FINANCE Start of Lecture · Start of Lecture 34 I. Corporate Finance 35 HR Tech Finance Accounting...

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MEDIA FINANCE

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© Eli M. Noam, November 14, 2010

Start of Lecture

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Lecture

I. Corporate Finance

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HR Tech Finance

Accounting of

Performance

Strategy Production Marketing Distribution

Resources:

Value C ti

The Media Value Chain

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Strategy

IP Creation Pricing

Distribution

Environment:Info.

Environment DemandLaw &

Regulation

Creation:

In this chapter we will discuss how media

and communications

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and communications firms can fund their

activities38Eli M. Noam, Media Finance 38

http://www.cma-canada.org/multimedia/CMA_Magazine/Archives/2004/April_2004/BusStrat.jpg

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• We will go over the financing options such as various types of debt and equity, and see how they are applied in media

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finance.

•We will also ask the question, how the various funding options affect-The structure of media

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The structure of media companies and industries

-Content-Conduct

• There have been many discussions about the effects of ownership and its types on media content and performance.

• For example

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For example- Private ownership

» Disney, Berlusconi, Murdoch- Versus non-profit, public ownership

» PBS, BBC, NHK

• We are also used to public discussion of the effects of media concentration on media content and diversity.

Competitive media

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- Competitive media- Versus a monopoly or oligopoly

• And there have also been many discussions of the effects of the quantity of channels on content.- “narrow-casting” versus

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“broadcasting”- “specialty formats” versus “mass

audience channels”

•What has been less clear is whether and how the financing types of media l ff t

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also affect- media content- media performance

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• Just to introduce the topic:

What would Finance Theory suggest about the impact of

financing type?

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p- In finance theory one of the major

concepts is know as the “Miller-Modigliani Theorem (1958).

Franco Modigliani

Merton Miller

http://en.wikipedia.org/wiki/File:Franco_Modigliani.jpg

• According to “M-M,” the value of a firm is unaffected by its funding—whether debt, or capital, etc.

• Company value is based on

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Company value is based on performance, not on funding types. This means that the conduct & behavior of a firm are independent of its funding. These are separate decision processes.

• Applied to a media firm, this would mean that its conduct and content are not affected by its funding

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g

• M-M is based on several unrealistic assumptions• Efficient market, no taxes, no

bankruptcy cost, symmetric information

Y t ti f th

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• Yet even correcting for these assumptions, is the basic point plausible?

• Is content indeed entirely independent of financing the media operations? 50

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• First, lets briefly look at- Finance theory- How finance is handled inside

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large companies,- And what the special aspects of media finance are

OUTLINE: FINANCING MEDIAI. CORPORATE

FINANCE & THEORY II. SPECIAL ASPECTS OF

MEDIA FINANCEIII. CASE DISCUSSION-

TWIT & SNITIV. INTERNAL FUNDING

VII. RISK REDUCTION STRATEGIES• Insurance• Diversification• Hedging, Options• Impact of Debt on Content

VIII. EQUITY FINANCING• Partnerships

P i t E itV. DEBT FINANCING• Types of Debt• ST vs. LT Debt, Impact• High-Yield “junk” bonds

VI. OTHER TYPES OF DEBT• Securitization• Vendor and buyer finance • Government• Lease Finance

• Private Equity• Venture Capital• Public Equity

IX. MODELS FOR OWNERSHIP

X. CAPITAL STRUCTURE• Optimal Capital Structure• Financial Life Cycle

XI. CONCLUSIONS 52

I.1. Corporate Finance Theory

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inance heo yThe study of financial

decisions made by firms

I.1.A. Key Questions of Q f

Corporate Finance

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Key Questions of Corporate Finance

• Investment policy- How the firm spends its money (real and

financial assets)Financial policy

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• Financial policy- How the firm obtains funds (debt,

equity) and disposes of excess cash• Payout policy

- How to firm pays out its earningsLewellen, Katherina. “Capital Structure, cont.”MIT. 1 July 2004. <http://ocw.mit.edu/NR/rdonlyres/Sloan-School-of-Management/15-402Finance-Theory-IISpring2003/LectureNotes/>

Key Questions Addressed by Corporate Finance Theory:

1. How much short-term cash flow does a company need to pay its bills?– “Optimal liquidity”

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2. How much debt should a firm take?3. What is the best relation of debt vs. equity

for the firm? (“Capital Structure”)4. How much: Short-term vs. long-term debt?

(“Term Structure”)

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5. What long-term investment strategy should a company take on?

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6. How can funds be raised for the required investments?

7. How can the firm reduce its risk exposure?

Stephen A. Ross, Randolph W. Westerfield, and Jeffrey Jaffe, Corporate Finance. New York: McGraw-Hill, an imprint of The McGraw-Hill Companies, Inc., 2002, Page 2.

I.1.B. Tools of Fi i l ThFinancial Theory

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Some Tools of Finance Theory

• Time Value of Money• Portfolio Theory• Asset Pricing Theory

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sset c g eo y• Efficient Markets Hypothesis• Option Pricing Theory• Agency Theory

Lewellen, Katherina. “Financial Theory II, cont.” MIT. 1 Febuary 2003.

The selection of projects for investment is a question dealt

with in Capital Budgeting

60http://www.swlearning.com/finance/students/images/capital_bgt.jpg

Capital Budgeting• Capital Budgeting is a firm’s

process of identifying and selecting investments

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• Aggregated from the capital-budgeting analysis of all projects of a firm

I.1.C. Major Techniques for

Projects Evaluation

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6

Major Techniques to Evaluate Projects

A. Payback Period TechniqueB. Discounted Payback Period

T h i

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TechniqueC. Net Present Value (NPV) TechniqueD. Profitability Index TechniqueE. Internal Rate of Return (ROI)

Technique

• These topics are the subject of several useful courses and textbooks in Financetextbooks in Finance

• The reader is referred to them• They will periodically be used

within this unit64

Hurdle Rate

D i i R l-- Decision Rule: Accept if IRR > hurdle rate

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Nominal hurdle rates that the sample firms used for a typical project in year 2004-2005

Iwan Meier, Vefa Tarhan, “Corporate Investment Decision Practices and the Hurdle Rate Premium Puzzle”, February 27, 2006

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I.2. The Finance

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Function in Companies

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• Every company, industry and project requires funding

• Financing is never easy or simple

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http://www.mce.k12tn.net/ancient_greece/maze.gif

I.2.A. Finance FunctionFunction

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Finance FunctionIn large firms, the finance functions are usually managed by the Chief Financial Officer

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by the Chief Financial Officer (CFO)

• The treasurer and the controller report to the CFO

CEO

CFO

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Controller Treasurer

Controller

• Handles the accounting function,

• Includes taxes

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• Includes taxes - Cost and financial accounting - Information systems

Treasurer• Handles cash flows• Implements capital-

expenditures decisionshttp://www.georgiagardner.or

g/

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expenditures decisions• Makes financial plans

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http://www.bizstrat.com/Data/FileManager/feature1_july05.jpg

CFO• Raises funds necessary to carry out

business operations and support the firm’s assets

id h d

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• Decides on the amount, source, and type of financing

• Conducts financial analysis to ascertain performance of the firm

Financial Scandals after 2000: Greater Responsibilities of CFO

• Direct authority to take “fail safe” actionsR i d t

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• Required greater independence of auditors, with liability

• More clearly defined accounting standards http://www.mscllc.com/images/cash.jpg

I.2.B. The Main Financial

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Financial Statements

Main Financial Statements• Balance Sheet• Income Statement

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• Statement of Cashflow

Other Major Required Disclosure for Public

Companies• Major Ownership changes

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• Insider transactions

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81 82












XI. CONCLUSIONS 83

II. SPECIAL ASPECTS OF

Eli M. Noam, Media Finance 84

MEDIA FINANCE

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II.1. Problems Specific to Media

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Specific to Media Finance

What Are Particular Problems for the

Financing of Media

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Financing of Media and Communications

Firms?

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Fundamental Economic Characteristics of MediaA. Supply Side

1. High fixed costs, low marginal costs2. Convergence of production3. Divergence in cost trends in value chain4. Accelerating returns5. Excess supplyB. Demand Side

Eli M. Noam, Mobility, 2006 87

B. Demand Side6. Network effects7. Non-normal distribution of demandC. Markets8. Price deflation9. Intangibles 10. Public11. Non-maximizers of profit12. Role of Government 87

• All of these affect the financing of mediag

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II.1.A. High Investment Needs

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Investment Needs

Problem: • Investment needs in media

products, platforms, and devices are high and keep

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devices are high, and keep increasing.

• Many projects extremely long-term with huge capital outlays (telecom & cable distribution)

Problems for Distribution Networks

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(telecom & cable distribution)

Mobile Wireless Investments

92Source: Standard & Poor

11

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Telecom Networks

• Cost of full residential fiber-connection of US: $500 billion

• 1997-2001: over $4 trillion invested in European. and U.S. telecom ventures and firms, old and new

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Financing Dries up • 2002: 43.5% default rate on

telecom loans

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Financial Needs of Content• Content productions and

networks are - expensive- risky

perishable

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- perishable- period of main revenue

maybe short for content- Lag in collection of revenues- Intangibles hard to use as collateral- Volatility

Hollywood Film Budgets (average incl marketing, $m)

1984 12

98

1999 53

2007 110

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Television Program Costs

• Average hourly cost for new prime-time network programs

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p g- 1971: $200,000- 1991: $1 mil- 2008: $1.9 mil

Theater Pre-Opening Budget (2002)

• Broadway: $2,000,000• Off-Broadway

(commercial):$600,000• Off-Broadway (nonprofit):

$219,761• Off-Off-Broadway: $7,475

"Wonderful Town: The Future of Theater in New York." National Arts Journalism Program, Columbia University, 2002

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• Lag time between production and collection.

http://www.linuxinsider.com/images/rw3180/2001-reach-profits-3.jpg

Annual U.S. Investments in Content Media

• Film: $25 Bil.• TV and cable programs: $25 Bil.

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• Games: $5 Bil. • Music: $3 Bil.

Problem: Volatility of Investments

• US Internet & Dot Com. Capital Investment- 1996: $4 Bil.

103103

- 2000: $79 Bil.- 2004: $9 Bil.- 2007: $11 Bil.- 2008: $5 Bil.

Sources: NVCA Yearbook 2008, for 2008 data: NVCA/PwC Press Releases, http://www.gazeta.ru/2003/12/11/images/bankrupt.jpg

U.S. Internet Related Investments

50,00060,00070,00080,00090,000

2 5003,0003,5004,0004,5005,000

Amount invested

104Source: NVCA Yearbook 2008

010,00020,00030,00040,000

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

05001,0001,5002,0002,500

# of deals

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II.1.E. Riskiness of Media Products

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Media Products

Problem Riskiness• 80% of all films, books, music do

not generate enough audience to become profitable

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become profitable.• Most new online sites fail• 2/3 of new magazines fail in 1st

year.

• Public good characteristics affect the role of government (funding and regulation)

• Excess supply and price deflation lower probability of success and raise risk

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• Economies of scale affect the potential of small firms to be profitable

• Instability and risk raise• Instability and risk raise cost and availability of financing;

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• But it’s not simply the small odds that are the problem

• But that the distribution of success is weird

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success is weird• The statistical distribution

of media performance is not normally distributed

• Zipf’s distribution –success is extremely high for a few products, low for the long tail

110

g

Image source: http://planetmath.org/encyclopedia/ZipfsLaw.html

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• For many media products, the average (of revenues, or of profits) is not the most probable outcome. The average is dominated by rare,

t t d i it

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extreme outcomes and is quite far above the most probableoutcome.

De Vany and Walls, “Does Hollywood Make Too Many R-Rated Movies? Risk, Stochastic Dominance, and the Illusion of Expectation” Journal of Business, July 2002, vol. 73, no. 3 112












XI. CONCLUSIONS 113

III. Case DiscussionFunding of New

i

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Ventures: Time Warner vs. New

Entrant

• Time Warner considers starting a new Internet-TV project

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• Time Warner Internet TV—(TWIT) for streamed video entertainment.

Time Warner

• Global conglomerate- its business units produce

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pvirtually all forms of print, video, and electronic content

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TWIT Constitutes 4 Sub-Projects

• Each project has its own timeline and funding needs

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–Software development–Programming development–Infrastructure upgrade–Marketing/Administration costs

TWIT Investment Needs: $1 bil

$200$100

Marketing &Software

10%Administrative

20%development

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$400$300

Upgrade Cable30%

Programming40%

Infrastructure

Interactive

Capital Costs of Project: $1bn

– Development of streaming software, incl. DRM secure micro payment feature by TWIT d AOL

$100 M

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TWIT and AOL– Production of interactive TV

programs by TW film studio subsidiary WB (I hr./day original programming, @ 1mil./hr)

$400 M

–Upgrade of Time Warner Cable network infrastructure(7.5 mil. Subs., $40/sub)

Capital Costs of Project: Cont

$300 M

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( , )–upfront marketing and

administrative costs by TWIT

$200 M

• An alternative entrant considers Internet TV

• The new firm is

SNIT

provisionally called “Start-up New-Generation Internet TV” (SNIT)

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• SNIT is a startup entity that will need variety of funding source, different from TWIT.

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Assumptions for SNIT:• The founders have a total of

$.5 million of their own money to invest

SNIT

• The initial investment, instead of requiring $1 billion as for TWIT, will be only $100 mil for SNIT 123

• We assume each sub-project scaled down to 1/10–Software development: $10–Programming development - $40

million

SNIT

million–Infrastructure: $30 million–Marketing/Administration: $20

million• We also assume that revenues are

scaled down to 1/10 124

•We start with the question:-Where does the financing of media activities—

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of media activitiescontent, networks, technology—come from?

