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Transcript of Afhandling
BSc(IM) 6. semester Exam Group: S09 – 13,54 Authors: Pia Lundanes Mette D. Kremmling Advisor: Thomas Riis
Strategic Accounts Analysis and Valuation of Bang & Olufsen
Department of Business Studies The Aarhus School of Business
2009
1
Table of Content 1. Executive Summary ....................................................................................................................................... 4
2. Introduction ................................................................................................................................................... 5
2.1 Problem Statement ................................................................................................................................. 6
2.2 Method .................................................................................................................................................... 7
2.3 Delimitation ............................................................................................................................................. 9
3. Strategic Analysis ........................................................................................................................................... 9
3.1 Bang & Olufsen ...................................................................................................................................... 10
3.2 PESTEL-Analysis ..................................................................................................................................... 12
3.2.1 Political Aspects .............................................................................................................................. 12
3.2.2 Economic Aspects ........................................................................................................................... 13
3.2.3 Socio-Cultural Aspects .................................................................................................................... 14
3.2.4 Technological Aspects .................................................................................................................... 14
3.3 Porter’s 5 Forces. ................................................................................................................................... 15
3.3.1 Bargaining Power of Suppliers ........................................................................................................ 15
3.3.2 Bargaining Power of Buyers............................................................................................................ 16
3.3.3 Threat of New Entrants .................................................................................................................. 17
3.3.4 Threat of Substitutes ...................................................................................................................... 17
3.3.5 Competitive Rivalry......................................................................................................................... 18
3.4 Core Competencies................................................................................................................................ 18
3.5 Porter’s Generic Strategies .................................................................................................................... 19
3.6 BCG – Matrix .......................................................................................................................................... 20
3.6.1 Question marks ............................................................................................................................... 21
3.6.2 Stars ................................................................................................................................................ 21
3.6.3 Cash cows ....................................................................................................................................... 22
3.6.4 Dogs ................................................................................................................................................ 22
3.7 Conclusion on the strategic analysis – SWOT analysis .......................................................................... 22
3.7.1 Strengths ......................................................................................................................................... 23
3.7.2 Weaknesses .................................................................................................................................... 24
3.7.3 Opportunities.................................................................................................................................. 24
3.7.4 Threats ............................................................................................................................................ 24
3.8 Analysis of the New Pole Position Strategy 2008 .................................................................................. 25
4. Accounts Analysis ........................................................................................................................................ 26
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4.1 Reorganization of Accounting Statements ............................................................................................ 27
4.1.1 Reorganization of the Statement of Changes in Equity.................................................................. 27
4.1.2 Reorganization of the Balance Sheet ............................................................................................. 28
4.1.3 Reorganization of the Income Statement ...................................................................................... 29
4.2 Common Size- and Index Analysis ......................................................................................................... 30
4.3 Profitability ............................................................................................................................................ 31
4.3.1 Analysis of Return on Equity ........................................................................................................... 32
4.3.2 Analysis of Return on Invested Capital ........................................................................................... 33
4.3.3 Analysis of Profit Margin ................................................................................................................ 33
4.3.4 Analysis of Asset Turnover ............................................................................................................. 34
4.4 Financial Leverage ................................................................................................................................. 35
4.5 Growth and Permanent Income ............................................................................................................ 37
4.6 Liquidity Level ........................................................................................................................................ 40
4.7 Conclusion on Accounts Analysis ........................................................................................................... 42
5. Budgeting ..................................................................................................................................................... 44
5.1 Scenario one .......................................................................................................................................... 45
6. Valuation...................................................................................................................................................... 47
6.1 Choice of Model..................................................................................................................................... 48
6.1.1 The Dividend Model ....................................................................................................................... 48
6.1.2 The Free Cash Flow Model ............................................................................................................. 49
6.1.3 The Residual Income Model ........................................................................................................... 49
6.2 The Weighted Cost of Capital (wacc)..................................................................................................... 50
6.2.1 Estimating the Systematic Risk (β) ................................................................................................. 51
6.2.2 Estimation of the Required Rate of Return on Equity (��)............................................................. 52
6.2.3 Estimation of the Weighted Average Cost of Capital (wacc) .......................................................... 53
6.3 Valuation of B&O ................................................................................................................................... 55
6.4 Conclusion of the Valuation of B&O ...................................................................................................... 56
7. Alternative Scenario for the Future Economic Development ..................................................................... 57
7.1 Comparison of scenarios ....................................................................................................................... 57
8. Conclusion ................................................................................................................................................... 58
Bibliography ..................................................................................................................................................... 61
Appendix A – Exchange Rates .......................................................................................................................... 63
Appendix B – Euromonitor Data ...................................................................................................................... 65
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Appendix C – Reorganized Accounting Statements ........................................................................................ 66
Appendix D – Common Size Analysis ............................................................................................................... 70
Appendix E – Index Analysis ............................................................................................................................ 73
Appendix F – Calculations for Profitability Analysis ........................................................................................ 76
Appendix G – Calculations for Financial Leverage Analysis ............................................................................. 78
Appendix H – Growth and Permanent Income Calculations ........................................................................... 79
Appendix I – Calculations of Liquidity Level .................................................................................................... 82
Appendix J – Budgeting ................................................................................................................................... 83
Appendix K – Average Growth Rate of B&O .................................................................................................... 84
Appendix L – Estimation of the Systematic Risk (β) ........................................................................................ 85
Appendix M – Valuation of B&O ..................................................................................................................... 86
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1. Executive Summary (Written by Mette D. Kremmling)
This thesis has the purpose to evaluate Bang & Olufsen A/S (B&O) based on publicly available
information. A strategic analysis and an accounts analysis will function as the basis for a valuation
of the company and there through give a calculated value of the B&O stock. Hence, the thesis will
be of interest for investors, as it will show whether or not the B&O stock is valued correctly in the
market.
B&O is a Danish audio/visual company with operations throughout the world that are targeting the
high-end consumer market through a strong focus on quality and design. The strategic analysis of
B&O depicts a company that should be flourishing, as consumers are increasingly valuing good
design in audio/visual products. However, the main competition of B&O has also increased their
focus on design and is now offering well-designed audio/visual products at a fraction of the price of
B&O products. Furthermore, there seem to have been a tendency for B&O to defocus on their core
products and concentrate on a wider product portfolio, which have not paid off. Lastly B&O is se-
verely affected by the financial crisis, as luxury products are among the first product groups to feel
decreasing disposable income among consumers. B&O have recently initiated a strategy to refocus
on their core products, but still need to find areas to excel above its competition in order to keep its
brand value and be able to charge premium prices in the future as well.
By looking at the annual reports from the financial year 2004/05 to 2007/08, it can be seen that the
general development of B&O’s return has been positive until 2006/07. This positive development
was driven by higher profit margins from sales, increased financial leverages, and at first also
through increasing asset turnovers. However, the analysis also shows some negative underlying
trends. Already from the beginning of the analyzed period, a decreasing level of liquidity was seen,
leading to B&O needing extra capital in the current financial year, which they plan to acquire
through a share issue. Furthermore, from 2005/06 the asset turnover started decreasing indicating
excessive inventory buildup. These factors became increasingly important as the financial crisis had
its effect on the annual report of 2007/08, where sales decreased radically and thus decreased the
return significantly. A major factor for the decrease in the level of return, can also be found in the
general expense level, which B&O have not been able to fit to the new lowered sales level in
2007/08.
As theoretical basis for the valuation of B&O the Residual Income Model is used. This model
draws on the company’s own capabilities of valuing their own assets, and thus put large emphasis
on the booked values of the company’s assets and less on the projected future return. As the value
5
of B&O’s equity in the market is valued below the booked value, it must thus be expected that the
market quote for the B&O share will be lower than the estimated value in this thesis. This proved to
be true as the value was calculated to 411,88 DKK/share against the quote of 72,00 DKK on March
25th 2009.
Hence this thesis indicates that the B&O share at the moment is undervalued, and an investor would
thus be able to profit from buying B&O shares.
2. Introduction (Written by Pia Lundanes)
During the last months the financial crisis has affected the business world in various aspects. The
world market has been facing a recession, and companies as well as private investors and consum-
ers have had to deal with difficult economic conditions. There is reason to believe that many world
markets have been overheated in the last few years, and that they have experienced growth rates far
beyond normal levels. Consumers have had a large disposable income and have not been afraid to
spend. This suddenly came to an end as the crisis started. According to George Soros, the crisis in
the world markets today is a result of a superboom which has lasted for more than 60 years. A
breakdown of the western markets was therefore unavoidable (Pedersen 2008).
One of the markets which has been facing sky-scraping growth rates in the last decade, is the con-
sumer electronic market which has seen growth rates of up to 10% in the last years (Nikolajsen
2008). Bang & Olufsen (B&O) has had great success in the past, and had its share of the significant
growth rates in the consumer electronics market. However, as B&O are selling what can be classi-
fied as luxury products, the impact of the financial crisis has been especially significant for the
company as consumers have turned away from luxury products as the crisis has expanded (Bjerrum
2009).
As B&O has been facing disappointing sales levels in the last accounting year, the management has
several times been forced to adjust their expectations for the result of the accounting year 2007/08.
In addition, the company has had to lay off rather many employees in order to keep cost levels
down (Bang & Olufsen). This has naturally contributed to a lack of confidence from B&O’s inves-
tors and has led to a drastic decrease of the company’s stock value which hit its lowest level in sev-
eral years in December 2008 (Børsen). The development in the stock price has however improved
during the last few months and the surprising increase in the World Luxury Market Index during the
last month might show signs of better times ahead for B&O (Bjerrum 2009).
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Investors are now interested in finding out whether or not the current stock value of B&O is over-
or undervalued compared to the real value of the company.
2.1 Problem Statement (Written by Pia Lundanes)
This paper will determine whether or not the B&O stock is a good investment for investors. A stra-
tegic analysis and an accounts analysis will be prepared based on publicly available information in
order to determine the present value of Bang & Olufsen A/S. This will be done in order to deter-
mine whether the market value of the stocks is in accordance with the actual value of the company.
In a static world, it would be sufficient only to look at historical data to predict the future. The con-
sumer electronics market today is however constantly evolving. It is therefore necessary to perform
a strategic analysis of companies in order to be able to measure the relevant changes in the value
drivers (Elling and Sørensen 2005: p. 18). In relation to B&O’s strategy the following questions
will be investigated:
• How are external and internal factors affecting Bang & Olufen as a company?
• How is the resulting situation expected to change with the implementation of the new strate-
gy?
The historical data will together with the strategic analysis provide a sound base of information to
make predictions of the future operations of B&O. The question that will be answered by perform-
ing an historical accounts analysis is as follows:
• How is the current economic state of Bang & Olufsen? And how has the development been
the last four years?
To find the present value of B&O, the answers to the above mentioned questions will be the base
for the future budgets and thereby the valuation of the company. The last sections will seek to an-
swer the following:
• How are important financial ratios expected to change in the next eight years, based on the
historical values and the strategic analysis of the company?
• What is the value of Bang & Olufsen compared to the market value of the stocks?
7
When answers to the above mentioned questions are found, it will be possible to give a qualified
recommendation to whether or not the B&O stock is an attractive purchase for investors.
2.2 Method (Written by Mette D. Kremmling)
Several authors have through time produced different models and frameworks for valuation of
companies e.g. the classical work by Tom Copeland et al., “Valuation, Measuring and Managing
the Value of Companies” (2000). For several reasons this paper takes its starting point from the
framework of Jens. O. Elling and Ole Sørensen presented in “Regnskabsanalyse og værdiansættelse
– en praktisk tilgang” (2005). Firstly, the accounting statements of B&O to be analyzed are made
from Danish accounting standards and a Danish framework might therefore better draw attention
towards areas of accounting practices that might need adjustment for the sake of valuation. Second-
ly this framework was found easy comprehendible and accessible for less experienced analysts. The
framework has however been adapted somewhat to the case of B&O and some analyses have been
added where this was found to enhance the understanding of the situation of B&O. This paper will
hence follow the structure in figure 1.
The accounts analysis will go into debt with the areas recommended by Elling and Sørensen (2005),
which can be illustrated by the extended DuPont model as depicted in Figure 2. Furthermore the
analysis will be supplemented with an analysis of the liquidity level of B&O.
8
Figure 1 – Structure of the Paper (Source: Own making)
Figure 2 – Extended DuPont Model (Adopted from Elling and Sørensen 2005: p. 173 and altered to fit the structure of this paper)
9
2.3 Delimitation (Written by Mette D. Kremmling)
The outlook of this thesis is that of an external analyst, hence only information available for such a
person has been used. Concretely this means that no contact has been made to B&O to acquire fur-
ther knowledge about the organization. Instead publicly available information on the company web-
site e.g. annual reports and company announcements, and information from newspaper articles and
books form the main information basis in the thesis.
Only accounting information available until March 25th 2009 are used in this thesis.
As a basis for the accounting analysis annual reports from the financial year 2004/2005 to present
will be analyzed.
As the interim report of January 15th 2009 is not in sufficient detail for full reclassification, the ac-
counting statements from this report will not be included in the accounts analysis, even though this
is the latest accounting information available.
The B&O organization consists of several business units. Since the core business area “Au-
dio/Visual” represents the large majority of the turnover in the organization this will be the main
focus area of this thesis, which will especially be visible in the strategic analysis of B&O. Other
business areas such as Automotive and ICEpower will be included where this is found sufficiently
relevant.
Accounting policies of B&O will not be analyzed or discussed.
In the interim report of January 15th 2009 it is stated that the board of directors will propose a share
issue of 400 million DKK on an extraordinary meeting of shareholders. Since the share issue has
not yet taken place and there therefore are no concrete figures for the result of the issue, the share
issue will not be taken into account in the accounts analysis and in the valuation process. However,
the issue will be mentioned where this is expected to change the future position of B&O.
All values, unless otherwise written, are in DKK.
All figures in the appendices are of own making.
3. Strategic Analysis (Written by Mette D. Kremmling)
In a static world an analysis of the historic accounts of a company would be enough to project the
financial developments of that company in the future (Elling and Sørensen 2005: p. 66). However,
the business world is far from static, which the current financial crisis is a textbook example of.
