CASES Arundel Partners: The Sequel Project

1. CASES Arundel Partners: The Sequel Project Introduction and Questions Prof. Hugues PirotteSOLVAY BUSINESS SCHOOLUNIVERSITÉ LIBRE DE BRUXELLES

2. Arundel Partners: The Sequel Project The Context • April 1992: David Davis must take a look at a unusual business idea • Arundel Partners would purchase sequel rights from major studios • Before the first film was made • Purchase all sequel rights and not choose based on own judgment, or at least a random selection of them • Pay upfront in cash on a “fixed price per-movie” basis, for the whole lot. • Interesting to studios because • Provides cash when it is most needed, i.e. at the production stage • Help in reducing studio’s borrowing (privately-financed industry in US  Europe) • A price of $2 mio or more per movie would be tempting • Steps in movie production • Production • Distribution • Exhibition • Statistics • Major studios distributed 35% of all films accounting for 93% of revenues coming from exhibitions. H.Pirotte

3. Arundel Partners: The Sequel Project The Context (2) • Cost structure • The total production cost is called “the negative cost”, including • Pre-production costs: story acquisition, script development, set design, casting, film crew creation, costume design, location scouting, budget planning. • Principal photography: fixed salaries of actors, directors, writers and other personnel; rent, wages for soundstages, set construction, lighting, transportation, costume making, special effects, etc… • Post-production costs: editing, laying down sound and music, titles and credits. • Distribution costs: deducted from revenues collected by the distributor form theaters and ancillary markets • Distribution expenses: advertising, etc… • Distribution fees: % charged by distributors on revenues perceived • Exhibition costs: • On average, in 1991, 50% was remitted by the theaters to the distributors • Net Profits = all revenues (proceeds remitted to distributors + …) – negative cost – distribution costs – exhibition costs H.Pirotte

4. Arundel Partners: The Sequel Project About the sequel • The median release data for a sequel was 3 years after the first film’s release, and most were released with 1 to 5 years. • Profit structure (averages) • Costs: 120% of original movie • Revenues: 70% of original movie • Arundel Partners proposal • Critical to agree on the number of movies and the price per movie before either Arundel or the studios knew which films would be produced. • A satisfactory method of payment should be agreed upon (escrow account, etc…) + maybe some incentive plan for the studio still. • For tax purposes, desirable to fix an expiration date for the rights like 3 years from the first film’s release. • Arundel could grant the studios a right of first refusal on any rights it planned to sell. • The contract also could provide that Arundel would use the original studio for distribution, assuming its distribution fees are competitive. H.Pirotte

5. Arundel Partners: The Sequel Project Time scale Distribution and Exhibition Distribution and Exhibition Production Production Time (years) 0 1 2 3 4 5 First movie Delay Sequel The Data we have in the case PV(Neg Cost)Hypothetical PV(Rev)Hypothetical H.Pirotte

6. Arundel Partners: The Sequel Project Data • Data is provided in the external spreadsheet on the website. • This data includes • Hypothetical sequel costs and revenues based on first film’s estimated data, under some assumptions • Projections assuming the sequel would be produced and would be typical • Not surprisingly however, most movies’ hypothetical sequels would not be produced because of poor projected performance. • The questions on the next slide are related to the pricing per movie of these sequel rights… • Choose those that would be produced, estimate how much net money that would make and give a price per sequel then… • Can be stress-tested by scenario analysis. • Apply a simple option pricing model… H.Pirotte

7. Arundel Partners: The Sequel Project Study Questions • Why do the principals of Arundel Partners think they can make money buying movie sequel rights? Why do the partners want to buy a portfolio of rights in advance rather than negotiating film-by-film to buy them? • Estimate the per-film value of a portfolio of sequel rights such as Arundel proposes to buy. (There are several ways to approach this problem) • What are the primary advantages and disadvantages of the approach you took to valuing rights? What further assistance or data would you require to refine your estimate of the rights’ value? • What problems or disagreements would you expect Arundel and a major studio to encounter in the course of a relationship like that described in the case? What contractual terms and provisions should Arundel insist on? H.Pirotte