Let’s Do a Quick Overview of Funding Sources

• Creator/ entrepreneur personally, and families

• Banks• Other financial institutions

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- insurance companies• Private investors

- small- large

•Institutional investors- mutual and pension funds PE funds etc

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funds, PE funds etc.•Governments• Vendors

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• Funding mix keeps changing • Look at film financing in the

past 30 years

• There was a public equity wave (examples Cannon and Carolco). 1980

• Then there was a Japanese direct financing wave, 1980s - Matsushta acquired Universal, and Sony

acquired Columbia).Th th F i b k f di• Then there was a Foreign bank funding wave (e.g., Credit Lyonnais). 1990s

• Then there was the insurance-backed financing wave in the 1990s, crashed 1998.

• Then there was a German public equity wave 1990s, crashed in 2004.

Schuyler Moore. The Next Wave Of Film Financing: German Tax Shelter Funds- German tax shelter funds – Government Activity- International Pages, July 30, 2001. http://findarticles.com/p./articles/mi m5072/is 31 23/ai 77338376

• And the question is, how these different sources of financing are used by media and affect media

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• We will look at the different funding options, and how they work in practice

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For more details seeAppendix A:Evaluating

Investment ProjectsEli M. Noam, Multichannel 133133

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XI. CONCLUSIONS 135

IV. Internal FundingFunding

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Internal Funding for Start-Ups• Self-funding by the

entrepreneur, family, friends

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• Small businesses initially lack- audited financial statements- Collateral–worthy assets

repayment history

138

- repayment history- traded securities that are

continuously evaluated in the market

Allen N. Berger and Gregory F. Udell, “The Economics of Small Business Finance” Journal of Banking and Finance, Volume 22, 1998

• Debt therefore typically not available to small businesses i th l t

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in the early stages

Allen N. Berger, Gregory F. Udell, “The Economics of Small Business Finance: The Roles of Private Equity and Debt Markets in the Financial Growth Cycle,” Journal of Banking and Finance, Volume 22, 1998

• Most small business loans are therefore personally guaranteed by inside owners.

• Leads to a focus on the reputation of the entrepreneur, personal

t d l d t

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assets, and personal data. • Distinction “insider” and “debt”

financing in early stage is not bright. “Intertwining.”


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MEDIA FINANCE

http://www.gmfin.com/images/suit1.jpg

• But also at the other extreme:- For large firms, internal funding, too, often makes sense

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sense.- funding from the pool that was raised or retained on corporate level for entire firm

Sources of Internal Finance for Established Firms

• Retained earnings- Reinvested instead of distributing to

shareholders• Reduce working capital

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Reduce working capital• Sale of assets • Delay accounts payable • Collect accounts receivable faster

Lynch, Richard, Corporate Strategy. Harlow: FT Prentice Hall, 2003, p.287.

Howard H. Stevenson, Michael J. Roberts, H. Irving. New Business ventures and the Entrepreneur. Homewood, Illinois: Richard D. Irwin, INC, 1985, P. 190-199

Internal Funding for Established Firms

• Firm uses internal resources-Small projects are funded internally large projects may

144

internally, large projects may need external financing

Startups Early Growth Medium Large

Internal Funding Over the Firm’s Life Cycle

145


Internal Finance Internal Finance

• Early for startups• Late for established firms

20

Benefit of Internal Funding for Large Firms

• Lower transaction costs • No outside approval needed• Less financial disclosure to public

and competitors

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and competitors• Better evaluation of the project and

its risk by the firm than by outside financiers

Drawbacks of Internal Funding For Large Firms

• Potentially less stringent evaluation

148

• Opportunity cost of capital

Cash – Microsoft and Google• Microsoft had cash holdings of

around $60 bil in 2004, and $23 bil in 2007

149

• Google had in 2007 more than $14B in cash

• Used for general capital expenditures, possible acquisitions

Source: What corporate cash is really considered king , The Associated Press 2005

Self-financing in Media• Google faces problem of being

treated like an investment fund under the Investment Company

150

under the Investment Company Act of 1940

Source: Google pleads for cash hoard exemption , Chattanooga Times 2006

• The issue at hand is that investors do not want Google or Microsoft to diversify themselves; the investors

151

themselves can invest in a diversified portfolio and do no better from their perspective

152

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IV.3. Self-financing: Impact

153

on Content & Performance

•Owner in clear control- Can reflect own opinions and aesthetics

•Can take greater risks

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(in small projects)•But since using one’s own money, this may reduce risk taking (in large projects)

Self-financing Film:The Passion by Mel

Gibson

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Self-financing Film:The Passion by Mel Gibson

• Hollywood industry did not share his message, so Gibson self-financed 40

156156

gmil of production and marketing (distributor New Market Film)•Worldwide gross $610 mil

• Black Swan (2002, renamed to “Murder in Hopeville” for US audience) was a $800 000

Self-financing Film

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US audience) was a $800,000 film mostly self-financed

“Don’t be afraid of self finance,” Canadian Filmmaker. Last accessed June 29, 2007. http://www.canadianfilmmaker.com/content/view/83/38/

157

• Canadian filmmaker Wendy Ord had to mortgage her house, sell her car, and rack up debt on her credit card.

158“Don’t be afraid of self finance,” Canadian Filmmaker. Last accessed June 29, 2007. http://www.canadianfilmmaker.com/content/view/83/38/

158

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XI. CONCLUSIONS 160

V. Debt

161

Financing

Debt Over the Life Cycle of the Firm


162


Financial Institution Loans

V.1. Pros and Cons of Debt

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of Debt

Advantages of Debt• Other than internal funding, debt

is usually the cheapest form of financing

164

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Fallacy: “Debt is Better Because Debt is Cheaper Than Equity

• The difference is significant: 4% vs. 13% expected return!

• So, companies should always

165

finance themselves with debt because they have to give away less returns to investors, i.e., debt is cheaper (False).

• What is wrong with this argument?

• But “hidden” cost of debt» raising more debt makes existing equity more risky and

166

existing equity more risky, and therefore also makes debt more risky.

Advantages of Debt• Interest payments are tax deductible

expenses• Quicker to create than equity

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• Retains existing shareholder structure• The upside potential of a project stays

with shareholder• Lender not directly involved in

management

• Loans have to be repaid, can lead to early bankruptcy

• Possibility of loss of collateralB h l

Disadvantages of Debt

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• Borrower may have personal liability as guarantor

Bank’s Role in Lending• Goes beyond supply of capital

–Assess firm’s business plan and management

–Evaluate other financial backers• Assure that financial controls and

reporting systems ok• Evaluate regular financial reports

Debt Covenants• Intended to give the lending

institution some control and prevent borrowers from increasing riskiness

Requires specific financial ratios–Requires specific financial ratios–Activity restrictions linked –Periodic submission of financial

informationAllen N. Berger, Gregory F. Udell, “The Economics of Small Business Finance: The Roles of Private Equity and Debt Markets in the Financial Growth Cycle,” Journal of Banking and Finance, Volume 22, 1998

24

Debt for Film?• Debt is the most common

financing type for films after pre sale of distribution rights

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pre-sale of distribution rights- From distributor - From outside financial institutions

• Commitment by distributor to purchase or license film distribution rights

• This commitment by distributor

“Negative Pick-Up Deal”

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• This commitment by distributor can be taken to commercial bank, use the pick-up letter as collateral, to borrow production funds from bank.

• For details on film debt and vendor participation, see late section on Vendor Financingsection on Vendor Financing

173

Debt for Internet Firms ?

• Difficult for internet firms whose cash flows are low and

fit ft ti

174

profits often negative• In order to obtain debt, the firm

must have real assets or use the debt to get real assets.

• Internet firms usually do not have assets

• In contrast, established telecommunications and cable TV firms are fairly stable, less

Debt for Telecoms & Cable?

175

y ,volatile, have assets, and hence use debt.

• Therefore, equity financing more likely for telecom and cable

• For established businesses with assets (e.g., cable or telecom) debt usually represents 40-90% of capital structure

176

25

Examples of companies (debt rating and current debt

ratio%, 2006)• Time Warner (BBB+, 24%),

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Verizon (A, 49%)• Hearst-Argyle (35%)

Source: finance.yahoo.com (company key statistics); www.standardandpoors.com (company credit ratings search)

Major Four Publicly Traded Media Companies 2006

Market Cap($ bil)

Total Debt($ mil)

Debt to Equity

Time Warner 67.88 23.47 0.37

178

Disney 62.12 12.67 0.39

Viacom 23.29 7.66 1.11

News Corp. 59.71 11.43 0.38

(http://finance.yahoo.com , Market Cap. Column at 2006/9/6 10 AM, other Columns till 2006/6/30)

V.2. Hierarchy of D bt

179

Debt

The Hierarchy of Debt• From most liquid, most secure

and first to be paidl li id l

180

• To less liquid, lesssecure and last paid in case of bankruptcy

The Hierarchy of Credit

181

A. Revolving Line of Credit• Most common and least expensive

form of borrowing for small and mid sized companies

• Companies enter into revolving• Companies enter into revolving credit facilities

• Secured by accounts receivables and inventory

• Example: DVD production

26

• Line of credit is appropriate for Mid-Sized Firms–Company size: +$100 milp y

• Bank lines increase when cash flows and assets increase

184

B. Senior Term Debt• 2nd most common, and

expensive form of financing for small and mid sized companiesp

• Loaned against less liquid collateral of property, plant, and equipment

• Example: Cable TV financing

• The Private Equity firm, Babcock & Brown Capital Limited, (shareholder) acquired the Irish National Phone Company Eircom by using senior debt.

Example: Eircom debt financing package

• € 4 Billion Eircom debt financing package included € 3.5 Billion senior debt– Credit Suisse, Deutsche Bank and JP

Morgan– Moodys and S&P ratings of Ba3 / BB

Source: http://investorrelations.eircom.net/news/rns_369.htm

• Term Loan A € 650 Million –Maturity 8 years

• Term Loan B € 1,250 MillionM i 7

Eircom debt financing package

–Maturity 7 years• Term Loan C € 1,250 Million

–Maturity 9 years• Total First Lien Debt € 3,150 MillionSource: http://investorrelations.eircom.net/news/rns_369.htm

• Eircom debt financing package

Term Loan B

Term Loan A

Term Loan C

First Lien Debt


Senior Debt

Total First Lien Debt € 3,150 Million

Senior Debt € 3.5 Billion

27

189

C. Subordinated Non-Collaterized Debt

• Ranks below senior debt in repaymentp y

• Can be secured either by a second charge on company assets, or unsecured

Subordinated (Non-Collaterized) Debt

• Used for film early development funding, or p g,financing of ultra-low-budget film

Examples for Subordinated Debt Telewest and NTL (Cable &

Digital TV in UK)• Issues subordinated debt for

M&A deal for $285Mil

Source: Media business: Cable merger revives telecom sector calls for access to network: Telewest-NTL union puts regulator under pressure: $ 6bn deal will give options bonanza to executives, The Guardian 2005

Net debt (2008)Verizon: USD 42bnAT&T: USD 75bnBT: USD 13bnComcast: USD 31bn

Source: Company Information, Google Finance, Own calculation

Impact of Debt on Content

194

on Content

28

• The more secured a lender is, the

195

- greater support of risky activities by firm in content, technology, etc.

• Content productions will rarely have collateral of value until near completion.

196

p- Could have a slate of films as collateral

• Where there is no collateral, lenders will want

197

- Low risk content production- Insurance, risk-shifting- Collaboration with competitors

For more details seeAppendix B:Appendix B:

Types of DebtEli M. Noam, Multichannel 198

198

199

Debt comes -In short term vs long

200

In short term vs long term

29

V.2.D. Short-T D bTerm Debt

Types of Short-Term Loans in Media

1. Gap financing2 Completion loans

202

2. Completion loans3. Bridge loans4. Commercial paper

• “gap”: the difference between h i d f h l

Gap Financingfor Film

203

the amounts raised from the sale of distribution rights and the actual cost of finishing the film

Source: Insurance Journal, Jan. 2002 Film Financing Trial Starts in London

http://www.insurancejournal.com/news/international/2002/01/14/15980.htm

Gap Financing

• For films, gap levels typically 15% - 25% of budget

204

• Costs of gap financing are high, starting around 10% to 12%

•Gap finance availability often based on strength

f l

205

of pre-sales•Presale easier for established players

• The "gap" is repaid from a film's initial income

• Often provided by insurance company, which finances slates of films(~6)

206

- reduces risk (portfolio)- Implication: more difficult for

producers of a single project to get gap financing

30

• Example: New Bridge Gap funding by Merrill Lynch's Global Asset Based Finance

Gap Financing for Film

207

Global Asset Based Finance Group, and Rizvi Traverse Management

Source: Deadline Hollywood, May 2006

http://www.deadlinehollywooddaily.com/new-indie-super-gap-fund-debuts-la-based-new-bridge-film-capital/

• The Aviator (2004)

• Gap financing provider:

Examples for Gap Financing

208

Union Bank of

CaliforniaSource: Deadline Hollywood, May 2006

http://www.deadlinehollywooddaily.com/new-indie-super-gap-fund-debuts-la-based-new-bridge-film-capital/

For Added Security: Gap Financing Insurance

• Insures the lender if the producer cannot repay loan

209

p y• Insurance by companies such as

AXA (France)• Insurers lost $1.5 bil in 2000 on

bad film projects 210



211


Completion Loans / Funds• Completion loans are for films that

V.D.(2) Completion Loans

212

phave already been finished or are close to being finished

212

31

• Similar to gap financing• Designed to provide partial film

production or post-production financing

213

financing.• Funds for films that have

completed principal photography; or are in post-production

• Gap financing is usually provided by banks to studios that they trust from previous experiences

• Completion loans / funds are

214

often provided to smaller filmmakers, for distribution costs and are usually much smaller

214Alberstat, Philip. The Insider’s Guide to Film Finance. London: Focal Press, 2004.

• Completion fund example: Frameline provided completion funds for four LGBT films in 2004, for $3000-$5000

215215

“Frameline: Completion fund” Frameline. Last accessed June 21, 2007, http://66.39.24.176/fund/

• Completion fund example: the UK Film Council is completion fund, providing ₤50,000 for short film projects already shot but not

t fi i h d

216

yet finished. –“The Other Man” shown at 60th

Edinburgh Film Festival

216

“The Short Film Completion Fund,” Maya Vision International. Last accessed June 21, 2007, http://www.mayavisionint.com/Funding/The_Short_Film_Completion_Fund/index.html

217



218


32

V.D.(3) Bridge Loans

• Quick loans (bridge loans) from one long-term capital structure to

219

g panother

•Example: In 2000, Time Warnerpurchased the assets of the bankrupt competitive local exchange carrier GST Telecommunications for $700 million via a bridge loan.