There is therefore a need for an analysis of the causes behind the development of a company, in
10
order to be able to make reasonable projections of the future and set realistic budgets. The strategic
analysis contributes to this by drawing up a profile of the company’s strength and weaknesses,
which can be used to evaluate a company’s possible opportunities and evaluate the realism in the
budget in relation to the pursued strategies (Schack 2006: p. 205).
This section will hence analyze the external environment of B&O through the PESTEL-analysis
and Porter’s Five Forces model in order to see how external factors are affecting B&O and their
strategy. Furthermore, an internal analysis of B&O’s core competencies and product portfolio will
be carried out as well as a determination of their strategy. In order to be able to give a fair analysis
of B&O and its strategy it is necessary to gain some basic knowledge about the company, therefore
this section will start with a short description of B&O as a company and the major lines of their
strategy.
3.1 Bang & Olufsen (Written by Mette D. Kremmling)
Bang & Olufsen A/S was founded in 1925 in the rural West Jutland in Denmark by two newly edu-
cated engineering students, Peter Bang and Svend Olufsen, who both shared the dream of develop-
ing a superior radio which neither needed batteries nor an accumulator1. Initially the company was
based in Svend Olufsen’s parents’ manor, Quistrup, where the company became greatly influenced
by the hard-working nature of the local community. The culture that this environment gave the
company of B&O should prove to be a lasting competence and help B&O through several crises
(Bang and Palshøj 2000; Bang and Palshøj).
The first product to be launched was the “B&O Eliminator”, which could connect a battery receiver
to the mains, and later they had their big break through with “The Fiver Lamper”, a mains radio in
an elegant cabinet of walnut (Bang and Palshøj 2000: pp. 24-34). Today B&O still keeps their main
focus within the audio industry and has added the visual part as well, which today makes them an
audio/visual company. Their main products range from audio-devises, televisions, telephones,
loudspeakers, digital media, and home integration (Bang & Olusen). Additionally, B&O, among
others, equip hotels and exclusive property projects with audio/visual products through their Enter-
prise department, develop Car-HIFI for Audi, Mercedes, and Aston Martin in their Automotive de-
partment, and benefit from patents on special technology developed by B&O, e.g. the compact digi-
tal amplifiers managed in the ICEpower subsidiary. The main focus of the analysis in this thesis
will be on the main business the audio/visual part. However, other business areas will be included
1 Accumulator: a large battery that you can fill with electrical power (Source: Oxford Advanced Learners 7
th edition)
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where relevant for the description of possible business opportunities (Bang & Olufsen Group 2008:
pp. 10, 13).
The audio/visual industry has through time seen many significant changes and is still a highly tur-
bulent industry. First the introduction of the Common Market following the Treaty of Rome in
1957, forecasted the death of the Danish radio-industry caused by German competition (Bang and
Palshøj 2000: p. 52). Later the entry of the Asian technology companies into the global market put a
pressure on all of Europe and North America. A small company like B&O with its main customer
base in Denmark was not the obvious survivor in this environment. However, B&O kept their focus
on quality which had been prevalent since the very beginning of the company. Furthermore, they
added a focus on modern design since their traditional wooden designs were criticized by some of
the great Danish furniture designers of that time (Bang and Palshøj 2000: p. 48). This led B&O to a
position in the market which they still posses today; the niche of producing quality audio/visual
products with a unique design “for those who discuss taste and quality before price” (Bang and
Palshøj 2000: p. 62). This strategy has proven so successful that B&O today is a world renounced
audio/visual producer with major operations in Europe, North America and Asia. Furthermore, the
brand has developed to become one of the world’s strongest brands, and was in 2008 among others
declared the 4th Coolest Brand in the 2008/09 CoolBrands survey and the “Best Brand 2008” in the
Car-HIFI category by “Auto Motor und Sport” (CoolBrands; Bang & Olufsen Group 2008: p. 10).
Not everything has been going smooth for B&O though, and through time they have had to face
several crises. Most severely was the crisis in the 1980’s were they suffered from declining loyalty
in their distribution network together with an immense pressure from Asia. The solution came in
“Break Point 1993” were the stock of finished goods and parts were removed from subsidiaries, a
new concept of dedicated B&O outlets (B1 stores) arose, cost were cut, and non-core activities were
disposed (Bang and Palshøj 2000: p. 102-108; Bang & Olufsen Group 2008: p. 9). This strategy has
since been the growth driver through the 90’s were B&O widened its product range to also include
e.g. mobile phones and mp3 players.
Nevertheless, B&O has now entered into yet another crisis and is severely affected by the current
financial crisis. A fantastic fall in 2007 with high hopes for the future has been exchanged for se-
vere sales slowdowns and hopes for again only just breaking even in the financial year of 2009/10
(Bang & Olufsen A/S 2009: p. 1). The reasons for this downturn are among others mentioned to be
the lacking launches of new products (Bang & Olufsen A/S 2009: p. 4). This has led to a new CEO
and President being announced, Karl Kristian “Kalle” Hvidt Nielsen, and yet another change in the
12
strategy. B&O will once more go back to their core skills, which means that all production of e.g.
mp3s, mobile phones, and DVD-recorders will be suspended and focus will instead be laid on prod-
ucts with secure sales volumes, which will cut unnecessary development costs. This will further-
more be supported by gathering their regional sales departments into a global setup, and by provid-
ing for larger integration between B&O products and other brands by developing one single tech-
nological platform instead of the current four (Børsen 2008; Bang & Olufsen 2008). Whether this
strategy will prove to be successful is yet to be seen.
3.2 PESTEL-Analysis (Written by Mette D. Kremmling)
When analyzing the external environment there are a lot of possible aspects to consider, which
makes it difficult to reduce the analysis to the parts of the environment that is actually influencing
the company in question. To facilitate this problem the PESTEL-analysis can be used to direct the
attention towards the political, economic, socio-cultural, technological, environmental, and legal
aspects of the external environment (Lynch 2006: p. 84). However, the PESTEL-analysis should
only be seen as a checklist, and there might therefore be other aspects to consider as well. Further-
more, some of the aspects mentioned might have comparably little relevance for the company at this
moment in time. For B&O it has been decided to concentrate on the political, economic, socio-
cultural, and technological aspect. The legal aspect is left out since the relevant issues in this area
all can be related to other categories in the analysis, especially the political and economic aspects.
In addition the environmental aspect will be covered in the changing trends in the socio-cultural
aspect.
3.2.1 Political Aspects (Written by Mette D. Kremmling)
National and international political decisions often affect companies greatly, since it is the outcomes
of these decisions that govern the conditions and laws that the companies have to operate under.
Such influences was clearly visible by the signing of the Treaty of Rome and there through the in-
troduction of the Common Market, which nearly extinguished the Danish radio industry (Bang and
Palshøj 2000: p. 52). Furthermore, the work of the World Trade Organization towards fewer trade
barriers has created a more liberal trade environment and has thus opened for an increased competi-
tion from Asia in the European and American markets (Rittberger and Zangl 2006: p. 153).
The political decisions that will affect B&O most significantly in the near future will be the eco-
nomic rescue plans that politicians all over the world are providing. The Danish rescue plans “Bank
13
Package 1 and 2” will affect the ease with which B&O can borrow funds in the future. Even though
B&O plans to obtain 400mill DKK through a share issue (Frovst and Kirketerp 2009), it is very
likely that B&O will need funds in the future as well, especially if the current financial crisis proves
more difficult to turn around. In the long run the investors will not be satisfied by continuous share
issues and hence B&O will need to borrow from the banks.
The rescue plans will furthermore affect B&O on a more general level, since the overall purpose of
these plans is to turn around the world economy. Especially a plan such as President Obama’s plan
for the US economy will have significant influence on B&O because the US is such an integral part
of the world economy, and since it is one of B&O’s important markets. Hence the success rates of
these rescue plans will through improvements in the world economy boost the sales of B&O. This
influence can be expected to be extra strong in the case of B&O since they sell luxury items, whose
sales is greatly dependent upon economic conditions.
3.2.2 Economic Aspects (Written by Mette D. Kremmling)
As mentioned above, the current economic crisis has affected B&O in a negative direction. A large
part of this effect comes from the decrease in purchasing power that an economic downturn brings
with it. Especially companies selling high-end products are sensitive towards these kinds of up- and
downturns in the purchasing power (Kotler and Keller 2006: p. 86; Brownsell 2008).
However, as 88% of B&O’s turnover is in foreign currencies, the economic trends have also af-
fected B&O’s cash in and outflows through the movements in the exchange rates (Bang & Olufsen
Group 2008: p. 55). The movements in the most significant currencies for B&O can be found in
appendix A. The foreign currency that B&O by far deals most in is the Euro. However, since the
Danish Krone is pegged to the Euro, the movements in this currency will have less relevance. Other
currencies which are of importance to B&O are British Pounds and Swiss Franc, which have a net
cash inflow, and US Dollars, which has a net cash outflow (Bang & Olufsen Group 2008: pp. 54-
55). Especially the fall in the value of the British Pound has affected the cash inflow of B&O in a
negative way. On the other hand the negative trend in the value of the US Dollar has helped B&O’s
cash outflow. All in all the currency movements had a negative impact on the turnover of B&O of
60 million DKK in the financial year of 2007/08 compared to the previous financial year (Bang &
Olufsen Group 2008: p. 26). Looking at the development since the ending of the financial year of
2007/08 on the 31st of May, the development looks even grimmer. The British Pound has continued
its fall in value compared to the Danish Krone, and the US dollar has strengthened a bit again.
14
3.2.3 Socio-Cultural Aspects (Written by Mette D. Kremmling)
The boom that was seen in the world economy before the financial crisis increased purchasing pow-
er of consumers and increased focus on luxury design and status symbols. This all indicated a fa-
vorable environment for B&O. However, this also drove many of B&O’s competitors to focus on
design as well, exemplified in Apples iPods and Samsungs flat screen TVs. These products are in-
creasingly communicating the type of style and status symbol that consumers have been demanding,
but at a fraction of the price of B&O’s products (Brownsell 2008).
Another trend that should affect B&O in a positive direction is the increased awareness of the envi-
ronment and green production. Within this area B&O have continuously been trying to improve
their performance by e.g. reducing the stand-by electric consumption, changing their packaging, and
working on Corporate Social Responsibility (Bang & Olufsen Group 2008: pp. 41-43). The ques-
tion is however, whether B&O is communicating this clear enough for consumers to see B&O as an
environmentally responsible company, and how much it matters when their products are in a much
higher price range then their competition in Samsung and Sony.
3.2.4 Technological Aspects (Written by Mette D. Kremmling)
The consumer electronic industry is, as mentioned earlier, a very turbulent industry with fast devel-
opments. In the days of the radio B&O was among the first with the new technology (Bang and
Palshøj 2000). However, the Asian companies are today in the forefront with the development of
new technologies. An example of an area where B&O is behind the competition is in the develop-
ment of Full HD flat screen TVs. B&O has not been able to introduce this technology before the 1st
half of 2009, after the TV stations began using the format (Bang & Olufsen A/S 2009: p. 1). On the
other hand, B&O is still one of the frontrunners on other aspects of technology and owns profitable
patents on for example digital amplifiers in their subsidiary ICEpower.
Another threat for B&O can be found in computers, mobile phones, and mp3 players, which to a
greater and greater extend get more technologies integrated. Especially the functions that are core to
B&O are in focus. Examples of this trend can all be found in the mobile phones which are develop-
ing into devises that can play music of a high quality and display TV programs through the wireless
internet.
15
3.3 Porter’s 5 Forces. (Written by Pia Lundanes)
When conducting a strategic analysis the external factors should be analyzed on the following le-
vels, the general environment, the competitive industry and the individual company (Schack 2006:
p. 207). As the general environment has been analyzed through the PESTEL- model, it is now bene-
ficial to have a look at the competitive industry environment.
Figure 3 - Porter's 5 Forces Matrix (Adopted from Schack 2006: p. 212)
One of the frameworks widely used to analyze a given industry is Michael Porter’s 5 forces, de-
picted in figure 3. This framework identifies 5 basic forces which can influence the competitiveness
of a company; bargaining power of suppliers, bargaining power of buyers, threat of new entrants,
treat of substitutes, and competitive rivalry. The analysis is done in order to discover opportunities
and threats in the environment which the company needs to take into consideration when forming a
strategy for the future (Lynch 2003: pp.102-103).
3.3.1 Bargaining Power of Suppliers (Written by Pia Lundanes)
The first force is the bargaining power of suppliers. In the case of B&O, the company generally
tries to keep a good and close relationship with its main suppliers which are also able to provide
B&O with knowledge and skills for the development of products (Bang & Olufsen Group 2008: p.
39). Hence, it is indicated that B&O cooperates with its suppliers and form partnerships. This co-
operation can be assumed to be beneficial for both parts, and will therefore decrease the incentive
for suppliers to use their bargaining power.
Another aspect which forms the bargaining power in the audio/visual industry is the large amount
of suppliers of electronic goods. Many companies produce each of the small components needed to
16
make one of B&O’s products. This makes the bargaining power of the suppliers decrease, as it is
not difficult for a company like B&O to find an alternative supplier for a small component. On the
other hand, a company like B&O has special requirements when it comes to product quality. This
may decrease the number of possible suppliers and thereby increase their bargaining power. Other
factors like level of customization will also affect the number of possible suppliers. If B&O’s com-
ponents are unique, the switching costs of going from one supplier to another would be high. There
will also be issues of security and protecting the company’s technology.
The risk of suppliers conducting forward integration and thereby undertaking the value adding
process of the organization is a great risk in some industries (Schack 2006: p. 216). This risk is
however not considered substantial in the audio/visual industry because of the large number of dif-
ferent components required to make an audio/visual product. Hence, it would require a very large
investment, as most suppliers are assumed to produce only a small part of what is required to make
a complete product. Overall the bargaining power is considered to be a minor threat in the au-
dio/visual industry, especially for B&O as they are trying to involve themselves in partnerships ra-
ther than simply purchasing the products from the suppliers.
