Arundel Partners Case Analysis
A group of investors (Arundel group) is looking into the idea of purchasing the sequel rights associated with films produced by one or more major movie studios. Movie rights are to be purchased prior to films being made. Arundel wants to come up with a decision to either purchase all the sequel rights for a studio’s entire production during a specified period of time or purchase a specified number of major films. Arundel's profitability is dependent upon the price it pays for a portfolio of sequel rights. Our analysis of Arundel’s proposal includes a net present value calculation of each movie production company. In order to decide whether Arundel can make money buying movie sequel rights depends on whether the net present value of the production company’s movies is higher than the estimated 2M per film required to purchase the rights.
How are the principals of Arundel Partners planning to make money by buying rights to sequels? They would be interested in purchasing the sequel rights for one or more studios¡¦ entire production over an extended period of not less than a year. If a particular film was a hit, and Arundel thought a sequel would be profitable, it would exercise its rights by producing the sequel. Alternatively, they can sell the rights to the highest bidder. Inevitably, the performance of the original films would not justify sequels, and for them the sequel rights would simply not be exercised. For most movies it becomes quite clear after their first few weeks in theaters whether a sequel would be economical or not, based upon each film's box office performance.
Why do the partners want to buy a portfolio of rights in advance rather than negotiating film-by-film to buy them? It is of critical importance to Arundel that a number of films and a price per film is agreed upon before either Arundel or the studio knew which films would generate the option of a sequel. In addition, once production started, the studio would inevitably form an opinion about the movie and the likeliness that a sequel would be possible. This would put Arundel at a disadvantage, because they would then have to negotiate the price for sequel rights on each film produced, while knowing much less than the production studio about the film.
What are primary advantages and disadvantages of the approach that was taken by us in valuing the sequel rights? Our analysis of Arundel’s proposal includes a net present value calculation of each movie production company. Arundel feels that waiting to purchase sequel rights until after the movie goes into production will make it more difficult and costly to purchase the rights. Below are advantages and disadvantages of our approach.
- Because all available data was used, there is a greater sample in our analysis. We assume that more data points will lead to a more accurate conclusion.
- We did not eliminate any outliers because we felt outliers are characteristic of the industry.
- The analysis is based upon historical data rather than fabricated assumptions.
- We believe that breaking out the data by studio is an advantage because it provides direction.
- It is assumed that historical performance is indicative of future performance in the short term based on historical data. Our assumption is supported by Exhibit 1which shows that all production companies tend to have similar performance over time.
- Only 1 year of historical data is available
- We assume that production companies are willing to sell the sequel rights under our terms.
- Probabilities of success have been calculated, but we have not been able to apply them to the per film value. In short, it is necessary to be subjective about the risk based on the probabilities of success.
- More historical data would be useful to support our assumptions.
- More data on success probabilities may help to direct the course of action
- We would also like to have information about the willingness of production companies to sell sequel rights at a pre-negotiated price.
Given our analysis of the motion picture industry, we recommend that Arundel carefully select the major film studios from which they intend to purchase sequel rights. The net present value of hypothetical sequels taken from the available previous years shows not only that the industry is highly volatile, but also that certain production studios are more volatile than others in terms of their recent performance. In addition, some studios are consistently less profitable than others. (See "NPV for Each Production Company" chart in appendix) Since the success of film studios are relatively stable in the short term (see "Rental Shares of Major Film Distributors" table and graph) Because of this stability, it is possible for Arundel to approach more profitable studios with their offer to purchase sequel rights. Out of all the major film studios, only MCA-Universal, Warner Bros., and The Walt Disney Company generate a positive net present value on a per-film basis. However, according to casual inquiries, it is unlikely that any movie studio would enter negotiations with Arundel on a per film price that is less than 1 million. Instead, the film studios seem to indicate that they would be willing to sell the sequel rights for about $2 million per film.
Based upon this information, only Walt Disney and MCA-Universal Studios would generate profit, if the $2 million per film price were agreed to. If Arundel were interested in purchasing rights from Warner Bros. Studios, it would need to negotiate a price of less than 2 million per film, and should not pay Warner Bros. more than $1.92 million per film. Despite the fact that these three studios appear profitable, it would be prudent for Arundel to consider the success rate of films produced by each studio. This is the percentage of profitable films produced by the studio. By far, MCA-Universal is the most successful in that regard, with a 71.4% success rate, followed by Walt Disney with 45% and Warner Bros, with only 21%.
Although this "success rate" may not be directly applied to the calculated per-film values, it does indicate the classic case of "risk vs. return" and should be considered by Arundel. Whether or not Arundel chooses to simply purchase the rights of all films to be produced by the studio, or some mixed combination, they should focus on MCA, Walt Disney and Warner Bros. If the $2 million estimated per-film price holds, then Warner Bros. should no longer be considered. Arundel should not, at any price purchase sequel rights from Sony Pictures, 20th Century Fox, or Paramount Pictures.
1. Why do principals of Arundel Partners think they can make money buying movie sequel rights? Who do partners want to buy portfolio of rights in advance rather than negotiating film-by-film to buy them?
An analysis of Arundel’s proposal includes a net present value calculation of each movie production company. In order to decide whether Arundel can make money buying movie sequel rights depends on whether the net present value of the production company’s movies is higher than the estimated 2 million required to purchase the rights.
As can be seen in the exhibit to solution 1, Arundel would likely profit from purchasing the sequel rights of MCA Universal and Walt Disney Co. Although other production companies such as Warner Brothers generate a positive net present value, the 2 million per movie investment would lead to negative cash flows.
2. Estimate the per-film value of a portfolio of sequel rights such as Arundel proposed to buy.
As can be seen in exhibit to solution 2, we have estimated the per-film value of each production company. MCA Universal, Warner Brothers and Walt Disney Co are the only production companies that provide a positive per film value, with values of 9.89, 1.92, 12.56 million respectively. This value is calculated by dividing the net present value of all the movies by the total number of movies. We also calculated the average value of each production company based upon their share of the total number of movies produced. The companies with positive values were MCA Universal, Warner Brothers and Walt Disney Co is also the only production companies that provide a positive per film value, with values of 1.40, 0.37, 1.40 million respectively. These values are based on the average value per film multiplied by the company’s average share of the industry.
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