Sec1 Group6 Arundel Partner Final

Arundel Partners: The Sequel Project

Dec 1, 2009

Congxuan YanMaoning Zhang

Nan Zhong

Agenda

• Issue Identification

• Valuing the Sequel Project: NPV and Real Options Approaches

• Evaluation of Valuing Approaches

• Studio’s Entire Production Sequel Rights VS Major Films’ Sequel Rights

• Other Issues

• Recommendation

Issue Identification—Introduction of Arundel Sequel Project

• Innovative Idea!

• Purchase the sequel rights associated with films produced by one or more major U.S. movie studios


(cont)

• Purchase sequel rights before the first film made

a. Studio formed opinions about the movie and the likeliness that a sequel would be possible once production started.

b. Arundel would then have to negotiate the price for sequel rights on each film produced

c. Arundel knows much less than the production studio about the film.

d. Conclusion: the number of films and a price per film are agreed upon before either Arundel or the studio knew which films would generate the option of a sequel.


(cont)

• Help finance production of initial films

• Purchase all of the sequel rights for a studio’s entire production during a specified period

• Purchasing Studio’s Entire Production Sequel Rights or just Major Films’ Sequel Rights

Valuing the Sequel Project—Outline

• Profits depends on whether the NPV of the production company’s movies is higher than the estimated 2 million required to purchase the rights.

• NPV Approach

Using studios’ sequels discounted inflows and negative costs, and find the PV of profits

• Real Option Calculation

Consider the investment on sequel rights as a call option, and use Black-Scholes formula to find price for the option

Valuing the Sequel Project—NPV Approach

• Interest rate = 6% semi-annually;

Compound Interest = – 1 = 12.36%

NPV Sequel Right at time 0

= –

Average sequel right based on movie share is calculated by

NPV SR0 X

NPV Approach—estimation of per-film value of a portfolio of sequel rights

Major StudiosNPV for average sequel right

Average sequel right based on produced movie share

Number of Movies Produced

MCA UNIVERSAL 4.47 0.63 14

PARAMOUNT PICTURES

-4.67 -0.47 10

SONY PICTURES ENTERTAINMENT

-7.66 -2.86 34

TWENTIETH CENTURY FOX

-4.83 -0.54 11

WARNER BROTHERS

-0.51 -0.10 19

THE WALT DISNEY COMPANY

6.08 0.68 11

99

0.63 = 4.47 * (14 / 99)

Valuing the Sequel Project—Simple Option Pricing Model

• Call Price• C = S*N( ) – K* *N( )• S = expected revenue of a company’s sequels

discounted to t=0• K = expected cost of a company’s sequels• T = time-to-maturity (assume 1 year period)• σ = standard deviation of one year return• r = compound rate per period• = and = -

Option pricing—estimation of per-film value of a portfolio of sequel rights

Major Studios S K T σ r N ( ) N ( ) C

MCA UNIVERSAL 4.47 22.3 1 0.7198 12.36% -1.6985 -2.4183 0.0447 0.0078 0.0465

PARAMOUNT PICTURES

-4.67 24.7 1 0.8717 12.36% N/A N/A N/A N/A N/A


-7.66 22.5 1 1.3155 12.36% N/A N/A N/A N/A N/A


-4.83 21.9 1 0.5894 12.36% N/A N/A N/A N/A N/A

WARNER BROTHERS

-0.51 22.2 1 1.6303 12.36% N/A N/A N/A N/A N/A


6.08 23.2 1 1.0975 12.36% -0.5587 -1.6562 0.2882 0.0488 0.75

Evaluation of Valuing Approaches

• NPV approach• Advantages:

• Simplicity • We have a plenty of data from 6 major studios, 99 films

in total• The analysis is based on historical data with fewer

assumptions• Disadvantages:

• The prediction of future performance is relied on historical performance

• Only 1 year of historical data is available

Evaluation of Valuing Approaches(cont)

• Real option approach

• Disadvantages:– Lack of information volatility – Assume the risk-adjusting probabilities is based on

normal distribution

• Advantages:– Provide a valuable insight into the scenarios

Studio’s entire production sequel rights VS Major films’ sequel rights

Major Studios Average NPV for Sequel Rights

Highest Single Film Sequel Rights

Movie Name

MCA UNIVERSAL 4.47 $28.31 PARENTHOOD

PARAMOUNT PICTURES

-4.67 $14.86 PET SEMATARY


-7.66 $56.25 LOOK WHO'S TALKING


-4.83 $15.14 THE WAR OF THE ROSES

WARNER BROTHERS

-0.51 $94.04 BATMAN


6.08 $47.91 HONEY, I SHRUNK THE KIDS

There are total 23 films’ expected sequel rights with NPV higher than 2 million (the inquiry price)

Other Issues—Problems or disagreements Arundel and a major

studio to encounter

• Studios may asked for prices higher than $2 million

• Arundel was using a real option similar to a call option

• As for Arundel, the risk of losing money is limited and the benefit is unlimited; on the other hand, studios may have unlimited losses.

• Arundel considered financing its own production, while studios may wish to individually financed the films

Other Issues—refining the estimates of the right’s value

• More historical data would be useful to support the assumptions

• Useful information about the willingness of production companies to sell sequel rights at a pre-negotiated price was needed

Other Issues—What contractual terms and provisions should Arundel insist

on?

• Arundel will prefer to elasticity

• Insist on buying the rights before the first film was made

Recommendation

We suggest the Arundel Partners should choose to purchase all of the sequel rights for a studio’s entire production during a specified period.

Thank You

Documents

Sec1 Group6 Arundel Partner Final