3.3.2 Bargaining Power of Buyers (Written by Pia Lundanes)
The next category in Porter’s model is the bargaining power of buyers. When analyzing this it is
necessary to make a separation between B&O’s private customers and the enterprises buying B&O
products in the Automotive and Enterprise subsidiaries of B&O. In the consumer market, the cus-
tomer can probably negotiate with the seller to get a good deal, especially in these days of the fi-
nancial crisis, but in general the bargaining power is low. This is due to the fact that B&O products
are differentiated from other brands, which gives them a possibility to charge a premium price. The
bargaining power is however expected to increase in the future as it is getting harder to pursue a
differentiation strategy in the audio/visual market, because of the increased focus on design and
quality by all companies.
In the Automotive and Enterprise sections the case looks a lot different. As of today, B&O is co-
operating with three major car manufacturers, Audi, Aston Martin and Mercedes AMG (Bang &
Olufsen Group 2008: p. 33).This means that each of the three customers in this section will have
substantial importance both financially and image wise for B&O Automotive’s future. B&O will
therefore probably be willing to make compromises and sacrifices in order to retain the good rela-
tionship with each of the three customers.
17
3.3.3 Threat of New Entrants (Written by Pia Lundanes)
The third element in Porter’s model is the threat of new entrants. When looking at the audio/visual
industry, it is obvious that it is difficult for a company to penetrate the market starting from scratch.
The level of investments required for producing such products are immense and as the competition
in the market is fierce it will definitely be a hard task for a new brand to be established along the
companies which have existed in the business for decades.
What really pose a threat to B&O as a company is, on the other hand the companies which are al-
ready established in the audio/visual industry. There is a potential threat that these companies which
to a great extend currently are focusing on other segments than the high end consumers, will in the
future pursue a differentiation strategy and thereby enter the high end niche market which B&O is
focusing on (Brownsell 2008).
Today consumers are focusing more on intangibles. It is the whole experience of the product that
matters and small, intangible elements is now what is separating one brand from another. The focus
on the experience of the product, both when it comes to design and technical specifications, is what
has been keeping B&O in front of the development for a number of years. However, the other
brands now seem to catch up with B&O by increased focus on design and innovation. Companies
like Apple have changed the way people listen to music by providing excellent portable devices. In
addition B&O has been challenged by companies like Samsung and Sony in the design element of
products. These huge corporations have large marketing budgets and are able to provide high-end
products at a lot lower price than B&O (Brownsell 2008: p.24). All in all this indicates that the
threat of totally new entrants is small in the audio/visual industry, but the threat of other companies
entering B&O’s niche market is increasing.
3.3.4 Threat of Substitutes (Written by Pia Lundanes)
Another substantial threat is the one of substitutes. Lately there have been several examples of mul-
tiple functions being included in a single device. Today there are numerous products which can
serve as a mobile phone, computer, mp3-player, and TV all at the same time. As B&O have been
focusing on “single-function” products, they are in a bad position if the consumers in the future will
prefer having one multifunction product. This trend seems already to have started as people are
watching more videos and TV online and through mobile devices and also believe they watch less
TV as a result of it (BBC News 2006). B&O must therefore in the future have an open mind when
considering who their competitors are and act according to changing consumer habits.
18
3.3.5 Competitive Rivalry (Written by Pia Lundanes)
The last of the five forces is the extent of competitive rivalry. One of the factors which influence
this rivalry is the number of competitors in the industry. In the audio/visual industry there is a fairly
large number of actors of which most are based in Asian low cost countries. The fact that there is no
clear market leader makes the large international companies like Sony, Phillips and Samsung con-
stantly fight for market share in order to survive. Another aspect which makes the competition in-
tense in this market is the difficulty of differentiation of the products. The technology is developing
in such a high speed that none of the companies have technology which will give them a competi-
tive advantage for a longer period of time. B&O was able to differentiate itself because of its design
and the functionality of its products, but as other companies have recognized this opportunity it
seems as though all the companies are doing more or less the same.
3.4 Core Competencies (Written by Mette D. Kremmling)
According to Kotler and Keller (2006: p. 39) core competencies have three distinct characteristics:
(1) They are a source of competitive advantage that contribute to perceived consumer benefits, (2)
they are applicable in a wide variety of markets, and (3) they are difficult for competitors to imitate.
Thus a company needs core competencies in order to gain advantage over competitors.
In B&O’s annual report for the financial year of 2007/08 (2008: p. 35) they state that “Bang &
Olufsen’s core competencies are directed at enhancing the user’s experience when using the prod-
ucts”. This statement fits well with their focus on design and quality, which both gives the consum-
er a superior experience when their products are turned on and when they are turned off. Quality has
been an area of importance since the very beginning of B&O, and is a necessity for B&O to be able
to charge as high prices as they do. Furthermore, quality give the consumers extra value by letting
the products live long and even have a recognizable scrap value. Design has also for a long time
been a focus point for B&O and the classical aluminum panel design started by Jacob Jensen has
become a clear mark for B&O products. For a long time this simple design was what really sepa-
rated B&O from the Asian black plastics TVs and stereos. However, this core competency is today
being challenged by companies such as Apple, Samsung and Sony, and might in the future move
from being a competitive advantage for B&O to simply being a qualifier for being in the market
(Brownsell 2008).
The final core competency of B&O is their brand value. By building well designed products of a
high quality and at a high price, they have established a brand which functions as a status symbol.
19
This immaterial asset might allow B&O to still charge significantly higher prices than the main-
stream players in the market even though their other competitive advantages are becoming weaker.
However, the quality and design will still need to be superior for this to last.
3.5 Porter’s Generic Strategies (Written by Pia Lundanes)
In order to determine B&O’s value it is essential to consider the company’s future strategy in addi-
tion to the historical financial information provided. When evaluating B&O’s strategy and predict-
ing the effects of the newly implemented strategy, a classification using Michel Porter’s Generic
Strategies Model might be beneficial. In this model Porter distinguishes between three different
generic strategies, which offer a good starting point for a company strategy: cost leadership, diffe-
rentiation and focus strategy (Shown in figure 4). (Kotler & Keller 2006: p. 56) This section will
analyze which strategy B&O is pursuing in addition to the advantages and pitfalls connected with
such a strategy.
Figure 4 - Generic Strategies Matrix (Adopted from Elling and Sørensen 2005: p. 92)
B&O’s source of competitive advantage is differentiation. The company is committed to innovation
and product development, and will seek to differentiate its products and deliver surprising products
which set new standards. (Bang & Olufsen Group 2008: p. 5). The disadvantage for B&O is related
to the fact that the company is situated in Denmark where the labor costs are significantly higher
than in Asian countries where many of the rivaling companies are located. The labor costs make it
an impossible task for B&O to be a market leader on price. The company is therefore aiming to
achieve a higher price through making special products for which the customers are willing to pay a
premium.
20
The problem for B&O today is however that the premium the customers have to pay for their prod-
ucts might be too high. B&O’s competitors have improved in areas like design, leading to them
offering equally good looking products. Some people therefore do not think B&O is differentiated
enough to justify the significantly higher price that they charge for their products (Brownsell 2008:
p.24). A disadvantage of the differentiation strategy can therefore be, that it is difficult to maintain a
competitive advantage for a long period of time. In order for B&O to stay differentiated from its
competitors, it will have to be ahead of the development and not let the competitors copy the ideas
and steal market share. Furthermore, they have to maintain a superior brand value in order to keep
charging higher prices.
3.6 BCG – Matrix (Written by Pia Lundanes)
In order to get a good picture of a company’s future possibilities for success it is favourable to ana-
lyze the company’s product portfolio. The products are the basis for B&O’s success and the com-
pany will have to keep on producing innovative and appealing products in order to maintain their
position in the market and their brand value.
Figure 5 - Boston Consultancy Matrix – adopted from Schack 2006: p. 218
A widely used framework for analyzing product portfolios is the Boston Consulting Group Matrix.
This model provides a tool to analyze whether the product portfolio is put together in an adequate
way by defining which products are weak and which products have got potential for the future (El-
ling and Sørensen 2005: p. 83). The model consists of two axes where one is the total market
growth and the other is market share relative to the market share of the company’s strongest com-
petitor as shown in figure 5 (Schack 2006: p. 218)
B&O has an enormous range of products in various product groups. In order to limit the analysis
and make it more feasible, product groups will be used as the basis for analysis instead of the indi-
21
vidual products. This will be limiting in one sense, as there might be very big differences within a
product category e.g. TV’s. However, it is assumed that a better overall picture about the current
state of the company will be provided by focusing on the product groups instead of individual prod-
ucts.
The product groups that will be analyzed are as follows: TV’s (where integrated TV/DVD players
will also be included), home audio players, portable media players, mobile phones, and in-car media
players (where the speakers are also included).
When performing this analysis, an assumption is made that high growth markets are markets with a
yearly growth above 10%. If we were to place these different categories in the BCG-matrix, the
results would be as follows.
3.6.1 Question marks (Written by Pia Lundanes)
The question marks are products that are in high growth markets but where the relative market share
is fairly low. These are considered development projects where a lot of money will have to be in-
vested in order to make the product succeed, and will therefore put a pressure on the liquidity of a
company (Schack 2006: p. 219). Before the implementation of the new strategy, B&O had two
products which could be placed in this category, the MP3 player and the mobile phones. These
markets showed growth of 20 and 14% respectively in 2006-07.
B&O’s relative market share in these markets are however considered to be very low, as they have
no possibility to compete with huge international corporations like Apple and Nokia which have
capturd large shares in the market.
3.6.2 Stars (Written by Pia Lundanes)
Stars are products which are also in high growth markets, but where the relative market share is
high compared to its competitors (Lynch 2006: p.131). At the moment B&O seems to have one
product group in this category, namely the B&O Automotive section. The in-car media players
market had a growth of 13% in 2006-07. B&O is assumed to have a large market share in this sec-
tion as it has agreement which Audi, Mercedes and Aston Martin, which are three important brands
with a large total market share of the car industry.
The stars require liquidity in the same way as the question marks as they operate in high-growth
markets where investments are required to capture a share of the growth. These products are consi-
dered an important part of the company’s future and are expected to eventually move into the cash-
22
cow category where they will provide liquidity to invest in new question marks (Schack 2006: p.
219).
3.6.3 Cash cows (Written by Pia Lundanes)
Cash cows are products where the market growth is low but where the company has a high market
share. The requirement for investment in cash cows is low due to the limited expansion opportuni-
ties and the profit margin is high. Hence, these products are expected to produce liquidity to finance
activity in the high growth market, (Elling and Sørensen 2005: p. 84).
For B&O one could say that televisions belong in this category. The market growth for TVs and
projectors was 10% in 2006-07, but there is reason to believe, that there is a big difference in the
market for flat screen and non-flat screen TV’s as well as integrated solutions with DVD’s. The
latter category actually shows a strong decline in the market of about 15%.
B&O’s market share for TVs is considered to be high in its niche, especially in the European mar-
ket. The market share of B&O in the overall TV market is though not very high, as they are target-
ing such a small niche of the overall consumer electronics market.
3.6.4 Dogs (Written by Pia Lundanes)
Dogs are products placed in a market where both the market growth and the market share are consi-
dered to be low. The market is therefore very static and the company is not able to take significant
market share from its competitors. These markets do not require significant investments nor do they
produce substantial liquidity, so unless the products have a strategic importance for the company or
compliments other products in the portfolio they should be excluded (Elling and Sørensen 2005: p.
85). At the moment of the analysis none of B&O’s products were considered to belong in this cate-
gory.
3.7 Conclusion on the strategic analysis – SWOT analysis (Written by Pia Lundanes)
In order to sum up the strategic situation of B&O a SWOT- analysis will be made. In this analysis
the strengths and weaknesses of the internal analysis will be identified, in addition to the opportuni-
ties and threats posed by the company’s environment, as shown in figure 6. This is a useful way of
reviewing the company’s current situation, and will conclude the strategic analysis of B&O (Lynch
2003: p.464). A SWOT analysis can also be used to analyse whether the strategy chosen by the
company seems to be the right one. In order for a strategy to be successful there has to be a strategic
23
fit, which means that the strengths and weaknesses of the company matches the opportunities and
threats in the environment (Elling and Sørensen 2005: p. 103)
Figure 6 - SWOT model - adopted from Elling and Sørensen 2005: p. 105
3.7.1 Strengths (Written by Pia Lundanes)
The first category of the SWOT analysis is the company’s internal strengths. One of the most im-
portant strengths of B&O as a company is the brand value. B&O is a well known company which
through the years of producing excellent innovative products has established itself as a top brand.
The brand value has also been increased by the numerous awards the company has received for
great design and technical solutions (Bang & Olufsen).
Quality and design are other aspects which can be considered great strengths for the company. The
company has been focusing on superior design for a long time and has been establishing develop-
ment centres and working with architects and designers in order to keep this strength superior rela-
tive to its competitors.
The company has also got some strong core products and some usable patents which both have been
and will be essential for the company in the future. The core products are bestsellers for B&O and
make it possible for the company to invest in new development projects. The patents have given the
company some time to develop and gain from their innovation. In an industry with such rapid tech-
nological changes, it has been essential for B&O to prevent their competitors from copying their
products. Taking patents has proven a good way of achieving this.
The last strength discussed here, is the good relationship that B&O has with its suppliers and some
of its buyers. The company tries to establish a cooperating relationship with its business partners.
This has enabled B&O to get assistance and benefits from both suppliers and buyers (Bang & Oluf-
sen Group 2008: p. 39).
24
3.7.2 Weaknesses (Written by Pia Lundanes)
When it comes to B&O’s weaknesses as a company, an important issue is the fact that 88% of the
turnover is in foreign currency (Bang & Olufsen Group 2008: p. 55). This creates a great currency
risk and makes it difficult for the company to maintain complete control of the financial situation.
Fluctuations in the currency rates will therefore affect the company a lot.
Another weakness is the fact that B&O’s products are not competitive when it comes to price. The
reason for this is partly due to the high labor costs in Denmark. This has become an even bigger
problem for the company the last few years. The increased focus on design and functionality from
the competitors has meant that B&O’s products are no longer as special and unique as they used to
be. It is now possible to get a TV with a great design to a lot lower price than a B&O TV, which
makes it difficult for the company to sell its products.
In addition to the mentioned weaknesses, the company seems to have been lacking focus on the
core competencies and the core products in its portfolio. This has lately prevented the company
from producing new bestsellers, which will be a problem in the future. It seems like the company
has focused too much on developing new products like mobile phones and mp3 players, and thereby
entering new markets. This has however not been successful, and many of these products are
through the newly presented strategy taken out of the product mix.
