Arundel Partners: The Sequel Project
Arundel Partners: The Sequel Project
1. Executive Summary
“Nobody knows anything”. This famous line coined by William Goldman, a well known
Hollywood screenwriter, simply but honestly sums up the movie industry. Numerous academic studies have tried to gauge the determinants of movie success but have yet failed to deliver a satisfying answer. Ravid A. (1999) for example finds that neither stars nor big budgets contribute to profitability of a movie. This case study investigates the case of buying sequel rights to original movies. These rights can be understood as a real option allowing the holder the flexibility of decision making depending on the success of the original movie.
In 1992 Paul Kagan Associates Inc. appointed Mr. David …show more content…
A. Davis, a movie industry analyst, to investigate whether there would be economic potential to profit from buying sequel rights for movies produced by U.S. movie studios and creating an investment group, Arundel
Partners (AP thereafter) that would exploit this investment strategy. The idea was that a successful original movie was more likely to be followed by a successful sequel.
One could then earn a profit by exercising the right to produce the sequel or leaving it unexercised based on the expected future return of the sequel that would depend on the performance of the original movie. The business strategy incorporated several key insights regarding the movie business: movie returns are hard to predict, production and distribution of movies is risky and there exist conflicts of interest between creative and business considerations. AP believed it was possible to solve these issues by buying a portfolio of rights to movie sequels from production companies before the original movies were produced. Buying such rights upfront with an equal dollar value attached to each film was advantageous to AP but also to production companies. With a portfolio or slate of movies AP essentially spread the risk and kept the potential of having a best-seller. Further, they avoided the problem of asymmetric information due to the fact that as movie projects progressed the production companies would gain an informational edge over AP that would eventually induce higher prices for the sequel rights. And by providing seed capital to the movie producers, AR gained negotiating …show more content…
power with respect to the setting of the price for sequel rights.
The two approaches that we employed in our estimation of the per-film value of a portfolio of sequel rights have several advantages and drawbacks that we shall address in the following.
The classic NPV approach is both easy to understand and straightforward. We simply select the films from the sample that have positive estimated returns for their sequels.
In our case these are 28 films out of a total sample of 99 films. Then we recognise that the negative costs will be incurred three years ahead, while the revenue (net inflows) will accrue in four years time. Thus, we calculate the discounted value for both the negative cost and the net inflows on a one-film basis by multiplying the corresponding mean values by the fraction of sequels with positive estimated returns over the total sample size (28/99). We obtain a break-even value per sequel right of $6.47 million as of 1988 which is above the minimum required amount of
$2 million that producers would require in order to give up the rights to sequels (see case study). We note that the NPV only considers one year of data, thus a sample with only one observation, which does not allow for reliable inferences. Further, the model neglects the modelling of uncertainty of future cash flows. Since we evaluate all the studios in the same
“package” we disregard the possibility that movie studios may differ with respect to results
(revenue and returns). Thus, a prudent investment decision should be based on a refined analysis that concentrates solely on the studio one wants to do business
with.
In contrast, the option pricing approach based on Black-Scholes-Merton allows for uncertainty (see presentation handout for the input parameters). We compute a break-even value per sequel right of $8.69 million in 1988. Underlying the B-S-M approach is the assumption of lognormal distributed returns. This is in contradiction to the empirical results of
De Vany and Walls (1996) who find that Bose Einstein distributions provide a good approximation to the distribution of revenues in the movie industry. These distributions allow for the fat tails observed in movie returns and the “winner takes all” phenomenon which describes the situation where only a few movies account for the junk of total revenues.
Finally, we recognize that valuing the sequel rights as European style options is most likely too restrictive since AP, depending on the clauses of the contracts with the production companies, may exercise the options before or after maturity.
There remain several potential problems of disagreement between AP and the major studios.
Successful movies could tempt movie producers to breech sequel contracts and resell sequel rights to other bidders at a higher price. This risk could be mitigated by adding contractual terms that would ask for compensation in case of a contract violation. AP should also make sure that the financing will be distributed evenly on the portfolio in order to have as many movie releases as possible that may lead to potential sequels. Otherwise, producers may be inclined to favour personal projects instead of guaranteeing a good portfolio of films. To keep the production studio committed to the original movie and subsequent sequels AP will have to give incentives that may come in the form of percentage participation rights in the profits of sequels or by allowing the production companies to produce sequels of sequels.
In the end, AP would have to know something about the protfolio of movies that they have at hand. This may be a quantifiable variable that predicts success or some component that captures the taste of the movie viewers. AP would have to try to reproduce the formula of a successful original movie as close as possible in order to guarantee a successful sequel that would turn the real option into a profitable investment strategy.