220

a bridge loan. •It then issued 4.4 million shares of common stock and private placement of senior notes to repay the bridge loan. (see figure)

Time Warner

$700 million Bridge Loan

Financing purchase

221

4.4 million shares of TW common stock valued at $317 million

Private placement of $400 million of TW’s senior notes

Public stock offering

Private debt offering

• The TW senior notes, due 2011, were being sold to “qualified institutional buyers”.

• The senior note offering save Time W T l i l

222

Warner Telecom money via lower interest rates.

• The bridge loan provided the time to structure the new financing.

Toby Weber, “Time Warner Telecom moves to settle GST loan” from TelephonyOnline, Jan 22, 2001

223

V.D.(4) Commercial Paper

224224http://www.hunton.com/files/tbl_s33PracticeGroups%5CImage5695%5C807%5Ccommercial.jpg

33

Commercial Paper• unsecured promissory note issued

by a company • maturities up to 270 days

225

• maturities up to 270 days

Commercial Paper Over the Life-Cycle of the Film


Commercial Paper

226


• Buyers are banks, insurance, money market funds, pension, funds, institutional investors.

227

• Issued normally by companies with good credit rating

• The “kind of loans to companies who don’t need loans.”

• CP buyers need not do much due dili

228

diligence • “Back-stop”: issuing bank guarantees

payment • Commercial paper interest is paid at

maturity date

• Companies use of CP sometimes as primary f di b lfunding but mostly to even cash flows and needs

229

• In 2001 AT&T had $16-18 billion outstanding commercial paper (out of $50 Bil. debt)

CP Media Example: AT&T (Old)

230

of $50 Bil. debt) • AT&T had difficulty to access long-

term quality bond market in 2000• Would roll-over CP periodically

34

• Strategy: build balance sheet, then refinance ST CP’s by long

CP Example: AT&T

231

then refinance ST CP s by long term quality debt

• Strategy did not work

Levels of Commercial Paper

•Tier 1•Tier 2

232

•Tier 2•Tier 3

Levels of Commercial Paper• Tier 1: mid-grade AA or A1/P1• Below LIBOR

-(“London Interbank Offered Rate”): the rate at which banks borrow from each other in

233

borrow from each other in London. Fluctuates

-May 2000: 7.34%-Oct 2003: 1.42%-Aug 2004: 2.3%-Aug 2006: 5.23%

• Tier 2: mid BBB ratings or A2/P2 • Near LIBOR rate(72 points +)• Market less deep, less liquid,

smaller fewer buyers greater risk

Commercial Paper Tier 2

234

smaller, fewer buyers, greater risk • Ceiling for issue maybe $6-8 billion

CP in Media Tier 2• Example: Walt Disney

company had in 2004 $4.5B CP at Tier 2 status

235

CP at Tier 2 status

Source: Fitch Revises Disney's Outlook to Stable; Affirms 'BBB+/F2' Ratings, Business Wire 2004

• Tier 3: Mid BBB -Smaller issues, $ 200- 300M-Well above LIBOR

236

Well above LIBOR -Example: Global Crossing

35

CP in Telecom• 2006: China Unicom, (mobile-

phone operator) issues $0.75B of commercial papers for

237

p pinvestments in 3G network

• 2006: Sprint Nextel issues CP for $2B

Source: China Unicom to sell 6b yuan notes to raise working capital; Operator's short-term debt sale follows US$1 billion bond deal with SK Telecom, South China Morning Post 2006

Current LIBOR Rates• 2008: 2.96%• January 2009: 2.09%• January 2010: 0.98%

239

E. Long Term Debt

240

E.(1). Corporate Bonds

(Public Debt)

Next Stage in Firm’s Development

•Firm is established enough to access long term

242

to access long-term corporate debt

•“Public Debt” is publicly traded

36

• Length to maturity- 3-30yrs

Long Term Corporate Bonds

243

- Some 100yr issue- <10ys: “note”- >10ys: debenture

• Many deals have “multi-tranche” maturities

http://www.durham21.co.uk/images/2002-2003/epiphany/1689/bonds.jpg

Long-Term Debt• Appropriate for companies with

steady cash flows, or strong growth prospects

244

• Examples: Cable TV, DBS, Wireless, Telecom

Call Feature• Some bonds allow the borrower

(“issuer”) to "call" the bonds- Pay back the bond's face value to

the investor prior to the maturity date

245

• The borrower will do this if interest rates drop, so it can refinance at a lower rate

• For that, they pay an premium in interest rate

246

• Viacom in 2006 held 99% of its debt in LT- Debt accounted for 52% of its

enterprise value

247

enterprise value.

• 2001 Deutsche Telekom issued €8 billion bonds to pay for 3G

bil h li

Media Examples for Long-Term Bonds

248

mobile phone licenses

• 2004 Korea Telecom issued 30 years $ 100 mil corporate bonds

Source: Financial Times, 5 September 2001,

Bonds are back as German companies turn to debt markets, http://global.factiva.com/

37

• 2006: Telecom Egypt issued 20 million Egyptian Pound callable bonds with maturity of 5 years.

249

Source: Investegate Jan. 2006

http://www.investegate.co.uk/Article.aspx?id=200601300726026060X

http://ir.telecomegypt.com.eg/Bonds.asp250

Public Debt Over the Life-Cycle of the Firm

Startups Early Growth Medium LargePublic Debt

251


E.(5). Ratings of Corporate f p

Bonds

The Rating Agencies• Credit quality based on

economic, financial and credit analysis

• There three firms are the

253

• There three firms are the market leaders in world credit rating market

• Rating agencies focus on the debt levels and cash flow

• Moody’s, S&P, and Fitch were three original Nationally Recognized Statistical Rating Organizations (NRSRO) recognized by the US SEC in 1975

254

• Dominion and A.M. Best are also now recognized as NRSROs• There are also second-tier and web-

based rating services254

US Credit – Fitch Ratings. Last accessed June 19. http://db.riskwaters.com/public/showPage.html?page=209190

38

Bond Quality RatingsMoody's Investor

Service, Inc.Standard &

Poor'sAaa AAAAa AAA A

Bonds with these ratings are termed

"investment grade"

255

Baa BBBBa BBB B

Caa CCCCa CCC C

D

investment grade

Bonds with these ratings are termed

"noninvestment grade", "high yield", or "junk"

• Bonds with an acceptable risk of default are Baa bonds and higher, (investment grade)

• Bonds rated Ba or lower are l ti d d h

256

speculative grade and have a higher risk of default

Credit Ratings of Major Media Firms 2006

Company Rating Approx. %AT&T A 5.50%CBS BBB 6.10%Comcast BBB+ 5.90%

257

News Corporation BBB 6.10%Time Warner BBB+ 5.90%Verizon A 5.50%Viacom BBB 6.10%Vodafone A- 5.70%Disney A- 5.70%

Source: Standard & Poor’s 2006

Cost of Debt of Major Media Firms 2006Company Approx. % Total Debt

in $BAnnual Cost of Debt in $B

AT&T 5.50% 30.47 1.68CBS 6.10% 7.04 0.43Comcast 5.90% 24.12 1.42

258

News Corporation 6.10% 11.43 0.70Time Warner 5.90% 23.47 1.38Verizon 5.50% 42.36 2.33Viacom 6.10% 7.66 0.47Vodafone 5.70 37.78 2.15Disney 5.70% 12.67 0.72

Source: Standard & Poor’s 2006, Yahoo Finance 2006

Annual Savings in Cost of Debt if Rating were AAA

Company Actual Annual Cost of Debt in $B

Annual Cost of Debt if rating AAA in $B

Annual Savings if rating AAA in $B

AT&T 1.68 1.52 0.16CBS 0.43 0.35 0.08

259

Comcast 1.42 1.21 0.21

News Corporation 0.70 0.57 0.13

Time Warner 1.38 1.17 0.21

Verizon 2.33 2.12 0.21

Viacom 0.47 0.38 0.09

Vodafone 2.15 1.89 0.26Disney 0.72 0.63 0.09

• Internationally most telecom monopolies rated AA

• But after some telcos took on huge debt spectrum auctions in 2000,

260

and acquisistions such as VoiceStream (T-Mobile)the credit ratings were cut for BT and DT to A3/A- and Ba1/A- from AA

39

Downgrading of Long Term Debt Rating

• BT, in 1998, only had debt of £1.5 billion, but in 2000 had £30 billi i d bt

261

30 billion in debt• Leverage (debt to equity) rose

to 220%

European Telecoms Borrowing Rate Rose

262

Downgrading of Long Term Debt Rating

• BT interest rates rose in 2000 alone by 1%

263

alone by 1% • On BT debt of £30 B, this is an

extra ~ £300 M/yr. in interest payments

Other Consequence of High Debt

• Some investors may not own bonds less than BBB and must sell

• Clauses in some bonds increase interest % i ld b d if fi d d d

264

% in old bonds if firms are downgraded

Public Debt Over the Life-Cycle of the Firm

Startups Early Growth Medium LargePublic Debt

265


E.(9). High Yield ‘Junk

Bonds’

40

High Yield(“Junk”) Bonds

267 268

http://store1.yimg.com/I/oldstocks_1742_27454282

Junk Bonds• A "high yield" or "junk" bond is

issued by a company with a higher credit risk than

269

higher credit risk than investment grade bonds

• Investment grade firms have debt up to ~ 3x EBITDA

270

• Junk bonds: 4-8x- Above 8x: hard to place

High-Yield Debt Over the Life Cycle of the Firm


271


Junk Bonds

Who Issues "Junk" Bonds?1. “rising stars” (new company)2. “fallen angels” (former blue

chip)

272

chip)3. companies that borrow heavily

to finance an acquisition or leverage buyout

41

• The average junk bond yields about twice as much as a comparable Treasury bond of

273

comparable Treasury bond of the same duration

Default Rates• Junk bond default rate ~3% -

4%Hi h i d t h

274

• Higher in downturn such as after 2000

Yield Premium for Junk Bonds

275Smith Barney Fixed Income Report, 9/04

• 1997-2001: over $4 trillion invested in Euro. and U.S. telecoms

• Wall Street threw $billions on entrepreneurs of telecoms

• Level 3 Communications: 1998 issued

276

largest junk bond offering of the ’90s, raising $2 billion, later $3 billion more

Disaster • 2002: 43.5% default rate on loans• Firms in bankruptcy• Banks lose hundreds of $millions

277

• Subsequent closing of debt financing market for telecom startups

Burns, Mairin, “Feet to the Fire: Distressed-debt investors force needed discipline on telecoms,” The Investment Dealers' Digest: IDD. New York: May 5, 2003. pg. 1 278

42

• In 2007, Alltel issued $7.7 bilworth of junk bonds to help fund the $27.5 billion buyout of Alltel by Texas Pacific

279

Group and Goldman Sachs

279

Davies, Paul J. “Alltel to launch record junk bond” June 14, 2007. Last accessed June 21, 2007. http://www.ft.com/cms/s/4efcec5e-1a9e-11dc-8bf0-000b5df10621.html

• The junk bond issue along with $15.5 bil in loans would help financed the leveraged buy-out (LBO)

280

• Bond issue became hard to sell by underwriter

280

Davies, Paul J. “Alltel to launch record junk bond” June 14, 2007. Last accessed June 21, 2007. http://www.ft.com/cms/s/4efcec5e-1a9e-11dc-8bf0-000b5df10621.html

• 1990s: Telecommunications and other growth companies borrowed heavily to finance their expansion plans.

Media Junk Bonds

281

p p• Many startups, --Covad, Qwest, Level 3 -

-raised $11 billion through “zero coupon” bonds- Defer interest for five years to be paid

upon final maturity

Junk Bonds - SunGard• In 2005 $11.3B leveraged buy-out

of SunGard Data Systems by a private equity consortium led by

282Eli M. Noam, Media Finance 282

private equity consortium led by Silver Lake Partner

• Financed by $1.25B in junk bonds in order to have high leverage

Source: SunGard to test market with Dollars 1.25bn junk bond HIGH-YIELD DEBT, Financial Times 2005

283

V.3 Short Term vs. Long Term Debt

284

43

• “Maturity analysis”: review of the pattern of future cash-flows from operations, and of financing requirements costs

285

g q(interest expenses and dividends).

Short-Term vs. Long Term• General principle: match funding

to life of asset• When is short term debt

appropriate?

286

pp p-Far project-oriented industries

TV programsFilm productionsGame and software

• Companies match amounts and timing of debt maturities to the respective projected dates of positive future cash-flows.

287

p• This process is called “duration

matching”: to match incomes and liabilities.

• Asset-liability mismatches can have unfavorable consequences

• If funds are raised before actually needed, the issuer suffers “negative arbitrage”, with interest earned on the deposited cash lower than

288

the deposited cash lower than borrower’s cost of funds.

• Or issuer needs to retire debt before the completion of the project

• If the firm’s income is particularly vulnerable to interest rate upswings, it will prefer long-term fixed-rate debt

• To reduce annual interest expense it could use debt with

289

expense, it could use debt with shorter maturities, and repay them with proceeds from fresh issues (“roll-over of debt”).

• For example, the company can roll its short-term commercial paper over and over again.