3.7.3 Opportunities (Written by Pia Lundanes)
One of the most important opportunities for B&O in the future is the consumers´ increased focus on
design. The consumers today seem to value electronic equipment which not only has got great tech-
nical abilities and functionality, but which also looks stylish and can symbolize a high social status.
B&O has always been known for its great design, and it therefore looks like the market is adjusting
to and appreciating B&O’s core values.
Other opportunities for B&O are apparent in the company’s B2B sections like enterprise and auto-
motive. During the last few years both the enterprise and automotive section has had a major in-
crease in turnover. This is promising for the future, and as there are still a large number of hotels
and luxury car brands to cooperate with, there should be potential for future growth for B&O.
3.7.4 Threats (Written by Pia Lundanes)
At the moment the biggest threat for B&O is the financial crisis affecting the world economy. Gov-
ernments all over the world have established rescue plans in order to end the recession as soon as
25
possible. However, there is a threat that these plans will not have a significant effect and that the
financial crisis will last for a long time and thereby affect B&O’s turnover in the next few years.
The extent to which B&O will be affected however depends on whether the company is able to
keep its brand value through the crisis. According to Euromonitor International (2009), the top level
technological goods have a strong position in the marked and will be less affected by the crisis than
the middle range companies.
Other threats are related to B&O’s competitors. At the moment it seems like the other companies in
the industry are ahead when it comes to technological development. This leads to B&O’s products
might seeming outdated. When the competitors at the same time seem to be spotting the consumer’s
increased desire for superior design, it makes it difficult for B&O to stay differentiated. These as-
pects contribute to a very competitive environment which in itself is a threat to B&O.
The last threat which will be discussed here is the one of new substitute products. B&O has been
specializing in in-home products, and the development towards using more portable products for
audio/visual entertainment will be a challenge for the company in the years to come.
3.8 Analysis of the New Pole Position Strategy 2008
B&O is considered to be a company with a high brand value, but unfortunately the company is at
the moment not able to produce high earnings. B&O has been greatly affected by the financial cri-
sis, and a new approach is required for the company to prosper in the future. B&O’s management is
aware of this, and on October 21st 2008, B&O announced a new strategy called Pole Position Strat-
egy. The main elements of the new strategy are to increase profitability, boost sales and to create a
stronger and more focused product line (Bang & Olufsen 2008).
In order to increase the profitability, the company will be focusing on cutting their costs. This proc-
ess has already started, and a number of employees have been laid off all across the B&O organiza-
tion (Børsen 2009a). In addition to lay-offs, the company will cut down their costs on external ser-
vices.
The second element of the new strategy is to boost sales. To achieve this goal, the management will
make some significant changes in the organization. Firstly, the sales organisation will be central-
ized. B&O will make one globally managed sales operation, one globally managed support system
and one globally managed 24-7 after sales service organization instead of having 7 regional organi-
zations. In addition, the company will attempt to achieve one global approach to sales based on their
best practise and invest in shop support in order to secure a global expression of their brand (Bang
& Olufsen 2008). B&O has also implemented the concept of price flexibility, meaning that it is
26
possible to select or deselect certain features of a products, enabling the consumer to regulate the
price of a product (Bang & Olufsen). Price flexibility will make it more possible for consumers to
purchase B&O’s products even in a time of financial crisis, and will enable B&O to increase sales
without affecting their image as a luxury brand.
In the new strategy of B&O, changes in the product portfolio are also included. The company wants
to be the best at what they do and has therefore decided to dismiss co-branding products, mobile
phones, mp3-players and stand alone DVD-players from their portfolio. B&O will focus on their
core products and will attempt to increase efficiency by creating one single technology platform
which will decrease the investment needed for new product development. This will enable the com-
pany to launch more products (Bang & Olufsen 2008).
By changing its strategy, B&O will attempt to improve some of its strengths and remove some of its
weaknesses. When relating the new strategy to the strengths discusses in the previous section, there
is reason to believe that the new strategy will increase the brand value. If B&O succeeds in creating
the new technology platform and thereby increase the number of product launches, this will give
B&O a stronger image as an innovative company. In addition the common technology platform will
strengthen the core products of the company even more.
Some of B&O’s weaknesses will be dealt with by implementing the new strategy as well. The fact
that B&O’s products are not competitive when it comes to prices will be improved as the price
flexibility is included. When the new strategy is implemented the consumer will to a certain extent
be able to affect the price of a product based on which features is selected. B&O has also attempted
to increase the focus on their core product. They have cut unprofitable products like mobile phones
and mp3-players which will enable the company to focus on developing the core products of their
portfolio. This increased focus on a narrower portfolio will facilitate B&O to develop new best-
sellers within their core products which will hopefully increase turnover in the years to come.
4. Accounts Analysis (Written by Mette D. Kremmling)
As stated in section 3 the business world is a dynamic environment, which makes the strategic anal-
ysis of a company necessary. This analysis should however be seen as complementary to the analy-
sis of the historic accounting statements, since a company’s future is greatly dependent on actions
of previous periods (Schack 2002: p. 9). This might among others be reflected in the financial struc-
ture of the company, the assets the company posses, and the know-how of the employees. Further-
27
more, Coopland et al. (2000: p. 157) argues that a thorough understanding of a company’s past per-
formance provides an essential perspective for developing and evaluating future performance.
Hence, this section will analyze the past and current economic state of B&O through the use of key
value drivers. The data for the calculations is gathered from the annual reports of Bang & Olufsen
Group for the financial years of 2004/05, 2005/06, 2006/07, and 2007/08.
4.1 Reorganization of Accounting Statements (Written by Mette D. Kremmling)
In order to analyze the actual value created during a period, there is a need for reorganizing the ac-
counting statements, since some of the value creation/loss will be hidden as increases/decreases in
equity and will therefore not be directly visible from the accounts. This mismatch between the re-
sults reported in the income statement and the actual value created might give a wrong impression
of the economic situation of a company when calculating the key value drivers, and hence lead to
misleading estimations of the future performance of the company.
By reorganizing the statement for changes in equity, it will be possible to calculate the comprehen-
sive income, which measures the result of the period on the basis of all changes in value posted on
the equity (Elling and Sørensen 2005: p. 107). The comprehensive income is an essential element in
the calculations of many value drivers, and is thus important to calculate correctly.
A company creates value from two main activities, operating activities and financing activities.
However, these activities are not clearly separated in the balance sheet and income statement, and
hence need to be separated through a reorganization of these accounts (Elling and Sørensen 2005: p.
19). This will furthermore give a clearer picture of the company’s primary value creation through
the operating activities (Elling and Sørensen 2005: p. 121).
For all of the reorganized statements it applies that the minority interests should be deducted since
these are the part of the result, which does not go to the shareholders of B&O, and is thus not rele-
vant for the valuation of B&O. The reorganized statements can be found in appendix C.
4.1.1 Reorganization of the Statement of Changes in Equity (Written by Mette D. Kremmling)
In the annual reports of B&O Group a separate statement for the changes in equity is shown. How-
ever, according to Jens O. Elling and Ole Sørensen (2005: p. 108) the optimal statement of changes
in equity show the difference from primo balance to the ultimo balance of the equity account as:
Equity� � ���� � = Equity������ � ���� � ± Comprehensive Income ± Transactions with Owners
28
This method is not the method generally used in Danish accounting and not the method B&O uses
in their annual reports either. Reorganizing the statement of changes in equity therefore exists of
two parts: calculating the comprehensive income and calculating the transactions with the owners. It
should be noted though that some argue that some of the components of the comprehensive income
are irrelevant as they are non-permanent, however, since the ultimate goal of the analysis is a valua-
tion of the B&O through forecasting future performance, it is necessary to ensure that all income is
taken into account both realized as well as unrealized (Elling and Sørensen 2005: p. 109).
In the case of B&O, the transactions with the owners concern the dividend paid to shareholders and
received from the company’s own shares, as well as purchase and sales of shares. In addition em-
ployee shares, grant of share options and the tax concerning these options belong in this category
together with these transactions as well.
The comprehensive income consists of the income of the period and profit and losses posted direct-
ly on the equity account also called “dirty-surplus items” (Elling and Sørensen 2005: p. 114). For
B&O there are two dirty surpluses that have to be taken into account: changes in the translation
reserve stemming from changes in the exchange rates between the reported currencies of the ac-
counting statements of independent foreign entities and the DKK (the reporting currency of B&O),
and changes in the fair value of derivative financial instruments resulting from gains and losses in
the value of financial derivatives which are calculated into the equity until the secured cash flow
can be calculated into the income statement.
4.1.2 Reorganization of the Balance Sheet (Written by Mette D. Kremmling)
As mentioned above when reorganizing the balance sheet the items have to be divided into operat-
ing- and financing activities. By making this division and classifying e.g. trade creditors as operat-
ing liabilities, it is possible to observe how well the company is capable of creating value from its
operating activities solely (Elling and Sørensen 2005: p. 123).
In some instances it will not be possible to make a clear distinction between operating- and financ-
ing activities, since the information in the annual report is simply not detailed enough. In these cas-
es there will be a need for carefully considered approximation of the placement.
In the cash account some of the cash will be working capital, which should be classified as an oper-
ating asset, and the rest will be placed in interest bearing accounts or papers, and should therefore
be classified as financial assets. It is however, not possible to distinguish between these two from
the annual report. It must however, be expected that B&O each day place cash on interest bearing
29
accounts, which justifies classifying all the cash as financial assets (Elling and Sørensen 2005: p.
125).
Since investment in associates is investments in other companies’ operations these should be seen
as operating assets (Elling and Sørensen 2005: p. 126).
Deferred taxes arise from differences between the calculation of the taxable profit for taxation pur-
poses and for accounting purposes. Since this is related to the daily operations of the company,
these will be classified as operating assets and liabilities (Elling and Sørensen 2005: p. 127).
4.1.3 Reorganization of the Income Statement (Written by Mette D. Kremmling)
The income statement is also divided into operating and financing activities when reorganized. Fur-
thermore, dirty surplus items are included to change the profit of the period to the comprehensive
income (Elling and Sørensen 2005: p. 134).
As investments in associated entities were classified as operating assets in the reorganization of the
balance sheet they should also be so in the reorganization in of the income statement (Elling and
Sørensen 2005: p. 137).
Exchange rate gains and losses should be divided into those relating to operating activities and
those relating to financing activities as well. However, it has not been possible to do this division
from the information in the annual reports. In such a case Elling and Sørensen (2005: p. 137) rec-
ommend that gains and losses on exchange rates all be classified as operating income/loss.
In order to illustrate the complete picture of the operating and the financing activities, their relevant
tax consequences should be allocated as well. Through this reasoning financial costs result in tax
advantages, since they are deductable in the tax accounts. The effect of this deduction can be found
as:
Tax Advantage = Net Financial Costs × Tax Rate
For the financial years 2004/05, 2005/06, and 2006/07 the tax rate was 28%, however it changed to
25% now, and hence this rate is used for the financial year 2007/08 and for the budgeting further
on. The tax on the operating activity can then be calculated as:
Tax on Operating Activities = Tax on the Result of the Year + Tax Advantage
30
By isolating the operating- and financing activities like this, a measure for the operating profit is
generated that is independent upon the financial activities (Elling and Sørensen 2005: p. 135-136).
4.2 Common Size- and Index Analysis (Written by Pia Lundanes)
A good starting point for analysis of the financial ratios of the company is to make some benchmark
analyses. The first one is the common size analysis where the different items in the financial state-
ments are expressed as percentages of a given size. The items in the income statement are divided
by the net turnover whereas the balance sheet items are normally divided by the total assets. How-
ever, an approach which is considered more informative is to divide the different operating assets,
operating liabilities, financial assets and financial liabilities based on the respective total sum of
each category (Elling and Sørensen 2005: pp. 143-145).
By making a common size analysis it will be possible to point out the comparative sizes of the dif-
ferent items in the financial statements and it will therefore provide a possibility for discovering
structural changes and relevant characteristics of the company (Schack 2006: pp. 60-61).
The second benchmark analysis is the index analysis. Here the first year of the analysis is equal to
100 and the following years are calculated as percentages of the index year. By making such an
index, it is easy to analyze the direction and speed of development of the different items in the fi-
nancial statements (Schack 2006: p. 60).
The index analysis can also be used to find and analyze the yearly growth rate of the individual
items in the financial statements, as the change in index from one year to the next represents the
yearly growth (Elling and Sørensen 2005: p. 148). The common size and index analyses of B&O
can be found in appendix D and E respectably.
By performing the analysis based on the reorganized versions of B&O’s latest annual reports sever-
al observations can be made. The common size analysis shows that the most important items in the
income statement are the Production Costs, the Development Costs and the Distribution and Mar-
keting Costs. By looking at the index analysis for these items, it can be seen that the Production
costs had an increasing tendency in 2004/05 to 2005/06 but have gone down in the last accounting
year. This decrease is probably due to a lower activity in the company as we can see that the pro-
duction costs have a very high correlation with the net turnover. The development costs have shown
a strong increase, particularly in 2005/06 and 2007/08. This could be related to the high number of
new product launches. The Distribution and Marketing costs have also been increasing in the pe-
riod, particularly in the last accounting year. This might indicate an enlarged network through new
31
shops and an increased marketing effort in order to increase the turnover. Increased Marketing
Costs in the present, can though be justified if it leads to increased turnover in the future.
Of the balance sheet items Land & Buildings, Inventories, Trade Receivables, Trade payables,
Cash, and the long term Financial Liabilities are the most important items. Land & Buildings has
had a very inconsistent development and has been fluctuating from increases to decreases in each
consecutive year. Inventories have been increasing strongly throughout the period. This might be
due to a failing sale which has been building up inventories, but might also be indicating declining
control by B&O. Trade receivables had a strong increase in 2005/06 – 2006/07, followed by a de-
crease in 2007/08. This is correlating to the net turnover which is natural. Trade payables have
stayed fairly stable, with a minor increase the last two years. Cash has been decreasing dramatically
throughout the period which is a sign of decreased liquidity. The different financial liabilities have
showed different development patterns, but the trends from the last year is that the long term mort-
gage loans and the short term bank loans have increased dramatically.
