Anna Burckhardt, Brett Cychosz, Sam Pickett Faculty Advisor: Belinda Mucklow February 2 nd, 2017

Transcription

1 Anna Burckhardt, Brett Cychosz, Sam Pickett Faculty Advisor: Belinda Mucklow February 2 nd, 2017

2 Agenda I. Executive Summary II. Company Profile III. Industry Overview IV. Valuation I. Discounted Cash Flow II. Comparable Company III. Precedent Transaction V. Potential Buyers I. Strategic Buyers II. Financial Buyers VI. Game of Thrones Damages VII. Appendix 1

3 2 Executive Summary

4 Executive Summary Industry Overview HBO is the product of a merger between TV and movie producers and suppliers. This segment of the industry is called Streaming Video On Demand (SVOD) and is growing rapidly. Company Profile HBO creates and distributes movies and television shows. HBO s content has historically been distributed through traditional cable providers, but has recently seen a shift towards its streaming service, HBO Now. Valuation Discounted cash flow, comparable companies, and precedent transaction analysis on HBO yielded a valuation range of $28 - $32 bn. Potential Buyers We recommend a strategic buyer for HBO because of the synergy opportunities and premium price. Google and Disney are two optimal buyers for HBO because of their interest in content and/or the SVOD industry. HBO is a poor candidate for a financial buyer because of high investment required to create new shows. GoT Damages Methodology for valuing the lost cash flows resulting from illegal online downloads of the 6 th season of Game of Thrones 3

5 4 Company Profile

6 Industry Definitions Industry Terms: SVOD and OTT Subscription Video on Demand (SVOD): A service that provides users unlimited streaming for a monthly flat rate Over-the-Top (OTT) Content: Media delivery over the internet without the involvement of a multi-system operator in the control of distribution or content 5 Sources: IBIS World; WSJ.com; Apple.com; techopedia.com; Wikepedia

7 Streaming Timeline February 2007 Netflix launches streaming service February 2010: HBO Go Launched April 2015: HBO Now launched September 2006 Original Amazon Prime streaming service launched March 2008 Hulu launches streaming service February 2013 Netflix releases first original content series, House of Cards 6 Sources: IBIS World; WSJ.com; Apple.com; techopedia.com; Wikepedia

8 TWX Overview 7 Sources: insidermonkey.com; turner.com; logodesignlove.com; hdiimagelib.com; hdreport.com; Cinemaxasia.com; sharealogo.org; americanbankingnews.org

9 HBO Products Subscription: Purchase subscription through cable provider. Includes 13 multiplex channels, 7 24-hour multiplex channels, and an HBO Go Subscription Price to Consumer: $10 - $20 per month Programming: Game of Thrones, Curb your Enthusiasm, The Wire, other original TV series, and Blockbuster movies Subscription: Included free with your paid TV package Price: Free with HBO Programming: Unlimited access to HBO Devices: Computers, tablets, Xbox, Apple products, PlayStation, Roku Subscription: Purchased from an internet provider or on a smart phone; Over-the-top (OTT) Price: $15 per month Programming: Unlimited access to HBO Devices: Same as HBO Go Subscription: Purchased through cable provider. Online streaming service (Max Go) included. Price: ~$10 per month Programming: Action, comedy and science-fiction movies and series Devices: TV, Apple products, Android 8 Sources: Cinemax.com; HBO.com

10 Company Profile % of TWX Revenue Subscribers (mms) Company Overview HBO Subscribers CEO: Richard Plepler Headquarters: New York, NY Parent Company: Time Warner (TWX) HBO as % of TWX Revenue 21.50% 20.70% 19.70% 19.90% 19.50% 18.50% 18.50% 17.50% 2012A 2013A 2014A 2015A 2016p HBO Revenue * Domestic Subscribers International Subscribers *15.8 million subscribers for HBO India transferred to Turner operations Dec. 31 st, 2014, which are included in 2015 subscribers Award Winning Network HBO received 126 Emmy nominations in 2016 o Most primetime nominations by any network for the 15 th year in a row o Game of Thrones received 24 Emmy nominations 9 Sources: TWX K; HBO.com; tvweek.com

