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The Story Behind the Numbers
Imagine you are the editor of one of the largest book publishers in the world. You learn that an unpublished, 70‐year‐old manuscript by one of your best‐selling authors has just been “discovered” by her lawyer. What sort of business and financial decisions will you have to make as you decide when, how, or whether to publish? If you decide to publish, how will you judge the financial success of this venture?
To Kill a Mockingbird, Harper Lee’s first novel, burst onto the scene in 1960 and quickly became a best seller and a critical success. The book received the Pulitzer Prize in 1961 and actor Gregory Peck picked up an Oscar in 1962 for his portrayal of the lawyer Atticus Finch in the movie. Over the next five decades, the coming‐of‐age novel about social and racial justice in the South during the 1930s became a staple in classrooms around the country, winning over several generations of fans and selling more than 40 million copies. However, in 1964, dismissing the entreaties of fans who hoped she would write another book, Lee retreated to her hometown of Monroeville, Alabama, and “retired” as an author.
Therefore, an announcement by HarperCollins in February 2015 caught the literary world by surprise and immediately provoked controversy: a new novel by Lee had been discovered, and HarperCollins planned to publish it in July. The press quickly learned that Go Set a Watchman, described by HarperCollins as a long‐lost “sequel” to Mockingbird, was actually the original, unedited draft manuscript of her Pulitzer Prize‐winning novel.
Longtime friends questioned whether Lee, who was now 90 and living in a nursing facility, fully understood that her lawyer was negotiating the sale of the first draft of Mockingbird. Critics accused HarperCollins of placing profit over integrity, by releasing on July 14, 2015 “a not‐very‐good first draft … hoping to sell millions of books and boost the bottom line.”
Why did HarperCollins decide to publish Go Set a Watchman? What drove the business decision about when to publish Watchman? How would executives at HarperCollins determine if the decision to publish was a successful financial venture?
Book publishing is the oldest of mass mediums, and it was one of the first to experience the disruptive effects of digital technology. Much about the industry has changed in recent years. However, the business imperative has not. Publishers who are not profitable do not survive. That is why successful publishing entrepreneurs have a deep and nuanced understanding of how each of the processes and procedures involved in producing and selling a book affect the bottom line and the long‐term sustainability of their company. This is true whether they are managing a start‐up enterprise or a legacy media company, such as HarperCollins.
In this chapter, we will explore how the economics of a media enterprise are reflected in a company’s financial statements, identify some of the key information contained in each of these statements, and discuss what can be surmised about the financial challenges and opportunities media executives face. Among the questions we’ll consider are:
- How do the underlying economics of a media enterprise flow through a company’s financial statements?
- What does the income statement tell us about past and current profitability?
- What are a company’s most valuable assets and most onerous liabilities?
- How does a company make and spend money?
The Basic Economics of Book Publishing
Over the past two decades, book publishers have confronted, and attempted to adjust to a new economic reality, driven by technological innovation. First, in the 1990s, they had to contend with the rise of e‐commerce and online retailing giant Amazon, which disrupted their distribution and sales processes. Next, came the advent of e‐books and the development of easy‐to‐use software that allows practically anyone with minimal training to publish his or her masterpiece. Taken together, these developments affected all the processes involved in producing books and had a significant impact on both expenses and revenue.
Roughly 2.7 billion books are sold annually in the United States, generating approximately $27 billion in revenue. According to industry estimates, the five largest English‐language publishers, known as the “Big Five,” account for between 50% and 80% of all sales and a similar amount of revenue (see Figure 2.1). Penguin Random House, the largest publisher, employs more than 12,000 people and releases 16,000 new titles annually under 250 imprints. It has an estimated 35–40% market share. HarperCollins is the world’s second largest consumer book publisher with operations in 18 countries and roughly a 20% share. It oversees the production and distribution of 10,000 titles under more than 120 imprints including Avon, William Morrow, and Harlequin. Over its 200‐year history, this venerable media franchise has published works by talented authors such as Mark Twain, Maurice Sendak, H.G. Wells, and Agatha Christie, and popular titles such as The Hobbit, Goodnight Moon, and the Divergent series.
Figure 2.1 Percentage of market share for the Big Five publishers, 2015.
HarperCollins is one of five divisions in the News Corporation, a multimedia global conglomerate, headquartered in New York. In 2013, the parent corporation separated into two separate companies, each listed separately on the New York Stock Exchange. Twenty‐First Century Fox includes the film and television assets and has annual revenues of $25–30 billion. The other company, which assumed the News Corp name, houses the various publishing enterprises and generates annual revenues of $8–8.5 billion (Table 2.1). Almost half of 2015 revenue in News Corp came from the United States and Canada, with the other half from Europe and Australia. The largest division in the recently reconstituted News Corp is the News and Information Services, with annual revenues of $5–6 billion. It includes newspapers in the United States, Great Britain, and Australia, as well as digital financial services. HarperCollins is the second largest division in News Corp with annual revenues of approximately $1.7 billion. In 2015, News Corp had three other smaller divisions with revenues ranging from $109 million (Digital Education) to $625 million (Digital Real Estate Services).
Table 2.1 News Corp divisions and revenue, 2015 (in million $).
Source: News Corp Annual Report, 2015.
| Division | Revenue |
| News and Information Services | 5,731 |
| Book Publishing | 1,667 |
| Digital Real Estate Services | 625 |
| Cable Network Programming | 500 |
| Digital Education | 109 |
Every year, an estimated 700,000 titles are published in the United States. This includes 400,000 titles that are self‐published. Since most books published ultimately sell only a few hundred or a few thousand copies, HarperCollins and its “Big Five” brethren, depend on a small number of blockbusters each year to cover all their expenses, including overhead. Book publishing is an industry with significant fixed marketing and distribution costs that do not vary, regardless of whether a book sells 1,000 copies or one million. Therefore, economies of scale are important so that these costs can be spread across thousands of titles.
This means each editor at HarperCollins is making a quick economic calculation, estimating the size and type of audience for a particular book compared with the upfront costs of producing and distributing the book. It may be up to two years between the time a book proposal is first approved by the editor and the bound copy is available and sold through online and brick‐and‐mortar retail outlets. Until a book is printed and released for sale to the public, HarperCollins has no revenue to offset against its expenses.
Among the significant costs for publishers are:
- Marketing costs, including paying the retail chains for upfront display space for books.