4.3 Profitability (Written by Pia Lundanes)
An analysis of a company’s profitability is based on the financial ratio Return on Equity (ROE).
This ratio can be decompounded into the Financial Leverage and Return on Invested Capital
(ROIC). ROIC can be further decompounded into Profit Margin and Asset Turnover, which can be
subdivided into individual profit margin drivers and asset turnover drivers. This framework, as
shown in figure 2, is called the extended DuPont-model and is a widely used framework for analyz-
ing profitability as a financial ratio (Elling and Sørensen 2005: p. 172).
The DuPont framework provides a systematic approach to analyzing the different causal relation-
ship between the financial ratios. The analysis gives a better understanding of what causes the
changes in the higher level ratios and thereby provides the analyst with better information to base
the future predictions on (Schack 2006: p. 36).
The results of the profitability key ratios can be seen in table 1. For extended calculations see ap-
pendix F.
32
Tabel 1 - Profitability key ratios
(Source: Own making)
When analysing a company’s key financial ratios, the analyst should focus on the level of the ratios,
the direction of change from year to year, and the speed of the changes from the different account-
ing periods. In order to analyse the levels, it would be beneficial to compare the level of B&O’s
ratios with the level of the ratios of another company operating within the same industry, or with
industry averages. It would also be interesting to see whether or not the financial crisis has affected
the consumer electronics industry as a whole and whether or not B&O has been more affected by
the crisis than its competitors. A comparable company is difficult to find in the case of B&O as
most of their competitors are large multinational companies which have a much more extensive
product portfolio than B&O. This makes the comparison with both a single company and product
averages unreasonable, and a comparison is therefore not included in the thesis.
4.3.1 Analysis of Return on Equity (Written by Pia Lundanes)
A company’s Return on Equity (ROE) is the highest level in the Dupont Pyramid. It is an expres-
sion for the profitability of the applied capital (Schack 2006: p. 30), and is calculated as follows:
ROE = Comprehensive IncomeEquity
(Elling and Sørensen 2005: p. 171). When looking at the development of this financial ratio for
B&O during the analyzed period, one can see that the development was positive until 2006/07,
where it increased by a total of almost 6 percentage points. This development however drastically
changed in the last accounting period. The ROE dropped drastically and is now on a level of about
7% which can be considered to be very low compared to previous years.
33
4.3.2 Analysis of Return on Invested Capital (Written by Pia Lundanes)
The Return on Invested Capital (ROIC) measures how good the company is at making profit based
on the net operating assets that are available. The better a company is at utilizing its existing re-
sources to create profit, the higher the ROIC ratio will be. As mentioned above ROIC is a subcom-
ponent of ROE, the relationship being as follows:
ROE = ROIC + (Financial Leverage × (ROIC − r66
Hence the higher the ROIC ratio is, the higher the ROE will be given the same level of financial
value drivers (Elling and Sørensen 2005: pp. 175, 173).
When analyzing B&O’s ROIC for the period, there are patterns correlating with the ROE, which is
natural as ROIC is one of the components of the ROE. ROIC was quite stable in the first three years
of the period, with a small decrease from 2004/05 to 2005/06, which was compensated by an equal
increase from 2005/06 to 2006/07. In the last accounting period, however, the same massive de-
crease as in the ROE is obvious. In order to find out what has triggered the dramatic decrease in
ROE and ROIC, it is important to analyze the underlying factors of ROIC, the profit margin and the
asset turnover, as ROIC is composed as:
ROIC = Pro8it Margin × Asset Turnover
(Elling and Sørensen 2005: p. 186)
4.3.3 Analysis of Profit Margin (Written by Pia Lundanes)
The Profit Margin describes the relationship between income and expenses of the company and
measures the profit of one DKK sales from the operating activity (Elling and Sørensen 2005: p.
186). In other words, it tells us how much of the company’s activity that is translated into profit
(Schack 2006: p. 33).
Pro8it Margin = Operating Pro8itNet Turnover
34
(Hillebrandt et al. 2004: p. 15) When looking at B&O’s Profit Margin for the period we see a simi-
lar pattern as for the ROIC, a small decrease followed by a small increase and then a large decrease
in the last accounting period.
To get a better understanding of the development of the profit margin, we can look at yet a deeper
level of analysis to figure out which of the individual elements in the financial statements has the
biggest impact on the profit margin. When looking at appendix F it is given that the Gross Margin
stays fairly stable throughout the period. This means that the development must mainly be caused
by increased costs other than production costs. From the common size analysis in appendix D it was
found that both the Development Costs and the Distribution and Marketing Costs are some of the
most substantial elements. The index analysis indicated that the Development Costs and Distribu-
tion and Marketing Costs have increased considerably in comparison to the Net Turnover. This
means that the negative development in the last year is mainly caused by increased costs in relation
to development, distribution and marketing. Whether this is favorable or not depends to which ex-
tent these are investments that will cause increased turnover in the future or whether it is related to
poorer productivity and efficiency.
4.3.4 Analysis of Asset Turnover (Written by Pia Lundanes)
The Asset Turnover describes how much sales is achieved per DKK invested in net operating as-
sets. If we take the inverse value of this ratio, we find how much investment is required in net oper-
ating assets to produce a sale of one DKK (Elling and Sørensen 2005: p186). Asset turnover is cal-
culated as shown:
Asset Turnover = Net TurnoverNet Operating Assets
(Elling and Sørensen 2005: p. 173) The development of this ratio has been a bit different from the
other financial ratios, as there has not been such a massive change in the last period. The Asset
Turnover increased slightly in 2005/06, and has since then been decreasing with 12% and 14% re-
spectively. This means that the amount of investment required to produce a given amount of sales
has increased.
Once again this number is based on a number of individual calculations of the turnover of individu-
al assets, which can be seen in appendix F. The Intangible Assets have shown a fairly negative de-
velopment in the last two years. If we look at the index analysis, this could be due to a very large
35
increase in goodwill and acquired rights and in the 2006/07, as well as a general increase in all
years except for 2007/08 of completed development projects. The reason for the increase in Intang-
ible Asset turnover in the last year is therefore a relatively less decrease in intangible assets in com-
parison to net turnover.
Inventory was found to be one of the important items in the common size analysis. The inventory
turnover has been increasing significantly, and did in the last two years increase with over 20% an-
nually, and actually accounts for approximately 70% of the increase in asset turnover. The reason
for the increased inventory turnover is that inventory increased comparatively more than net turno-
ver.
The same unfavorable development is seen in the trade receivables where there has been an increase
in receivables turnover for the last two years. The most important individual item in this calculation
is the trade receivables which increased strongly from 2004/05-2006/07, but has been decreasing in
2007/08 which is natural due to the lower level of activity. The trade receivables increased relative-
ly less than net turnover, leading to increased receivables turnover.
All in all it means that Inventory and Trade Receivables are the most important sources for the de-
creased Asset Turnover.
By analyzing the levels for Profit Margin and Asset Turnover we find that the drastic drop in ROE
and ROIC in the last accounting year is mainly due to a drop in the profit margin of 63% in the pe-
riod, which was mainly caused by Development and Distributing and Marketing costs. The Asset
turnover however also had a decreasing tendency of 14% in the last year where some of the main
factors were Inventory and Trade Receivables turnover.
4.4 Financial Leverage (Written by Mette D. Kremmling)
As mentioned above, the financial ratio Return on Equity (ROE) can be decompounded into a func-
tion of Return on Invested Capital (ROIC) and Financial Leverage:
ROE = ROIC + ((ROIC − Interest6 × Financial Leverage6
(Elling and Sørensen 2005: p. 174). Since B&O also have minority interests, these should be added
to the equity in the calculations of ROE and Financial Leverage. Financial leverage measures the
proportion of the invested capital that is financed through financial liabilities in relation to the pro-
portion that is financed through equity, and is thus calculated as:
36
Financial Leverage = Net Financial LiabilitesEquity
(Hillebradt 2004: p. 19). The difference between ROIC and the interest is also called SPREAD and
measures the difference between what the company can earn on its operating activities and its cost
of borrowing, and thus whether a company can profit from borrowing money and investing it in its
own operations. Hence, with net financial liabilities a positive SPREAD will mean that the compa-
ny is earning more on the money borrowed than it costs to borrow them, and is therefore gearing
ROIC up to give a higher ROE. However, with net financial assets a positive SPREAD will gear
ROE down, since some of the investors’ funds are invested in assets giving a lower return than the
return on operations (Elling and Sørensen 2005: pp. 174-177). The size of the financial leverage is
thus decisive for how much a positive SPREAD gears up/down ROE.
In table 2 the financial leverage drivers for B&O are shown. For the full calculations see Appendix
F and G.
Table 2 – ROE, ROIC, and Financial Leverage Drivers
(Souce: Own making)
Historically B&O have been relative conservatively financed, with the proportion of liabilities of
total equity and liabilities not reaching 50% during the last 4 years. In the financial years 2004/05 –
2006/07 B&O had net financial assets, meaning that their balance of cash and financial receivables
was higher than their loans and other financial payables. Consequently, this gives a negative finan-
cial leverage. There has however, been a trend for B&O to move towards having net financial liabil-
ities, mainly due to decreases in the cash balance and increased mortgage loans.
The negative financial leverage have also led to negative interests in 2004/05 and 2006/07, since
these years have not had net financial costs but net financial assets. In connection with the increase
in loans, especially in 2007/08 a permanent increase in financial costs can be expected.
37
From the financial year 2004/05 to 2006/07 the SPREAD have been positive, but with the negative
financial leverage this have actually led to a decrease in ROE. The main reason for the large posi-
tive SPREAD can be found in the fact, that almost all financial assets are in cash or cash equiva-
lents, and therefore generate no or little revenue.
In 2007/08 the cash balance has decreased to approximately 7 times less the value in 2004/05 and
B&O have taken up a large amount of mortgage loans, leading to B&O having net financial liabili-
ties. However, the financial costs have also increased, and ROIC has decreased significantly to a
level below the interest rate. This has led to a negative SPREAD in 2007/08 decreasing ROE in
comparison to ROIC.
The question arises, whether B&O have carried out the optimal financing strategy. B&O could have
increased their financial leverage to a positive value by borrowing and investing in operations. This
would probably lead to increased costs of borrowing. However, with the high level of ROIC in
2004/05 – 2006/07 it would take considerable increases in the interest for it to result in negative
effects. Hence, this would have increased ROE and thus the shareholder value. On the other hand,
this would have left B&O more vulnerable to the downturn in ROIC in 2007/08.
In the following year B&O plan to increase its solvency ratio by issuing new shares for 400 mill
DKK (Bang & Olufsen 2009: p. 1). This will increase the equity, and thus lower the financial leve-
rage depending on whether the capital will be invested in operational or financial assets.
4.5 Growth and Permanent Income (Written by Mette D. Kremmling)
As mentioned, for the valuation of B&O the residual income model will be used. It is therefore of
interest to analyze how the residual income, which is driven by ROE and growth in equity, has de-
veloped historically (Elling and Sørensen 2005: p. 203). This section will hence supplement the
previous sections’ analysis of the levels and development of key financial drivers by analyzing the
impact of their changes on ROE. In order for this analysis to be valuable for the budgeting process,
the income statement will be further reorganized to exclude items not relating to the permanent in-
come of B&O. As can be seen in the reorganized income statement in appendix H the extraordinary
items are identified as gains on a settlement on a defined benefit plan and sales of shares in subsidi-
aries and non-current assets. Furthermore revenues and costs relating to exchange rates and protec-
tion against these are seen to be unpredictable and therefore non-permanent. Through this division
ROIC can be separated into three different components (Elling and Sørensen 2005: 208):
38
ROIC = Core ROIC from Sales + Core ROIC from other Core activites + Extraordinary Items ROIC
Table 3 - ROIC division
(Source: own making)
Since only a very small part of ROIC is driven by extraordinary items profit is said to be of high
quality (Elling and Sørensen 2005: 208), which increase the validity of using the historical results
for projecting future performance. Hence it is the development in Core ROIC from Sales and the
underlying factors influencing this key ratio that is relevant for budgeting future performance. Core
ROIC from Sales can be decompounded as follows:
Core ROIC from Sales = Core Pro8it Margin from Sales × Asset Turnover
(Elling and Sørensen 2005: p. 217). And the effect of changes in these two components on Core
ROIC from Sales can afterwards be determined as follows, where the first component explains the
effect of changes in Core Profit Margin from Sales with a stable Asset Turnover, and the second
component the effect of changes in Asset Turnover for a stable level of Core Profit Margin from
Sales:
∆Core ROIC from Sales== (∆Core Pro8it Margin from Sales= × Asset Turnover=>?6 + (∆Asset Turnover=× Core Pro8it Margin from Sales=
(Elling and Sørensen 2005: p. 218). The total change in the overall ROIC is thus a function of the
effect of changes in Core Profit Margin from Sales and Asset Turnover and changes in Core ROIC
from other Core Activities and Extraordinary items ROIC, as shown in table 4. For full calculations
see appendix G
39
Table 4 – Changes in ROIC
(Source: Own making)
The Core Profit Margin from Sales should be seen as an essential financial ratio for projecting fu-
ture performance, as it is a clean measurement for the company’s ability to earn a profit on its pri-
mary activities, sales. From 2004/05 – 2006/07 this ratio had a positive effect on ROIC since distri-
bution and marketing costs did not increase with the same speed as the net turnover (see the com-
mon size analysis in appendix D). However, in 2007/08 the change in the Core Profit Margin from
Sales had a severely negative effect on ROIC. This is due to the fact that development- and distribu-
tion and marketing costs increased significantly even though net turnover actually decreased.
For the last two consecutive years the change in asset turnover has had a negative effect on ROIC
which is primarily due to buildup in inventory and trade receivables relative to the increase in net
turnover as described above.
The return from B&O’s other activities especially had a negative effect on the overall ROIC in the
financial year 2007/08; this is due to the significant increase in the loss from investments in asso-
ciates that were booked this year. Lastly extraordinary items have had both positive and negative
effects on B&O’s ROIC through the period accounting for the majority of the change in 2004/05
and 2005/06. However, as these items are unpredictable this should not be taken into account in the
budgeting analysis.
