Duff & Phelps YOUniversity Deal Challenge

YOUniversity Deal ChallengeValuation of Home Box Office (HBO)

November 11 2016

Prepared for

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Time Warner Engagement Team

Zachary SpencerJunior

• Auburn University• Finance• Spring 2018

Bailey SullivanSophomore

• Auburn University• Industrial Engineering• Spring 2019

Jordan CarrJunior

• Auburn University• Mechanical Engineering• Spring 2018

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Time Warner Engagement Team Cont.

David AldermanSenior

• Auburn University• Mechanical Engineering• Spring 2017

Jason McKinleySenior

• Auburn University• Information Systems • Spring 2017

Daniel Robinson 1st Year MBA

• Auburn University• Finance • Spring 2017

4

Section Topic Page

I. Industry Overview 4

II. Executive Summary 12

III. Deliverable 1: Fair Market Value Analysis 14

IV. Deliverable 2: Buyer Types & Recommendations 20

V. Deliverable 3: Damages Methodology and Valuation 29

Appendix A Financial Information 37

Appendix B Financial Forecasts 39

Appendix C Damages Calculation and Select Data 43

Table of Contents

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Industry OverviewSection 1

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• Entertainment businesses are characterized by one of two activities:

– Content Creation

– Distribution

• Content creation requires substantial upfront investment and often utilizes a deficit financing model

• Distributors generate revenues from various kinds of distribution arrangements:

– Sale or rental of their content to consumers

– Advertising sales

– Subscription service sales.

• The recent convergence of media platforms is providing both challenges and opportunities to market participants.

– For example, content creation control has begun from businesses to the hands of consumers. (User generated content is making up an increasing portion of the content provided on the Internet)

– New forms of distribution, (e.g. mobile, digital download, etc.) have resulted in opportunities (i.e. Netflix, YouTube, Facebook) and threats (Cord Cutters, publishing industry, music labels, etc.) for the industry players.

Entertainment & Media Platforms

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Television Industry Overview

• The television industry is comprised of companies (both fee-based and free) that produce and distribute entertainment content.

• Traditionally, Broadcasters have relied on local TV stations that transmit TV signals over the air through their FCC licenses.

• Cable Networks, on the other hand, rely on the multiple-system operators (“MSOs”) and telco companies (e.g., AT&T) for distribution to American households.

• Pay-TV is a subset of the Cable Networks segment of the Television Industry, where consumers can access content by paying MSOs a fee for a specific channel (HBO).

• Subscription Video on Demand (SVOD) services use a subscription business model, where subscribers are charged a monthly fee to access unlimited instant streaming to a program library. HBO NOW began in 2015 and is provided to subscribers via SVOD.

Content

Distribution

Consumers

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Global Entertainment & Media Industry Structure

Global Entertainment & Media Industry

Television

Content

Major StudiosIndependent Production Companies

Distribution

Broadcasters

Terrestrial Television

Owned &

Ooperated

CBS,

FoxNBC, ABC

IndependentSinclairHearstMedia GeneralGannett

Over-the-Top

Cable Networks

Over-the-Top

NetflixHulu

WWE NetworkUFC Fight Pass

HBO NOWSling TV

PlayStation Vue

Multiple-

System

Operators (MSO

s)

Wired Cable

Alternate Del ivery Systems

Movie Studio

The following illustrates the landscape of the television industry using 21st Century Fox (Fox) as an example:

• Cable Networks Fox produces and licenses programming for distribution primarily through cable television ➦systems, direct broadcast satellite operators, telecommunications companies and online video distributors.

• Broadcast Television Fox operates two main segments:➦ Fox Broadcasting Company – Fox has 207 FOX affiliates, including

17 stations owned and operated by the Company, which reach approximately 99% of all U.S. television households.

Fox Television Stations – owns and operates 28 full powerstations. 17 stations are FOX affiliates.10 stations are MyNetworkTV stations. 1 station is independent.

• Over-the-Top (OTT) The Company has an ➦approximate 33% equity interest in Hulu which operates an online video service that offers video content from Fox, the other one-third partners in Hulu, NBCUniversal and The Walt Disney Company, as well as over 400 other third party content licensors.

• Pay-TV (Premium Cable) Currently, Century Fox ➦ does note operate a Premium Cable Channel.

Pay-TV (Premium Cable)

Cable Network

s

Over-the-Top (OTT)

Broadcast

Television

Television Landscape: 21st Century Fox Example

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• Subscriber-based business; No advertising

– Direct selling to customers

– Partnership with cable operators

• Premium Content

• Pay-per-view sports content

• Video on Demand

• General strategy: Releasing theatrical titles on TV andproducing and airing original content (films, TV series)

• Reliance on film studios and producers for quality products

• Providing a specific program that appeals to each segment of the population

– Creating original content (e.g. The Sopranos, Sex and the City, Game of Thrones)

Pay-TV Industry Overview

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Pay-TV Providers• Netflix has been targeting the premium network window

for several years and has secured Relativity Media film rights, renewed its deal with DreamWorks Animation in 2016, and secured Walt Disney Co. film rights beginning with those released in 2016.