- Advance royalty payments to the author. Not all books sell enough copies to cover the amount of a cash advance on projected royalties that a publisher gives to the author. When a book fails to “earn out” its advance, the publisher must absorb the costs.
- Unsold copies of hardcover and paperbacks that are returned by retailers to the publisher where they are remaindered (sold at very steep discount clearing out space in the warehouse for new releases) or destroyed. Roughly a third of books printed are returned to the publisher by the retail outlets.
Approximately 70% of all books sold today are print copies. But only a very small number of books—less than 1% of those printed—will actually be stocked on the shelves of most bookstores since even the largest brick‐and‐mortar chains have space for only 175,000 volumes compared to the three million stocked by Amazon. Depending on the genre, publishers will distribute their books through a variety of channels—including book clubs, large discount retail chains (Walmart, Costco), and specialty retailers (such as pet stores for books about dogs and dog owners). But the vast majority of books, especially best sellers, are sold at discounted prices through large bookstore chains (such as Barnes and Noble) or the online retail giant, Amazon.
Publishers have the potential to make more profit on e‐books than print copies since there are fewer costs associated with the production and distribution of the content, and they do not have to account for returns on unsold books. To illustrate this point, The New Republic in 2014 published a graphic showing the discrepancies between the retail price, publisher profit, and profit margin of hardcover and e‐books (Table 2.2). However, despite initial projections that e‐books would rapidly replace print copies, e‐book sales have plateaued around 30% industry‐wide. Sales of digital books at HarperCollins have trended lower, around 20% of total sales.
Table 2.2 Price of hardcover versus e‐book, 2014.
Source: New Republic, 2014.
| Hardcover | e‐book | |
| Retail price ($) | 27.99 | 14.99 |
| Publisher’s profit ($) | 5.67 | 7.87 |
| Profit margin (%) | 41 | 75 |
Hardcover titles, which carry a list price of $26–30, tend to sell best around the holidays, such as Christmas and Father’s Day, while fictional paperbacks, with a list price of $6–15, are popular beach reading. Authors typically receive royalties of 6–15% of the list price of hardcover or paperback books and up to 25% on electronic books. Only authors with proven track records, or well‐known “celebrities” with large followings, will get a large advance payment against the royalties. Typically, sales of general interest books are highest in the first six months of a release. So, HarperCollins writes off advances that have not “earned out” in six months to a year. While the royalties for Go Set a Watchman were not disclosed, industry experts estimate that it was most likely in the 15% range, which means that for every million copies sold, the estate of Harper Lee received $3–4 million in royalties. (Lee died in February 2016, seven months after HarperCollins published Watchman.)
General interest fiction and nonfiction titles tend to dominate all of the top dozen or so yearly best‐seller lists, while children’s and religious literature (both of which HarperCollins publishes under its 120 imprints) tend to sell consistently across many seasons. The Girl on the Train and a sequel to Fifty Shades of Grey topped Amazon’s best‐seller list for 2015, for example. That list of the top 20 best sellers included half a dozen mysteries, a couple of romances and history books, and an adult coloring book. The “Big Five” book publishers try to publish a wide variety of genres, hoping to have several dozen best sellers in any year. In the 12 months preceding the publication of Go Set a Watchman, HarperCollins had 214 titles on The New York Times print and digital best‐seller lists, with 15 reaching the number one position.
Predicting which book will become a best seller is a big gamble. Any profit on a newly released title often disappears when unsold print copies of the book are returned by retailers. Publishers often refer to their “front list”—consisting of books that have been recently released—as a breakeven proposition (meaning the costs equal revenue) and their “backlist” as a profit center. The backlist consists of books released in prior years that continue to sell thousands of copies annually. The only costs are the royalties paid to the author and the printing and distribution expenses. By some estimates, the “backlist” accounts for a quarter of sales at large publishing houses. HarperCollins has more than 200,000 titles on its backlist, including To Kill a Mockingbird, which sells tens of thousands of copies each year because it is assigned reading in many junior and senior high school classes.
As a result, on both the cost and revenue sides of the equation, economies of scale determine the financial success of the “Big Five” publishers. On the revenue side, a Big Five publisher needs a couple of hundred best sellers each year, plus a backlist of several hundred books that sell consistently year‐over‐year, long after publication. This allows the publishing house to cover the costs of all the potential literary masterpieces that receive critical acclaim but sell so few copies that they are unprofitable. Specific genres—such as romance and mystery—are more likely to become best sellers and backlist profit centers. The more genres a publisher offers, the better the chances of having dozens of best sellers and a profitable backlist. Therefore, the “Big Five” are continually purchasing other publishers, and contemplating merging their operations. In 2012, HarperCollins considered merging with Simon & Schuster, the third largest English‐language publisher. It also contemplated purchasing Penguin in 2013. Instead, in August 2014, it purchased Harlequin, which publishes more than one hundred romance titles a month, with strong readership in both Europe and Asia.
When Harper Lee’s lawyer arrived at HarperCollins headquarters in New York in fall 2014 with the manuscript for Go Set a Watchman, the various executives at the company were still focused on integrating Harlequin into the book publishing division. They knew that this newly “discovered” manuscript was an unedited first draft that had been returned in 1957 to the author by an editor at one of their imprints, with suggestions for rewriting and reframing the plot from the 1950s to the 1930s. Still, they undoubtedly recognized immediately the potential economic impact that publishing the manuscript could have on both revenue and profits. Given the popularity of Mockingbird, this “newly discovered” manuscript would most certainly be a best seller. Watchman could also boost backlist sales of Mockingbird. Like Mockingbird, it might even become a staple in the classroom and become a perennial backlist star.
Therefore, they pushed ahead with the decision to publish. How would the publication of Watchman ultimately affect the bottom line of both the book publishing division and its parent, News Corp? The answer to that question can be found by analyzing the data found in the company’s annual financial statements.
Digging into the Numbers: Understanding the Story behind Financial Statements
Numbers tell a story. The 2015 News Corp annual report states, “Historical results may not be indicative of future results [since] operating performance is highly contingent on many factors, including customer tastes and preferences.” However, by understanding the factors, or key financial drivers, that influenced current and past performance, you can identify strengths and weaknesses, project future trends in revenue, costs and profits, and adjust strategy accordingly. In short, you can determine how well a business is actually doing by understanding how the economics of an enterprise flow through the financial statements.