11 SWOT Analysis Strengths High-quality original content Extensive library of major motion pictures Large amount of brand recognition Ability to charge premium prices International presence Weaknesses High pricing can turn away customers Late to streaming content Success highly dependent on consumer preference Only HBO content on OTT (HBO Now) service Opportunities HBO Go and HBO Now can capture growing streaming market share Licensing deals with other players could generate additional revenue Cord-cutters could replace premium cable packages with HBO Now Threats Explosive growth and high competition within streaming services Other original content creators drawing viewership Relative ease of pirating content 10

12 11 Industry Overview

13 Industry Overview US Television Producers Industry Description: Industry produces programming and content that is then sold to cable providers. Key Players: 3 Arts Entertainment, Bad Robot, ABC Studios Major Deals AT&T to purchase Time Warner for $85.4 bn Comcast purchased 49% stake in NBCUniversal for $16.7 bn NBCUniversal purchased Dreamworks for $4.2 bn Charter communications purchased Time Warner Cable for $78.2 bn Lionsgate purchased Starz for $4.1 bn US Cable Networks Industry Description: Distributes TV programs through cable providers and other platforms. Industry excludes content creators. Key Players: Time Warner Inc., Walt Disney Companies, NBC Universal Media LLC Pre-Consolidation Content Producer Post-Consolidation Changes to Supply Chain Content Producer Content Provider Consumer Consumer 12 Sources: IBIS World; Global Media & Consumer: The Big Shift Series Bernstein (2015)

14 2003A 2004A 2005A 2006A 2007A 2008A 2009A 2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E US Dollars Millions of Connections Industry Drivers Cable vs. Broadband Subscriptions Disposable Income Cable Subscribers Broadband Connections Total Advertising Expenditure Increases in disposable income lead to higher demand for premium entertainment Customers with greater disposable income are more likely to add additional services Disposable income is projected to increase 4.3% year over year into 2024 US Per Capita Disposable Income Most cable networks generate a significant portion of their revenue from selling advertising time HBO is not dependent on advertisements to drive revenue Lack of advertising is a major driver behind customer preference for premium subscription or streaming services $50,000 $45,000 $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 13 Sources: IBIS World, Bureau of Labor Statistics, Broadband Commission for Digital Development

15 Industry Outlook Percent Penetration Revenue ($mm) US Pay-TV Penetration Moving Instigates People to cut Cable 90% 88% 86% 84% 82% 80% From survey of US Adults 87% 87% 87% 86% 84% 83% HBO Now Revenue Impact 21% of people who moved in the past year do not subscribe to a pay TV service, up from 12% in % of non-subscribers get a subscription video On-Demand (SVOD) service 41% of US Households had an SVOD by end of 2014 Projected Revenue in US SVOD Market Very little advantage of using HBO Now for consumers o Growth prospects aren t higher due to HBO Now o Protection against cable cutting 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, ,511 7,029 6,508 5,949 5, A 2017E 2018E 2019E 2020E 14 Sources: IBIS World; Pay TV Penetration Rates, marketingcharts.com; statista.com

16 Streaming Competitors Service Overview Popular Content Pricing Total Subscribers Video streaming platform offering current and past HBO content. Original series, blockbuster movies $14.99/month 1 million Video streaming platform available across multiple devices. Most entrenched player in the space. Original series, legacy TV content $9.99/month basic package 81.5 million Video streaming platform offering current-season TV, Hulu Originals, and movies. TWX currently owns a 10% stake in the company. South Park, Seinfeld, Saturday Night Live $7.99/month with ads - $11.99 without ads 12 million On demand video streaming available to Amazon customers with Prime subscription. New release movies, HBO licensing $99/year includes other services 54 million 15 Sources: Netflix.com; Hulu.com; Amazon.com; TWX 10K 2015; Netflix 10k 2015; Hulu Grows to 10 Million Subscribers techcruch.com; Amazon 10K 2015

