertainment, and Universal Music Group, collectively cognize as the majors, dominated the music industry in the early twenty-first century and accounted for more than dickens-thirds of the worlds recorded music and produce sales.3 shew 2 contains a list of the global top-10 record albums with their respective record labels for the abide four years. Recorded music and music produce were the two main revenue drivers for the music industry. EMI divided its organization into two alike(p) divisions. EMI Music, the recorded-music side, sought out artists it believed would be long-term commercial recording successes. distributively EMI record label securities industryed its artists recordings to the public and change the releases through a variety of retail outlets. EMIs extensive music catalog consisted of more than 3 million songs. Recorded-music division sales came from both refreshing and old recordings with existing catalog albums constituting 30% to 35% of the divisions unit sales. Exhibit 3 contains a list of EMIs well-nigh successful recording artists in FY2007. EMI Music Publishing focused not on recordings but on the songs the mselves. Generally, in that location were three categories of publishing-rights ownership in the music industry the lyrics author, the musics composer, and the publishing firm who acquired the right to exploit the song. These publishing-rights owners were entitled to royalties whenever and however their music was used. Music publishers categorise their revenue streams as mechanical royalties (sales of recorded 2In the fall in Kingdom, companies typically declared dividends twice a year, first with the midyear results and due south with the full-year results. Typically, EMI paid an temporary dividend of 2p per share and a final dividend of 6p per share. In addition, both EMIs interim and final dividends were paid out to shareholders in the following pecuniary year. In November 2006,EMIs board committed to paying the interim dividend of 2p per share following its 2007 fiscal midyear results with actual payment to shareholders evaluate in April 2007. both(prenominal) the 2p in terim dividend and the recommended final dividend would be reflected in the 2008 financial statements. 3EMI included a fourth category of royalties labeled other, which included sales of sheet music and, makeively, mobile ring tones and ring backs. Similar to the recorded-music division, the music-publishing division set songwriters with commercial capability and signed them to long-term contracts. The division then assisted the songwriters in marketing their works to record companies and other media firms. EMIs current publishing catalog encompassed more than 1 million musical compositions. Exhibit 3 includes a list of EMIs most-successful songwriters in FY2007. EMIs publishing business generated onefourth of the total group revenue. Revenue in the publishing business was stable, andoperating benefits were positive.In addition to seeking out and subscribe flourishing recording artists and songwriters to long-term agreements, both EMI divisions also strained and intensify th eir individual catalogs and artist rosters by strategic proceedings. Two key eruditenesss for EMIs recorded-music division were the 1955 acquisition of a leading American record label, Capitol Records, and the 1992 acquisition of Virgin Music Group, then the roundst independent record label. Together the transactions added such key recording stars as Frank Sinatra, Nat King Cole, Janet Jackson, and the whorl Stones. The music-publishing division similarly targeted existing publishing assets with large, proven commercial potential such as the purchase in various stages of Motown founder cull Gordys music catalog in 1997, 2003, and 2004.Since the companys existence in 1897, EMIs model had been that of constantly seeking to expand their catalog, with the hits of straight off forming the classics of tomorrow.4 Both divisions pursued the goal of having the top-selling artists and songwriters and the deepest, mostrecognized catalog assets. EMI welcomed technological innovations, wh ich lots drove increased music sales as consumers updated their music collections with the in style(p) music medium (e.g., replacing an LP or cassette with the same recording on compact disc). But the latest technology, digital audio on the Internet, was distinguishable and revolutionary. Digital audio on the Internet demanded re sound offing the business model of all the majors, including EMI.Digital Audio and the Music IndustryDigital audio had been well-nigh since the advent of the compact disc (CD) in the early 1980s, but the nineties combination of digital audio, Internet, and MP3 file format brought the music industry to a new crossroads. The MP3 format had nearly the same sound quality as CDs, but its small file size allowed it to be easily downloaded from the Internet, stored on a computer hard drive, and transferred to a digital audio player, for the most part referred to as an MP3 player. Peer-to-peer file-sharing Internet services, most notably Napster, emerged in th e late 1990s. initiatory available in mid-1999, Napster facilitated the exchange of music files. The use of Napsters file-sharing program exploded, and Napster claimed 20 million users by July 2000.EMI Group PLC annual report, 2007.Napsters lively growth did not go unnoticed by the music industry. season the Recording Industry Association of America (RIAA) was eventually successful in using the court system to force Napster to remove copyrighted material, it did not stop peer-to-peer file sharing. New services were quickly developed to set back Napster. The International Federation of the Phonographic Industry (IFPI), an organization representing the recording industry worldwide, estimated that well-nigh 20 billion songs were downloaded illicitly in 2005.EMI was an early presence on the Internet in 1993. In 1999, EMI artist David Bowies 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 prep ared, however, for how quickly peer-to-peer file sharing would change the kinetics of the music industry and become a seemingly permanent irritant in the music industrys side. In the wake of Napsters demise, the music labels, including EMI, attempted various subscription services, but most failed for such reasons as cost, CDburning restrictions, and incompatibility with available MP3 players. Only in the spring of 2003, when Apple launched its easy Web site, iTunes Music Store, did legitimate digital-audio sales really take off in the United States, the worlds largest music market. Apple began to expand iTunes globally in 2004 and sold its one-billionth download in February 2006.harmonize to the IFPI, there were500 legitimate on-line music services in more than 40 countries by the beginning of 2007, with $2 billion in digital music sales in 2006. Despite the rise of legally downloaded music, the global music market continue to shrink due to the rapid decline in physical sales. N ielsen SoundScan noted that total album units sold (excluding digital- footprint equivalents) declined almost 25% from 2000 to 2006.5 IFPI optimistically predicted that digital sales would compensate for the fall down in physical sales in 2006, yet in