In this section we’ll closely examine News Corp’s financial performance in the months leading up to the publication of Go Set a Watchman. This will help us understand why HarperCollins made the decision to publish and how that decision might affect the financial results of both News Corp and HarperCollins in the following year.
There are three main financial documents that companies produce: (1) the income (or earnings) statement; (2) the balance sheet; (3) and the cash flow record. Each of these documents tells a slightly different story:
The income statement will give you valuable information about how a company’s revenues, costs, and profits are trending. You can use that information to compare its performance to its competitors and to its financial outcomes in prior years. But an income statement will not show you what liabilities might be looming in the immediate future—such as loans that are coming due or pension obligations that are suddenly ballooning. You need to consult the balance sheet to learn about that. Similarly, profits can fluctuate year‐to‐year, depending on when and how expenses that do not require an outlay of cash, such as depreciation, are recognized. To learn how much cash a company has on hand and how it earned that cash, you need to study the cash flow statement.
The size of annual reports can be intimidating. The annual financial report for News Corp typically exceeds 180 pages, the size of a small novel published by HarperCollins. The three financial documents account for less than ten of those pages. The remaining pages are devoted to the overview and summary of operations (80 pages) and the footnotes that follow. This verbiage often contains valuable insights into how executives made certain business decisions. For those who know what to look for, reading financial statements is like reading a good detective story.
A company’s fiscal (or financial) year may or may not correspond with a calendar year. For example, the fiscal year for Apple begins in October and ends the following September while the fiscal year for the New York Times begins in January and ends in December. News Corp’s fiscal year runs from July through June. Therefore, the 2015 annual report for News Corp covers the financial results for the 12 months prior to the publication of Go Set a Watchman, which was released in July 2015.
In the next three sections of this chapter, we’ll be examining News Corp’s 2015 annual report which can be accessed at: https://newscorpcom.files.wordpress.com/2015/09/newscorp‐fy2015‐10k.pdf to gain key insights into what business challenges News Corp and HarperCollins were confronting prior to publishing Watchman. Finally, we will compare and contrast the results of News Corp’s fiscal year 2015 (July 2014–June 2015) with fiscal year 2016 (July 2015–June 2016) to determine exactly what impact Go Set a Watchman had on the bottom line of both HarperCollins and its parent corporation.
We will be seeking insight into these questions:
- How have revenue and profitability been trending at HarperCollins and News Corp in recent years?
- How efficiently does HarperCollins operate?
- How does News Corp finance acquisitions?
- What are the biggest challenges confronting HarperCollins and News Corp?
- How important is financial success in the book publishing division to the financial success of News Corp?
What Does the Income Statement Reveal about Profitability?
The income statement is one of the most quoted in news stories. It is also known as the “Profit and Loss Statement,” the “Statement of Revenue and Expense,” or the “Consolidated Statement of Earnings/Operations.” It shows the financial results for a certain period of time, either quarterly or annually, and gives a summary of a company’s revenue, expenses, and profit. It is predicated on the matching principle, in which revenues are paired with related expenses during a specific period. It shows both an operating profit (which is the income generated before taxes and interest) and a net profit (which reflects what the company made after paying interest and taxes). We’ll examine five key indicators—revenues, expenses, operating income, EBITDA, and net income, in Box 2.1.
Revenues
This is the first line on any income statement and is sometimes referred to as a company’s “top line.” It is the amount of money that a company received during a certain period (monthly, quarterly, or yearly) from selling its products or services. Revenue is the price of the goods sold times the number of units sold. Fluctuations are due to either the price of the product increasing or decreasing, or the volume (or number of units) sold moving in either direction. If volume is increasing and the price holds steady, that is usually a sign of increased consumer demand. However, if either volume or price is declining, that is usually a sign that a company is facing increasing competitive pressure.
Media companies often receive revenue from three or four different sources: from advertising (newspapers, magazines, television, and cable networks), from subscriptions (newspapers, cable providers, streaming services), from sales to consumers (books, movies, music), and from licensing, syndication, and other income (television and cable networks).
You should always ascertain if a company has acquired another enterprise during the period covered by the income statement. Typically, in the comparison to the previous reporting period, revenues of the acquiring company will increase significantly because it has sold more units, thanks to the inclusion of the revenue of the acquired company.
What We Learn about Revenue at Harper Collins and News Corp
In Table 2.3, we see that the 2015 revenue from News Corp’s five divisions (News and Information Services, Book Publishing, Digital Real Estate Services, Cable Network Programming, and Digital Education) totaled $8.6 billion, an increase of $59 million, or 1% growth, over the previous year. Both of the largest categories—advertising ($3.8 million) and circulation ($2.7 million)—were down a total of $218 million. However, the third largest source of revenue, sales to consumers or sales of books ($1.6 million) increased significantly by $220 million. According to the book publishing segment data provided in the News Corp annual report, the book division was up a total of $233 million (Table 2.4).
Table 2.3 News Corp revenues, 2014 and 2015 (in $ millions).
| Revenues | 2015 | 2014 | Change |
| Advertising | 3,835 | 4,019 | (184) |
| Circulation | 2,654 | 2,688 | (34) |
| Consumer | 1,594 | 1,374 | 220 |
| Other | 550 | 493 | 57 |
| Total | 8,633 | 8,574 | 59 |
Table 2.4 HarperCollins revenues, 2014 and 2015 (in million $).
Source: News Corp Annual Report, 2015.
| Revenues | 2015 | 2014 | Change |
| Consumer | 1,594 | 1,374 | 220 |
| Other | 73 | 60 | 13 |
| Total | 1,667 | 1,434 | 233 |
Even from this high‐level analysis of News Corp’s income statement, we can begin to understand how much HarperCollins contributed to the company’s overall revenue increase in 2015. Even though sales from the book division accounted for only about 20% of total revenue for News Corp, the increase of $233 million year‐over‐year counteracted the decline in advertising and circulation revenue in the News division.
What drove the increase at HarperCollins? There are two ways for book publishers to dramatically increase year‐over‐year revenue: by publishing several runaway best sellers or by purchasing another company. By studying the management comments that come before the financial results, we learn that sales of HarperCollins’s wildly successful Divergent series by Veronica Roth had declined dramatically, from 19.2 million units sold in 2014 to only 8.2 million in 2015. So, “the increase [in revenue],” according to the management overview, “was primarily the result of the acquisition of Harlequin [in August 2014], which contributed $281 million … [while] consumer revenues associated with print and digital book sales at HarperCollins’s other divisions decreased $44 million.” Without Harlequin’s revenue contribution, the top line of both HarperCollins and News Corp would have been less than 2014. HarperCollins’s revenue for 2015 would have been $1.3 million, and News Corp’s total revenue for 2015 would have been $8.3 billion.