1. Executive Summary
“Nobody knows anything”. This famous line coined by William Goldman, a well known
Hollywood screenwriter, simply but honestly sums up the movie industry. Numerous academic studies have tried to gauge the determinants of movie success but have yet failed to deliver a satisfying answer. Ravid A. (1999) for example finds that neither stars nor big budgets contribute to profitability of a movie. This case study investigates the case of buying sequel rights to original movies. These rights can be understood as a real option allowing the holder the flexibility of decision making depending on the success of the original movie.
In 1992 Paul Kagan Associates Inc. appointed Mr. David …show more content…
A. Davis, a movie industry analyst, to investigate whether there would be economic potential to profit from buying sequel rights for movies produced by U.S. movie studios and creating an investment group, Arundel
Partners (AP thereafter) that would exploit this investment strategy. The idea was that a successful original movie was more likely to be followed by a successful sequel.
One could then earn a profit by exercising the right to produce the sequel or leaving it unexercised based on the expected future return of the sequel that would depend on the performance of the original movie. The business strategy incorporated several key insights regarding the movie business: movie returns are hard to predict, production and distribution of movies is risky and there exist conflicts of interest between creative and business considerations. AP believed it was possible to solve these issues by buying a portfolio of rights to movie sequels from production companies before the original movies were produced. Buying such rights upfront with an equal dollar value attached to each film was advantageous to AP but also to production companies. With a portfolio or slate of movies AP essentially spread the risk and kept the potential of having a best-seller. Further, they avoided the problem of asymmetric information due to the fact that as movie projects progressed the production companies would gain an informational edge over AP that would eventually induce higher prices for the sequel rights. And by providing seed capital to the movie producers, AR gained negotiating …show more content…
power with respect to the setting of the price for sequel rights.
The two approaches that we employed in our estimation of the per-film value of a portfolio of sequel rights have several advantages and drawbacks that we shall address in the following.
The classic NPV approach is both easy to understand and straightforward. We simply select the films from the sample that have positive estimated returns for their sequels.
In our case these are 28 films out of a total sample of 99 films. Then we recognise that the negative costs will be incurred three years ahead, while the revenue (net inflows) will accrue in four years time. Thus, we calculate the discounted value for both the negative cost and the net inflows on a one-film basis by multiplying the corresponding mean values by the fraction of sequels with positive estimated returns over the total sample size (28/99). We obtain a break-even value per sequel right of $6.47 million as of 1988 which is above the minimum required amount of
$2 million that producers would require in order to give up the rights to sequels (see case study). We note that the NPV only considers one year of data, thus a sample with only one observation, which does not allow for reliable inferences. Further, the model neglects the modelling of uncertainty of future cash flows. Since we evaluate all the studios in the same
“package” we disregard the possibility that movie studios may differ with respect to results
(revenue and returns). Thus, a prudent investment decision should be based on a refined analysis that concentrates solely on the studio one wants to do business
with.
In contrast, the option pricing approach based on Black-Scholes-Merton allows for uncertainty (see presentation handout for the input parameters). We compute a break-even value per sequel right of $8.69 million in 1988. Underlying the B-S-M approach is the assumption of lognormal distributed returns. This is in contradiction to the empirical results of
De Vany and Walls (1996) who find that Bose Einstein distributions provide a good approximation to the distribution of revenues in the movie industry. These distributions allow for the fat tails observed in movie returns and the “winner takes all” phenomenon which describes the situation where only a few movies account for the junk of total revenues.
Finally, we recognize that valuing the sequel rights as European style options is most likely too restrictive since AP, depending on the clauses of the contracts with the production companies, may exercise the options before or after maturity.
There remain several potential problems of disagreement between AP and the major studios.
Successful movies could tempt movie producers to breech sequel contracts and resell sequel rights to other bidders at a higher price. This risk could be mitigated by adding contractual terms that would ask for compensation in case of a contract violation. AP should also make sure that the financing will be distributed evenly on the portfolio in order to have as many movie releases as possible that may lead to potential sequels. Otherwise, producers may be inclined to favour personal projects instead of guaranteeing a good portfolio of films. To keep the production studio committed to the original movie and subsequent sequels AP will have to give incentives that may come in the form of percentage participation rights in the profits of sequels or by allowing the production companies to produce sequels of sequels.
In the end, AP would have to know something about the protfolio of movies that they have at hand. This may be a quantifiable variable that predicts success or some component that captures the taste of the movie viewers. AP would have to try to reproduce the formula of a successful original movie as close as possible in order to guarantee a successful sequel that would turn the real option into a profitable investment strategy.