early 2007, IFPI admitted that this holy grail had not yet occurred, with 2006 overall music sales estimated to have declined by 3%.6 IFPI now hoped digital sales would occur the decline in physical sales in 2007.Credit Suisses Global Music Industry Forecasts incorporated this view with a comparatively flat music market in 2007 and minor growth of 1.1% to 1.5% in 2008 and 2009.7 The Credit Suisse analyst also noted that the music industrys operating banks were expected to rise as digital sales became more significant and related production and distribution costs declined.8 Lehman Brothers was more conservative, take for granted a flat market for the close few years and commenting that the continued weakness in early 2007 implied t hat the market could remain tough for the next 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 entire album at a physical retail storewould put negative pressure on music sales for the foreseeable future. A Bear Stearns research report notedWhile music consumption, in terms of listening time, is increasing 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 power of heavy(p) 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.10Recent Developments at EMIThe last few years had been unbelievably difficult, particularly 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 EMIs financial statements through FY2007.) Fortunately, downloadable digital audio did not have a similar harmful effect on the publishing division. EMIs publishing sales were a small buffer for the companys performance and hovered in a tight range of GBP 420 million to GBP 391 million during that period. CEO Eric Nicolis sell at the July 2006 annual general meeting indicated good things were in store for EMI in both the short term and the long term. Nicoli stressed EMIs exciting upcoming release schedules, growth in digital sales, and success with restructuring plans. EMIs digital sales were growing and stand for an increasingly large percentage 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 bounteous the digital revenue to GB P 112 million, which represented 5.4% of total group revenues.The expected 2007 digital sales for EMI were close to 10% of group revenues. Given the positive expectations for its 2007 fiscal year, financial analysts had expected EMIs recorded-music division to see positive sales growth during the year. EMIs surprising negative earnings guidance on January 12 quickly changed its outlook. EMI disclosed that the music industry and EMIs second half of the year releases had underperformed its expectations. While the publishing division was on track to achieve its goals, EMIs 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.With barter volume nearly 10 times the previous days volume, EMIs market capitalization ended up down more than 7%. EMI further shocked the investment community with some other(prenominal) profit warning just one month later. On February 14, the company inform tha t the recorded-music divisions FY2007 revenues would actually decrease by about 15% year-over-year. EMI found its new dismal forecast on worsening market conditions in North America, where SoundScan had calculated that the physical music market had declined 20% in 2007. The investment community punished EMI more severely subsequently this second surprise profit warning, and EMIs stock price dropped another 12%. British newspaper The Daily Telegraph reported shareholders were increasingly disgruntled with performance surprises. single shareholder allegedly said, I recover Nicolis 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 merchant ship of the numbers. EMI analyst Redwan Ahmed of Oriel Securities also decried EMI perplexitys recent news Its disastrous they give themselves a big 6% to 10% range and a mo nth later say its 15%. They have lost all credibility. I also think the dividend is freeing to get slashed to about 5p.11 Exhibit 6 contains information on EMIs shareholder profile.As its fiscal year came to a close, EMIs internal reports indicated that its February 14 forecast was close to the mark. The recorded-music divisions revenue was down, and profits were negative. The publishing-division revenue was essentially flat, and its divisions margin improved 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 watchfulness planned to make a joint announcement with Apple in the next few days that it was going 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.Management was pleased with the progress of the restructuring program announced with the January profit warning. The plan was being implemented quicker than expected and, accordingly, more cost savings would be realized in FY2008. The program was going to cost closer to GBP 125 million, as unconnected to the GBP 150 million previously announced. Upon completion, the program was expected to remove GBP one hundred ten million from EMIs 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 forrevenue 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 di vision.The Dividend DecisionSince the board had already declared an interim dividend of 2p per share in November 2006, the question was whether to maintain the past payout level by recommending that an additional 6p final EMI dividend be paid. Considering EMIs struggling financial situation, there was good reason to question the wisdom of paying a dividend. Exhibit 7 provides a forecast of the cash flow effects of maintaining the dividend, based on market-based forecasts of 11Alistair Osborne, Nicoli a dead duck as EMI issues new warning, Daily Telegraph, February 16, 2007. Restructuring efforts over the previous three years had collectively rescue the company GBP 180 million annually however, the result was a one-time instruction execution cost of GBP 300 million.Omitting the dividend, however, was likely to send a message that management had lost confidence, potentially accelerating the ongoing stock price declinethe last thing EMI needed to do.13 (Exhibit 9 depicts trends in th e EMI share price from may 2000 to May 2006.) Many believed that music industry economics were on the term of turning the corner. A decision to maintain the historical 8p dividend would emphasize managements expectation of business improvement despite the disappointing recent financial news. Forecasts for global economic growth continued to be tender(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 convinced there was still a lot going for EMI.Historically, there was strong certainty of significant negative stock-price reactions to dividend cancellations (see Balasingham Balachandran, John Cadle, and Michael Theobald, Interim Dividend Cuts and Omissions in the U.K., European financial Management 21 (March 1996), 2338, for a study using only British firms, a nd Roni Michaely, Richard Thaler, and Kent Womack, Price Reactions to Dividend Initiations and Omissions Overreaction of Drift? Journal of Finance, 50, 2 (June 1995), 573608, for a larger study using U.S. firms. Both academics and practitioners vigorously debated the impact of dividend policy. In fact, Nobel laureate economists had argued that dividend policy should maintain little relevance to investors. Exhibit 8 contains a summary of Modigliani and Miller arguments.