Expenses
Revenues should be matched against expenses in the same reporting period. There are three types of expenses that are typically recognized: (1) operating costs (sometimes referred to as cost of goods sold, or cost of production); (2) sales, general, and administrative costs (often referred to as SG&A); and (3) depreciation and amortization.
Operating cost is essentially the cost of using resources to actually produce the products or services that were sold. It includes raw materials, advances paid to authors, design and research on the product, and the salaries of those involved in the production (creation, packaging, and manufacturing) process. SG&A can include administrative salaries, selling expenses (such as advertising), and rent, for example. Depreciation and amortization form a “noncash” expense, in contrast to the other two expenses. It is an accounting method of spreading the cost of acquiring an expensive asset over the expected usefulness of the asset. Depreciation is used on tangible assets, a piece of equipment, such as a printing press, which will be operated for many years to produce many editions of a newspaper, while amortization prorates the cost of creating or purchasing intangible assets. For example, the cost of designing a new product is often amortized over the lifetime of a patent or copyright. There are a number of “generally accepted” accounting methods for recording depreciation and amortization, which can have a huge impact on both operating and net income. (The footnotes in an annual report explain which method or methods a company is using for depreciation and amortization.)
What We Learn about Expenses at HarperCollins and News Corp
In addition to increasing revenue, acquisitions often increase expenses significantly. Such was the case with Harlequin (Table 2.5). For News Corp in 2015, total expenses for the five divisions (including operating expenses, SG&A, and depreciation) decreased by $71 million. Based on information provided in the management summary, the News and Information division posted the most significant cash savings of $360 million, but that was offset by an additional $249 million in expenses, “as a result of the Harlequin purchase.”
In addition to acquiring Harlequin’s revenue, HarperCollins also acquired its expenses (Table 2.6). As News Corp acknowledges in its annual statement, it takes time to efficiently integrate a newly acquired company and realize projected cost savings. Including depreciation expenses, the book publishing division expenses increased $225 million in 2015 versus the previous year: $77 million in operating expenses, $132 million in SG&A, and $16 million in depreciation.
Table 2.5 News Corp expenses, 2014 and 2015 (in million $).
Source: News Corp Annual Report, 2015.
| Expenses | 2015 | 2014 | Change |
| Operating | (5,025) | (5,139) | $114 |
| SG&A | (2,756) | (2,665) | ($91) |
| Depreciation | (530) | (578) | $48 |
| Total | (8,311) | (8,382) | $71 |
Table 2.6 HarperCollins expenses, 2014 and 2015 (in million $).
Source: News Corp Annual Report 2015.
| Expenses | 2015 | 2014 | Change |
| Operating | (1,106) | (1,029) | (77) |
| SG&A | (340) | (208) | (132) |
| Depreciation | (52) | (36) | (16) |
| Total | (1,498) | (1,273) | (225) |
Operating Income (EBIT) and Margin
This is also referred to as operating profit or loss or EBIT (Earnings Before Interest and Taxes). This is a measure of how efficiently a company has been managed during the reporting period. Managers of businesses aim to increase operating profit year‐over‐year. If it is decreasing, investors will often look to see whether this is driven by decreases in revenue (which can signal lack of consumer demand for the products the company produces) or increases in expenses, which cannot be covered by price increases in the product. Industry analysts and investors like to compare the operating efficiency of a company within industries (book publishing, for example) and across industries (book versus newspaper publishing). To do this, they calculate an operating or EBIT margin by dividing the operating income by the total revenue generated during that period.
What We Learn about the Operating Income of Harper Collins and News Corp
While News Corp does not provide an “operating income” line for either the company or its divisions, this can easily be calculated by subtracting total expenses (operating, SG&A, and depreciation) from total revenue (Table 2.7). Due to costs savings of $360 million in the News and Information Services division and revenue increases of $220 million from HarperCollins, operating income for News Corp for 2015 was up $130 million to $322 million. The operating margin increased from 2.2% to 3.2%. However, many of News Corp’s competitors—such as the New York Times or the Walt Disney Company—posted operating margins of 10% or more in 2015.
Table 2.7 News Corp EBIT, 2014 and 2015 (in million $).
Source: News Corp Annual Report 2015.
| 2015 | 2014 | Change | |
| Revenues | 8,633 | 8,574 | 59 |
| Expenses | (8,311) | (8,382) | 71 |
| Operating profit | 322 | 192 | 130 |
| Operating margin (%) | 3.7 | 2.2 |
In Table 2.8, we see that expenses of more than $200 million associated with the Harlequin acquisition offset revenue increases of $223 million. Therefore, operating profit at HarperCollins increased only $8 million to $169 million, and its operating margin dropped from 11.2% to 10.1%.
Table 2.8 HarperCollins EBIT, 2014 and 2015 (in million $).
Source: News Corp Annual Report 2015.
| 2015 | 2014 | Change | |
| Revenues | 1,667 | 1,434 | 233 |
| Expenses | (1,498) | (1,273) | (225) |
| Operating profit | 169 | 161 | 8 |
| Operating margin (%) | 10.1 | 2.2 |
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
Many media companies have significant noncash expenses (depreciation and amortization) that can depress operating income, as well as net income. Therefore, industry analysts and investors use EBITDA calculations to estimate the amount of actual cash the company is generating from its operations and gain additional insight into the operating efficiency of a company or division. An EBITDA calculation adjusts operating profit by adding back depreciation and amortization. (EBITDA is not listed on the income statement.) An EBITDA margin is calculated by dividing EBITDA by total revenues. With an EBITDA margin, investors can compare the operating efficiency of a company to its competitors.
What We Learn about EBITDA at HarperCollins and News Corp
The annual statement from News Corp notes management’s preference for using this measure instead of operating profit or margin: “Segment EBITDA provides management, investors and equity analysts with a measure to analyze operating performance of each of the Company’s business segments and its enterprise value against historical data and competitor’s data.”