17 16 Valuation

18 Financial Overview X Income Statement 2015A 1Q16A 2Q16A 3Q16A 4Q16P 2016P 2017P 2018P 2019P 2020P 2021P Subscription Revenue 4,748 1,236 1,253 1,262 1,259 5,010 5,311 5,576 5,799 5,973 6,153 Growth 3.7% 4.8% 6.1% 5.2% 6.0% 5.5% 6.0% 5.0% 4.0% 3.0% 3.0% Content and Other Revenue Growth 5.7% 23.3% (16.7%) (1.8%) 1.0% 0.8% 1.0% 1.0% 1.0% 1.0% 1.0% Gross Profit 2, ,985 3,221 3,461 3,585 3,683 3,783 % Margin 49.9% 48.0% 51.7% 51.6% 51.6% 50.7% 52.0% 53.5% 53.5% 53.5% 53.5% Depreciation and amortization (95) (22) (23) (21) (24) (90) (101) (97) (92) (86) (84) as % of Revenue 2.0% 1.8% 1.8% 1.7% 1.9% 1.8% 1.9% 1.7% 1.6% 1.4% 1.4% EBITDA 1, ,088 2,320 2,520 2,610 2,682 2,755 % Margin 41.2% 40.4% 40.2% 43.7% 49.4% 41.7% 43.7% 45.2% 45.0% 44.9% 44.8% Capex (68) (19) (74) (77) (81) (84) (86) (88) as % of Revenue (1.4%) (1.5%) (1.5%) (1.5%) (1.4%) (1.4%) (1.4%) (1.4%) Change in Working Capital (7) (29) (26) (22) (17) (18) % of change in revenue (9.7%) (9.7%) (9.8%) (9.8%) (9.9%) (9.9%) Pent up demand for OTT service boosts sales, then growth is expected to fade into 2019 as business is relatively mature Growth estimates are line with analyst estimates Gross margins increase slightly as customers transition to the slightly higher margin, HBO Now service. Revenues generated through cable subscribers are subject to discounts based on subscriber numbers or other performance metrics 17 Sources: TWX 10-k & 10-Q

19 Financial Overview X Income Statement 2015A 1Q16A 2Q16A 3Q16A 4Q16P 2016P 2017P 2018P 2019P 2020P 2021P Subscription Revenue 4,748 1,236 1,253 1,262 1,259 5,010 5,311 5,576 5,799 5,973 6,153 Growth 3.7% 4.8% 6.1% 5.2% 6.0% 5.5% 6.0% 5.0% 4.0% 3.0% 3.0% Content and Other Revenue Growth 5.7% 23.3% (16.7%) (1.8%) 1.0% 0.8% 1.0% 1.0% 1.0% 1.0% 1.0% Depreciation and amortization fall to meet capital spending. Previous years D&A was increased to account for unusually high acquisition costs Gross Profit 2, ,985 3,221 3,461 3,585 3,683 3,783 % Margin 49.9% 48.0% 51.7% 51.6% 51.6% 50.7% 52.0% 53.5% 53.5% 53.5% 53.5% Depreciation and amortization (95) (22) (23) (21) (24) (90) (101) (97) (92) (86) (84) as % of Revenue 2.0% 1.8% 1.8% 1.7% 1.9% 1.8% 1.9% 1.7% 1.6% 1.4% 1.4% EBITDA 1, ,088 2,320 2,520 2,610 2,682 2,755 % Margin 41.2% 40.4% 40.2% 43.7% 49.4% 41.7% 43.7% 45.2% 45.0% 44.9% 44.8% Capex (68) (19) (74) (77) (81) (84) (86) (88) as % of Revenue (1.4%) (1.5%) (1.5%) (1.5%) (1.4%) (1.4%) (1.4%) (1.4%) Change in Working Capital (7) (29) (26) (22) (17) (18) % of change in revenue (9.7%) (9.7%) (9.8%) (9.8%) (9.9%) (9.9%) Capital spending is in line with HBO s historical data Working capital was taken as a percent of revenue consistent with industry average 18 Sources: TWX 10-k & 10-Q