• Netflix paid $30.0 million in 2008 to gain the rights to stream Starz films. The deal expired in 2012.

• HBO / Cinemax extended its deal with Universal Studios and Fox until 2021 and 2022, respectively.

• Epix, a joint venture of Viacom (Paramount Pictures), Metro-Goldwyn-Myer and Lions Gate Entertainment, was launched in 2009 as a premium cable network and a subscription video on demand service.

• Original programming may receive much of the press, but theatrical films remain a significant content source for premium networks.

• On June 30, 2016, Lions Gate Entertainment Corp. (NYSE:LGF) agreed to acquire Starz Inc. (NASDAQ:STRZA) for $4.4 billion in cash and stock.

Executive SummarySection 2

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Executive Summary

• The Entertainment and media industry continues to change as consumer demand increases for smart–connected–device and internet media distribution platforms.

• These changes have led to increased M&A activity across the industry as larger firms adapt to industry restructuring.

• Home Box Office (HBO) has significant concerns over online piracy of their most–watched show, Game of Thrones, via the software titled Bit Torrent.

• Increase in subscribers due to new distribution platform HBO NOW. The addition of HBO NOW has led to increase in growth and potential of future increase in subscriber revenue.

• The FMV of HBO is determined to be $29.95 billion based on a weighted average of discounted cash flows, trading comparables, and precedent transactions valuations.

• Amazon is willing to pay the highest premium for HBO as they will be able to extract the greatest value through Amazon Video and are financially capable.

• Lawsuit against Bit Torrent for piracy of Game of Thrones should not be pursued because increase in demand is greater than cost incurred from the illegal download of 2 million copies.

Situation Overview

Valuation and Potential Buyers

Recommendations

• HBO content and platforms has steered HBO as a high potential target for strategic buyers looking for new content and to enter Over–the–Top (OTT) distribution platform.

• Amazon and Apple are able to integrate HBO content and platforms into Amazon’s OTT platform Amazon Video to boost OTT market share.

Deliverable 1:Fair Market Value Analysis1

Section 3

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1. Financial Data sourced from Bloomberg Terminal (licensed) on 11/06/2016.

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Discounted Cash Flow$mm, except per share figures

* See Financial Projections for Net Working Capital (#11); * See Appendix A for WACC

Enterprise ValuePerpetuity Growth Rate

$36,764 1.5% 2.0% 2.5% 3.0% 3.5%10.0% $28,813 $30,230 $31,836 $33,672 $35,7909.5% $30,632 $32,262 $34,124 $36,273 $38,7809.0% $32,695 $34,584 $36,764 $39,307 $42,3138.5% $35,053 $37,265 $39,845 $42,894 $46,5548.0% $37,775 $40,393 $43,486 $47,200 $51,738

WA

CC

Enterprise Value (Perpetuity)Normalized FCF in last forecast period (t) 2,595.3Normalized FCFt+1

2,660.2

Long term growth rate (g) 2.50%Terminal value 40,945.8Present value of terminal value 28,685.8Present value of stage 1 cash flows 8,078.3

Enterprise value 36,764.1Implied TV exit EBITDA multiple 14.00x

2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020EIncome StatementTotal Revenues 4,686.0 4,890.0 5,398.0 5,615.0 6,015.5 6,413.9 6,782.7 7,112.9 7,397.4 % growth 4.35% 10.39% 4.02% 7.13% 6.62% 5.75% 4.87% 4.00%Total Cost of Revenues 2,400.0 2,368.0 2,708.0 2,811.0 3,007.7 3,207.0 3,391.3 3,556.5 3,698.7Gross Profit 2,286.0 2,522.0 2,690.0 2,804.0 3,007.7 3,207.0 3,391.3 3,556.5 3,698.7 % margin 48.78% 51.57% 49.83% 49.94% 50.00% 50.00% 50.00% 50.00% 50.00%Total Operating Expenses 647.0 631.0 813.0 831.0 872.2 930.0 983.5 1,031.4 1,072.6EBITDA 1,639.0 1,891.0 1,877.0 1,973.0 2,135.5 2,276.9 2,407.8 2,525.1 2,626.1 % margin 34.98% 38.67% 34.77% 35.14% 35.50% 35.50% 35.50% 35.50% 35.50%Depreciation & Amortization 92.0 100.0 91.0 95.0 102.3 105.2 107.2 103.8 103.6EBIT 1,547.0 1,791.0 1,786.0 1,878.0 2,033.2 2,171.8 2,300.7 2,421.2 2,522.5 % margin 33.01% 36.63% 33.09% 33.45% 33.80% 33.86% 33.92% 34.04% 34.10%Tax Rate 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0%EBIAT (NOPAT) 1,546.7 1,790.7 1,785.7 1,877.7 2,032.9 2,171.5 2,300.4 2,420.9 2,522.2

Depreciation and amortization 92.0 100.0 91.0 95.0 102.3 105.2 107.2 103.8 103.6Change in Net Working Captial 82.1 81.7 75.6 67.7 58.3Capital Expenditures (72.2) (77.0) (81.4) (85.4) (88.8)

Unlevered FCF 1,638.7 1,890.7 1,876.7 1,972.7 2,145.1 2,281.3 2,401.7 2,507.1 2,595.3

Discount factor 13.1% 113.1% 213.1% 313.1% 413.1%Present value of FCF 276.9 2,069.6 1,999.0 1,914.5 1,818.2

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Trading Comps

• Trading comparables is a valuation model that incorporates the trading value of publicly traded companies that are similar to the company in question.