As mentioned in section 5.4 ROE can be decompounded into a function of ROIC, SPREAD, and
Financial Leverage, hence, it is also important to analyze the changes in SPREAD and Financial
Leverage to fully describe the underlying factors for the changes in ROE. The effect of changes in
these financial key ratios can be calculated as follows:
∆ROE= = ∆ROIC= + (∆SPREAD= × Financial Leverage=>?6 + (∆Financial Leverage= × SPREAD=6
(Elling and Sørensen 2005: p. 219), where the second component describes the effect on ROE of
changes in SPREAD given a constant Financial Leverage and the third component describes the
40
effect of changes in Financial Leverage on ROE given the SPREAD in the present year. The calcu-
lated effects can be seen in table 5.
Table 5 – Changes in ROE
(Source: Own Making)
Since B&O had net financial assets in 2004/05 - 2006/07 a decrease in SPREAD would have a posi-
tive effect on ROE, since this would decrease the gearing on the negative financial leverage, and
there through decrease the negative effect on ROE. This is the effect visible in 2005/06 and re-
versed in 2006/07. In 2007/08 a combined effect of the significantly lowered ROIC and increased
financial costs on financial liabilities leads to a significant decrease in SPREAD according to the
analogy before has a positive effect on ROE. This should though not be interpreted as a fully posi-
tive thing, since SPREAD actually have decreased so far that it is negative in 2007/08, meaning that
B&O is not ably to earn as high a return on their investments as they have to pay for their debt.
The Financial Leverage has steadily changed from being negative to being slightly positive in
2007/08. This is due to the decreased cash holding through the period and the increased debt taking
in 2007/08. As the SPREAD was positive this development had a positive effect on ROE since
B&O were actually able to earn a higher return on the increased net financial liabilities than they
paid in interests. However, as SPREAD became negative this was no longer the case, and hence, an
increase in Net Financial Liabilities had a negative effect on ROE. The main reason for the signifi-
cant decrease in ROE in 2007/08 does though still come from the large decrease in ROIC.
4.6 Liquidity Level (Written by Mette D. Kremmling)
The decreasing cash holdings of B&O raise some worries about the risk of B&O suspending their
payments. An analysis of the liquidity level thus seems suitable when forecasting the future opera-
tions and performance of B&O. For this purpose two main ratios can be calculated, the acid test and
the current ratio, which are calculated as follows:
Acid test = Most liquid assetsCurrent loan capital
41
Current ratio = Current AssetsCurrent loan capital
(Schack 2002: p. 71). There are no clearly agreed upon opinion about how to define the factors in
the equations. In this paper the most liquid assets are defined as cash, other financial receivables,
and trade receivables, while current assets are defined as assets held for sales, cash, and receivables.
Furthermore, current loan capital is defined as current liabilities in the balance sheet less deferred
income, since these do not demand capital payments.
The ratios hence describe B&O’s short term ability to pay its liabilities, where the acid test takes a
shorter time horizon into account than the current ratio. The detailed calculations can be seen in
appendix I while the ratios are depicted below in table 6.
Table 6 – Liquidity Level
(Source: Own Making)
It is argued that a satisfactory level for the acid test is a ratio preferably above 1 (Schack 2002: p.
72). This is recommended since a ratio below 1 will indicate that the company is not able to pay of
its short term liabilities without raising extra capital. In the case of B&O a clear trend of deteriora-
tion of the ratio can be seen. In 2004/05 the ratio was at a very nice level of 1,92, meaning that the
company could pay its current liabilities almost twice with its most liquid assets, giving them plenty
of working and spare capital. However, in the end of the financial year 2007/08 the ratio was only
1,00, meaning that B&O could only be expected to be exactly able to pay their short term liabilities
in the next financial year, unless they get some kind of extra capital.
Likewise it can be argued that the current ratio should be above 2 (Schack 2002: p. 72). This num-
ber is higher than the one for the acid test, since the current ratio takes a bit longer time horizon into
perspective and consequently need to take the long terms liabilities into account as well. Hence in
the long run it is not enough just to be able to pay off the short term liabilities. However, here the
number 2 should not be taken as literally as the level of 1 in the acid test. In this ratio the same de-
creasing trend as in the acid test is visible. Nevertheless, the indications of the current ratio are not
as bad. This is mainly due to the increased inventory and the relatively stable level of trade recei-
42
vables which keeps the level of current assets from decreasing as much as the level of most liquid
assets.
A remark should though be made about the problems about relying on these ratios. Firstly, the ra-
tios assume non-going concern, since this is the only situation in which all assets and liabilities are
realized. Furthermore, the ratios see larger trade debtors as a positive influence while large trade
creditors have a negative influence on the ratios (Schack 2002: p. 72). However, in the daily run-
ning of the company trade creditors is a cheap way of financing and thus a positive thing, while
trade debtors bear a certain amount of risk, since all debts might not result in cash flows. The con-
sequence of this is that the liquidity ratios have a tendency to somewhat overestimate the situation
of the company. This however, only strengthens the above conclusion about the liquidity situation
of B&O.
In B&O’s interim report from January 15th 2009, they mention that the plan is to increase their equi-
ty by 400 million DKK through share issues (Bang & Olufsen A/S 2009: p. 1). Already a few days
after this statement Færch Holdings acquired shares of a worth of 42 million DKK of B&O’s own
shares and plan to invest the same amount in the upcoming share issue (Bang 2009). Hence B&O
should be secured operation in the coming year as well. However, it is still necessary for B&O to
stop the negative tendencies in their cash flows, if they are to be sure not to end up in the same
troublesome situation again.
4.7 Conclusion on Accounts Analysis (Written by Mette D. Kremmling)
As mentioned above B&O has traditionally been conservatively financed with very little debt and in
fact earlier had a higher holding of cash than it owed in debt. This have led the return of B&O to be
almost solely dependent upon the running of the daily operations, previously retained earnings and
the original investments of the shareholders. However, this also means that the company has de-
clined possible opportunities for higher revenues by borrowing and investing in its operations at a
higher rate of return. This possibility must be said to be highly relevant in the case of B&O, since
they from 2004/05 – 2006/07 had a stable high Return on Invested Capital (ROIC). On the other
hand the current strategy might put B&O in a better position to manage through the financial crisis,
since they have very little expenses in the form of repayment of debt.
In the financial years 2004/05 – 2006/07 the general development in B&O was positive and the Re-
turn on Equity ROE increased from 15,81% to 21,62%. This development was, as mentioned above,
driven by an increase in the Financial Leverage. However, this increased was only driven in a small
43
part by an increase in debt and thus the above mentioned income effect was only utilized to a very
small part. Rather the increase in Financial Leverage was due to a decrease in the cash holdings,
which in 2007/08 ended at a point that very well could give B&O problems in form of not having
enough liquidity.
During the same period the Core Profit Margin from Sales increased, most significantly in the fi-
nancial year 2006/07, leading to a positive effect on ROIC and there through on ROE. This positive
effect was in 2005/06 helped along by an increasing Asset Turnover, indicating a better profitability
of the assets. However, from 2006/07 this effect reversed as the Asset Turnover decreased indicat-
ing among others inventory build-up. It seems though that B&O is aware of this effect, as they have
instituted a new central inventory instead of local inventories in all sales outlets (Bang & Olufsen
Group 2008: p. 12).
In the financial year 2007/08 B&O felt the effect of the financial crisis, especially in the last 6
months of that period, which has put a visible mark on the key financial ratios. Overall ROE de-
creased to 7,07% against 21,62% in 2006/07. As mentioned this should be seen as an effect of the
decreased ROIC, which is due to significantly increasing development- and distribution and market-
ing costs against the decrease in net turnover. Innovation and development is an essential part of
B&O’s survival strategy, however, there has been the notion that the company have used too many
resources in the wrong business areas (Skouboe 2008: Rasmussen 2009). With the new focused
“pole position” strategy of B&O (Bang & Olufsen 2008) the level of this might however change to
a more suitable level, since the focus will be in the company’s core product areas. As for the distri-
bution and marketing cost, these expenses might increase future sales by increasing the public
knowledge of B&O. Whether this however is worth the investment in a time with a financial crisis
is to be seen in the future.
In 2007/08 the Asset Turnover, furthermore, kept decreasing caused from further inventory build-
up. However, this must be seen to be natural in a situation with significantly lower sales before the
production is fitted to the new level of demand. This development can furthermore be seen in the
decreased turnover of trade receivables.
The situation of B&O is hence critical at the moment especially concerning the needed liquidity.
However, there have also been some warning signs in earlier years, and the effect has been in-
creased by the current financial crisis.
44
5. Budgeting (Written by Pia Lundanes)
After having analyzed the financial statements, the next step towards determining the value of B&O
is to create budgets for the future years. The future value creation of a company is based on a mix of
the operating- and financing activities combined with the investments that are made. This value
creation will determine the future shareholder value. A budget can be created using several me-
thods. One alternative is to forecast the development of each individual item in the financial state-
ments, whereas another is to make the budgets based on the condensed and reorganized financial
statements. This means that only certain numbers and ratios will be forecasted (Elling and Sørensen
2005: p. 225). The forecasted budgets can be seen in appendix J.
In theory the different valuation methods discount the cash flows from all future years to find the
value of the company, but as this is not possible a certain budget period is chosen. When deciding
upon how long the budget period should be, several factors should be taken into consideration. In
general the length of the budget period depends on the number of years in which there can be made
reasonable predictions of the underlying factors. More precisely, there are four conditions which
need to be satisfied in the terminal period. These conditions are that the sales growth, profit margin,
asset turnover and financial gearing all must reach a constant level (Elling and Sørensen 2005: pp.
234-235). Elling and Sørensen (2005: p. 35) claim that the budgeting period is normally between 3
and 10 years.
In these days making budgets for future value creation is especially difficult due to the financial
crisis. The duration of the crisis will have a very significant impact on the budget of B&O as well as
a number of other companies all over the world. Futurologist Jeffrey Saunders claims that it is im-
possible to know when the crisis will end. On the other hand he predicts four different scenarios
which are likely to happen. The first is called “A serious hangover” and claims that the financial
crisis will be finished by the end of 2009. In this scenario the different government initiatives for
ending the financial crisis will start improving the economy by the end of this year. The second is
named “A new world order” and predicts that the crisis will end in the beginning of 2010 and as-
sumes that the western markets will face a period of stagnation due to their high levels of debt. The
Asian markets are however expected to prosper. The scenario “Global capitalism’s checkmate” pre-
dicts that the crisis will end in 2012 but that the global economy will experience limited growth in
the future. The last scenario, “Sustainable new growth” also assumes the crisis to last until 2012 but
that the recession will cause substantial growth rates after the crisis has ended (Koszyczarek 2009).
In the following sections, two budgets and valuations will be made based on the first two scenarios.
45
These budgets will provide a picture of how important the duration of the crisis will be for the fu-
ture of B&O. The last two scenarios will not be evaluated here as there is reason to doubt the ability
of B&O to survive the crisis if it will last until 2012. It should be mentioned that both of the budget
scenarios are built on the assumption that B&O survives the financial crisis and that they succeed in
implementing their new strategy.
5.1 Scenario one (Written by Pia Lundanes)
The first factor to be budgeted is the future sales growth for B&O. Companies with very high or
very low growth rates have a tendency to adjust to a normal level within a period of 3 to 10 years
(Elling and Sørensen 2005: p. 227). The objective is therefore to find the terminal value of the sales
growth which will be used in the valuation of the company. The normal level that growth rates tend
to adjust to is according to Elling and Sørensen (2005: p. 227) somewhere in the interval from 6 to
9 percent per year. Branchen Forbrugerelektronik (BFE) (A Danish association for consumer elec-
tronics) however, claims that the growth in the electronics industry will only be about 2% annually
in the future. The retail chains 2tal and Expert disagree with this pessimistic prediction and believe
that the sales growth will be above a level of 2% (Nikolajsen 2008: p.12). In order to find which
growth rate is the most likely for B&O, elements from the strategic analysis will have to be taken
into consideration. The competition in the consumer electronics industry has been increasing
strongly the last few years, which has resulted in a downward pressure on prices. This is affecting
B&O since their competitors have been entering B&O’s niche market by making high quality prod-
ucts with an emphasis on attractive design.
Because of the above argumentation for increased competition it is unlikely that the growth rate of
B&O will be as high as the 6% suggested by Elling and Sørensen (2005: p. 227). The historical
sales growth rate of the company is another source which can provide an indication of what the
growth rate will be like in the future. When considering the accounting periods from 2000/01 until
2007/08 the average sales growth has been about 2.4%. However, if we exclude the effect of the
financial crisis which impacted the sales in the last accounting year, the average growth rate is 3.5%
(Calculations for this can this can be seen in appendix K). A future growth rate of 3.5% seems ra-
tional according to the discussion above. The rate is significantly lower than the 6% suggested by
Elling and Sørensen which is related to the fierce competition in the industry. The 3,5% is however
higher than what the BFE has been predicted for the electronics industry in general. When consider-
ing that B&O is operating in a niche within the market and has changed their focus towards new
46
product creation and boosting their sales (Bang & Olufsen 2008), a future sales growth estimate of
3,5 is reasonable.
In addition to the terminal value, the sales growth rates in the years up until the terminal year have
to be estimated. The sales growth is estimated to be -25% in the 2008/09 accounting year according
to B&O’s own predictions in the last interim report (Bang & Olufsen A/S 2009: p.1). In the subse-
quent year the sales growth is expected to be 0. The reason for this is that the new product launches
of the core products of B&O are expected to increase sales to a certain degree. It is however likely
that the market for luxury products will take longer to recover from the financial crisis and that
B&O will not experience the full effect of their product launches until the year 2010/11 and beyond.
It is forecasted that the sales growth will increase gradually from the year 2009/10 until the account-
ing year 2012/13. In the end of this period it is anticipated that the sales growth will be above the
terminal value. The reason for this is the postponed purchases of TV’s and other electronic goods
during the financial crisis. As consumers will find themselves in a better economical situation they
will make the investments in luxury goods which they could not afford during the years of the cri-
sis. When these postponed purchases have been made, the growth rate will decrease gradually and
reach the terminal value of 3,5% in the years 2014/15 and 2015/16.