• Exposes the issuer to “roll-o er” risk

290

over” risk

44

• Long debt maturity (beyond investment maturity) would increase interest costs

291

increase interest costs, decreasing the value of the investment to equity holders

Aivazian, Varouj, “Debt maturity structure and firm investment,” Financial Management. Winter 2005. Last accessed July 18, 2007. http://findarticles.com/p/articles/mi_m4130/is_4_34/ai_n16083956 291

• Without knowing what investment opportunities are available in the future, the firm must decide on a capital

292

structure that minimizes costs while allowing the firm to invest in high NPV projects

• It is impractical for the firm to maintain some fixed LT/ST financing ratio that minimizes cost of capital

293

• However, even with the firm’s retained earnings smoothing the need for financing, there are incentives for the firm to

294

match investment maturity with financing maturity, to minimize costs while maximizing revenue

• Alternatively, if debt matures before investment maturity, the firm would have to turn over its short-term debt,

295

renegotiating with debt holders to acquire more capital

Aivazian, Varouj, “Debt maturity structure and firm investment,” Financial Management. Winter 2005. Last accessed July 18, 2007. http://findarticles.com/p/articles/mi_m4130/is_4_34/ai_n16083956 295

• However, in spite of these advantages of matching maturities, there are also incentives to not match

296

maturity

45

• The firm itself, when investing in a portfolio of projects, can naturally combine the projects so that each project does not

297

have to be financed individually

• If each investment is individually matched with financing, significant costs (logistical, time) are incurred

298

• Short term financing is often less expensive than long term financing

• In situations where the firm believes the invest rate will go down, it might be profitable to not lock in a relatively high

299

interest rate (although the firm could use long term floating debt)

• Large firms more LT debt• Highly regulated more LT debt• Intermediate credit risk (ie: TW

ith ti f BBB+) LT d bt

300

with rating of BBB+) LT debt• More growth options more ST

debt

Firm Size & Debt• It’s easier for large firms to

hold more LT debt.• Media examples:

301

- Verizon (93B Market Cap 2006) holds 40% LT debt

- Motorola (53B Market Cap 2006) holds 18% LT Debt

Regulation & Debt• Highly regulated firms hold

more LT Debt.TV/R di /Wi li

302

• TV/Radio/Wirelinetelecommunications are the most heavily regulated media industries.

46

• Disney, with diversified entertainment businesses, has more investment options. It held 18.5% ST debt, a

303

relatively high percentage compared to similar companies.

304

Growth Option & Debt

• Firms with more growth options tend to carry more

305

ST debt.• High-growth firms carry less

debt in capital structure.306

V.4. Impact of Short Term vs. Long Term Debt on

307

Term Debt on Media Company

Behavior

• A media company that must seek frequent re-financing is under greater performance pressure, under greater

b i d b

308

pressure not to be perceived to be risky and it needs to be non-risky, non-controversial in content, technology, labor relations.

47

• Greater time horizon for managers to create & innovate

• But investors require a risk premium for this loss of control

309

p• i.e., creative long-term

opportunity is also more expensive than short-term

310












XI. CONCLUSIONS 311

VI. Other Types of Ot e ypes o

Debt312

Other Types of Debt

1. Hybrid debt-equity2. Securitization3. Vendor and buyer finance4. Government

313

Other Types of Debt

1. Hybrid Debt EquityA. Convertible equity bondsq yB. Mezzanine financeC. Preferred stock

314

48

Convertible Bonds

315

• When a firm’s stock price is high, firms sometimes do not want to issue additional equity, which may be a sign that the

316

company believes its stock is overpriced

316

• Convertible bonds offer to investors the security of regular bonds, but with the option of converting to equity

317

if stock price goes up

317

• Example: In 2003, Sony issued ¥220B or $2B in euroyen convertible bonds, to raise cash to invest in next-gen

318

microchips as well as help finance a restructuring plan.

318

“Sony to Pump $2B for next-gen chips,” Information Technology News. December 2, 2003. Last accessed June 21, 2007. http://www.ciol.com/content/news/2003/103120201.asp

• Sony set the conversion premium at 48% higher than the current stock price

• These convertible bonds un-

319

convertible unless stock price reaches 110% of conversion price

319

“Sony to Pump $2B for next-gen chips,” Information Technology News. December 2, 2003. Last accessed June 21, 2007. http://www.ciol.com/content/news/2003/103120201.asp

• Convertible bonds are worth more than regular bonds, so Sony can sell them for more than regular bonds

320320

49

• Example: In 2001, France Telecom issued convertible bonds worth US $2.68bn to help reduce its debt.

321

• It issued convertibles because the equity market was depressed at the time, allowing high bond values if the market rose

321

Robert, Paul. “France Telecom Launches Mammoth $2.68 Bil. Bond Issue,” KaganResearch LLC. November 21, 2001. Last accessed June 21, 2007. www.kagan.com/archive/kagan/2001/11/21/20011121france.shtml

• Example: In 2004, Charter Communications. Announced a $750 million convertible bond offering to

322

million convertible bond offering to ease debt– its shares were traded at $2.75

http://www.businessweek.com/magazine/content/06_22/b3986081.htm?chan=search 322

• Shareholders hated it• stock continued to plunge by

20% when the market realized

323

that the deal’s conversion price would be $2.42 in 2009, i.e. a lower price thou 5 years later

http://www.businessweek.com/magazine/content/06_22/b3986081.htm?chan=search 323

Example for Convertible Bond• China Unicom sold $1 billion

convertible bond to SK Telecom

SK T l h h

324Source: WSJ 22 June 2006, SK Telecom Commits $1 Billion In Alliance With China Unicom

http://global.factiva.com/

• SK Telecom can exchange the bond after a year into a 6.67% equity stake in China Unicom

325

Another hybrid between debt and

Equity: Mezzanine q yFinancing

326

50

B. Mezzanine Finance (MF)• Term developed in UK in mid-1980s

for to describe arrangements that provide layer between senior debt and eq it in financing package

327

equity in financing package • May be short-term, interim financing• Riskier and more expensive –typically

1-3% higher than senior debt

• MF used extensively by private middle market companies and useful in financing for buyouts, recapitalizations, acquisitions and growth where there is a capital need

328

growth where there is a capital need beyond what the senior secured lender is willing to provide and more than the equity provider can afford or is willing to invest.

• Mezzanine financing is generally structured as subordinated debt with warrants with a term of less than three years.

• If the loan is not paid off the

329

pamount of warrants (to get convertible shares) is increased like an option

• Ranks below senior debt, but ahead of equity in entitlements to repayment

330

repayment• Includes both debt and equity

•2004 International Finance Corporation (IFC) of World Bank invested in TV3 Russia a terrestrial

Media Example for Mezzanine Finance

331

invested in TV3 Russia, a terrestrial broadcaster

•TV3 Russia structured $ 3.5 million by mezzanine financing(http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTINFORMATIONANDCOMMUNICATIONANDTECHNOLOGIES/0,,contentMDK:20709829~menuPK:1891839~pagePK:210058~piPK:210062~theSitePK:282823,00.html)

• 2006: Casema, major Dutch Cable TV, internet, and phone providers, sold a record €1 billion of mezzanine debt.

• Used for an acquisition by

332

• Used for an acquisition by buyout firms Warburg, Pincus, Cinven from Carlyle, GMT, and Providence Equity

Gutscher, Cecile. “Investors scramble for mezzanine seats,” Bloomberg News. January 18, 2007. Last accessed June 25, 2007. http://www.iht.com/articles/2007/01/17/bloomberg/bxinvest.php

332

51

• Casema offered interest at 9.25 percentage points above the euro interbank offered rate or

333

euro interbank offered rate, or euribor. That was triple the 3 percentage-point margin on its senior loans.Gutscher, Cecile. “Investors scramble for mezzanine seats,” Bloomberg News. January 18, 2007. Last accessed June 25, 2007. http://www.iht.com/articles/2007/01/17/bloomberg/bxinvest.php

333

• If Casema had tried to issue low-interest senior debt, there might not have been enough of

334

might not have been enough of a market in 2006

• Nobody would lend to them at the low interest of senior debt

334

Hybrid Debt Equity:C. Preferred Stock

• Receive a set dividend (interest)b i il

335

- becomes similar to a corporate bond except in bankruptcy claims.

For more details see Appendix C: see ppe d C:

Hybrid Debt

336

337

2. Securitization

Other Types of Debt

338

52

Problem for IP Originators (e.g. Artists):

• Intellectual property assets often illiquid

• Traditional lenders do not consider

339

Traditional lenders do not consider intellectual property as collateral

• But problem for artists: funds for upfront investment and expenses.

• Independent music producers or artists and labels must borrow capital for marketing -

Music

340

p gfor making videos, and promotion.

Securitization• Creates long term debt

investments by bundling short term projects.

• Securitization allows the owner

341

• Securitization allows the owner to keep 100% ownership of the assets being financed. It is not a sale, and no taxable event.

Securitization Over the Life-Cycle of a Firm


342


Securitization

Est. 25%

“Bowie Bonds”• David Bowie, Elton

John, Sting, others have issued publicly

343

have issued publicly traded bonds using future album revenues to back the debt issuance http://theland.antgear.com/sting.jpg

• David Bowie: $55 million

• James Brown: $30 million

344

$30 million • Rod Stewart• Michael

Jackson tried in 2003

Source: pullmanco.com

http://www.teenagewildlife.com/Appearances/Concerts/2001/0226/1109/xinfo/pics/reuters01.jpg

53

• Banks/investors lend against a future stream of bundled cash flows rather than against collateral assets

345

collateral assets-Music royalties-Projected movie revenues-Long term telecom traffic agreements

• Receives lump sum of payment for royalty payments that otherwise wouldn’t be received

346

otherwise wouldn’t be received for years to come.

Kane, Sean F, “Securitization May Work Beyond Music Royalty Income Stream,” Entertainment Law & Finance, Vol. 19:5, August 7, 2003. p.1-3

Securitization

• Owner/Originator of the intellectual property (IP) sells

347

p p y ( )these rights to a company Special Purpose Vehicle (SPV) for a lump sum


Pooling of Rights• But only few artists have revenue

stream consistent and large enough for securitization

348

enough for securitization• Problem solved by pooling several

IP rights together


• TVT Records issued bonds backed by future revenue from a catalog of record masters ($23 million)

• TVT could raise cash without i i it

349

giving up equity.• Most banks will only lend to major

labels, against royalty streams 70% - 80% of estimated future revenue.

• RZO provides loans as small as $500,000 to performers or composers.

• Financings of less than $15 million are “warehoused,” until they collectively amount to $50 million

350

collectively amount to $50 million.• Then packaged and sold, e.g. to

Prudential as a bond.• Prudential likely to hold the bond

until maturity

54

Securitization: Radio Stations

351

Radio Stations

Securitization: Radio Stations• Radio stations had trouble

financing acquisitions up to 1980s

352

• Could not use the FCC license (the most valuable asset of a station), as collateral for bank loans, and banks were reluctant to provide loans

• Hicks Muse, Infinity, Clear Channel and others therefore financed their borrowing to buy

353

financed their borrowing to buy stations into large station groups by securitizing their future earnings

Securitization: Books• Steinbeck estate – future

earnings

354John Steinbeck

http://www.uprod.music.umich.edu/past/01-02/images/drama/grapes/steinbeck.jpg

Securitization: Films• Dreamworks 2000: $ 540 Mil

by AmRe insurance company• Pools a slate of movies against

sale of security, with the future

355

y,revenue streams of all the films covering payment on securities.

http://www.salespromo.com/DreamWorks_logo.gif

Securitization: Film

356

55

• Disney issued bonds tied to performance of pictures - “Senior participating bonds”.

Securitization: Film

357

Senior participating bonds .- Smoothed earnings flows. Interest cap and floor.

• Hybrid, difficult to place.

Securitization: Film• Vivendi Universal: ~2000-2002

active securitization for shares of films

358

of films

Securitization: Telecom • 2001: Telecom Italia used

receipts from telephone bills as collateral against issuing

359

collateral against issuing bonds. (Europe’s first public telecom securitization)

Willams, Thomas, “Italian first points to bright future for telecoms securitization,” International Financial Law Review. London: Aug 2001.Vol.20, Iss. 8; pg. 22

• Deutsche Telecom and France Telecom followed Telecom Italia’s lead. -Securitization of $2-3 Bil

h

360

each.

Willams, Thomas, “Italian first points to bright future for telecoms securitization,” International Financial Law Review. London: Aug 2001.Vol.20, Iss. 8; pg. 22

Securitization Finance: Expensive

• Including transaction cost, has been estimated at 25%.

361

•“Bowie bonds” securitization did, so far, not become a major factor.

• Securitization is a type of off-balance sheet (OBS) financing.

• Neither the debt nor the assets securing the financing appear on the company’s balance sheet. By

362

p y yremoving debt financing from the balance sheet, securitization improves some companies’ financial ratios.

56

Impact of Securitization

363

Financing on Content?

• Favors established artists and firms with track record- David Bowie

364

- John Steinbeck- Telecom Italia- Madame Tussaud

365

3. Vendor And Buyer

Other Types of Debt Finance

366

Buyer Financing

• Short- term “Trade credit” (i.e., giving buyer a few months to pay) may provide a cushion during

Vendor Financing

367

a cushion during credit crunches

• Long-term vendor credit to clinch a deal


Lender Financing Production Loans

• In commercial lending, loans to low-risk firms (major studios) are ½% to 1% above the prime rate½% to 1% above the prime rate

• Small production companies pay 3% above the prime rate

• A typical bank financing deal for a firm ~7.4%

57

• Suppliers often have advantages over financial institutions in extending credit–they may have better private information about the business

–they may be able to use

369

y yleverage in terms of withholding future supplies

–may be better positioned to repossess and resell collateral


• Short term trade credit can be expensive.• typical trade credit arrangement makes

payment due in full in 30 days, but gives a 2% discount if payment is made within the first 10 days

• The implicit interest rate is 2% for 20 d 36%/

370

days, or 36%/yr.• But in some cases, vendor credit cheap,

as a sales tools.


Vendor Financing over the Life-Cycle of the Firm


371


Vendor Finance

Long-Term Vendor Financing in Telecom

• New entrant networks turned to large equipment vendors (Nortel, Cisco, Lucent, etc.) for financing of

372

, , ) gequipment purchases.

• Rates were usually low relative to risk: ~3% below interest paid to finance high yield bonds.

Vendor Financing in Telecom

• Shifts risk to equipment firms• When market for telecom turned

373

• When market for telecom turned, the equipment vendors were left holding the bag

• The theater owner once received 25-30% share of gross revenue for providing the house, stagehands, ushers, box-office staff, etc.