• Each company listed is included because these companies are the best publicly traded companies to represent the value of HBO as a standalone company.

• Median of LTM EV/EBITDA is determined as best multiple to represent HBO value as mean was skewed by Netflix.

Comments

$mm, except per share figures

Current Share Equity Enterprise LTM LTM LTM EBITDA Enterprise Value /Company Ticker Price Value Value Sales EBITDA Margin LTM Sales LTM EBITDA

Time Warner Inc. TWX 86.42$ 69,063.3 91,226.3 28,506.0 7,256.0 25.45% 3.20x 12.57xTwenty -First Century Fox FOXA 26.94$ 50,135.3 66,743.3 27,755.0 6,749.0 24.32% 2.40x 9.89xViacom VIAB 36.56$ 14,496.0 26,932.0 13,050.0 3,528.0 27.03% 2.06x 7.63xDiscovery Communications DISCA 25.64$ 15,812.1 23,831.1 6,471.0 2,131.0 32.93% 3.68x 11.18xWalt Disney DIS 92.45$ 150,217.6 169,384.6 56,002.0 17,868.0 31.91% 3.02x 9.48xCBS Coporation CBS 57.01$ 25,357.2 34,135.2 14,442.0 2,954.0 20.45% 2.36x 11.56xNetfilx NFLX 115.02$ 51,067.0 52,097.7 8,176.5 391.8 4.79% 6.37x 132.97x

Mean 53,735.5 66,335.7 22,057.5 5,839.7 23.84% 3.3 27.9Median 50,135.3 52,097.7 14,442.0 3,528.0 25.45% 3.0 11.2

HBO Implied Enterprise Value

LTM Sales

LTM EBITDA

LTM Sales

LTM EBITDA

5,752.0 1,964.0 17,397.6 19,709.3

Implied Valuation of Home Box Office

As of 6/30/16 Multiple Range Implied EVEBITDA 1,964 8.89x - 11.89x 17,458.7 - 23,350.7

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Precedent Transactions

• Precedent Transaction approach is a valuation model that incorporates the transaction value of deals where the target is a comparable company. Precedent Transaction is an included model as it incorporates an acquisition premium to the value of the company in question.

• Each transaction listed is included because these transaction have targets very comparable to HBO as a standalone company which will best represent HBO’s value.

• Median of LTM EV/EBITDA determined as best multiple to represent HBO value

Comments


Announcement Transaction LTM LTM EBITDA TV/LTM TV/LTM TWC Inc Acquirer date Form of consideration value

Sales EBITDA % Margin Sales EBITDA

Direct TV AT&T 5/18/2014 Partial Cash/Stock 66,668.8 31,479.0 8,287.0 26.3% 2.12x 8.04xTWC Inc Charter Communications 5/26/2015 Partial Cash/Stock 79,249.8 22,617.0 8,244.0 36.5% 3.50x 9.61xMarvel Walt Disney 8/31/2009 Partial Cash/Stock 3,834.3 632.4 322.9 51.1% 6.06x 11.87xStarz Lions Gate Entertainment 6/30/2016 Partial Cash/Stock 4,137.0 1,734.0 395.6 22.8% 2.39x 10.46x

Mean 3.52x 10.00xMedian 2.94x 10.04x

HBO Implied Enterprise Value

LTM Sales

LTM EBITDA

TV/LTM Sales

LTM EBITDA

5,752.0 1,964.0 16,939.1 19,709.3

Implied Valuation of Home Box Office

LTM as of 6/30/16

Multiple Range Implied EV

EBITDA 1,964 9.04x - 12.04x 17,745.3 - 23,637.3

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Financial Statement Analysis$mm, except per share figures

Working Capital Forecast

Net Working Capital 1151.0 1233.1 1314.8 1390.4 1458.1 1516.4

WC/Revenue 20.50% 20.50% 20.50% 20.50% 20.50% 20.50%

Change in Net Working Capital 82.1 81.7 75.6 67.7 58.3

Subscription Forecast Assumptions HBO NOW Launch date 4/7/2015Latest Fisical Year End Date 12/31/2015Year Fraction from Lauch to FY 2015 73.33%Launch to FY 2015 New Subscribers 2.70 Launch to FY 2015 growth rate 5.83%Annualized growth rate 7.95%

Assumptions

OTT Impact• Number of subscribers in 2015 and subscriber growth from

launch of HBO NOW to fiscal year end of 2015 is 49 million and 2.7 million, respectively. (Found in TWX 2015 10K)

• Subscriber growth annualized from fraction of year from launch to fiscal year end

• Subscription revenue grown by subscribers times revenue per subscriber held at $97/subscriber

Other• Net working capital is held at Industry Average and grown as a

percent of revenue.