The next rate to be estimated is the asset turnover. The terminal value for the asset turnover is ex-
pected to be 3,1. This number is slightly lower than the periods of very high growth in the past. In
the year 2008/09 the asset turnover is expected to decrease to 1,8 which is significantly lower than
the previous years. This is expected as the turnover is set to decrease with 25%, but it is not ex-
pected that B&O will be able to adjust their production to this level. Hence production is set to de-
crease with only approximately 15%, which increases the inventory. In 09/10 the asset turnover will
increase to 1,9 as it is expected that B&O will adjust the inventory to the demand in a better way
than in the previous year. From 2008/09 the asset turnover is expected to increase gradually until
2013/14 where the ratio will reach a peak. Here the value will be about 3,2 which is higher than the
terminal value. The reason for this is that the asset turnover is related to the development of the
sales growth, which is above the normal rate in this year (Elling and Sørensen 2005: p. 228). As the
sales growth stabilizes, so will the asset turnover which will therefore reach the terminal value of
3,1 in year 2014/15 and 2015/16.
When making the budget, the next ratio to be estimated it the core operating profit margin before
tax. In principle the change of different items such as marketing and R&D costs as well as salaries
and material costs should be estimated, but as detailed information about these items are not availa-
47
ble, the expected development of the core operating profit margin before tax as will be estimated as
a whole (Elling and Sørensen 2005: p. 229). When predicting the ratio in the year 2008/09 the last
interim report once again provides us with sufficient information. The management expects a net
loss of 440 million DKK, where 340 million DKK is operating loss and the remaining 100 million
DKK is related to restructuring costs in the company. The turnover is expected to be about 3100
million DKK, and expected core operating profit margin before tax can therefore be calculated to -
0,14. (Bang & Olufsen A/S 2009: p.1). The consecutive year, 2009/10, the management has a goal
of breaking even. This means a profit margin of 0 for the year which is considered a reasonable
estimate. The terminal value is set to a level of 7% which is similar to what the level B&O expe-
rienced before the financial crisis. It is expected that the company will be able to achieve this level
again as cost cutting is an important part of their new strategy (Bang & Olufsen 2008). From the
year 2009/10 the profit margin is expected to increase gradually until the terminal value is reached.
Effective tax rate is another value which will have to be calculated in order to make a valuation of
the company. By analysing the historical level of the effective tax rate of B&O it is found that the
effective tax rate has a tendency to be slightly above the corporate tax level which is now 25%. It is
therefore anticipated that the effective tax rate will be 26% in the future years.
The last number to be budgeted is the core other operating profit after tax. It is assumed that a rea-
sonable estimate is -15 in the year 2008/09. The reason for this is that the associated companies will
also be affected significantly by the financial crisis. In 2009/10 the ratio is expected to be -7 as it is
likely that the small associated companies will have a harder time recovering from the crisis, and
will therefore have an extra year of a negative result, compared to B&O which will break even in
this accounting year. The terminal value of this rate is expected to be 1, as there is a plan asset and a
small profit from the associated companies is expected. Extraordinary items should also be included
in the budget, but as these are impossible to forecast, the value is set to 0.
6. Valuation (Written by Mette D. Kremmling)
As explained under the delimitations, the framework of Jens O. Elling and Ole Sørensen (2005) was
chosen as the basis for the valuation of B&O. The authors mentions three main models for valuating
companies, the Dividend Model, the Free Cash Flow Model, and the Residual Income Model. Be-
fore valuating B&O it is hence important to carefully consider which model to use. The following
48
will therefore contain argumentation for, and a description of the choice of model; where after the
concrete valuation will be made.
6.1 Choice of Model (Written by Mette D. Kremmling)
The valuation models can be classified as either establishing the equity value or the firm value of a
company (Elling and Sørensen 2005: p. 32). The value of the company equity looks at the situation
purely from the shareholders view. Hence it values the part of the company that the shareholders are
entitled to. On the other hand the firm value looks at the value irrespectively of how the company is
financed and hence values the whole company, both the part that the lenders are entitled to and the
shareholders’ part. The connection between the two concepts can be written as follows:
VB = VBCDE − NFLB
stating that the present value of the company equity is equal to the present value of the net operating
asset (firm value) less the present value of net financial liabilities (Elling and Sørensen 2005: p. 22).
The end result of the valuation process should be a share price that is comparable with the share
price quoted in the market. Hence, the interest is in finding the value of the equity. Even so, the
models for establishing the firm value will be used to indirectly find the value of B&O’s equity.
This is done since these models make the simplified assumption, that the company only adds value
through its operating activities and not through its financing activity, which eases the budgeting
process (Elling and Sørensen 2005: p. 35). Furthermore, this outlook is found suiting in the case of
B&O since they have relatively few liabilities.
6.1.1 The Dividend Model (Written by Mette D. Kremmling)
The Dividend Model takes the view of the classical cash flow theory, that the value of a security is
equal to the present value of future cash flows, and thus calculates the equity value as the present
value of future expected dividend paid to the shareholders, as shown below:
VB = d?(1 + k�6? + dH
(1 + k�6H + ⋯ → ∞
where d = dividend paid and kL = the cost of equity (Elling and Sørensen 2005: pp. 36-37). Howev-
er, as can be seen the Dividend model can only be used to value the equity directly.
49
This model furthermore possesses one major problem for it to be relevant for establishing the value
of a company. Dividends are almost never directly connected to the profit of a company, but are
something the board of the company decides on. Some companies even avoid paying dividends
completely, in which case the value of the equity would become 0 according to the Dividend model.
Hence, the Dividend model does not establish a realistic view of the company value and will thus
not be used to value B&O.
6.1.2 The Free Cash Flow Model (Written by Mette D. Kremmling)
The Free Cash Flow model departs from estimated pro forma accounting statements drawn up by
the financial analyst, and has through time been preferred by many (Elling and Sørensen 2005: p.
21). This model can both be used to estimate the equity value of a company directly or indirectly
through the company value. Concretely the company value is calculated as:
VBCDE = FCF?(1 + wacc6? + FCFH
(1 + wacc6H + ⋯ → ∞
where the free cash flow (FCF), measured as the total cash flow from operating- and investment
activities, is discounted with the weighted average cost of capital of the company (wacc) (Elling and
Sørensen 2005: p. 42). By subtracting the claims of the lenders from the free cash flow mentioned
above, the maximum amount available for payment to the shareholders is found. There is thus a
clear connection between the Free Cash Flow Model and the Dividend Model. However, the Free
Cash Flow Model is to a much greater extent connected to the actual performance of the company,
and thus gives a truer depiction of the company’s actual value than the Dividend Model.
The Free Cash Flow Model though has some drawbacks as well. Much of the information needed
for its performance is not readily available and there is therefore a need for having or acquiring tho-
rough knowledge about the company in question. In this way the model does not draw on booked
values, but leaves the estimation of the normal income and residual income completely up to the
external analysts (Elling and Sørensen 2005: p. 48).
6.1.3 The Residual Income Model (Written by Mette D. Kremmling)
As the Free Cash Flow Model the Residual Income Model takes its starting point in pro forma ac-
counting statements forecasted by the analysts and can be used to calculate the value of equity both
directly and through the company value. However, instead of looking at the total cash flow generat-
ed through operating- and financing activities, the Residual Income Model looks at the book value
50
of the operating assets and the residual income generated in the period (Elling and Sørensen 2005:
p. 44). The residual income (RI) should here be seen as the above normal income, meaning the in-
come above the level expected by the shareholders in a company of an equal risk in the form of
dividends and stock price increases. When calculating the firm value the claims of the lenders are
also taken into account and hence wacc is used as a discount factor instead of only the cost of equi-
ty, as shown:
VBCDE = NOAB + RI from Operations ?(1 + wacc6? + RI from OperationsH
(1 + wacc6H + ⋯ → ∞
(Elling and Sørensen 2005: p. 46).
Contrary to the Free Cash Flow Model for the Residual Income Model a very large part of the data
necessary for the valuation is readily available, as the model bases a large part of the valuation
process on the accounting statements. The model therefore exploits the capabilities of the company
for valuing their own assets. However, this advantage is also the major disadvantage of the model,
as it becomes reliable upon, that the statements have not been manipulated in any way by the com-
pany (Elling and Sørensen 2005: pp. 48-49). In the case of B&O no warning signs of manipulation
are found and it is assessed that the statements are reliable enough to use the Residual Income Mod-
el in the valuation process. Hence, as the authors have no previous experience with budgeting and
valuation of companies, it is found preferable to exploit the competencies of the company in valuing
their own assets.
In practice, when valuing the company, the residual income cannot be estimated until infinity. Con-
sequently a terminal period will be chosen, in which all factors are believed to have reached a stable
level, where after the value of the rest of the periods is calculated as a perpetuity of this terminal
period.
6.2 The Weighted Cost of Capital (wacc) (Written by Mette D. Kremmling)
As shown in the above stated equation for the calculation of firm value through the Residual In-
come Model, wacc is used as the discount factor for the future residual earnings of the company.
Wacc is the expected return on the financing portfolio of a company, with the required rate of return
for each security weighted as their proportion of the total value of the company. Simplified wacc
can be calculated as:
51
wacc = MDV × (1 − TN6r��O=P + ME
V × r�QR�=SP
where D = the value of debt, V = the company value, TN = corporation tax, E = the value of the eq-
uity, and r = required rate of return for the respectable securities (Brealey et al. 2007: p. 339). Strict-
ly speaking should wacc be composed of weights for all different kinds of securities that the com-
pany has. However, as information about the precise financing structure is not available, and since
the required rate of return for all these possible securities is difficult to estimate, wacc will only be
estimated from the proportion of debt and equity.
To be able to calculate wacc from the above mentioned equation, it is first necessary to calculate the
required rate of return of the equity, which can be done as:
Required Rate of Return = Risk Free Rate + Risk Premium
r� = r� + β(rU − r�6
which is also called the capital asset pricing model (CAPM) (Brealey et al. 2007: p. 304).
6.2.1 Estimating the Systematic Risk (β) (Written by Mette D. Kremmling)
From the equation above, it can be seen that the value β is needed to calculate the required return on
equity and there through wacc. A stock’s β is its systematic risk in comparison to the volatility of
the market, and can be expressed as follows:
β = σ(�W6σ(�X6
× ρ(�WX6
where σ is the volatility of the share (i) and the market (m) and ρ the correlation between the share
and the market (Brealey et al. 2008: p. 298). A share with a β-value above 1 is thus more volatile
than the market, and vise versa for a share with a β-value below 1 (Brealey et al. 2007: p. 296).
The volatility and correlation of the B&O share and the market can be found by plotting the quota-
tions over a sufficiently long time period. In appendix L can be seen a table of the closing quotation
of each month of B&O and the Danish OMX C20 index over a three year period. Furthermore, the
percentage changes from one month to the next are calculated. The plot can also been seen in fig-
ure 7.
52
Figure 7 – Quotations of the Bang & Olufsen B share and OMX-C20 from March 31st
2006 to February 27th
2009 (Source: Own
making, adopted from historical quoted from EuroInvestor)
As can be seen from the plot, the B&O B share has been more volatile than the OMX-C20 index
during the last three years. It is therefore expected to have a β-value above 1. From the calculations
in appendix L it can be seen that this notion is correct, since the B&O B share is estimated to have a
β = 1,65.
Depending on the period measured over and the index compared with the estimate of β will change.
It is however believed that for the purpose of this thesis a period of three years is sufficient. Fur-
thermore, the OMX-C20 index is found suiting for comparison, since the B&O is a Danish share
and the index is the leading Danish index. Others have estimated β for B&O as well. EuroInvestor
get a β of 1,16 and the Danish bank Spar Nord got a β of 1,30 in their analysis from October 2008
(Falk-Sørensen: 2008). These are both lower than the estimate of 1,65. However, this is still the
value that will be used throughout the rest of the thesis.
6.2.2 Estimation of the Required Rate of Return on Equity (��) (Written by Mette D. Kremmling)
In order to estimate the required rate of return on equity (r�), there are still two factors to be deter-
mined, the risk free rate (r�) and the required rate of return on the market (rU).
According to Copeland et al. (2000: pp. 215-216) the risk free rate hypothetically is the return on a
portfolio or a security which is completely uncorrelated with the returns on anything else in the
economy and has no default risk. Practically however, this would correspond to a portfolio with a
minimum variance and a beta of zero. The easier way to estimate the risk free rate, which is rec-
ommended by Copeland et al., is to use the rate for the 10 year Treasury bond. This rate is consis-
53
tent with the betas and market risk premiums of the stock market index portfolio, and its prices and
therefore rates are less vulnerable to unexpected changes in inflation than a Treasury bond with a
longer duration, and thus have a smaller beta. According to Børsen the effective rate on a 10 year
Danish Treasury Bond was 3,77% on March 25th 2009, which is the risk free rate used further on.
From the equation for calculation of r� in section 6.2, it can be seen that the required rate of return
on the market, rU, is needed in order to find the difference between this number and the risk free
rate. This is also called the market risk premium. Hence if an estimate of the market risk premium
can be made, it will not be necessary to calculate rU directly. According to the Federation of Danish
Investment Associations (2009) the London School of Business, have analyzed on this number. The
analysis consisted of a historical analysis of the actual risk premiums in the years 1900 – 2005, and
gave a real risk premium of approximately 2%. Since the source of the analysis is viewed to be va-
lid and the historical horizon is very long, the 2% is found to be a valid estimate of the risk pre-
mium in the market. However, it should be remembered that this value assumes that the situation in
the market will be the same as it was in the past (Copeland 2009: p. 216).
The required rate of return on equity thus becomes:
r� = 3,77% + 1,65 × 2% = 7,07%
6.2.3 Estimation of the Weighted Average Cost of Capital (wacc) (Written by Mette D. Kremmling)
The missing factors in order to calculate wacc is the corporation tax, the debt rate, and the capital
structure.
The corporation tax is not expected to change in the near future, and is thus set at the current rate of
25%.
In B&O’s annual report the debt structure of mortgage loans and loans from banks etc. is mentioned
in note 32 and 33 (Bang & Olufsen Group 2008: pp. 116-117). The data from the notes are summa-
rized in table 7.