• By 1980s, theatre owners separated their

Vendor Finance in Theater:

374

By 1980s, theatre owners separated their landlord and risk-bearing roles and take a 2-part compensation fixed fee to cover the house expenses plus 5-10% of gross box-office revenues.

• i.e., they reduced their financing role • Source: Caves, Richard E. Creative Industries: Contracts Between Art and Commerce.

Cambridge: Harvard University Press, 2000

58

Vendor (or Buyer) Financing of Films

• Major sources for film finance- Distributors (studios)- Pre-sales from TV cable home

375

Pre sales from TV, cable, home video

- Photo laboratories

Retailer Financing

• Theater chain, cable or television networks put up

f it t

376

money for equity percentage participation in film’s revenue stream, for specific markets

One Reason for Vendor Financing in Film: the “Moral

Hazard” Problem• Who will lend when the artists gain

professional reputation from cost-increasing perfectionism thereby

377

increasing perfectionism, thereby increasing the cost and risk of project?

• Implication: Financing mostly from firms close to business (experts) and who do repeat business with producer, director, and artists

• Source: Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000

Presale Financing Deals• Licensing of the film’s rights to a

distributing media in a territory, before completion of film

• Can take form of funds

378

• Can take form of funds, guarantees, commitments, letters of commitment.

• Preselling deals can also bring future guaranteed minimum payments, which can be turned into bank loans, with h i i l di d il

379

the principal discounted until the film is distributed.


• Top talent agencies become financers of movie ventures by redistributing private equity

Agency Movie Financing*

redistributing private equity money and money of wealthy outsiders

380Hoffman, Claire. Talent agents get into film fundraising Los Angeles TimesNov 3, 2006

59

Studio PFD Deals(Production-Finance-Distribution)

381

Studio PFD Deals(Production-Finance-Distribution)

• The distributor agrees to lend the cost of producing the film, manage its distrib tion to some or all e hibition

382

distribution to some or all exhibition channels, and share with the producer and perhaps other participants the resulting net profits.


• A common split is 50% of profits to the studio, 50% to the producer and others

PFD Deals

383

pparticipating in net profits.


Alternative to Distributor Financing:

“Negative Pick-Up Deal”•Funding of film is independent

384

g pfrom the distributor

-“negative” refers to photographic negative

• Early “Negative Pickup”- Commitment by distributor to

purchase or license film distribution rights

“Negative Pick-Up Deal”

385

rights• This commitment by distributor

can be taken to commercial bank, use the pick-up letter as collateral, to borrow production funds from bank.

Advantages of Negative Pick-ups

• To distributor: no share in the risk of film running over budget

• To independent producer: removes

386

• To independent producer: removes risk of non-distribution

• To reduce risk, will favor producers with proven track record.

60

• Postponing a film’s distribution deal gives the advantage of offering a less uncertain product to the distributor and thereby getting

387

y g gbetter terms.

• But requires advance financing.


Class. Type of Finance DescriptionStudio Studio

development dealDistributor participation in earliest stage before all elements in place. Producer possibly employee of studio.

Studio Studio-based Independent company has

388

independent production company

headquarters at studio. Studio totally finance the company’s productions.

Studio Studio financing / distribution deal

Producer comes to studio withfully developed package. Studio finances production.

Studio Negative pickup deal

Studio agrees to pay for movie once it is finished in production. Producer uses this guarantee as

ll l f b k l S di

389

collateral for bank loan. Studio retains ancillary rights

Indep. Co-financing Studio pays for part of cost. Producer finds financing for rest. Studio does not retain all rights to film. Producer usually ownsnegative

Indep. Overseas Presale

Producer sells overseas and / or video rights to film. Uses

390

gadvances to finance film without obtaining domestic distributor.

Indep. Long-term independent finance

A producer arranges financing for a whole slate of films through an independent production company she runs

Indep. Single-film Producer arranges independent

391

p gindependent investor finance

g pinvestor financing, such as a limited partnership, just for one film

Indep. Self-finance Producer finances through personal savings, credit cards, and/or family. Primarily limited to small independently

392

limited to small independently distributed films

61

393

Impact of Vendor Financing on

394

gContent?

• Pre-sales require experienced sales agent to make presale arrangements.

• Talent agencies bundle foreign presale arrangements, intl co

395

productions deals, gov’t subsidies, etc.

• This arrangement favors established producers with track record.

• Projects that require financing by distributors of supplies give these distributors significant influence over

396

significant influence over content.- Hollywood studios and TV

networks over independent producers

• Distributors have superior access to cheaper financing since the riskiness of their portfolios is lower than that of each project.

• Even though the investment is sunk, they are distributors likely to push

397

they are distributors likely to push harder for films in which they have a financial stake, losting that investment looks bad for the studio managers.

• The right to make final editing (“final cut”) is an important right assigned in film financing contracts.

Di t ib t ll t i

398

• Distributors generally retain final cut for films they finance.

Fee, Edward “The costs of outside equity control: Evidence from Motion Picture financing decisions” from Journal of Business, 2002, vol. 75, no. 4

62

• In that way the distributor (studio) can make changes to make the film more commercially successful

399

commercially successful (happy endings, less ambiguity, less controversy.).


• In, contrast, Film makers choosing independent financing are often willing to sacrifice the higher monetary rewardsassociated with studio

400

associated with studio productions in exchange for the creative freedom associated with independent finance.Fee, Edward “The costs of outside equity control: Evidence from Motion Picture financing decisions” from Journal of Business, 2002, vol. 75, no. 4

• Movie producers are much more likely to face relinquishing control of artistic vision when financing a film h h di di ib

401

through a studio-distributor compared to obtaining independent funds

Fee, C. Edward, “The costs of outside equity control: evidence from motion picture financing decisions,” Journal of Business. October 2002. Vol75, Iss4.

401

• Independent financing is more often used for films in which the filmmaker’s artistic stake is high.

402

• The performance of these types of films suffer when financed by a studio


402

• It is important to note the difference between being independent financing, and independent distribution

• Independently financed films are

403

sometimes studio distributed, but not other way around (studio-financing but independently distributed)


403

• Studio financing sometimes demands daily screenings, cast approvals, script change approvals, etc

404

• Independent financing controls are less severe, are mostly budgeting


404

63

• Both studio and independent financing usually require professional standards

405

professional standards, insurance against deaths, lawsuits, damage, etc


405

• Independent financing sometimes has completion guarantor hired by the producer, who promises to step in and meet over budget issues, in

406

return for a 2.5% - 6% fee• Completion guarantor protects

budgetary interest of investorsFee, C. Edward, “The costs of outside equity control: evidence from motion picture financing decisions,” Journal of Business. October 2002. Vol75, Iss4.

406

• For studio financing, the studio usually owns the negative – can exploit film if new mediums emerge (eg pan + scan for t l i i )

407

television)• For independently financed films,

filmmaker retains ownershipFee, C. Edward, “The costs of outside equity control: evidence from motion picture financing decisions,” Journal of Business. October 2002. Vol75, Iss4.

407

• Independent financers of films more rarely try to affect the film because the investors are usually dispersed and do not

408

usually dispersed and do not have expertise, while studios are centralized and experienced


408

• Film Example 1: Mr. Jones

409


http://www.celebritywonder.com/cgi-bin/poster.cgi?width=8&height=10&listprice=5.9900&ourprice=5.9900&type=Photo&posterid=306310&url=http://www.allposters.com/IMAGES/73/039_66804_a.jpg

• The screenplay of Mr. Jones written by filmmaker Mike Figgis, was a dark story about the relationship between a manic-depressive man (Richard Gere).

410

p ( )• In test screenings, audiences did

not like Gere’s depressive side.


64

• Tristar (the studio-financer) therefore asked recut of movie by Figgis to de-emphasize the depressive side. Figgis refused,

411

and Tristar exercised its control and replaced him.


•Film Example 2: Rain Man

412


http://www.nada.kth.se/~johnny/rainman.gif

• At the airlines’ urging, United Artists(studio) cut scene in which Dustin Hoffman shouted airline crash statistics to avoid boarding a plane.

• Barry Levinson protested that the scene was crucial to the film’s plot

413

scene was crucial to the film s plot and characterization, but studio had contractual rights.


http://www.djfl.de/entertainment/stars/b/barry_levinson.jpg

Studio financing contract will also usually require a rating of

b tt th NC 17

414

better than NC-17.

• Financing contracts often specify minimum technical quality standards for the films’

415

quality standards for the films technical features, such as audio.


• Any financing contract will specify a budget and a deadline.

416Fee, Edward “The costs of outside equity control: Evidence from Motion Picture financing decisions” from Journal of Business, 2002, vol. 75, no. 4

65

• Require producers to insure the productions against hazards such as cast-member deaths, damage to the film stock, and

417

g ,so on.


• This tactic favors big-budget film as the profit on more modestly budgeted films would be consumed by the legal and

418

be consumed by the legal and administrative costs.

Source: http://en.wikipedia.org/wiki/Film_finance

419












XI. CONCLUSIONS 420

4.Government Fi i

Other Types of Debt

Financing

421

Government Financing Prevalent Around the World,

in• Film• Theater

422

• High tech• Public TV• Small business• Telecom

66

423

Government Film Financing• Many governments finance film

projects on grounds of cultural development- French CNC (Centre Nationale de la

424

- French CNC (Centre Nationale de la Cinematographie) ~$100m/yr

- India’s National Film Dev Corp.- EU Commission film subsidies

$850M/yr- Canada

Government Tax Incentives• French Sofica (Societes de

financement du cinema et de l’audiovisuel) provides tax

425

l’audiovisuel) provides tax write-offs of 50% for investments in film projects

• Lottery-funded film financing (~15 films/yr)

• All industry Fund – “voluntary” contribution of 0.5% of revenues from all

UK

426

companies whose business is exploitation of British films –exhibitors, distributors, video companies and broadcasters.- i.e., also from Hollywood distributors

• Skills Investment Fund, 0.5% of production costs up to $16.3m and 0.25% for those above this

427

level. Contributions voluntary but receipt of other public sector funding is conditional on contributing.

• UK: Tax breaks expanded, allowing 100% tax write-off of film production investment and

428

film production investment and acquisition costs in first year for films budgeted to $24.5m

67

Australia• Government money makes up

around 37 per cent of overall

429

investment.

Hancock, David, “Global Film Production

• http://www.deskflags.com/country/1000903.jpg

GERMAN FILM TAX LAWS

• German tax law permitted until 2006 the immediate deduction of the cost of creating "intangible" assets, including films.

Moore Esq., Schuyler, “The Next Wave of Film Financing: German Tax Shelter Funds-Government Activity” Los Angeles Business Journal, July 30, 2001

• Investors were able to immediately write off the entire cost of producing a filmfilm.


• This is in stark contrast to almost all other tax systems, which require the cost of creating a film to be amortized either over aamortized either over a number of years or as a percentage of revenues received (in order to match deductions and income).


• For example, if the debt/equity ratio is 1:1, the investor immediatelygets back more in taxgets back more in tax savings than the amount of the investor's actual cash investment


• Also the film does not have to be shot locally or employ locals to avail of this benefit.

• The film simply has to be owned by a German company that can share in the films profits.

68

• The Hollywood studio sells the copyrights of the film to a German company.

• The movie is then leased back with an option to repurchase in the future.

Epstein, Edward J, “How to Finance a Hollywood Blockbuster: Start with a German Tax Shelter”, Slate, April 5, 2005, http://www.slate.com/id/2117309/

• After 2005, increasing restrictions of German tax law

• Requirement that investors be at-risk

• Net benefit funds are waning and equity funds are gaining


EXAMPLE- LARA CROFT: TOMB RAIDER

EXAMPLE- LARA CROFT: TOMB RAIDER

• Paramount sold the copyrights of the film to a group of German investors for $94 $million through Tele-München Gruppe.


• Paramount raised another $65 million in pre-sales from the distribution rights of the Tomb Raider video game

• 6 countries- Japan, Britain, France, Germany, Italy, and Spain.


• The remainder $7 million of the budget was raised by licensing the US pay-TV rights to Showtime aTV rights to Showtime- a network owned by Paramount’s parent company Viacom.


69

• In this manner, although on paper Tomb Raider's budget was $94 million, the entire movie cost Paramount nothing of its own financial resources


• In contrast, a small budget film like Sideways would can not use many of the methods to pay off its much

ll b d f $16smaller budget of $16 million. Such an arrangement favors big films with an international appeal.


• German investors might not be interested

• Transaction and legal f f h lfees of such complex transactions are high


• Sideways, as a California story would not qualify for the British tax relief.


70

In the US, Federal Government Media and Communications Funding

• EDA (Economic Development Admin)• SBA (Small Business Admin)• NTIA (Nat. Telecom & Admin)• RUS (Rural Utilities Service)

447

• RUS (Rural Utilities Service)• Rural Telephone Bank (RTB)• CPB (Corp for Public Broadcasting)• ITVS (Independent TV Service)• Ex-Im Bank (exports)

- Similar programs by states and cities

Telecom/Broadband Rural Utilities Service

• A loan to finance the construction of broadband telecommunications services.

448

- to encourage telecom carriers to provide broadband service to rural consumers

• $100 million in treasury rate loans

The Corporation for Public Broadcasting

• Private nonprofit corporation created in 1967

• Public broadcasting's largest single

449

g g gsource of funds for creation.

• Funds >1,000 local public radio and television stations

Source: www.cpb.org

•A 10% tax credit or refund on a project’s spending in

New York

450

p j p gNew York.•Additional 5% tax credit if produced in New York City.

“California Considers Tax Breaks for Filming,” New York Times, August 18, 2005.

http://thebosh.com/archives/hide-and-seek.jpg

Impact of Government Financing on

451

Financing on Media Firms?

• Public funding usually tied (explicitly or implicitly) to:- Political balance- Quality- “national creature”

452

• But, content more likely to be controlled by appointees, or try to be inoffensive.- Similar for a system based on voluntary

donations

71

• Content – themes, team more likely to be controlled by appointees decisions, or try to be inoffensive.