Comments

2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020ERevenue ForecastRevenues

Subscription 4,010.0 4,231.0 4,578.0 4,748.0 5,109.5 5,467.1 5,795.2 6,084.9 6,328.3Content and Other 676.0 659.0 820.0 867.0 906.0 946.8 987.5 1,028.0 1,069.1

Total Revenues 4,686.0 4,890.0 5,398.0 5,615.0 6,015.5 6,413.9 6,782.7 7,112.9 7,397.4

Rev/Sub 100.9 96.9 97.0 97.0 97.0 97.0 97.0

Subscribers 45.4 49.0 52.7 56.4 59.7 62.7 65.2Growth % 7.95% 7.50% 7.00% 6.00% 5.00% 4.00%

Content and other 676.0 659.0 820.0 867.0 906.0 946.8 987.5 1,028.0 1,069.1Growth % (2.51%) 24.43% 5.73% 4.50% 4.50% 4.30% 4.10% 4.00%

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Fair Market Value Calculation

Valuation Model Weight

Discounted Cash Flow 60.0%

Trading Comparables 20.0%

Precedent Transaction 20.0%

Fair Market Value

Implied Exit EBITDA Multiple 11.4x

Enterprise Value

36,764.1

19,736.8

19,709.3

29,947.7

Weighted Enterprise Value

22,058.4

3,947.4

3,941.9

• HBO’s FMV was determined to be 29.95 billion with an implied exit EBITDA multiple of 11.4x• FMV was determined using a weighted average of each valuation model’s base case.• The DCF was weighted at a higher percentage because of the ability to incorporate the impact of

their OTT business, HBO NOW.• Implied Exit EBITDA multiple is for year 2020 and seems reasonable for a very successful

company looking to expand into OTT market.

Comments


Deliverable 2:Buyer Type & Recommendations

Section 4

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Buyer Types

• Value Criteria: Vertical/horizontal expansion to enhance existing operations

• Typically a company in a parallel or equivalent industry. Pursues targets that add value to existing segments and provide competitive advantages

• Willing to pay higher premiums due to future synergies and assumed added value

• Vertical and/or horizontal expansion and/or strengthening weaker areas of existing operations

• Value Criteria: Expected Future Earnings• Typically a Private Equity Firm, Venture Capital Firm or Hedge Fund• Pursues targets with robust earnings growth capacity, strong cash flow

levels and profitable exit opportunities• Evaluates targets as stand-alone entities instead of integrating into existing

business operations• Uses higher leverage ratios to finance acquisition; this increases IRR by

reducing equity exposure

Strategic

Financial


Buyer Type Comparison

Type of Buyer Synergies Leverage Premium Time

HorizonExit

Opportunities

Strategic

• Integrate HBO into existing content productions

• High value brand with very popular content– increase value of existing content operations

• Combination of equity and debt financing

• Larger funding resources (access to equity, etc.)

• Value enhancement of existing operations

• Elimination of competitor/leverage over current competitor

• High Market Share

• Long term(10+ years)

• Keep HBO as subsidiary while growing profitability

• Sell for higher

premium

Financial

• Excellent and innovative management team

• Existing contracts with leading media providers (Amazon, Apple, etc.)

• High use of leverage to increase ROE

• Utilize normal cash flows to pay off debt and build equity

• Valued brand with popular content

• 4-7 years before selling

• Sell HBO for premium by continuing to develop content offerings

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Strategic Buyer

Pros• Complements and enhances existing

media offerings• Higher premium due to estimated

synergies• Advantage over industry competitors• Large existing customer base to

increase HBO subscriptions

Cons• Consolidation of management team• Loss of talent due to merger /

acquisition fears from employees • Potential loss in brand value

Why Strategic?

• Technological and financial resources for the expansion of HBO offerings• Existing content infrastructure that HBO will enhance to formulate competitive industry

presence • Higher premium paid for value of HBO brand and operations• Understanding of industry operations and growth structure• Increased HBO subscription levels through existing customer database of acquirer• Innovative environment for sustainable development


Potential Strategic Buyers


Buyer Analysis – Overview

In comparison to other companies in the buyer universe, Apple and Amazon are the leading choices.

Amazon.com, Inc. (NASDAQ: AMZN)

Headquartered: Seattle, WAFounded: 1994Employees: 230,800Business: Online retailer with an extensive product network and service capabilities including online shopping and direct shipping. Financial DataMarket Cap $349,675P/E 168.19EV/EBITDA 30.13x

Apple, Inc. (NASDAQ: AAPL)

Headquartered: Cupertino, CAFounded: 1976Employees: 116,000Business: Designs and manufactures personal computing and mobile communication devices in addition to software and online content.

