Second Label Signing - rumor

[Miguel]

Haley wouldn't have to move.

There are essays on the Internet about Compass Records. You have to pay a premium to see the complete essays, but they contain some numbers. The essay must have been an assignment at some college(s).

Background

Compass Records is owned and operated by Alison Brown and her husband, Garry West. Alison Brown, a former investment banker, is a world-renowned bluegrass artist, and along with her husband, started Compass Records in 1995. Based in Nashville, it has been in business for 10 years. Compass is a small business compared to the rest of the global music business, but has been able to remain competitive by turning a profit on 80% of its titles compared to the industry average of 10%. Compass has a portfolio consisting of nearly 50 artists and averages 20 releases per year. Recently, Brown has shown interest in a new folk musician named Adair Roscommon. Brown needs to decide whether to produce and own the recording or just license it. Each decision will require different monetary investments in the artist and carries different risks.

Analysis/Assumption

● Producing cost: $20,000
● Licensing Advance: $3,000
● Sale Projections: 10,000 units
● Mechanical Royalty (MR): $0.85 per unit
● Recording Artist Royalty (RAR): $1.45 per unit
● Marketing/promotional costs the same for both licensing and owning/production
● No changes in net working capital (NWC)
● No capital expenditures
● Marginal tax rate: 40%
● Discount rate: 12%

Recommendation

With Compass projecting sales of 10,000 units, we recommend the company licensing the rights rather that owning and producing. Although owning the recording will result in lower artist royalty fees and higher potential upside, the net present value of owning the rights is -$8759.49, whereas the net present value of licensing Roscommon’s music is $6,111.02 (see appendix). One of the negative aspects of owning and producing the master recording is the upfront costs ($20,000), which are significantly higher than the licensing advance($3,000).Considering Compass Records turns a profit on 80% of its titles, every venture has a significant effect on an independent label, companies such as Compass cannot afford to...

Background:

Compass Records is run by Alison Brown and her husband Gary West and is a folk and grass roots label. Both Brown and West were entrenched in this industry and decided to open the label in 1995. Brown who received an MBA from UCLA is very business oriented and realizes that with a small recording company like Compass Records, they cannot afford to make mistakes when signing artists. The company was faced with a dilemma about whether the company should produce Roscommon outright or license the new upcoming artist. Historically, Compass had preferred to license their artists but realize that there is a risk in losing her. It is very expensive to produce an album (even with the advantage of purchasing their own recording studio) and could run the company 80-150 thousand dollars for a new artist. Their business is also 100 percent consignment. They are paid only for the number of records sold not for the number shipped.

Assumptions:

* Compass Records’ WACC is 12%.
* Projected to sell 10,000 copies of Roscommon’s CD at stated prices.
* Total marketing and promotion costs are upfront and at $17,000 of which only half of these costs are recoupable.
* Assume that Compass records will only have to pay half of the merchandise royalty if they choose to produce and own as stated.
* Assume all figures and projections for the production and selling of Roscommon or otherwise are correctly stated in case.

Solution:
As we can see in appendix 1, by simply licensing rather than producing and owning, Compass Records can achieve a higher NPV on their respective decisions. This is simply due to the fact that there are less upfront costs ($20,000 vs. $3,000). Additionally, all recoupable costs can be recouped under licensing but will not be if they decide to produce and own. The real question, however,...

Backgrounds
Alison Brown and her husband Gary West, who were both musicians, founded compass Records in 1995. Compass Records is a small independent recording company that centered on folk and roots music. Compass Records occupies only a tiny part of the 32-billion dollar music recording industry, competing with some multi-national corporations dominating 86% of the business, such as Sony/BMG, Universal Music Group, Warner Music Group, and EMI. However, the industry has witnessed a stagnant growth since 1995, with a decline on annual sales at a compound annual growth rate of 5%. By 2005, Compass Records had grown to include nearly 50 artists under contract and were averaging around 20 releases a year. With 40% of its albums selling over 5,000 units, Compass Records turned a profit on 80% of its titles in 2005. Brown and West also acquired a $100,000 recording studio in May 2004 in order to give the label and its artists more flexibility in the creative process and save $500 a day on studio rental.

Problems
* (General) Licensing vs. Producing and Own
* Compass Records has to decide between licensing the finished recordings, which is less risky and less expensive with a finite life to the future cash flows associated with the recordings, and producing and owning a master copy, which will be more risky and more expensive with an infinite life to the future cash flows associated with the recordings.
* (Specific) How to maximize firm value through the Roscommon decision
* Whether to license Adair Roscommon’s music or own the master recording outright.

Solutions...

Since inception, it grew at a Compounded Annual Growth Rate (CAGR) of 18.84%. Notably, in the years after 2003 when the music industry was declining at a CAGR of 5%, the company grew at a CAGR of 74.10%. In 2005, the company saw 80% of its titles turn in profits as compared to a 10% for the big four.

In June 2005, the company was contemplating on offering a recording contract (“the contract”) to a talented but new folk musician, Adair Roscommon (“the artist”). The artist, both a songwriter and a recording artist, had released an album in 2003 which sold 2,500 copies. Given a limited budget, the company needed to decide on the type of contract to offer: license for a limited period or produce and own. The company had historically preferred to license rather than produce and own. But with new distribution agents in Europe and Asia creating opportunities to sell CDs in new markets around the world, and the recently built studio making album production easier and cheaper, the company needed to re-evaluate their historical strategy.

Expenses

The expenses incurred by the company upon offering a contract are classified under these categories:

1) Royalties: Mechanical royalties are fixed to a statutory rate of $0.085 per song per CD sold. For artists who are both songwriters and recording artists, the company includes a controlled composition clause or negotiates a co-publishing agreement allowing the company to limit its mechanical royalty expenses. Recording artist royalties are negotiated between the company and the artist. Depending on the stature of the artist, recording artist royalties...