453

- Similar for system based on voluntary donations

- Do not antagonize

• High quality “classics” and historic documentaries fit these constraints best

454

constraints best- “Jane Eyre,” “Baseball”

Con:• Restricted in how funds can be

spent; strings attached

455

spent; strings attached• Long application process• Harder to maintain trade secrets • Greater public scrutiny

For more details seeAppendix D:G tGovernment

FinancingEli M. Noam, Multichannel 456456

457

Other Types of Funding:of Funding:

Grants

72

Media/Arts Most Targeted for Private and Public Funding

• Museums and Historical Societies’ Exhibtions

• Public TV & Radio• Theater• Symphonies

LeClair, Mark S. and Gordon, Kelly. Corporate Support for Artistic and Cultural Activities: What Determines the Distribution of Corporate Giving? Journal of Cultural Economics, Kluwer 2000

Who funds the Arts in the U.S.?• Federal Funding – National Endowment

for the Arts (NEA)• Corporate Funding – exceeded federalCorporate Funding exceeded federal

funding by over 50% in 1992• Foundations


Funding the Arts in U.S. 1980-1994


Decline in Corporate Giving• By 2000, corporate giving has

significantly declined– Their main focus will always beTheir main focus will always be

returning value to their shareholders• Corporate funding for the arts still

exceeds federal funding by 20%


Funding Individuals Artists• Receive federal funding, but rarely

corporate funding• Corporate funding generally seeks toCorporate funding generally seeks to

enhance corporate networking and prestige– As a result, it is unlikely to be a force

of major cultural innovationLeClair, Mark S. and Gordon, Kelly. Corporate Support for Artistic and Cultural Activities: What Determines the Distribution of Corporate Giving? Journal of Cultural Economics, Kluwer 2000

Factors Affecting Corporate Giving

• Corporate image• Advertising• Pre tax profits• Pre-tax profits • Tax incentives• Business cycle fluctuations• Rivalry within an industryLeClair, Mark S. and Gordon, Kelly. Corporate Support for Artistic and Cultural Activities: What Determines the Distribution of Corporate Giving? Journal of Cultural Economics, Kluwer 2000

73

Non-Market Factors of Corporate Giving

• Size may be the most important, since larger companies may have more organized programs

• Relationships with communities p– Social responsibility is more important in

some countries than others• Interest level of management on firm’s

position within a community

Corporate Giving

to the Arts Per Industry


Model for Corporate Giving

• Three Factors for giving as a proportion to sales.– Advertising activity (indicates

competition and need for high profile) – Number of Employees – factor for

morale, employee retention, and local presence

– ProfitabilityLeClair, Mark S. and Gordon, Kelly. Corporate Support for Artistic and Cultural Activities: What Determines the Distribution of Corporate Giving? Journal of Cultural Economics, Kluwer 2000

Empirical Model for Corporate Giving


Findings• Corporate giving to the arts as a percentage of

sales grows with advertising expenditures, profitability, and employment.


Table Summary of Results


74

6. Lease Finance

Other Types of Debt

472

Lease-Back as a Source of Financing

• Leasing is an important financing vehicle• Instead of buying assets, enter into a long

term lease

473

• Leasing frees cash for working capital purposes

• Reduces debt on balance sheet- Long-term lease creates off-balance

sheet obligations

Leasing• Many companies lease some or all of

their equipment- Allows companies to conserve capital, keep

ith t h l d d

474

pace with technology, and expand purchasing power

• In the US, equipment under lease accounts for nearly 1/3 of total annual new equipment investment.

Advantages of Leases• Tax and accounting benefits• Sales tool• Arbitrage of credit risk between the

lessee and the lessor

475

lessee and the lessor• Payments do not show up on the

balance sheet as debt- Does not reduce the company’s

ability to borrow

LEASE FINANCE

http://www.laptopshop.co.uk/leasing/leasing_title.jpg

75

• Payments are tax deductible expense

• Contracts can transfer risk to

Advantages of Leases: Tax and Accounting Benefits

477

Contracts can transfer risk to parties who are able to bear them cheaply

• Possible to transfer tax benefits from lightly taxed to more highly taxed parties

Advantages of Leases: Sales Tool

• Equipment firms offer leasing through subsidiaries to market products

478

products

Advantages from Leasing

• Broader access to sophisticated financial instruments

479

• Arbitrage of the credit risk between the lessee and the lessor

• Movie theaters may lease new-generation digital projection equipment from a consortium of movie studios in return for a

480

share of ticket prices.

Matthews, Anna and Orwall, Bruce. “Bit Players: major studios discuss plans to equip theaters to show digital films.” Wall Street Journal, May 17, 2001. Last accessed June 25, 2007. http://proquest.umi.com/pqdweb?did=73072636&sid=10&Fmt=3&clientId=15403&RQT=309&VName=PQD 480

• Boeing also offered to lease digital equipment to theaters, along with use of its system of transmitting signals from studios to the theatersThi t ld ll th t

481

• This system would allow theaters to take care of Boeing’s technical expertise.

Matthews, Anna and Orwall, Bruce. “Bit Players: major studios discuss plans to equip theaters to show digital films.” Wall Street Journal, May 17, 2001. Last accessed June 25, 2007. http://proquest.umi.com/pqdweb?did=73072636&sid=10&Fmt=3&clientId=15403&RQT=309&VName=PQD 481

Lease-back leasing• Company A sells an asset to

Company B, then leases it back from Company B

482

p y• This type of leasing is

attractive for cash-flow or tax shelter purposes

482

76

• If a company is in need of immediate cash, a lease-back would be attractive

• The company can use the asset

483

p ywithout having excessive capital tied up in it

• In 2007, XM Satellite Radio entered into a lease-back agreement with Satellite Leasing LLC

484

• Sold and leased back a XM-4 satellite worth $288.5 million

“SEC Info – XM Satellite Radio Holdings,” SEC Info. February 13, 2007. Last accessed June 29, 2007. http://www.secinfo.com/d14D5a.uT7j.htm

484

UK Film Lease-Back

• Buying the ownership of a film from its producer, then leasing it back at a pre arranged cost thus

*

back at a pre-arranged cost, thus creating a fixed stream of revenue from investment

Richards, Matthew. "Lights, camera – and action for small investors," Financial Times, Dec 2006. 486












XI. CONCLUSIONS 487

VII. Risk Reduction

488

Reduction Strategies

77

• How can one reduce the riskiness

489

of investment in media projects?

Risk Reduction Strategy #1:

490

Insurance

Risk Reduction Strategy #1: Insurance

• 1.3% to 1.5% of a film budget spent on general insurance.

491

• Film must buy a completion bond, (an insurance policy, cost 3-5% of the budget.)

• Film must buy a completion bond, (an insurance policy, cost

492

3-5% of the budget.)

• The bond commits the guarantor to take over and finance/finish the shooting of a film if it has run over

493

some stated amount date or budget

• Guarantors typically charge 6% of production budget, with 3 % rebated if the guarantee is not invoked.

• The guarantor rarely steps in, but ensures financial prudence- Completion of film after Natalie Wood

494

- Completion of film after Natalie Wood drowning

• Can require special conditions- Chaperone for Courtney Love

Courtney Lovehttp://images.usatoday.com/life/_photos/2004/2004-03/16-courtney-love-inside.jpg

Natalie Wood

http://asterpro.bizhosting.com/graphic/thumbnails/12_4b_natalie_wood_t.jpg

78

495 496

•The bond enhances the credit quality of a product from subordinated debt (high risk) to

497

subordinated debt (high risk) to wards investment-grade level (lower risk).

498


499

gyShifting Risk

Shifting Risk• Shifting financial risk to

investors, performers, distributors TV channels

500

distributors, TV channels, foreign distributors

79

Risk Shifting• Push outside investors recovery

of investment to later stages of revenues (last-dollar)( )

• Whereas distributor gets to keep “first dollar to cover its various distribution changes, interest, loans, etc. 501

• The main participants typically take combinations of fixed compensation and a share of gross box-office receipts.

Theater: Actors’ Risk Sharing

502

ece pts.• Investors in a show divide 50% of

net profits among themselves; the other 50% goes to the producer.

Source: Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000

503


504


gyDiversification

• A studio or other media company pools numerous risky projects, making their aggregate cash flow

Risk Reduction Strategy #3:Diversification

505

making their aggregate cash flow reasonably safe for the lender.

• A venture capital fund pools numerous projects for investments


• If a company is producing many projects, each project will have an expected return

506http://www.amler.com/personal/graphix/Battlefield%20Earth.jpg

80

Portfolio expected rate of return =(fraction of portfolio in first asset *

expected rate of return on the first asset) +

(f ti f tf li i th d

507

(fraction of portfolio in the second asset * expected rate of return on the second asset) + etc.

The goal of diversification is to reduce the variances of the portfolio as a whole

508

portfolio as a whole.

• In order to estimate the rate at which the two stocks covary, multiply the deviation of asset a by the deviation of asset b in

h f i d h

509

each of N scenarios, and then average the products.

• Project Portfolio Balances- Among project age (life-cycle)- Among audiences (advertiser considerations)- Among projects (non-variance, risk factors)- Among cast (overall budget constraints)- Among project development stages (avoid

510

Among project development stages (avoid bunching)

Advantages of Product Variation:

• Gives studios a better chance of hitting a moving target

• reduces the risks of concentrating on

511

• reduces the risks of concentrating on the wrong market segment

• generates information on developing market trends

• But it also increases the number of flops

512

81

513

• In the early 2000s, big studios have encouraged hedge funds and other investors to back “slates” of several dozen films

514

spread many years.

“Hollywood’s new model,” Economist. March 15, 2007. Last accessed June 28, 2007. http://www.economist.com/business/displaystory.cfm?story_id=8853762

514

• Reliable money-makers such as “Harry Potter” or “Spider-Man” are not offered for investment.

515

are not offered for investment.


515

• 2006: Merrill Lynch estimates that outsiders to the film industry covered more than 30% of the cost of film

516

production.


516

For more details seeAppendix E:

Portfolio Diversification and Risk

Eli M. Noam, Multichannel 517517 518

82

4th Risk Reduction Strategy:

519

Strategy:Hedging

4th Risk Reduction Strategy:Hedging

• Using derivatives (futures, options, forwards, and swaps)

520

• Derivatives transfer risk from people who don't want to bear it to others who are willing to do so in return for the chance to

521

so in return for the chance to make a profit.

Examples of Common Derivative Contracts in Media

• Futures: Commodities, Foreign Exchange, (ie: telecom

522

Exchange, (ie: telecom bandwidth)

Futures vs. Forwards• Futures are highly standardized,

whereas each forward is uniqued d

523

• Futures are traded on an exchange, whereas forwardsalways trade OTC.

Futures vs. Options• A futures contract gives the

holder the right and the obligation to buy or sell.

524

• An option gives the buyer the right, but not the obligation, and the option writer (seller) the obligation, but not the right.

83

• A call option is an option to buy an item at a certain price.

• For example, a studio may have a call option to buy the

525

p yrights to a movie for a certain amount

525

• A put option is an option to sell an item at a certain price

• For example, an investing party may hold a put option to

526

p y y p pcancel an investment at any time

526

• Newspaper companies purchase options on paper to protect against changes in the prices

Example:

527

g p• Purchase options to buy paper at a

certain price. If the market price exceeds that price, they exercise them

• A film option is a contractual agreement between a movie studio, or a production company, and a writer, in

528

company, and a writer, in which the producer obtains the right to buy a screenplay from the writer, before a certain date.

Example: • Paramount optioned a book by

Philip K. Dick.

529

• Sony Pictures optioned the book The Da Vinci Code.

• Central role of an option structure:-The investing party holds the

i h l l

530

g p yright to cancel at several defined steps

84

Example for Put Option• In 2002, KirchMedia, a huge

German privately owned media empire became insolvent andempire, became insolvent and was threatened with bankruptcy

• Had debts of almost €10 billion that it could not meet

531

James, Jennie, “Are you ready for your close-up, Mr. Kirch,” Time Manazine. February 4, 2002. Last accessed July 17, 2007. http://www.time.com/time/magazine/article/0,9171,198987,00.html

• KirchMedia had overinvested in pay-TV, especially in Kirch’s flagship pay-TV company, Premier

532

• Kirch had paid ₤1B each for rights to the World Cup and German football league, €1.6B for Formula One

Shah, Saeed, “Kirch Insolvency may allow Murdoch,” The Independent, April 9, 2002. Last accessed July 19, 2007. http://findarticles.com/p/articles/mi_qn4158/is_20020409/ai_n12614772

• Kirch sought an urgent injection of capital from a bunch of minority investors (including Murdoch) to

533

(including Murdoch) to restructure the company, in return for a controlling interest in the company


• However, Murdoch had a put option to sell back its 22% share of KirchPayTV back to

534

share of KirchPayTV back to Kirch for an estimated €1.3B-€1.7B


• Murdoch originally acquired the put option in 1999 when Murdoch’s company BSkyB

535

Murdoch’s company, BSkyB, invested $1.4B in Kirch’sKirchPayTV

Jack Enwing, Kerry Capell, “A big score for Murdoch?” BusinessWeek, April 8, 2002. Last accessed July 19, 2007. http://www.businessweek.com/magazine/content/02_14/b3777073.htm

• The put option may have been included in the deal for several possible reasons:

• Kirch may have strongly believed that the stock price would continue

536

rising• Murdoch may have had doubts on

the continued success of Kirch, and wanted a put option as a way to guarantee its ability to pull out

85

• If Murdoch exercised the option, it would effectively bankrupt KirchMedia

• Alternatively, Murdoch could

537

Alternatively, Murdoch could lever the put option to gain greater control of KirchMedia


• Murdoch could use the put option to either try to get his money back (by exercising the put option, he would be able to

ll th h i Ki hP TV

538

sell the shares in KirchPayTVfor significantly more than market value)

Harding, James, “Dream chance to teach the world Aussie rules: Taking control of the remnants of Leo Kirch's media empire may prove irresistible for Rupert Murdoch,” Financial Times, March 30, 2002. Last accessed July 17, 2007. http://search.ft.com/nonFtArticle?id=020330001545

• Alternatively, by leveraging the existence of the put option but not using it, Murdoch could gain control of KirchMedia

539


• In the end, Murdoch decided to exercise the put option try to get the money from his

540

get the money from his investment back, bankrupting KirchMedia


• By exercising the put option, BSkyB would have a higher claim to Kirch’s assets during bankruptcy

541

• Its 22% equity stake would have been worthless, since debt holders have higher claim than equity holders

• Firms with extensive foreign h t

Currency derivatives: for whom?