Financial DataMarket Cap $577,062P/E 13.17EV/EBITDA: 6.05x

• Diverse network of products and services, including Amazon Prime

• Expanding content offerings through Amazon Studios • Stable and extensive customer network• No previous acquisition of cable network

• Seeking to expand into content space based on guidance from executives

• Large cash position – ability to finance acquisition • Looking for catalyst to offset declining iPhone sales • No previous acquisition of cable network


Amazon

• Both service a diverse range of customers

• Expand on existing HBO contract that offers limited programing

• Improve Amazon’s content service, Amazon Studios, through HBO offerings

• Strong projected free cash flow

• Low leverage and high coverage

• High cash balance

• Increased online consumer traffic and Prime subscriptions driven by HBO’s content

• Acquire innovative HBO management team

• Prime members enjoy HBO’s popular content library without a fee increase

“…we want things that customers will love, can grow to be large, will have strong financial returns and durable and can last for decades…We have pillars of the business right now with Marketplace, AWS and Prime and we're actively looking for a fourth and fifth pillar.” (Brian Olsavsky, Amazon CFO, Q3 Earnings Call)

Strategic Alignment Financing Ability Value Enhancement

• HBO could be bundled into the existing $99/year Prime membership plan. Non-Prime members and/or current HBO subscribers would have the option of an HBO only subscription for the current monthly price of $14.99.

• The “Prime + HBO” bundle improves the experience of Prime members while also recruiting new members from the HBO viewer base.

Conclusion


Apple

• Expands current partnership created through HBO Now

• Innovative company structure to foster HBO’s growth

• Provides HBO with exposure to massive customer network

• Strong cash balance • Low cost of debt• High level of free cash flow

• Reverse mediocre performance of past content servicing

• Jumpstart company sales after period of declining iPhone sales

• Enhance the experience of Apple TV users through fresh content offerings

“I would confirm that television has intense interest with me and many other people here. In terms of owning content and creating content, we have started with focusing on some original content, as you point out… We've got a few things going there that we've talked about. And I think it's a great opportunity for us both from a creation point of view and an ownership point of view. and so it's is an area that we're focused on…we’re always looking in the market about things that could complement things that we do today, become features in something we do, or allow us to accelerate entry into a category that we’re excited about…” (Tim Cook, Apple CEO, Q3 Earnings Call)

Strategic Alignment Financing Ability Value Enhancement

Conclusion

• Apple needs a growth catalyst to jumpstart company sales following several periods of mediocre growth. HBO is an innovative content provider that fits within Apple’s business model and grants ownership rights to valuable media content.

• HBO would strengthen Apple’s competitive position as a content provider through its reputable brand and popular media offerings.


Final Recommendation

• Amazon is the strongest candidate within the strategic buyer universe for the following reasons:– High level of value enhancement through integration within the Prime membership

package– HBO drives news customers to Amazon’s platforms. – Strategic alignment and financing capabilities to complete the acquisition

Deliverable 3:Damages Methodology and Valuation

Section 5

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Piracy Industry Overview

• Estimates suggest that piracy costs the film industry approximately $20 billion per year.

• Bit Torrent is a popular peer-to-peer file sharing website that is utilized by over 200 million users per year.

• While cases against torrent websites are common, the structure of the software makes it difficult to hold the owner of the site accountable for piracy that occurs through their platform.

• Piracy can increase viewership and publicity for TV series but it will prove problematic unless additional revenue can be realized as a result of the increased publicity.

• Game of Thrones has become the most pirated show in the world with a trend that has consistently increased during it’s existence.

"We've been dealing with this for 20, 30 years—people sharing subs, running wires down the backs of apartment buildings. Our experience is that it leads to more paying subs. I think you're right that Game of Thrones is the most pirated show in the world. That's better than an Emmy.”

- Jeff Bewkes (CEO, Time Warner)

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Drivers of Piracy and HBO’s “Solution”

• The legal viewing price of a TV Series is the key driver that affects piracy numbers.

• Cost to purchase a full season of Game of Thronesis comparable to other major TV series

• HBO Now is priced approximately 50% higher than other subscriptions.• Given that consumers heavily favor subscription over season purchases, this

increases piracy for HBO.

Price Level

Availability

• Piracy is a last resort for viewers who have no other way to access content.

• 90% of GOT piracy occurs outside the US• Release dates that differ by region incentivize piracy in that viewers

want to be current on the plot.• In many areas across the globe, viewers are forced to pay for an entire

cable package to gain access to HBO if they are to watch legally.

HBO has taken steps to reduce the impact that these two drivers have on the level of piracy that occurs with GOT

• HBO Now Released in 2015, this standalone streaming service is subscription based and allows users to watch HBO content ➦for a monthly rate of $15. While this will help with piracy, subscription numbers are low – in part because customers can only use HBO Now on Apple devices and also because it is only offered in the US.

• IP-Echelon HBO has recently enlisted the help of an anti-piracy firm, IP-Echelon to try to curtail piracy further.➦

• Damages can be simplified into two major components:

– The number of viewers who would have contributed to revenue (season purchase or subscription) if piracy was not an option

– The average revenue contribution per customer

» This is calculated by using a weighted average of the two consumption methods (monthly subscriptions and full season purchase)1

Damages Calculation & Methodology

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Total Damages

Number of

Piracy-Based

Viewers willing to pay

Average Revenu

e per Custom

er

1. Analysis of comparable data, current revenue streams and online information allows for relevant assumptions to be made

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Total Damages =(Wview* Nview )[Wseas Pseas+ Wsub Psub]

Unmonetized Demand (Wview * Nview)

Method of Consumption Weights (Wseas , Wsub)

Revenue per Consumption Method (Pseas , Psub)

• Wview is the percent of piracy-based viewers who would pay to watch Game of Thrones if it were not available through piracy.