20 HBO Discounted Cash Flow Cash Flows all in $millions x WACC Calculation 4Q16P 2017P 2018P 2019P 2020P 2021P Discount period EBIT $628 $2,343 $2,552 $2,652 $2,733 $2,812 Tax (220) (820) (893) (928) (957) (984) EBIAT 408 1,523 1,659 1,724 1,777 1,828 D&A Changes in working capital (7) (29) (26) (22) (17) (18) Capital expenditures (19) (77) (81) (84) (86) (88) Free Cash Flow $407 $1,517 $1,649 $1,710 $1,759 $1,806 Present value of FCF 398 1,363 1,360 1,295 1,222 1,152 Perpetuity Growth Sum of PV of FCF 6,789.9 Terminal Value 29,953.2 PV of terminal value 19,103.5 Implied Enterprise Value 25,893.3 Implied exit multiple 10.87x Perpetuity Growth Sensitivity Valuation Range: $24,166 - $27,901 mm LT Growth Rate: $25, % 2.50% 2.75% 3.00% 3.25% 8.44% 26,359 27,228 28,173 29,205 30, % 25,332 26,125 26,985 27,921 28,942 WACC: 8.94% 24,381 25,108 25,893 26,745 27, % 23,498 24,166 24,886 25,664 26, % 22,677 23,293 23,954 24,668 25,438 Market Rate 9.50% Risk Free Rate 4.00% Beta 1.3 Cost of Equity 11.04% Credit Spread 1.81% Pretax Cost of Debt 5.81% Tax Rate 35.00% Cost of Debt 3.78% Debt/Equity 40.5% Weight of Debt 28.85% Weight of Equity 71.15% WACC 8.94% LT Growth Rate 2.75% Risk free rate is the normalized 20yr US Treasury yield Weights of debt and equity taken from median industry capital structures Market rate is base US Equity cost of capital used by Duff & Phelps 19 Sources: TWX 10-k & 10-Q; Duff & Phelps Equity Risk Premium Client Alert, March 2016

21 HBO Comparable Company Analysis Final Comps # Company Enterprise NTM EBITDA 3 Yr Sales Name Value ($mm) EV/EBITDA Margin Growth Est. HBO % 15.2% The Walt Disney Company 171, x 26.3% 15.7% CBS Corporation 33, x 21.5% 6.2% Netflix, Inc. 53, x 3.5% 99.1% Starz 4, x 21.6% 9.5% Twenty-First Century Fox, Inc. 66, x 22.2% 6.6% Discovery Communications, Inc. 23, x 32.6% 14.5% Lions Gate Entertainment Corp. 4, x (1.8%) 83.2%* Comcast Corporation 210, x 21.1% 19.2% Time Warner** 83, x 27.9% 15.0% NTM Expected Multiple Range EV/EBITDA High 12.0x Low 9.5x Expected Valuation Range Implied EV High $26,469 Low $20,913 High 210, x 32.6% 99.1% Median 43, x 21.6% 15.1% Mean 70, x 18.4% 31.8% Low 4, x (1.8%) 6.2% *Lions Gate growth includes the acquisition of Starz **Time Warner statistics as of Sept 2016 (before acquisition announcement) 20 Sources: Capital IQ

22 HBO Precedent Transaction Analysis X Transactions Implied EBITDA LTM Announce Date Target Buyers/Investors Percent Sought Consideration EV ($mm) Margin EV/EBITDA 4/28/16 DreamWorks Animation SKG Inc. NBCUniversal Media, LLC % Cash 4, % 34.3x 5/26/15 Time Warner Cable Inc. Charter Communications % Cash; Equity 78, % 9.8x 6/30/16 Starz Lions Gate Entertainment Corp 95.37% Cash; Equity 4, % 11.3x 2/12/13 NBCUniversal Media, LLC Comcast Corporation 49.00% Cash; Equity 39, % 9.3x 10/22/16 Time Warner Inc. AT&T, Inc % Cash; Equity 107, % 12.6x High 107, % 34.3x Mean 46, % 15.5x Median 39, % 11.3x Low 4, % 9.3x Expected Multiple Range EV/EBITDA High 15.0x Low 12.5x Expected Valuation Range ($mm) Implied EV High 33,086 Low 27,571 Valuation Range: $27,571 - $33,086 mm 21 Sources: Capital IQ