From Table 2.9, page 34, we see that excluding depreciation expenses of $530 million (a noncash expense mostly incurred by the News and Information Division), News Corp had EBITDA income of $852 million in 2015. This compares to an operating profit of only $322 million. Therefore, its EBITDA margin rose to almost 10% compared to an operating or EBIT margin of only 3.7%. This brings News Corp’s efficiency more in line with its competitors, such as Bertelsmann (which owns Penguin Random House) or the New York Times Company. These two competitors posted EBITDA margins of between 13% and 15% in 2015.
Table 2.9 EBITDA for News Corp, 2014 and 2015 (in million $).
Source: News Corp Annual Report 2015.
| 2015 | 2014 | Change | |
| Revenues | 8,633 | 8,574 | 59 |
| Operating expenses | (5,025) | (5,139) | 114 |
| SG&A | (2,756) | (2,665) | (91) |
| Total News Corp EBITDA | 852 | 770 | 82 |
| EBITDA margin (%) | 9.8 | 8.9 |
In 2015, HarperCollins accounted for 17% of revenue for News Corp, but almost 25% of EBITDA (Table 2.10). As the largest division, News and Information Services, struggles to gain an economic footing in the digital era, News Corp relies on its second largest division, HarperCollins to provide consistent year‐over‐year financial performance and overall stability to the corporation’s bottom line.
Table 2.10 EBITDA for HarperCollins, 2014 and 2015 (in million $).
Source: News Corp Annual Report 2015.
| 2015 | 2014 | Change | |
| Revenues | 1,667 | 1,434 | 233 |
| Operating expenses | (1,106) | (1,029) | (77) |
| SG&A | (340) | (208) | (132) |
| Book Publishing EBITDA | 221 | 197 | 24 |
| EBITDA margin (%) | 13.3 | 13.7 |
Even though EBITDA increased $24 million at HarperCollins, its EBITDA margin is down slightly from 13.7% in 2014 due to the increased expenses that came with the Harlequin purchase. A 2015 EBITDA margin of 13.3% is slightly less than that of its direct competitor, Penguin Random House, the largest of the “Big Five” publishers. Penguin, which released 16,000 titles in 2015, had a 13.6% EBITDA margin on $452 million in operating income in 2015. Since sales of “major titles” drive most of the revenue of a book publisher in any fiscal year, this would suggest that HarperCollins editors would be seeking to publish as many best sellers as possible in Fiscal Year 2016 to offset the increased expenses that came with the Harlequin acquisition.
Net Income
This is often referred to as “net profit or loss,” “net earnings,” or, more colloquially, “the bottom line.” Net income is usually mentioned in the first or second paragraph of any news story about the financial results reported by a company. However, the third and fourth paragraphs often list a number of adjustments to the net income for “one‐time expenses” unrelated to the continuing operation of the business. For example, a company might recognize an income tax credit in one year and incur a significant income tax expense in the next year. Similarly, management often has discretion about when it recognizes noncash expenses (such as depreciation or impairment of assets) or when to set aside money for buyouts or impairment charges. That is why industry analysts, investors, and many companies, such as News Corp, prefer to use EBITDA calculations when comparing the annual financial performance of a company with that of its competitors.
Net income is calculated by adding to operating profit, or EBIT, any income that did not come directly from day‐to‐day operations (e.g., equity earnings in enterprises that are partially owned) and then subtracting a range of expenses, including interest payments, any one‐time restructuring costs (such as money set aside to buy out personnel or shut down operations) and any taxes owed.
What We Learn about Net Income at News Corp
News Corp posted a net “loss” in 2015 of $78 million, despite having an operating income of $322 million and an EBITDA of $822 million (Table 2.11). Two corporate expenses caused this wild swing from a $294 million net profit the previous year. In contrast to 2014 when it had an income tax credit of $691 million, in 2015, News Corp owed $134 million in income taxes. (Taxes for large corporations—especially global ones like News Corp—can fluctuate a good deal, depending on a number of factors.)
Table 2.11 News Corp net income, 2014 and 2015 (in million $).
Source: News Corp Annual Report 2015.
| Net income | 2015 | 2014 |
| Operating income | 322 | 192 |
| Impairment charges | (455) | (94) |
| Equity and interest earnings | 114 | 158 |
| Other | 75 | 653 |
| Income tax | (134) | 691 |
| Net income | (78) | 294 |
But even with the tax expense, News Corp would still have posted a net income of $377 million, if not for $455 million in impairment charges. News Corp recorded a $75 million restructuring charge related to buyouts in its News and Information Services division and a noncash impairment charge of $370 million related to its Digital Education division. When companies realize that the value of an asset is less than the amount listed on the balance sheet, they must “write down” the value of the enterprise by taking a charge against earnings. News Corp had purchased Amplify, the digital education company, in 2011 for $390 million. By taking an impairment charge of $370 million, News Corp was now estimating that this division was only worth $20 million in 2015. In October (in fiscal year 2016), News Corp sold its education division for an undisclosed sum to a group of investors that included Laurene Powell Jobs, Steve Jobs’s widow.
The Balance Sheet: What Are the Most Valuable Assets and Most Onerous Liabilities?
The balance sheet is separate from the income statement and provides insights into the value and type of a company’s assets, as well as the liabilities looming on the horizon. Think of the balance sheet as a sort of inventory. The assets are the resources the company has at its disposal to use in creating its products and services. The liabilities section lists the obligations a company has to its creditors (debt), employees (pension), and shareholders. The assets and liabilities balance one another; that’s why it is called a balance sheet (Box 2.2). There is typically no balance sheet for divisions within a company. Therefore, in this section, we’ll be looking at the balance sheet for News Corp.
Assets
There are two types of assets listed on a company’s balance sheet. Current assets can be used by the company during the coming year to produce additional income. It includes cash, income from stocks and bonds the company may have purchased, accounts receivable (revenue from sales that have not been collected), inventory, and pre‐paid expenses. Long‐term assets are often called fixed or capital assets since they are the source of the company’s continuing cash flows and income. Unlike current assets, they are not expected to be “used up” within a year and expensed. These assets are either depreciated if they are tangible assets (plant, equipment, real estate) or amortized, if they are intangible (copyright, patents, brand reputation, or customer and employee relations).
Goodwill is a long‐term asset and arises when one company purchases another enterprise and pays a premium price (based on either its stock price or its earnings or some other financial measure). If it turns out that the acquiring company overpaid for the asset—and the company can no longer be sold to another business for the original price—then the acquiring company will need to “write‐down” the value of the asset, as News Corp did by taking an impairment charge of $370 million against the Digital Education division. (See the Net Income section above.) Many media enterprises carry a significant amount of intangible assets and goodwill on their balance sheet.