• Nview is the estimated number of viewers who pirated Game of Thrones in 2016.− Unmonetized Demand - the number of viewers that would contribute to revenue if piracy was not an option.

• Wseas is the percent of customers who would purchase the full season of Game of Thrones. • Wsub is the percent of customers who would subscribe to HBO Now in order to gain access to GOT.

− These values can be roughly estimated using the common size income statement and looking at the percent of revenue associated with “Subscriptions” vs. “Content.”

• Pseas is the price to purchase full season of GOT ($29 per season).• Psub is the price to subscribe to HBO Now for the required time to watch entire season ($45 for three

months).

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Total Damages

• Given the high demand and interest for GOT, it is assumed for that 95% of piracy-based viewers would choose to purchase the series if piracy was not an option.

− When applied to the estimated two million piracy-based viewers, this implies that 1.9 million viewers would transition to purchasing GOT.

− Referring to the common size income statement, 85% of revenues are generated through “Subscription Services” and 15% are generated through “Content & Other” services.

• Taking into account the content purchases by other media platforms, weights for season purchases (Wseas) and subscription purchases (Wsub) were determined to be 10% and 90%, respectively.

− The price to purchase the full season (Pseas) is $29 and the price for a three-month subscription (Psub) is $45.

Total Damages$82, 4601

1Using this method, damages for the piracy associated with Game of Thrones were calculated to be $82.46 million – slightly less than ~1.5% of 2015 Revenues for HBO.

Precedent Piracy Litigation

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• One of the most notorious Torrent sites and based in Sweden

• Prosecution called for over $3 million in damages and prison time

• Court decided on community service and $148,000 in damages awarded to a film producer

In most cases targeting Torrent Websites, the owners or operators of the website are held accountable in court. Two recent lawsuits are detailed below:

• Currently the most visited bit torrent website in the world1

• Case filed by Universal Music, Sony Music, Warner Music and the Swedish and Nordisk film companies

• The ruling states that Pirate Bay’s operations cannot be deemed as infringement of copyright when these are utilized by it’s users to pirate media.

1. www.techtimes.com

Litigation Recommendation

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Partial Damages Reparation a

possibility

Precedent Rulings Subscribers held

accountableFew Trials on Record

Although significant damages have been incurred as a result of Bit Torrent, precedent rulings on torrent websites suggest that plaintiffs are typically awarded fractions of actual damages, if any reparations are paid at all. For that reason, it is recommended that HBO consider the costs associated with pursuing further legal action against Bit Torrent before filing a lawsuit.

Financial InformationAppendix A

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Weighted Average Cost of Capital Comparable Companies Unlevered Beta

Predicted Net Value of Debt/ Marginal UnleveredCompany Levered Beta Debt Equity Equity Tax Rate BetaTime Warner Inc. 0.817 22,163.00 69,063.26 32.1% 38.0% 68.1%Twenty-First Century 1.110 14,807.00 50,135.34 29.5% 38.0% 93.8%Viacom 1.307 12,173.00 14,496.04 84.0% 38.0% 86.0%Discovery 1.124 7,772.00 15,812.06 49.2% 38.0% 86.1%Walt Disney 1.012 15,214.00 150,217.61 10.1% 38.0% 95.2%CBS Corp 1.076 8,778.00 25,357.17 34.6% 38.0% 88.6%Netflix 1.540 6,649.70 51,066.96 13.0% 38.0% 142.5%

Mean 1.07 39.9% 94.3%Median 1.09 33.4% 88.6%

HBO Relevered BetaMean Target TargetUnlevered Debt/ Marginal ReleveredBeta Equity Tax Rate Beta

Relevered Beta 0.94 39.9% 38.0% 1.18

Company Name Net Debt Value of Equity Weighted Cost of Capital Time Warner Inc 22,163.0 69,063.3 Capital StructureTwent-First Century 14,807.0 50,135.3 Value of Debt 18.9%Viacom 12,173.0 14,496.0 Value of Equity 81.1%Discovery 7,772.0 15,812.1 Walt Disney 15,214.0 150,217.6 Cost of DebtCBS Corp 8,778.0 25,357.2 Cost of Debt 2.21%Netflix 6,649.7 51,067.0 Tax Rate 30.0%

Debt Adjustment Factor 1.43Mean 12,508.1 53,735.5 After-tax Cost of Debt 2.21%Median 12,173.0 50,135.3

Cost of EquityAmount % of Total Risk-free Rate 1.82%

Net Debt 12,508.1 18.88% Market Risk Premium 7.55%Value of Equity 53,735.5 81.12% Expected Market Return 9.37%

Levered Beta 1.18 Cost of Equity 10.70% WACC 9.1%

• Cost of Debt: Bloomberg (TWX) • Capital Structure: Industry Median • Tax Rate: 30%• Predicted Beta: Bloomberg