23 Valuation Football Field Enterprise Value ($mm) $35,000 Valuation Ranges $33,000 $33,086 $31,000 $29,000 $27,921 $27,000 $25,000 $26,469 $27,571 Suggested Valuation Range: $28,000 - $32,000 mm $23,000 $24,166 $21,000 $20,913 $19,000 $17,000 $15,000 DCF - Perpituity Growth Comparable Companies Precedent Transactions 22

24 23 Potential Buyers

25 Financial Buyers Definition Financial Buyer: Investors interested in return they can get from buying a business o Known as a private equity (PE) firm Leveraged Buyout (LBO) Methodology for the acquisition of a company using debt to finance a large portion of the purchase price Purchase Price PE firms often pay less than strategic buyers because they don t realize synergies Small equity stake from PE fund, remainder funded by leverage Exit Strategies Sale of business: Sell company to strategic buyer or another financial buyer o Strategic buyers often pay a higher price for synergies Initial Public Offering (IPO): Sells a portion of shares through equity offering o Partial monetization of investment initially, creating a liquid market for investment 24 Sources: Investment Banking by Rosenbaum and Pearl; Deal Book; TWX 10k

26 Strong LBO Candidate Characteristics Characteristic Analysis HBO Strong Cash Flow Generation Ability to pay down debt and make interest payments Growth Opportunities Creates EBITDA multiple expansion and increase Enterprise Value Low NWC and Capex Requirements Enhances a company s cash flow generation Strong Asset Base Pledged as collateral against a loan and dictates debt available for LBO Proven Management Team Necessary to operate leveraged company Leading and Defensible Market Position Predicts strong cash flow generation Strong brand recognition and stable customer demand resulting in consistent monthly payments Saturated market with strong competition Programming costs ~50% of revenues Illiquid intangible assets, rights to media content Lavish corporate culture will conflict with cost saving efforts of a financial buyer 49 million domestic subscribers with award winning content Game of Thrones and True Detective 25 Sources: Investment Banking by Rosenbaum and Pearl; Deal Book; TWX 10k

27 Strategic Buyers Strategy Strategic Buyer: Buyer that looks for synergies between its existing business and target company Stock Purchase Use an exchange ratio to trade buyer shares for seller shares Exchange Ratio = Shares issued by acquiring company Acquired company shares More expensive to buyer o Lack of interest payments provides more financial flexibility for issuer Often used in a merger of equals transaction Premium Maximum Premium: present value of synergies Higher premiums than financial buyers cause strategic buyers to pay more for acquisitions Types of Synergies: Cost Tax Revenue Financial Cash Purchase Use cash or issue debt to buy company o Debt financing options: revolving credit, term loan, bond, note, commercial paper Cheapest purchase consideration from tax benefits Preferred by buyer because of the concrete purchase price vs. stock purchase 26 Sources: Investment Banking by Rosenbaum and Pearl; Deal Book; TWX 10k

28 Types of Synergies Operating Synergies Definition: Allows firms to increase operating income, revenue growth, or both Sources of Operating Synergies Economies of scale Combined firm more cost-efficient and profitable Greater pricing power Stems from reduced competition and higher market share HBO Application Merger with content creator creates cost synergies from production costs HBO merges with an OTT service, increasing market share and power in SVOD Combination of different functional strengths Marketing skills, good product line, efficient supply chain The acquiring company has a more efficient supply chain with DVD sales and distribution Higher growth in new or existing markets Occurs when a company acquires a firm in a different market An international content creator buys HBO, giving the company a stronger presence internationally 27 Sources: NYU.edu