What We Can Learn about News Corp from its Assets
From Table 2.12, we learn that roughly a quarter (26%) of News Corp’s assets are current. Its tangible long‐term assets total $5 billion, including investments in financial securities ($2.3 billion), property, plant, and equipment ($2.7 billion), and $333 million in advances paid to authors for future books. It lists $5.3 billion in long‐term intangible and goodwill assets, of which $896 million is attributed to the book division. HarperCollins paid $455 million for Harlequin. On its balance sheet, News Corp recorded $115 million in tangible Harlequin assets (including accounts receivable and author advances), $165 million in intangible assets (including imprints with an indefinite life), and $185 million in goodwill (the excess over the fair value of the tangible and intangible assets). As management points out in the annual report, it has in the past paid a premium when acquiring properties, including the Dow Jones Company in 2007. As a result, every year it calculates the fair market value of its various assets compared to the value listed on the balance sheet and adjusts both the intangible and goodwill amounts accordingly.
Table 2.12 News Corp balance sheet, 2015 (in million $).
Source: News Corp Annual Report 2015.
| Assets | Million $ |
| Current assets | 3,975 |
| Long‐term assets | 11,118 |
|
2,379 |
|
2,746 |
|
2,242 |
|
3,063 |
|
688 |
| Total assets | 15,093 |
Liabilities
There are two types of liabilities on the balance sheet. Current liabilities are expenses that are due within the year. It includes accounts payable (bills owed to suppliers and vendors), accrued expenses (such as tax payments that are due but not yet paid) and any debt (such as notes payable to banks and finance companies or monthly payments due on long‐term debt). Long‐term liabilities include debt that is due a year or more out, as well as obligations to current and past employees, such as pension and benefits charges. Recent academic studies have shown that most companies finance at least 30% of their investments with debt. Interest expense (on the income and cash flow statements) increases as debt increases. In addition, creditors are often unwilling to lend more to a company that is heavily indebted, or, alternatively, they will charge a much higher rate of interest on subsequent loans.
In the liabilities section, the balance sheet will also provide some insight into the ownership of the company, and its shareholder commitments. There are typically two types of stock: preferred and common. Preferred shareholders have a priority over common stock holders in terms of claims on the company’s assets (if it were to go bankrupt, for example), but often do not have voting rights. Those who own common stock do have voting rights, including the ability to select members of the board of directors. However, many companies have two or more classes of common stock (often referred to as Class A and Class B), in which the founders of the company are assigned more voting rights than others who purchase the shares on the open market. Examples of companies that have two classes of stock include the New York Times and Facebook.
What We Can Learn about News Corp from its Liabilities
From Table 2.13, we learn that News Corp has no debt on its balance sheet in 2015, in contrast to most of its competitors. Bertelsmann, which owns a controlling interest in Penguin Random House, carries $3.1 billion in long‐term debt, and the New York Times Company lists $691 million. Even before News Corp was spun off as a separate company in 2013, the parent company with the same name (which included such diverse properties as MySpace, 20th Century Fox studios, and the Fox television network) carried only a small amount of debt and preferred to pay cash for its purchases whenever possible. Historically, this has had both competitive advantages and disadvantages. Without debt, News Corp does not pay interest expense, and this frees up more cash that can be used for more acquisitions. It also imposes a rigorous management discipline on assessing the price tag of potential acquisition targets since there is a financial limit—the cash on hand—as to what News Corp can afford to pay. On the downside, News Corp can be outbid by a company that is willing to pay more. Prior to its purchase of Harlequin, News Corp had attempted to purchase Penguin but was outbid by Bertelsmann.
Table 2.13 News Corp liabilities, 2015 (in million $).
Source: News Corp Annual Report 2015.
| Liabilities | Million $ |
| Current liabilities | 2,155 |
| Long‐term liabilities | 802 |
| Retirement obligations | 305 |
| Deferred income taxes | 166 |
| Other | 331 |
Because of this preference for funding acquisitions with cash, the founder of the original News Corporation, Rupert Murdoch, has always insisted that he and other executives in the company need the latitude to move quickly when they spot a potential investment opportunity. This is why News Corporation has two classes of stock—Class A, which can be purchased by anyone, and Class B, which is owned and controlled by the Murdoch family trust. These Class B shares control almost 40% of voting rights. This means Murdoch and his sons James and Lachlan (who also work in the company) have much more latitude in choosing members of the board of directors or withstanding takeover attempts by corporate raiders than CEOs at a media enterprise, such the Walt Disney Company, which does not have a dual class of stock.
The Cash Flow Statement: How Does a Company Make and Spend Money?
Think of the statement of cash flow as a sort of bank statement that records all the cash flowing into and out of a company. It is divided into three parts: Cash from operating activities, investments, and financing (Box 2.3). Investors pay close attention to how much cash is being generated from operating activities since this is an important barometer of the sustainability of a company’s business model. They also look to see how the company is spending its money by investing in new equipment or acquiring other enterprises, and whether it is using debt to finance its investments. Companies that are struggling will often raise “cash from investing” by selling properties they own. This temporarily solves the cash flow problem, but is not sustainable. Similarly, the dot‐com start‐up companies of the late 1990s relied primarily on “cash from financing” (IPOs and debt) to fuel their earnings growth. This is also not sustainable.
As is the case with the balance sheet, most corporations do not provide a cash flow record for their various divisions. Therefore, in this section, we’ll be looking only at News Corp’s cash flow record for fiscal year 2015.
Cash from Continuing Operations
This is calculated in two steps. First, all noncash items (such as depreciation, amortization, and impairment of assets) are added back and earnings from equity holdings in other companies are subtracted. Then increases or decreases in current assets and liabilities (such as accounts receivable and payable, inventory and benefit obligations) are calculated and either added or subtracted. The resulting number is the cash from continuing operations.
What We Can Learn about News Corp’s Cash from Continuing Operations
When all the noncash charges (such as depreciation and impairment of assets) are added back to the net loss ($78 million) recorded on the income statement, News Corp actually generated about $831 million in cash from its five divisions (Table 2.14). This number correlates closely with the 2015 EBITDA figure of $852 million for the company (Table 2.10). Therefore, EBITDA is usually a good approximation of the cash a company will generate from continuing operations, which is why News Corp places a strong emphasis on EBITDA in managing its various divisions and compensating executives based on their segment’s EBITDA performance. Additionally, when making acquisitions and/or deciding to sell a division or property, News Corp says in its annual report that it evaluates and estimates the future cash flows and EBITDA of the company it is acquiring or divesting.