542

exchange-rate exposure• Firms with economies of scale in

hedging activities• Film and experimental TV• IT hardware

86

General Electric

Interest rate swaps, currency forwards and options, interest rate forwards, interest caps, floors, collars, equity warrants

Hewlett-Packard

Interest rate swaps, forward contracts and options, warrants

IBM Forward contracts, futures contracts, interest rate and currency swaps, options, caps, floors

543

y p , p , p ,Intel Warrants and equity conversion rights,

currency forward contracts, currency options, currency interest rates swaps and currency, investments and borrowings, currency forward contracts, equity options swaps or forward contracts

Microsoft Foreign currency options and forwards, options to hedge fair values on equity securities, options forwards and swaps to hedge interest rate risks, swaps and warrants to hedge credit risks

AT&T Interest rate swaps and interest rate forward contracts

Verizon Foreign currency forward, equity options,

544

interest rate swap agreements interest rate locks and basis swap agreements

Walt Disney Interest rate and cross currency swap agreements, forward, option and “swaption” contracts and interest rate caps

Example of Media Derivative:A $400 million, 7-year Eurobond issued in 1992 by Disney.

545

y• The interest rate was tied to the

revenues from a combination of 13 Disney movies released in Europe.

Don M. Chance, Eric Hillebrand, Jimmy E. Hilliard, “Pricing an option on a Non-decreasing Asset Value: An application to Movie Revenue” Dec 16, 2005

• The rate was set at 7% for first 18 months.

• Beyond that date, the interest payment (coupon) was set at a f l l d h i

546

formula related to the movie revenues.

• The total rate would end up being between 3% and 13.5%.Don M. Chance, Eric Hillebrand, Jimmy E. Hilliard, “Pricing an option on a

Non-decreasing Asset Value: An application to Movie Revenue” Dec 16, 2005

Forward Trading in Telecom Bandwidth

• Possibility to buy or sell big blocks of excess bandwidth

547

of excess bandwidth • Players, such as Arbinet-thexchange

or InvisibleHand Networks

Source: Arbinet to Telecom Firms, The Wall Street Journal 2000

Arbinet

• Members log in price and quality of product and specify the route

548

the route• Revenue in 2005 $530Mln

Source: Arbinet to Telecom Firms, The Wall Street Journal 2000

87

Arbinet• Trades routes and settles

wholesale capacity• 375 members

549

• 13 billion minute annual run-rate• 20% of the minutes on Arbinet

are VoIP Source: Arbinet sees market fracture further, Telecommunications International 2005

InvisibleHand Networks• InvisibleHand provides a

software platform in order to price and allocate bandwidth

550

price and allocate bandwidth• Bandwidth is turned into a

commodity and can be traded

Source: InvisibleHand Networks 2006; Merkato Enables Dynamic, Real-Time Bandwidth Marketplace, Streaming Media 2005

InvisibleHand Networks• Prices are settled every 5

minutes • Based on a progressive auction

551

of IP bandwidth• They charge a one-time-fee of

$200 per accountSource: Merkato Enables Dynamic, Real-Time Bandwidth Marketplace, Streaming Media 2005; InvisibleHand Networks 2006

InvisibleHand Networks• InvisibleHand sells its platform to

telecommunication companies which can provide it to their customers

552

cus o e s• Telefonica, a telecommunication

company with $38B in 2005, for instance deploys it for its wholesale services

Source: Telefonica Deploys Invisible Hand's Merkato, 2003 Business Wire

XConnect• Interconnection between

VoBBs i h bli i h d

553

• Bypassing the public switched telephone network

Source: IBASIS, NEXTONE & YAK JOIN XCONNECT FOR NORTH AMERICAN LAUNCH, Networks Update 2005

iBasis• VoIP trading, in which the

Company connects buyers and sellers of international

554

sellers of international telecommunications services

Source: Arbinet faces steep climb, Daily Deal 2006; iBasis 2006

88

Pretense Media Derivatives

• “Virtual” derivatives on movies can be traded on the

555

Hollywood Stock Exchange• All trading is based on fictional

money.Wikipedia: http://en.wikipedia.org/wiki/Hollywood_Stock_Exchange

• Stocks and options on movies can be purchased and sold.

• The exchange also offers “bonds” on actors and actresses

556

bonds on actors and actresses in which value is accrued based on revenue generated by their movies.

Wikipedia: http://en.wikipedia.org/wiki/Hollywood_Stock_Exchange

557

5. The Impact of Debt Financing


Debt Financing on Content

558

• Lenders for a media project do not usually require profit maximization, only financial soundness

• No high upside needed, just no downside


• Will therefore give management more autonomy, as long as financial basics are ok, relative to equity holders such as financial institutions investing in growth. 559

• But less risk taking for radical innovation than for internal funding (small and medium


funding (small and medium range)

560

89

Impact of Secured Debt on Content

• The more secured a lender is, thethe –greater support of risky activities by firm in content, technology, etc.

• Content productions will rarely have collateral of value until near completion.–Could have a slate of films as collateral

–Which means that larger films can get higher risk content funded

• Where no collateral, lenders will want–Low risk content production–Insurance, risk-shifting–Collaboration with competitors

• Projects founded by debt are often bound by covenants, which are usually financial but could also could be content-

564

related

564

• Film covenants may be bound by covenants requiring certain ratings (G, PG, PG13, etc) or the participation of certain

565

stars

565

For more details seeAppendix F:Impact ofImpact of

Financing on Content

Eli M. Noam, Multichannel 566566

90

567 568












XI. CONCLUSIONS 569

VIII. Equity

570

Financing

Types of Equity Arrangements1. Partnerships2. Private Equity3. Venture Capital

571

3. Ve tu e Cap ta4. Public Equity

Sources of Equity for Small Business

(~ 50% of total funding in America)

572

Principal owner

angel finance

venture capital

other equity

total equity

31% 4% 2% 13% 50%Allen N. Berger, Gregory F. Udell, “The Economics of Small Business Finance: The Roles of Private Equity and Debt Markets in the Financial Growth Cycle,” Journal of Banking and Finance, Volume 22, 1998

91

Equity• Tends to be an expensive form of

financing for a company • For investor, higher risk than debt,

since total loss of investment a ibili

573

possibility• But offers greater upside• Startups and Internet firms are

mostly financed with equity

Why Sell Equity?• Raise capital• Increase liquidity of ownership• Avoid debt

574

• Pay off existing debt • Create an acquisition currency• Address estate planning issues

•When large amount of new financing is needed

•No automatic commitment to

Equity Advantages

575

No au o a c co e opay interest or capital

Disadvantages of Equity

• transaction costs (underwriting)• Dilution of control

576Lynch, Richard, Corporate Strategy. Harlow: FT

Prentice Hall, 2003, p.288.

• If company liquidated, others are ahead of common stock holders in right to repayment from selling off company assets

• In return for high risk, earn hi h d d d h

577

highest rewards earned and share in company profits after preferred dividend paid

• Usually have main voting rights and mgmt accountable to them

Different Stock Classes• Class A stock: held by

entrepreneur/mgmt/controlling family and carry most t kh ld ti i ht

578

stockholder voting rights• Class B stock: common stock.

Fewer voting rights, often, larger dividend entitlements

92

Media Finance - Voting Stock

• NewsCorp 27.4% (Rupert Murdoch)• Viacom 36% (Sumner Redstone) • Comcast (Roberts family owns 1 2%• Comcast (Roberts family owns 1–2%

of outstanding shares but 33% of voting stock)

• Barnes & Noble 19.8% (Leonard Riggio).

Media Finance - Voting Stock• In other cases, companies are held by

dynasties: • Cox (66%); • New York Times Co. 35%

(Ochs/Sulzberger) • Washington Post Co. 35.4%

(Meyer/Graham)

Example: Cablevision• Controlled by the Dolan family

which owns about 20% of Cablevision and 74% ofCablevision and 74% of corporate voting rights through ownership of preferred stock

http://www.businessweek.com/ap/financialnews/D8MNS4580.htm?chan=search

Media Finance - Voting Stock

• Bertelsmann (100% through a Mohn family-dominated foundation;

• Hearst 47.8%; Advance 75%, (Newhouse family);

• and Tribune 27%, (Medill and Chandler families, with ownership transferred to Sam Zell and the employees’ stock ownership plan).

583

VIII.3. Partnerships

584

93

Why Partnership?• Pooling of skills, resources, and

information

585Source:www.nolo.com

http://www.roseint.com/clients/images/partnership.jpg

Partnership Taxes• Partnership itself does not pay

income taxes on profits• A partnership is not a separate

586

p p ptax entity from its owners; it is “pass-through entity,” to each of the partners, who reports their share of profit

Source:www.nolo.com

The Uniform Partnership Act• States in U.S. have laws

governing partnerships-controls aspects of partnership unless spelled out different in

587

unless spelled out different in a written partnership agreement

Source:www.nolo.com

Two Types of Partnerships1. General partnerships: All

partners have a say in the day-to-day management

588

y g• Each partner is personally liable

for the entire amount of any business-related obligations

Source:www.nolo.com

2. Limited partnerships: At least one general partner is responsible for day-to-day management, and is personally liable for business dealings.Li it d t t ib t it l

589

• Limited partners contribute capital but have minimal control over business operations.- In return personal liability is capped at

the amount of investmentSource:www.nolo.com

• limited partnership is structured to address problems of asymmetric information and to align the

590

incentives of the general partners and the limited partners.


94

Limited-Partnerships in Media

• Cable TV• Film

591

• Early stage technology venture• Theater

• For cable TV: popular in 1980s- Jones Intercable $1.2 B retail

partnerships

Cable TV Partnerships

592

- 8-10 cable systems per partnership• Advantages:

- raises money fast, then buy partners out.

• Jones 20-30 cable TV partnerships, each ~5-6 systems.

Glenn Jones

593

- ~15% annual return• Not used much anymore• No strong tax angle after 1986

• Few movie partnerships have historically returned better than 10% to 15% annually. But occasionally they generate high profits

• Usually better to invest directly

594

• Usually better to invest directly in the common stocks of the production or distribution companies, and with greater liquidity

• However, investing in film partnerships often seen as

595

“glamorous”

• Film limited partnerships are popular in many countries with tax shelters

596

tax shelters

95

-Before 1976 and 1986 tax reforms, movie limited partnerships were among the best tax shelters

Film Limited Partnerships

597

best tax-shelters-Now, “passive losses” from tax shelters could no longer be used to offset income from wages, salaries, interest, and dividends

Limited Partnerships in Media

• Equity Pictures one of biggest German media investors

• Overall fond volume €310 M

598

• Overall fond volume €310 M• Issued 4 media funds as LPs• Financed movies such as Hostage,

Lonely Hearts or The Black Dahlia

Source: Equity Pictures 2006, News Aktuell 2006

• Limited Partnerships often used in private equity and in hedge funds

599

funds

• Broadway “angels” are individual investors with a strong personal interest in the

Theater Limited Partnerships

600

strong personal interest in the theater

• Aggregate pecuniary returns on theater limited partner (angel) investments - below normal

• A study of 948 shows produced in the seasons of 1972 - 1982 showed an

601

aggregate loss of $66.6 million on a total investment of $267.5 million

• (But omits several hits)• Source: Caves, Richard E. Creative Industries: Contracts Between Art and Commerce.

Cambridge: Harvard University Press, 2000

Angel Partners in High-Tech

• Typically individual (or

602

sometimes firm) specializing in high-risk, early-stage investments

• Term borrowed from theater

96

• Angel is a source of early stage capital

• Angel can also be advisor, mentor, and facilitator

603

• Angel likely to be individual with entrepreneurial experience

• Angel Capital Network, (ACE-Net) (www.ace-net.org).

• ACE-Net is online service where small businesses can list

604

securities offerings for review by qualified angel investors

• Subject to securities laws

Angel Finance in the Life Cycle of the Firm


A l Fi

605


Angel Finance

Richards, Matthew. "Lights, camera – and action for small investors," Financial Times, Dec 2006.

Incentives for individual investors (UK)

• Individual investors account for about 10% of the sector’s financingAlth h t t b k l th• Although most get back less than invested (an average capital loss of 20%), tax breaks enable investors to reduce tax bills


Income tax relief attracts investors

• Income of £100,000 in a tax year & an investment of £30,000 in a film means only £70 000 offilm means only £70,000 of income is taxable

• With a top income tax rate of 40%, savings equate £12,000


97

Schemes act to defer a tax payment, not avoid entirely

• However, investors pay tax on income received from the film in later yearslater years


Impact of Limited Partnerships on Content and Conduct

• Limited role to investors by law of “limited” partnership

610

of limited partnership• Potential large role of general

partner- Can be the manager, or an

investor

611

VIII.4. Private Equity

612

Equity

A. Private Equity Funding Sources

613

Funding Sources

Private Equity• Private equity is an important

source of funds for new firms, financially distressed firms, private mid-market firms, publicprivate mid market firms, public firms in need of buyout capital, firms seeking to reduce regulation and become a target for acquisition, and large shareholders who want to gain full control 614

98

Private Equity• Mostly small companies,

untraded stocki• Start-ups on way to going

public• Large companies withdrawing

from public trading615

• More recently many large and mature firms have been returned from public to privatereturned from public to private equity in attempt to re-create a growth phase

616

Private Equity• Small investments, small overall

amounts• Friends and family (due diligence

process less rigorous)• Less red tape time and expense

617

• Less red tape, time and expense of public offering registration

• But, there is no active market for shares

• Less information and liquid on stock

Private Equity in the Life-Cycle of the Firm


618

p y g


Private Equity

Private Equity• Basically, stock that does not trade

in public exchanges• Used to be for smaller firms

619

• Used to be for smaller firms• Increasingly, for large companies

to avoid regulatory scrutiny.