29 Types of Synergies Financial Synergies Definition: Synergies that create higher cash flows or lower costs of capital Sources of Financial Synergies Tax benefits Use of acquisition tax laws or using net operating losses to shelter income of buyer Increase in debt capacity Stability of combined company cash flows allows for more debt, and thus tax benefits HBO Application HBO is acquired by a European company with a lower corporate tax rate Merger of equals creates higher debt capacity for both companies Combination of a firm with excess cash and a firm with project opportunities Projects can be funded from firm with excess cash and create value Company with a big balance sheet has funds to develop HBO Now 28 Sources: NYU.edu

30 Strategic Buyer Characteristics Pre-Disposition for Acquisitions Companies tend to use same strategy for new business ventures o Mergers and acquisitions o Research and development Strategy Compatibility Interest in entering the SVOD and OTT market Media or technology company with similar corporate culture Content creation Capability for Large Acquisition Little long-term debt and/or large cash balance preferred o Can raise cash through equity offering or debt issuance Necessary because stockholders prefer cash over stock for consideration Synergies More synergies equate to a higher premium Acquirer characteristics for maximum synergies with HBO: o Global presence to expand HBO internationally o Competency in the media, content, or streaming business o Cash to invest in HBO Now 29 Sources: IBIS World; Investment Banking by Joseph Perella and Joshua Harris

31 Recommendation 1. Synergy Opportunities Sale to Strategic Buyer HBO s content creation platform is attractive to many potential strategic acquirers o Synergy opportunities exist with both content creators and content distributors o Economies of scale would reduce supply chain and/or production costs 2. Strategic Buyer Premium Strategic buyers have historically paid a premium for potential synergies o Greater premiums help the board to best maximize shareholder value 3. Poor LBO Candidate High cost of producing new shows reduces cash flow available for debt repayment o New content creation is a key driver of HBO s success Small tangible asset base o Limits ability for financial sponsor to add additional leverage 30

32 Google Profile Company Overview CEO: Sundar Pichai Headquarters: Mountain View, CA Year Founded: 1998 Prior Acquisitions Google occasionally acquires multi-billion dollar companies to enter new industries o o o $1.7 bn YouTube acquisition in 2006 Online Video $12.5 bn Motorola acquisition in 2011 Smartphone $3.2 bn Nest Labs acquisition in 2014 Home automation Revenue Key Financials Video Services Entry $85,537 mm EBITDA Margin 33.1% EV/EBITDA 16.6x Net Debt Enterprise Value -$79,188 mm $453,075 mm YouTube Red is a subscription based premium YouTube Google is creating a new live skinny bundle TV streaming service off of its YouTube platform o o CBS recently signed to distribute content 21 st Century Fox, NBC, and Disney also in talks with Google 31 Sources: Alphabet 10k, google.com; wsj.com; Capital IQ

33 Google Synergies with HBO Interest in Entering SVOD and OTT Space Google has shown interest in SVOD and OTT through new TV-streaming service, Unplugged o Service will be a skinny bundle of TV channels, ranging from $25-$40 o CBS reached agreement with Google o 21 st Century Fox, NBCUniversal, and Walt Disney Co. also in talks with Google HBO can give Google an edge in the new skinny bundle space o HBO content on Unplugged can create a premium service at a premium price Both Companies have a Large International Presence 46% of Google revenues and 37% of HBO subscribers are domestic Similar geographic presence will create an ease in HBO strategy integration to Google International markets are a source of SVOD subscriber growth 32 Sources: Google 10k; Google Signs up CBS for Planned Web TV Service wsj.com; Capital IQ