Table 2.14 News Corp net cash from continuing operations, 2015 (in million $).
Source: News Corp Annual Report 2015.
| Net (loss) | (78) |
| Adjustments | |
| Depreciation | 530 |
| Impairment | 371 |
| Other | 8 |
| Net cash from operations | 831 |
Cash from Investing Activities
This captures the amount of cash a company either earned or spent on investments. This includes cash spent to purchase equipment or other businesses (which is subtracted) and proceeds from selling properties or investing in long‐term securities (which are added) to yield a net amount of cash from investing activities. This figure can fluctuate dramatically from year‐to‐year, depending on whether a company has spent a lot on purchases, or conversely, disposed of property and assets.
What We Can Learn about News Corp’s Cash from Investments
News Corp is an actively managed company. It is continually disposing of underperforming companies or divisions and seeking acquisitions. Fiscal Year 2013, for example, was a big year for both acquiring and disposing of companies. In 2013, News Corp spent $2.1 billion on acquisitions—including a media investment company in Australia and Storyful, a social media news agency. At the same time, it received $865 million in cash by selling a group of community newspapers in the United States, the DJ Indexes, and SKY Network Television in Asia.
In Table 2.15, we see that Fiscal Year 2015 was a year for major acquisitions, with only minor dispositions. In addition to purchasing Harlequin for $455 million from Torstar Enterprises, News Corp paid $864 million for Move, Inc., which, through its website www.realtor.com and mobile applications, displays 98% of all properties for sale in the United States. Move was folded into the Digital Real Estate division. News Corp also spent $378 million in 2015 on major capital expenditures for its various divisions. Of this amount, $238 million was invested in software and equipment for the News and Information Services division, and only $12 million went to HarperCollins. (Unlike the News and Information division, HarperCollins has outsourced its printing and distribution functions. This decreases the need for substantial outlays of cash for capital assets, such as equipment, in the book division.)
Table 2.15 News Corp cash from investing activities, 2015 (in million $).
Source: News Corp Annual Report 2015.
| Investing activity | Million $ |
| Capital expenditures | (378) |
| Acquisitions | (1,190) |
| Other | (173) |
| Net cash investments | (1,741) |
Cash from Financing Activities
Net cash from financing activities is calculated by subtracting cash spent retiring debt, repurchasing shares of stock, and paying dividends to shareholders, and then adding cash raised from issuing debt. Investors and analysts keep a keen eye on the amount paid in dividends. How does the outflow of cash to pay dividends compare with the money produced from operations? Companies that are struggling financially often do not generate enough cash from continuing operations to pay dividends and instead will use cash from financing (borrowing money) or from investing (one‐time cash payments from the sale of property).
What We Can Learn about News Corp’s Use of Cash from Financing
In Table 2.16, we see News Corp spent only a small fraction of its cash on financing ($190 million) compared with the cash it spent on investments ($1.7 billion). Most large media companies pay a dividend on their common stock, either quarterly, twice yearly or annually. (Companies that do not pay dividends, such as Google and Facebook, reinvest all their earnings into company growth.) Like most other traditional media companies, News Corp pays out a portion of its earnings in dividends (10 cents per share, paid twice a year), which amounted to $30 million in 2015, or less than 1% of the cash it generated from operations. It also spent $129 million paying back its only loan.
Table 2.16 News Corp net cash from financing activities, 2015 (in million $).
Source: News Corp Annual Report 2015.
| Financing activity | Million $ |
| Repayment loan | (129) |
| Dividends paid | (30) |
| Other | (31) |
| Net cash from financing | (190) |
Changes in Cash Flow
Cash from all three activities (continuing operations, investments, and finances) are added and subtracted together to calculate the net increase or decrease in cash. This is followed by two more lines on the cash flow statement which record the beginning cash balance and the ending cash balance. This is the amount of money the company has available to spend in the following year.
What We Learn about the Cash Flow at News Corp
From Table 2.17, we see that News Corp began 2015 with $3.1 billion in cash carried over from the previous year. It generated another $831 million from operations and then spent $1.7 billion on investments, including $1.2 billion on acquisitions. At year’s end, it had almost $2 billion in cash that it could use in 2016 to acquire new properties or invest in current enterprises. According to the footnotes in the 2015 financial report, it also has the ability to tap into an additional $900 million in revolving credit, bringing the total amount of money that management can easily access to almost $3 billion.
Table 2.17 News Corp changes in cash flow, 2015 (in million $).
Source: News Corp Annual Report 2015.
| Net decrease | (1,100) |
| Cash at beginning | 3,145 |
| Cash at end | 1,951 |
By comparison, at the end of 2015, Bertelsmann, which had twice the revenue and EBITDA of News Corp, had only $1.3 billion in cash, and the New York Times Company had only $29 million. In short, News Corp, compared to its competitors, is cash‐rich, has no debt and is able to move quickly to acquire other publishing properties. As the annual report states, “The company has evaluated, and expects to continue to evaluate, possible acquisitions and dispositions of certain companies.”
Summary of Financial Results: 2015
News Corp’s 2015 financial statements reveal much about the economics of book publishing and the challenges confronting both HarperCollins and News Corp as management considered whether to publish Go Set a Watchman. Among the insights:
- HarperCollins accounted for only a fifth of total revenues for News Corp in 2015, but the increase of $233 million from the book division compensated for the loss of a similar amount of revenue in the largest division, News and Information Services.
- The News and Information Services division, which houses the company’s newspapers, is struggling to adapt to the digital era, with print advertising and circulation revenues declining much faster than increases from digital sources. This means that, in the short term, HarperCollins’s consistent, year‐over‐year performance has a significant impact on both News Corp’s top and bottom lines (its revenue and profitability).
- In evaluating the financial performance of its divisions, News Corp management relies heavily on the unit’s current and projected annual EBITDA or cash flow.
- In order to consistently meet profit and EBITDA targets set by News Corp management, HarperCollins needs to publish a number of best sellers each year (which sell a million or more copies) and it needs to offer several genres of literature (so that it appeals to the widest possible audience).
