Arundel Partners: The Sequel

Project
Dec 1, 2009

Congxuan Yan
Maoning 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
 Issue Identification—
Introduction of Arundel Sequel Project
(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.
 Issue Identification—
Introduction of Arundel Sequel Project
(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
Average sequel
NPV for average right based on Number of Movies
Major Studios sequel right produced movie Produced
share
MCA UNIVERSAL 4.47 0.63 14
PARAMOUNT -4.67 -0.47 10
PICTURES
SONY PICTURES -7.66 -2.86 34
ENTERTAINMENT
TWENTIETH -4.83 -0.54 11
CENTURY FOX
WARNER -0.51 -0.10 19
BROTHERS
THE WALT DISNEY 6.08 0.68 11
COMPANY
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 -4.67 24.7 1 0.8717 12.36% N/A N/A N/A N/A N/A
PICTURES

SONY PICTURES -7.66 22.5 1 1.3155 12.36% N/A N/A N/A N/A N/A
ENTERTAINMENT

TWENTIETH -4.83 21.9 1 0.5894 12.36% N/A N/A N/A N/A N/A
CENTURY FOX

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

THE WALT DISNEY 6.08 23.2 1 1.0975 12.36% -0.5587 -1.6562 0.2882 0.0488 0.75
COMPANY
 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 Highest Single Film Movie Name
Sequel Rights Sequel Rights

MCA UNIVERSAL 4.47 $28.31 PARENTHOOD

PARAMOUNT -4.67 $14.86 PET SEMATARY
PICTURES
SONY PICTURES -7.66 $56.25 LOOK WHO'S
ENTERTAINMENT TALKING

TWENTIETH -4.83 $15.14 THE WAR OF THE

CENTURY FOX ROSES
WARNER -0.51 $94.04 BATMAN
BROTHERS
THE WALT DISNEY 6.08 $47.91 HONEY, I SHRUNK
COMPANY 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