34 Disney Profile CEO: Bob Iger Company Overview Headquarters: Burbank, CA Year Founded: 1923 Recent Activity Disney took a large stake in Hulu in order to gain access to streaming market The company has made large acquisitions to increase its content portfolio o $4.1 bn Lucasfilms acquisition in 2012 o $3.9 bn Marvel Studios acquisition in 2009 Key Financials (as of LTM July 2 nd, 2016) Revenue $56,002 mm EBITDA Margin 30.63% EV/EBITDA 9.3x Net Debt $15,214 mm Enterprise Value $170,845 mm Brands 33 Sources: Capital IQ, Disney 10K FY2015; thewaltdisneycompany.com

35 Disney Synergies with HBO Disney Fully Monetizes its Customers 40% of Disney s FY2015 revenue was from consumer products, parks and resorts Disney can use popular HBO content to generate additional revenue o Game of Thrones themed rollercoaster at theme parks Creates competitive edge against Universal Studios for older generations o Memorabilia from content sold in Disney stores Costumes, toys, posters, DVDs Increased margin on content sold through Disney store Synergies Available with Disney and HBO Strength in Content Creation HBO s strength in the adult space and Disney s strength with children can help each content creator enter a different age bracket Disney content can be added to HBO Family channel and HBO Now o More valuable subscription to families since quality content is available for all age groups 34 Sources: Disney 10k; Capital IQ

36 35 Game of Thrones Damages

37 Background/Task Background Game of Thrones is one of the most popular TV shows on the air o 23 million people viewed the 6 th season finale BitTorrent made pirated copies of the 6 th season available for download within hours of broadcast o Over 2 million people illegally downloaded the season Traditional Cost of Game of Thrones Watch live over 4 month release period on HBO $15 x 4 months = $60 Purchase season on DVD $35 Purchase Episodes over Amazon Prime or itunes $3.99 x 10 = $39.99 Task Create a methodology to estimate the lost cash flows to HBO from the 2 million illegal downloads of season 6 Game of Thrones Broad Methodology 1. Estimate Lost Revenues Would the downloaders buy the season? How would they buy? Could piracy drive future sales? 2. Project effect on profits What are the marginal costs associated with revenues? 36 Sources: HBO.com

38 Methodology Estimating Lost Revenues Estimate the percent of downloaders that would have bought the season had the season not been pirated Estimate the method of purchase for the lost buyers o Find the breakdown of HBO subscribers vs. physical units sold o Estimate the average length of an HBO subscription Value new subscribers added o Illegal downloaders may want to watch more HBO content after seeing Game of Thrones o Illegal downloads could add subscribers Example Assume 40% of downloaders would make a purchase had the free version not been available o 2,000,000 2,000,000 x 40% x 40% = 800K = 800K lost lost unit unit sales sales The 15% of sales are physical copies while 85% are HBO subscriptions o 800K 800K x 15% x 15% = 120K = 120K physical physical units units o 800K 800k x 85% x 85% = 680K = 680K subscriptions subscriptions On average, season 6 sells for $40 o 120K x $ 40 = $4.8M lost revenue 120K x $40 = $4.8M lost revenue The average length of an HBO subscription is 4 months at $15 680K x 4 months x $15 = $40.8M lost revenue 5% of downloaders will create HBO subscriptions 2M x 5% x 4 months x $15 = $6M gained revenue 37

39 Methodology Estimating Margins Physical Sales o Determine the margins on permanent content purchase i.e. physical content (disks) or online marketplace purchase (itunes etc) HBO Subscriptions o Estimate any marginal costs for new subscribers o Include lost gains from subscribers added Corporate Tax Rate o Assumed 35% Example Physical Sales o Assume a gross margin of 30% $4.8M x 30% = $144,000 lost pretax income HBO Subscriptions o Assume a marginal cost of 1% $40.8M - $6M = $34.8 Net lost revenue $34.8M x (1-1%) = $34,452,000 lost pretax income Tax rate is assumed to be 35% $34,596,000 x (1-35%) = $22,487,000 Damages Total Damages = $22,487,000 38

40 Summary 1. HBO is a poor LBO candidate 2. We suggest a sale to a strategic buyer for $28 - $32 bn Summary 3. Google and Disney are recommended potential buyers 39

41 40 Q & A