Table 7 – Debt Structure of B&O
(Source: Addopted from Bang & Olufsen Group 2008: pp. 116-117)
54
If the interval means of 6,1% and 4,5% is used as the high and low debt rate the average debt rate
can be calculated as:
r��O= = 6,1% × 63% + 4,5% × 37% = 5,50%
The historical booked equity ratio in B&O is shown in table 8, and the corresponding ratio of the
market in table 9, assuming the same average number of circulating shares on March 25th 2009 as in
the financial year 2007/08.
Table 8 – Equity ratio of B&O
(Source: Own making)
Table 9 – Equity ratio of B&O (Market Value)
(Source: Own making. Share quoted from B&O’s annual reports of the corresponding years and Børsen)
According to Brealey et al. (2007: p. 326) the capital structure for the purpose of calculating wacc
should be measured in market terms, as this is the value that investors are actually willing to pay for
the equity. Furthermore, Copeland et al. (2000: p. 204) advises the use of target capital structures
which are not affected by changes in the value of the company.
In the most recent annual report of B&O the company states that they have a target equity ratio of
40-50% in book terms (Bang & Olufsen Group 2008: p. 53). This range is hence a bit lower than
the current level, meaning that it would be expected that B&O will acquire more debt in the future.
This range however, has to be translated into a target market rate.
55
At the current stock price from March 25th 2009 of 72,00 DKK per share the equity is valued signif-
icantly lower than the book value in the end of the financial year 2007/08. This is therefore also
affecting the equity ratio in market terms which is only 38%. It must however, be expected that the
stock price again will rise and to a greater extend resemble the book values of the equity. Hence, for
determining the target equity ratio it is assumed that the share price will rise again. The equity ratio
is however, not expected to rise to the level of 2004/05 – 2006/07, as it is believed that the stock
market generally had been overvaluing equity and that the share price therefore was an effect of a
stock market bubble. However, as B&O have a strong brand it is expected that the equity will have
a higher market value than booked value. With all of these factors in mind the target equity ratio in
market terms is set at 60% and hence the target debt ratio in market terms at 40%.
This leaves only the calculation of wacc through the above mentioned equation:
wacc = (40% × (1 − 25%6 × 5,50%6 + (60% × 7,07%6 = 5,89%
6.3 Valuation of B&O (Written by Mette D. Kremmling)
Appendix M show the calculations for the valuation of B&O. The operating profit is comprised of
the core operating profit after tax and the other core operating profit after tax found in the budgeting
process. ROIC is calculated in the same way as shown in section 4.3, and the residual income as the
operating profit less the required return (net operating assets × wacc). This value is then dis-
counted back using wacc as a discount factor, in order to get the present value of the future residual
earnings.
For the terminal period this procedure is repeated. However, here the residual income is calculated
as the payment of a perpetuity with wacc as the discount factor in order to get the value of the ter-
minal period in the year 2014/15. Hereafter the value is discounted back to get the present value in
year 2007/08.
These calculations give a company value of 4.968,59 million DKK and, by subtracting the financial
liabilities, an equity value of 4.685,79 million DKK. Assuming the same average number of circu-
lating shares as in the financial year 2007/08 this corresponds to an value of 411,88 DKK per share.
56
6.4 Conclusion of the Valuation of B&O (Written by Mette D. Kremmling)
The share price quoted for B&O shares was 72,00 DKK on March 25th 2009 (Børsen), which is
significantly lower than the value of 411,88 DKK calculated through the above mentioned process.
According to these calculations the market is hence currently undervaluing the B&O share, meaning
that an investor could earn a profit by buying B&O shares now and keeping them until the market
has corrected itself to reflect the correct value of B&O. It thus seems that among others the financial
crisis have made the investors too pessimistic and thus led to and undervaluation of the B&O stock.
In section 6.2.3 it was seen that the equity was valued significantly lower in market values than in
book values. This means that according to the market the assets of the company are also overvalued
in the accounts. Since the Residual Income Model uses the current book value of the net operating
assets as a large part of the company value, it would thus be expected that the value of the shares
would be calculated higher than the market value.
The calculations above are though made with some degree of uncertainty. First of all, the beta value
is estimated from monthly quoting over a three year period. Here both the time horizon and the in-
terval between the used quotes could have been altered to give a different beta value. However, if,
as EuroInvestor and Spar Nord suggests, beta is lower this would only increase the calculated stock
price and thus strengthen the above reached conclusion.
Furthermore, there are some different opinions about the size of the market risk premium. Copeland
et al. (2000: p. 216) suggest using 4,5 – 5,0% for U.S. companies, and Elling and Sørensen (2005:
p. 53) suggests risk premiums in a range of 3 – 5%. By increasing the risk premium the calculated
value per share would in fact decrease. However, keeping everything else as it is, the risk premium
would have to increase to more than 9% (currently 2%) in order for the calculated value to equal the
current stock price.
Lastly the sales growth is a factor of uncertainty. Elling and Sørensen (2005: p. 227) argue that
companies tend to reach a normal level of sales growth after a significantly high or low growth pe-
riod, which has historically been around 6 – 9%. Increasing the sales growth would though only
increase the value per share and strengthen the above mentioned conclusion. As mentioned above, it
is though not believed that B&O will have this high a growth level in the long run. The sales levels
could though also get worse if for example the financial crisis does not end as quickly as assumed in
the above calculations. Therefore the next section will explore the case of a longer financial crisis.
57
7. Alternative Scenario for the Future Economic Development (Written by Pia Lundanes)
As previously mentioned, nobody knows when the financial crisis will end. The second scenario
predicted by Futurologist Jeffrey Saunders is that the crisis will end in the beginning of 2010
(Koszyczarek 2009). Now a budget and a valuation based on this assumption will be made. In addi-
tion to expecting a longer lasting financial crisis – the sales growth rate predicted by Branchen For-
brugerelektronik will be used. This means that the terminal value of the sales growth will be 2%
instead of the 3.5% used in the previous section. By looking at such a negative scenario an under-
standing of the sensitivity of the budget will be provided.
The budgeting numbers are found using the same method as previously and are based on the same
arguments as in the previous section. The sales growth will experience an extra year of negative
growth as the recession in the economy will last longer than predicted in the first scenario. The ter-
minal value is as mentioned set to 2% instead of 3.5%. The asset turnover, core profit margin and
core other operating profit after tax are quite similar to the numbers found in the first scenario, with
the exception of 09/10 still being a year of negative results instead of breaking even as in scenario
one.
7.1 Comparison of scenarios (Written by Pia Lundanes)
When looking at the level of the company value in appendix M, it is obvious that the two scenarios
result in quite different conclusions. In the first scenario the value per share is found to be approxi-
mately 412 DKK, whereas in the second scenario the value per share is only about 342 DKK. This
equals a difference of 70 DKK and is quite essential for the attractiveness of the share for investors.
When analysing where the difference is between the two scenarios, the effect from the extended
financial crisis and the lowered sales growth can be looked at separately. The extent to which the
duration of the financial crisis will impact B&O is found in the present value of the residual income.
The effect of the lengthened financial crisis is especially found in the year 2009/10, where the pre-
sent value of residual income from operations is significantly different in the two scenarios. How-
ever, the lengthened duration of the crisis will also affect the remaining years of the budgets, as the
different key financial ratios will take longer to achieve their target values. The effect from the de-
creased sales growth is mainly found in the present value of the terminal period as we are calculat-
ing the perpetuity with sales growth ratios of 3,5% and 2% respectively in the two scenarios. This
calculation results in a difference in the company value of about 670 million DKK and is therefore a
substantial difference. The future levels of B&O’s sales growth rate will to a large extend depend
58
on how well they are able to implement their new strategy. If they succeed in creating new and
groundbreaking products for the consumers, in addition to reorganizing and boosting their sales
organization, a sales growth level of 3,5 might be possible. If the company however fails in differ-
entiating themselves from their competitors and shaping up their sales, the sales growth level of 2%
might be more reasonable. Based on the above arguments it is therefore essential for B&O to suc-
ceed in its new strategy, and the attractiveness of the share will depend on the investors confidence
in B&O’s ability to succeed with this.
8. Conclusion (Written by Pia Lundanes)
In this thesis a strategic analysis and an accounts analysis was prepared based on publicly available
information in order to determine the present value of Bang & Olufsen A/S. This value was found
by answering a number of sub questions relating to the current strategic and economic condition of
B&O.
The first question to be answered was how the external and internal factors are affecting B&O as a
company. It was found that B&O has some important strengths where the most significant is the
company’s brand value which has been developing through years of launching unique products with
a focus on design and quality. Other strengths are the company’s strong core products as well as
useful patents and beneficial relationships with its business partners. On the other hand, B&O has
got some significant weaknesses, where the most relevant is the lack of ability to compete on price.
The company’s products are no longer exceptional enough for B&O to charge the massive price
premiums that they do. B&O has also been lacking focus on their core products and have been in-
vesting in development projects like mobile phones and mp3-players which have turned out not to
be profitable. B&O should try to exploit the opportunities in the market. Consumers today seem to
be appreciating design and the status that luxury products, like B&O’s products, provide. The com-
pany has also got the opportunity to increase their brand value even more by continuing and
strengthening their cooperation with other luxury brands like Audi and Aston Martin. At the same
time the financial crisis and the increasing competition in the consumer electronics market will con-
tinue to pose a great threat in the future and the management will have to find a way to excel above
the competing companies and gain market share in their niche market.
The company’s new strategy is an attempt to improve B&O’s position in the market and by analys-
ing the effects of the new strategy; the second sub question is answered. The main focus of the new
59
strategy is to increase the profitability by cutting costs, as well as increasing sales through a new
structure of the sales organisation, and finally to strengthen the product portfolio through focusing
on core products and discharging superfluous products. This new strategy will hopefully enable
B&O to create new innovative products and bestsellers, which will ensure turnover for future years,
and thereby value for the shareholders.
In order to make a valuation of B&O, an analysis of historical key financial ratios is essential. The
profitability of the company looked positive in the years from 2004/05 to 2006/07. But the company
has been severely affected by the financial crisis, which seriously affected the ratios in the account-
ing year 2007/08. Both ROE and ROIC have decreased massively and are now on a level of about
7%. This negative development has mainly been caused by a decreased profit margin which is the
result of a very low turnover combined with high costs, especially relating to development and mar-
keting and distribution. These costs are however not necessarily a bad thing if the costs will create a
foundation for future sales growth. However, it seems like B&O have spent too much on develop-
ing products outside their core product range which are now dismissed from the portfolio. The li-
quidity of B&O is an area which has shown a disturbing development throughout the whole period
of analysis. Whereas the both the acid test ratio and the current ratio were at satisfactory levels in
2004/05, the ratios have decreased constantly and has now reached level of 1,00 and 2,16 respec-
tively. This development is a threat to B&O and they are hence planning to perform a stock emis-
sion in order to increase their liquidity. A share issue will improve the liquidity of the company
temporarily, but it is essential that the company changes the underlying factors for the decreasing
liquidity in order to secure a positive development in the future.
A valuation is based on budgets where the expected economic results for future years are predicted.
As the world markets are currently experiencing a financial crisis, making budgets are especially
difficult. The reason for this is that nobody knows when the crisis will end. Two different budgets
were therefore made which assumed two different durations of the financial crisis. The two scenar-
ios resulted in a value difference of 70 DKK per share. There is therefore a reason to believe that
B&O is sensitive to the length of the crisis. When calculating the value of B&O based on the most
positive scenario of the duration of the crisis, a share value of 411,88 DKK was found. This value is
significantly higher than the current stock price which was 72,00 DKK on March 25th 2009.
The fact that the calculated share value is higher than the current stock price indicates that the share
is undervalued, and it would therefore be an attractive investment. There are however several fac-
tors which affect the difference between the calculated value and the current price which needs to
60
be taken into consideration. The first element is that the stock market is currently influenced by the
financial crisis and could be argued to be pessimistic, which means that the market is undervaluing
the B&O share. The second factor is that the calculations made include a great deal of estimation of
ratios like beta, market risk premium, and sales growth. As these ratios have a significant impact on
the calculation it is very hard to predict the true value of the company. The third element is that the
Residual Income Model was used to calculate the value. This model uses the book value of the net
operating assets as a large part of the company value and will therefore tend to value a company
higher than the market when the market is pessimistic. The value of 411,88 DKK is as mentioned
also based on the most positive prediction of when the financial crisis will end, and that B&O will
succeed in implementing its new strategy.
61
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Appendix A – Exchange Rates
DKK/USD
DKK/EUR
Exchange Rates
63
DKK/GBP
DKK/CHF
Source: www.valutakurser.dk accessed on February 13th 2009
accessed on February 13th 2009
64
65
Appendix B – Euromonitor Data
Market Sizes - Historic - Retail Value RSP - US$ mn - Year-on-Year Growth (%)
2002-03 2003-04 2004-05 2005-06 2006-07
World
Televisions and projectors 11,2 26,6 19,2 16 10
VCRs and DVD Players 12,6 13,1 -3,2 -3,5 -5,7
TV and VCR/DVD combinations -7 -2,7 -12,7 -10,5 -15,5
Home audio and cinema 7,1 7 -3 0,1 -0,2
Portable media players 12,1 33,2 37,8 19,7 20,2
Mobile phones 22,8 27 10,7 13,1 14
In-car media players 16 9 3,8 8,7 13
In-car speakers 9,7 15,3 5,5 4,3 6,5
Sources:
1. Consumer Electronics: Euromonitor from trade sources/national statistics
Note: Historic regional/global values are the aggregation of local currency country data at current
prices converted into the common currency using y-o-y exchange rates
Date Exported (GMT): 18/02/2009 14:03:40
©2009 Euromonitor International
66
Appendix C – Reorganized Accounting Statements
67
68
69
70
Appendix D – Common Size Analysis
71
72
73
Appendix E – Index Analysis
74
75
76
Appendix F – Calculations for Profitability Analysis
77
78
Appendix G – Calculations for Financial Leverage Analysis
79
Appendix H – Growth and Permanent Income Calculations
80
81
82
Appendix I – Calculations of Liquidity Level
83
Appendix J – Budgeting
84
Appendix K – Average Growth Rate of B&O
(Source: Orbis.com)
85
Appendix L – Estimation of the Systematic Risk (β)
(Source: EuroInvestor)
86
Appendix M – Valuation of B&O