Assumptions

Financial ForecastAppendix B

Duff & Phelps 39

Duff & Phelps 40

Financial Statement Model Forecast2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

12/31/2012 12/31/2013 12/31/2014 12/31/2015 12/31/2016 12/31/2017 12/31/2018 12/31/2019 12/31/2020Income StatementRevenues

Subscription 4,010.0 4,231.0 4,578.0 4,748.0 5,109.5 5,467.1 5,795.2 6,084.9 6,328.3Content and Other 676.0 659.0 820.0 867.0 906.0 946.8 987.5 1,028.0 1,069.1

Total Revenues 4,686.0 4,890.0 5,398.0 5,615.0 6,015.5 6,413.9 6,782.7 7,112.9 7,397.4

Cost of Revenues Programing Costs

Acquired Films and Syndicated Series 885.0 894.0 1,007.0 1,003.0 1,073.8 1,144.9 1,210.7 1,269.7 1,320.4Originals and Sports 856.0 856.0 960.0 1,032.0 1,103.8 1,177.0 1,244.6 1,305.2 1,357.4

Total Programing Costs 1,741.0 1,750.0 1,967.0 2,035.0 2,177.6 2,321.8 2,455.3 2,574.9 2,677.9Other Direct Operating costs 659.0 618.0 741.0 776.0 830.1 885.1 936.0 981.6 1,020.8Total Cost of Revenues 2,400.0 2,368.0 2,708.0 2,811.0 3,007.7 3,207.0 3,391.3 3,556.5 3,698.7

Gross Profit 2,286.0 2,522.0 2,690.0 2,804.0 3,007.7 3,207.0 3,391.3 3,556.5 3,698.7

Operating Expenses Selling, General and Administrative 632.0 705.0 746.0 831.0 872 930 983 1,031 1,073Gain on Operating Assets 0.0 (113.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0Asset Impairment 0.0 0.0 4.0 0.0 0.0 0.0 0.0 0.0 0.0Restructing and Severence Costs 15.0 39.0 63.0 0.0 0.0 0.0 0.0 0.0 0.0Depreciation 85.0 91.0 77.0 81.0 90 92 94 90 89Amortization 7.0 9.0 14.0 14.0 12 13 14 14 15Total Operating Expenses 739.0 731.0 904.0 926.0 975 1,035 1,091 1,135 1,176

Operating Income 1,547.0 1,791.0 1,786.0 1,878.0 2,033 2,172 2,301 2,421 2,523

Segment EBITDA 1,639.0 1,891.0 1,877.0 1,973.0 2,135 2,277 2,408 2,525 2,626Less: Corporate SG&A 59.3 75.1 92.4 17.6 60 64 68 71 74

EBITDA 1,579.7 1,815.9 1,784.6 1,955.4 2,075 2,213 2,340 2,454 2,552

Segment Capital Expenditures 65.0 45.0 58.0 68.0 72.2 77.0 81.4 85.4 88.8

Allocated Portion of Corporate Expenses Capital Expenditures 8.0 14.4 7.6 4.1 14.2 13.7 13.3 12.9 12.5Depreciation 5.0 5.2 5.6 1.1 4.2 4.8 4.7 4.5 4.4


Growth Rates & Margins 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Trend Analysis (Year to Year)

Subscription Growth 5.5% 8.2% 3.7% 7.6% 7.0% 6.0% 5.0% 4.0%Content and Other Growth (2.5)% 24.4% 5.7% 7.0% 6.6% 5.7% 4.9% 4.0%

Total Revenue Growth 4.4% 10.4% 4.0% 7.1% 6.6% 5.7% 4.9% 4.0%Total Cost of Revenue Growth (1.3)% 14.4% 3.8% 7.0% 6.6% 5.7% 4.9% 4.0%Gross Profit Growth 10.3% 6.7% 4.2% 7.3% 6.6% 5.7% 4.9% 4.0%

Total Operating Expenses Growth (1.1)% 23.7% 2.4% 5.2% 6.2% 5.4% 4.1% 3.6%Operating Income Growth 15.8% (0.3)% 5.2% 8.3% 6.8% 5.9% 5.2% 4.2%EBITDA Growth 15.0% (1.7)% 9.6% 6.1% 6.6% 5.7% 4.9% 4.0%

Common Size Analysis (% of Revenue)Acquired Films and Syndicated Series 18.9% 18.3% 18.7% 17.9% 17.9% 17.9% 17.9% 17.9% 17.9%Originals and Sports 18.3% 17.5% 17.8% 18.4% 18.4% 18.4% 18.4% 18.4% 18.4%Total Programing Costs 37.2% 35.8% 36.4% 36.2% 36.2% 36.2% 36.2% 36.2% 36.2%Other Direct Operating costs 14.1% 12.6% 13.7% 13.8% 13.8% 13.8% 13.8% 13.8% 13.8%