- Economies of scale are important for the Big Five book publishers, which carry high fixed marketing, production, and distribution costs. Although it is number two in the market, HarperCollins is about half the size of Penguin Random House (in terms of revenue and EBITDA), and therefore has less room for error—when choosing best sellers or acquiring other companies.
- Unfortunately for HarperCollins, by 2015, the popularity of its Divergent series (which sold 19 million copies in 2014) was waning rapidly. By acquiring Harlequin, News Corp quickly added $281 million to the top line. Without the revenue from Harlequin, HarperCollins’s revenue for 2015 would have dropped back to 2013 levels.
- However, HarperCollins also acquired Harlequin’s expenses, which pulled down the division’s operating profit and margins in 2015, compared to Penguin Random House.
- The best way for HarperCollins to offset the increased costs associated with the acquisition was to aggressively seek out and publish best sellers in 2016, such as Go Set a Watchman.
According to management statements in the 2015 annual report, “Major new title releases represent a significant portion of the Book Publishing segment’s sales throughout the fiscal year.” In other words, best sellers have an outsized impact on both revenues and profits. Therefore, we can surmise that Watchman was released in July (the first month of News Corp’s 2016 fiscal year) so that HarperCollins and News Corp could recognize a full year of revenue and profit from what management anticipated would be a huge best seller.
Go Set a Watchman and HarperCollins: An Update
From the moment HarperCollins announced in February 2015 that it would publish Watchman, it appeared that the book would be a best seller. In the five months prior to publication, the book posted the largest number of preorders in HarperCollins’s history, with the online retailing giant Amazon reporting the strongest demand for a yet‐unpublished title since the release of Harry Potter and the Deathly Hallows in 2007. Advance orders for Watchman were so strong through all retail outlets that HarperCollins ordered the advance printing of 2 million hardcover copies. On July 14, 2015, at one minute past midnight, more than 90 bookstores and Amazon started selling the new novel.
Despite reviews that were “charitable at best, scathing at worst,” the sale of 1.1 million copies in the first week after the release of Watchman set yet another post‐publication sales record for HarperCollins. By Christmas, it had sold 1.6 million copies, roughly two‐thirds of which were hardcover books. Watchman was a bestseller, but it had not attained the level of Scholastic Publishing’s Harry Potter series, which sold 8.3 million copies of Deathly Hallows in the first day after its release. Even HarperCollins had produced bigger best sellers in recent years, including the Divergent trilogy, which sold more than 32 million copies and the Chris Kyle memoir, American Sniper, which sold 5.6 million copies.
Still, as the Wall Street Journal noted about its sibling division in News Corp, it was “a big haul in today’s book world.” Depending on the discount offered by sellers, the 1.1 million hardcover copies sold by the end of 2015 had already generated estimated revenue of $20–25 million, with the e‐book copies generating an additional $5–7 million. In addition, there were other supplemental materials that were released and offered for sale, including a teacher’s note and instructional manual for Watchman. Not only that, sales of To Kill a Mockingbird, HarperCollins’s perennial best seller on its backlist, increased as much as 200 times in the weeks just before and after the release of Watchman as readers reconnected with a book they hadn’t opened since high school.
Judging by these sales figures, publishing Go Set a Watchman was a successful business venture for HarperCollins and News Corp, despite the literary controversy it caused. Although sales of Watchman had already begun to slow by Christmas, News Corp reported in its 2016 financial statement that for the fiscal year (July 2015 to June 2016), Go Set a Watchman actually generated $42 million in revenue. (News Corp did not report the actual number of copies sold of Watchman. Industry analysts estimated 1.5 million hardback copies and an additional half a million e‐books.) Several Harlequin best sellers contributed an additional $23 million to HarperCollins’s revenue. But this was not enough to offset significant declines in other areas. The Divergent series sold only 2 million copies in 2016 compared with 8.3 million in 2015. Sales of the more profitable e‐books also dropped at HarperCollins from 22% to 19%, and foreign currency fluctuations negatively impacted the bottom line by $39 million.
As a result, despite the strong performance of Go Set a Watchman, both revenue and EBITDA declined at HarperCollins in 2016. Revenue dropped $21 million from $1.667 billion, while EBITDA declined to $185 from $221 million. This brought the EBITDA margin for HarperCollins in 2016 down from 13.3% in 2015 to 11.2%.
Adding to the woes at News Corp, performance at the News and Information Services division continued to deteriorate and drag down both the top and bottom lines of News Corp. Advertising and circulation revenue in the News and Information Services group declined by $400 million. Revenues at News Corp sagged by a similar amount to $8.2 billion. Even though expenses decreased by $200 million, the EBITDA margin at the News and Information Services Group dropped to 4% from 10% in 2015. As a result, the EBITDA of News Corp dropped to 8.2% from approximately 10% in 2015.
Even allowing for the vagaries of the book publishing industry, HarperCollins’s revenues and EBITDA were more consistent and predictable, year‐on‐year, than that of the News and Information Services Division. While literary critics may have scoffed, Watchman had been a significant contributor to both the top and bottom lines at HarperCollins, as well as News Corp.
Summary
Every strategic decision is a gamble that carries with it risks and opportunities. Sometimes managers and executives of media enterprises make short‐term decisions that boost revenue and profits for a year, for example, publishing Watchman. Other times, they make long‐term decisions, such as purchasing Harlequin, betting that these acquisitions will boost both top and bottom line in the years ahead.
Each of the three financial summaries provides insight into the health and long‐term sustainability of an enterprise. While past performance of a company is not necessarily indicative of future performance, recent trends in revenue, expenses and profitability, obtained from the income statement, provide clues about future performance of a company. The balance statement provides insights into a company’s assets and liabilities, including debt and pensions. The cash flow record shows how much money companies make from continuing operations and how they have used their cash to invest in new ventures.
The publishing industry is in the throes of what the economist Joseph Schumpeter called “creative destruction.” As this analysis of News Corp’s annual financial statement shows, technological innovation has changed the economics of the publishing industry, affecting both the revenue and profits of divisions within companies and their parent corporations. There are no guarantees that the media giants of the twentieth century, such as HarperCollins and News Corp, will survive in their current form. Successful media entrepreneurs, buffeted by what Schumpeter called “the gales of destruction,” understand how every strategic and tactical decision they make flows through the annual income statement, balance sheet and cash flow record. As we will see in Chapter 3, industry analysts and investors use the information in these financial records to decide how much a company is worth.