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

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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

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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?

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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.

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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)

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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

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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

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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

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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.

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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.

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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

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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