Total Cost of Revenues 51.2% 48.4% 50.2% 50.1% 50.0% 50.0% 50.0% 50.0% 50.0%

Gross Margin 48.8% 51.6% 49.8% 49.9% 50.0% 50.0% 50.0% 50.0% 50.0%

Selling, General and Administrative (% of Revenue) 13.5% 14.4% 13.8% 14.8% 14.5% 14.5% 14.5% 14.5% 14.5%Depreciation (% of Revenue) 1.8% 1.9% 1.4% 1.4% 1.5% 1.4% 1.4% 1.3% 1.2%Amortization (% of Revenue) 0.1% 0.2% 0.3% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2%

Operating Expenses Margin 15.8% 14.9% 16.7% 16.5% 16.2% 16.1% 16.1% 16.0% 15.9%Operating Income Margin 33.0% 36.6% 33.1% 33.4% 33.8% 33.9% 33.9% 34.0% 34.1%Segment EBITDA 35.0% 38.7% 34.8% 35.1% 35.5% 35.5% 35.5% 35.5% 35.5%

Corporate SG&A 1.3% 1.5% 1.7% 0.3% 1.0% 1.0% 1.0% 1.0% 1.0%EBITDA Margin 33.7% 37.1% 33.1% 34.8% 34.5% 34.5% 34.5% 34.5% 34.5%


Growth Rates & Margins (Continued)

2012A 2013A 2014A 2015A 2016A 2016A 2016A 2012A 2012AMargins (Other)

Capex (% of Revenue) 1.4% 0.9% 1.1% 1.2% 1.2% 1.2% 1.2% 1.2% 1.2%Depreciation (% of Capex) 130.8% 202.2% 132.8% 119.1% 125.0% 120.0% 115.0% 105.0% 100.0%Allocated Corp Capex (% of Corporate Capex) 17.9% 18.0% 19.1% 19.2% 19.2% 19.2% 19.2% 19.2% 19.2%Corporate Depreciation (% of Corporate Capex) 62.2% 36.4% 73.0% 27.6% 30.0% 35.0% 35.0% 35.0% 35.0%

Acquired Films (% of Total Costs) 36.9% 37.8% 37.2% 35.7% 35.7% 35.7% 35.7% 35.7% 35.7%Originals and Sports (% of Total Costs) 35.7% 36.1% 35.5% 36.7% 36.7% 36.7% 36.7% 36.7% 36.7%Other Direct Operating costs (% of Total Costs) 27.5% 26.1% 27.4% 27.6% 27.6% 27.6% 27.6% 27.6% 27.6%

• Capex is driven as a percentage of revenue. • Depreciation is driven as a percentage of Capex.• Allocated Corporate Capex and Corporate Capex are driven as a percentage of Corporate Capex• Acquired Films costs, Originals & Sports costs, and Other operating costs are driven as a percentage of the total

costs.• Total costs is driven by gross margin shown in the previous slide (41).

Comments

Damages Calculation and Select Data

Appendix C

Duff & Phelps 43

Piracy Overview and Drivers – Supporting Documentation

Duff & Phelps 44

• The Motion Picture Association of America performed a study that suggests costs of piracy to be $20.5 billion for the film industry on a yearly basis.1

• Torrent websites are set up such that the data is not stored at any particular location or central location. Rather, each user contributes bandwidth to allow for direct peer-to-peer sharing. For this reason, pinning responsibility to the torrent website has proved difficult for media originators.

• Two of HBO Now’s competitors, Netflix and Hulu, are priced at $8.99 per month and $7.99 per month, respectively. This is a considerable discount when compared with HBO Now’s price of $14.99 per month.

• With nearly 90% of piracy for Game of Thrones coming from outside the US, Australia leads the group with over 30% of GOT viewership due to piracy.2

1. http://moviepilot.com/posts/2889420 2. http://www.ew.com/article/2015/04/21/game-thrones-piracy-record

http://moviepilot.com/posts/2889420

http://www.ew.com/article/2015/04/21/game-thrones-piracy-record

Damages Methodology – Supporting Documentation

Duff & Phelps 45

• Many viewers who watch pirated films and TV series indicate that they are willing to pay for content, but often times the content is not available or is grossly overpriced compared to other forms of media. Given this willingness to pay for content and the obsession that many viewers have for Game of Thrones, the percent of piracy-based viewers that would have paid for GOT was estimated at 95%.

• The value of two million viewers who watched Game of Thrones illegally is an estimate that can be revised based on additional data.

• Weighting the costs based on consumption methods yields a weighted average cost for the consumer of $43.40 to watch the full season of GOT.

Litigation – Supporting Documentation

Duff & Phelps 46

• Comparing the amount sued for and the amount paid in reparation for the SwePiracy case, only 5.8% of the original amount was paid out by the Torrent website. This percentage was applied to the $82,460,000 damage calculation to yield a more appropriate value for HBO to expect.

• Both the SwePiracy case and The Pirate Bay cases could be revisited in the coming future. Given the relative youth of piracy, many precedents have yet to be set. For that reason, it is possible that a lawsuit becomes more practical in the future for HBO to pursue.

• Many precedent rulings are either ongoing or have ruled on the side of the Torrent websites. Additionally, trials are limited in number as they pertain to large torrent websites.

Date post:	16-Apr-2017
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