The main takeaway from Thursday’s news of EMI’s huge loss in its last fiscal year? Don’t overpay for an established company in an industry challenged by technological change.
As widely reported, EMI had an accounting loss of about 1.56 billion pounds in its fiscal year ended March 2009. That huge loss includes a one-time charge of 1.04 billion pounds to reflect a lower value of EMI. A restructuring charge of 412 million pounds also pulled down earnings.Accounting profit and loss is not necessarily an accurate reflection of a company’s performance. Unfortunately, many reports have not done an adequate job of explaining the one-time write down.
That charge is an operating expense but is the result of past errors — an on-paper admission by Terra Firma that EMI is not worth what it thought it was worth. Just as many U.S. homeowners are underwater on their mortgages — meaning they owe more than the house is worth. Terra Firma was underwater on EMI. Thus, it has written down its investment in the company to better reflect its actual value.
It’s best to separate EMI’s acquisition-related issues from its actual operational performance. The interest expense paid on EMI’s debt is a function of the acquisition price. The debt covenants, which become higher hurdles over time, are influenced by the amount of debt assumed when acquiring EMI.
But because effects of both the acquisition and operations intermingle in EMI’s numbers, it’s hard to say just how successful the company’s transformations have been.
Numbers released by EMI last November showed a 7.4% increase in revenue to 1.56 billion and a 81% increase in EBITDA to 298 million pounds. Publishing looks healthy, and recorded music improved. But we do not know how the operational performance would look if EMI did not have the interest expense of a company saddled with too much debt. We don’t even know the degree to which currency fluctuations played a role in the improvements. We see few numbers — none of them independently audited — and try our best to fill in the blanks.
Instead of the firm metrics available for audited public companies, we have less concrete measures such as market share and Grammy Awards. We see artists like Radiohead leaving EMI, and we see new artists like Lady Antebellum and Katy Perry developing into legitimate stars. We see A&R at work, we see consumers engaged and spending money, but we don’t know everything between the top and bottom lines.
All we know is that EMI’s divisions are each fighting with one hand behind their backs. The overvalued acquisition price leaves a burden one or more of its divisions may not be able to overcome. Even if Terra Firma had paid far less for EMI, it would still have to deal with the massive, ongoing changes affecting music companies. At least in that case EMI’s divisions would have a more fair fight on their hands.