• Private equity deals motivated by a desire to escape regulation and disclosure requirements of public companies.

620

• This reduces the transparency of the economy, even if companies become more efficient.

Noam, Eli. “Private Equity is a Problem for Public Media,” Financial Times. February 19, 2007.

620

99

Private Equity Funding Sources• Private Equity firms draw money for their funds from organizations and

individuals who invest professionally:

• insurance companies, • depository institutions,• pension funds, • Private Equity Firms1,

These Limited Partnerships or LP’s are the driving force

behind Private Equity Funds.

The lure of 25% returns is

621

• Government agencies• Fund of funds • mutual funds, • endowment funds. • Wealthy investors

There are currently approximately 2,744 LP’s with around $896 Billion2

allocated to Private Equity (includes VC, PE and Buyout)

The lure of 25% returns is attracting many new players to

Private Equity as an investment vehicle

Source(s): VCExperts.com1Some Private equity shops invest in other funds in addition to their primary direct investments2 Figures are according to Private Equity Intelligence (PEI) database

Top Private Equity Firms (by volume)

1) J.P. Morgan Partners Global 2001 fund2) Blackstone Capital Partners IV3) Thomas H. Lee Equity Funds4) KKR Associates 1996 Fund

)

622

5) TPG Partners IV6) KKR Associates 1987 Fund7) KKR Millennium Fund8) DLJ Merchant Banking Partners9) Warburg Pincus Private Equity VIII10) Goldman Sachs Capital Partners 2000

Source: CFO.com

• Mutual funds that invest in other mutual funds.

- invest in wide ranges of assets managed by other asset managers.

Funds of Funds of PE

623

• These funds are the largest source of private equity money, investing $325 B in PE.

Source(s): “2005 Limited Partner Universe”; 2005 Private Equity Intelligence

B. Leveraged

624

Buyouts

PE for Leveraged Buyouts• A LBO is an acquisition strategy in which

companies or investors buy other companies using mostly debt (often 90% debt)

*

625

• The acquiring firm repays this debt usually through collateralizing the target’s assets, and using the target’s future revenues to make payments on the debt.

C. PE in Media

626

Industry

Ronald Grover, “Vivendi Ups the Ante” from BusinessWeek, July 2, 2003

100

Media companies have been particularly attractive to private equity investors

627

private equity investors

2006-8 Media PE• $11.6 billion for VNU• $18.7 billion for Clear Channel

and $13 billion for Univision. Kohlberg Kravis Roberts and

628

Kohlberg Kravis Roberts and• ProSiebenSat 1 for $7.6 billion• SBS satellite broadcaster

(Luxembourg) Jill Goldsmith, “Hollywood edgy about Stealth Wealth,” Dec. 17, 2006, http://www.variety.com/article/VR1117955885.html?categoryid=18&cs=1

Financial Success for PE

• The new owners slashed staff and cut acts

• WMG went public in 2006 and

629

• WMG went public in 2006 and soon had a market cap of $3.6 billion.

• But then, its shares dropped alotJill Goldsmith, “Hollywood edgy about Stealth Wealth,” Dec. 17, 2006, http://www.variety.com/article/VR1117955885.html?categoryid=18&cs=1

Example for Private Equity DealsParts of MGM were bought by private-equity firms, (Sony bought the rest)

630

g )

“Business: A different breed of mogul; Private equity and the media business.” The Economist. London: Feb 26, 2005. Vol. 374, Iss.8415; pg.69

PE in Media Industry

• 2005, a KKR venture made a friendly takeover bid for

631

friendly takeover bid for Vivendi, a media giant with market cap of $40 billion.

Ronald Grover, “Vivendi Ups the Ante” from BusinessWeek, July 2, 2003

• 2002 PE partnerships vied for control of Spanish-language media giant Univision.

• 2006: The management of

632

• 2006: The management of Emmis Radio offered to take the company private for $567 million.Steve Rosenbush, “Private Equity’s Media Targets” from BusinessWeek, May 17, 2006

101

• Bertelsmann acquired back for $5.8 billion a 25.1% stake held by Group Bruxelles Lambert (GBL), in 2006.

633

- Took back company private- buyback freed Bertelsmann from the

prospect of an IPO for the stake.

Houston Chronicle: http://www.chron.com/disp/story.mpl/ap/fn/4023310.html

• 2005 Financier Carl Icahn’s hedge fund and some allies (Franklin Mutual Advisors, JANA Partners, and SAC Capital) tried to take control of Time Warner

634

control of Time Warner.

Steve Rosenbush, “Private Equity’s Media Targets” from BusinessWeek, May 17, 2006

• Largest tech deal in 2005:Silver Lake Partners and Bain Capital acquired SunGuard Data Systems Inc. (SDS) for

635

y ( )$11.3 billion in cash and assumed debt.

Private Equity Deal Structure SunGard

• SunGard is a software vendor and solution provider for financial services, higher education and the


public sector

Source: SunGard connects recovery facilities across the UK with THUS' National Ethernet Network, Total Telecom 2006

Example Private Equity Deal Structure

• PE consortium consisted of Bain Capital, Blackstone,


Kohlberg Kravis Roberts, Texas Pacific Group, Goldman Sachs Capital Partners and Providence Equity Partners

Source: SunGard set to agree Dollars 11bn bid, Financial Times 2005

Example Private Equity Deal Structure

• Deal includes –$2B in junk bonds–$4B term loan

*


–$4B term loan–$1B revolving facility –$3B in bonds –$10B total debt

Source: SunGard to test market with Dollars 1.25bn junk bond HIGH-YIELD DEBT, Financial Times 2005

102

Other PE Deals in Media• Warner Music• VNU

F il d C bl i i

639

• Failed: Cablevision• Cox• Clear Channel

• Venture capital based media company Journal Register Company (1990), became America’s 22nd largest newspaper chain.

640

- Debt to build the company through acquisitions and convert to a public company.

- (formed by Warburg, Pincus, & Co.)

Dennis Derrick, “Media Management in the Age of Giants,” Iowa State Presshttp://www.21stcenturynewspapers.com/header/head_logo.gif

PE in film projects• Private equity firm Clarity Partners

LP • Focused on investments in

*

641

communications and media • Partner of Crescent Entertainment a

television and film production company - TV Series “Terminal City”

Source: Clarity Partners 2006, http://www.claritypartners.net/portfolio.html#

PE in film projects Limited Partnership in Media

• Crescent Entertainment - Movies such as “Showdown at

Willi C k” Mi

642

Williams Creek” or Mirage

Source: Crescent Entertainment 2006, http://www.crescent.ca/

PE Not Always Successful• Quadrangle Group, founded by

longtime media banker and former chairman of Lazard Freres, Stevechairman of Lazard Freres, Steve Rattner, acquired a video company called Good Times Media in 2003 for $90 million plus the assumption of $160 million in debt.

643

PE Not Always Successful

• In 2005, Good Times filed for bankruptcy and was acquired by a concern called Gaiam for $40

illi

644

million.

Jill Goldsmith, “Hollywood edgy about Stealth Wealth,” Dec. 17, 2006, http://www.variety.com/article/VR1117955885.html?categoryid=18&cs=1

103

Financial Success for PE• Warner Music acquired from

Time Warner in 2004 for $2.6 billion by Edgar Bronfman Jr., P id B i C it l d

645

Providence, Bain Capital and Thomas H. Lee


D. Major Telecom PE D lPE Deals

646

1. PE Acquisition of Danish National Telecom Company-

TDC• Consortium including Blackstone,

Kohlberg Kravis Roberts, Apax

647

Kohlberg Kravis Roberts, Apax Partners and Permira purchased Denmark's largest telecommunications company, TDC (13 Mln customers throughout Europe, espec. Denmark and Switzerland) for $15.3B in 2005

Source: The New York Times 2005

Example PE - TDC• $12 bil in cash • Purchase price includes a 39.3

percent premium to the

648

company's share price before announcement of a possible deal

• Largest private equity deal in Europe to that time

Source: The New York Times 2005

• The Private Equity firm, Babcock & Brown Capital Limited, (shareholder) acquired the Irish National Phone Company Eircom by using senior debt.

2. Irish National Telecom Eircom debt financing package

649

• € 4 Billion Eircom debt financing package included € 3.5 Billion senior debt– Credit Suisse, Deutsche Bank and JP

Morgan– Moodys and S&P ratings of Ba3 / BB


http://en.wikipedia.org/wiki/Eircom

104

• Term Loan A € 650 Million – Maturity 8 years

• Term Loan B € 1,250 Million– Maturity 7 years

T L C € 1 250 Milli

PE Acquisition of Irish National Telecom Company

651

• Term Loan C € 1,250 Million– Maturity 9 years

• Total First Lien Debt € 3,150 Million• Second Lien € 350 Million

– Maturity 9.5 years• Senior Debt € 3.5 Billion



• Eircom debt financing package

Term Loan B

Term Loan A

Term Loan C

First Lien Debt

652Source: http://investorrelations.eircom.net/news/rns_369.htm


Second Lien Debt

Senior Debt

Total First Lien Debt € 3,150 Million

•Second Lien € 350 MillionSenior Debt € 3.5 Billion

3. Canadian #1 National Telecom Company

• 2007: PE acquisition of the major Canadian Telecom Company Bell CanadaCompany Bell Canada

• Buyer: Ontario Teacher Retirement Fund and Wall Street Funds

653

E. Private Equity

654

in Film

Sources: Broadcasting & Cable, BusinessWeek, Media Week, Wall Street Journal

Private Equity in Film• Historically, Private equity

firms have not invested in Hollywood, because of lack of h d d d h

655

hard assets and steady cash flows. They have typically invested in TV stations, newspapers, movie theaters, etc. Sources: Broadcasting & Cable, BusinessWeek, Media Week, Wall Street Journal

• Texas Pacific Group owns a big chunk of MGM (and therefore part of Tom Cruise's newly

656

part of Tom Cruise's newly reconstituted United Artists),


105

• Thanks to Goldman Sachs, Bob and Harvey Weinstein were able to set up a new film studio just two months after

657

they left Disney in 2005.


657 658

F. Impact of PE Acquisitions on

Content

659

• Private equity deals often lead to a break-up of media conglomerates to reduce debt that paid for the acquisition.

660

• Clear Channel (previously very concentrated) is selling off almost half of its 1,100 radio stations.


660

• Unlike start-up venture capital, this kind of private equity is basically conservative in its search for cash flows to meet

661

debt payments and position the company for resale.


661

• It is also short-term orientated and unlikely to undertake big upgrades of communications infrastructure that have long-

662

term benefits for the economy.


662

106

• Regular institutional investors (eg Fidelity), own most of the largest US media companies

• But they rarely interfere with

663

y ymanagers beyond pressure to keep the stock price up.


663

• In contrast, private equity funds’ management company controls the acquired media company fully and often

664

installs new management with tough performance mandates.


664

• Increasingly, private equity fund partners play a hands-on operational role beyond the merely financial.

665


665

Cost Cutting

• VNU, which owns the Hollywood Reporter and Billboard, among other publications.

666

• Severe job cuts


• Other PE ventures are simirarly often financed by debt on the acquired company buy. In consequence, preoccupied withconsequence, preoccupied with repaying debt- Taking out salaries- Dividends and early payments- Going public or flipping to another PE

company 667

• Thomas H. Lee Partners, a $20bn Boston private equity firm that has acquired singly or in partnerships Clear Channel, U i i i VNU H ht

668

Univision, VNU, Houghton Mifflin and Warner Music, does not appear to maintain a website.


668

107

• No SEC filing requirements• Information is not available to

the press. • Securities analysts stop

669

Securities analysts stop following the stock.


669

PE is conservative,

670

,VC is innovative

671












XI. CONCLUSIONS 672

VIII.5. Venture

673

Venture Capital

VENTURE CAPITAL

http://khazaen.com/App_Themes/Khazaen/Images/imgHome.gif

108

Equity Types in the Life Cycle of a Firm


A l Fi V C i l

675


Angel Finance Venture Capital Public Equity

~25%

VCs• Finance new and rapidly growing

companies• Purchase equity securities• Assist in development of new

676

pproducts or services

• Add value by active participation• Take higher risks with expectation

of higher rewards• Have long-term orientation

VC Funds• Pools of capital, organized as

limited partnership, invests in companies that represent opportunity of high rate of returnHi h t h f

677

• High-tech focus• Limited involvement in media

Venture Capital• Venture capital firms invest in a

beginning company • VC takes a percentage of

678

• VC takes a percentage of ownership- Typically looks for a 35% to 40%

return on investment

• The managers of venture-capital funds take an almost-universal fee of “two and 20”; a 2% annual management fee

679

and up to 20% of any profits made by their funds. Angel investors set their own terms.

“Giving Ideas Wings,” Economist. Sept. 14, 2006. Last accessed June 20, http://www.economist.com/business/displaystory.cfm?story_id=7905466

679

• Skype was founded by Niklas Zennstrom and Janus Friis with help from investors, who invested €2m initially.

680

September 2005 Skype was bought by eBay €2.1 billion

“Giving Ideas Wings,” Economist. Sept. 14, 2006. Last accessed June 20, http://www.economist.com/business/displaystory.cfm?story_id=7905466

680

109

• In early days of VC in 50’s and 60’s, typical venture investors were rich individuals

• Venture firm emerged later as major investment vehicles

681

• public pension funds (26%), corporate pension funds (22%), commercial banks and lif i i

Sources for VC Funds

682

life insurance companies (18%), and endowments and foundations (12%).


• Prior to the 1980s, U.S. pension funds were effectively barred from any economically significant investment in venture capital because of the “prudent man rules”

683

prudent man rules


• However, in 1979 the U.S. Department of Labor reinterpreted the Employee Retirement Income Security Act (ERISA) to permit pension fund investment in venture capital if it did not endanger the

684

capital if it did not endanger the entire portfolio

• These and other regulatory changes led to a large increase in the flow of funds into venture capital


• The limited partners typically put up 98% or more of the funds and receive 80% of the partnership’s profits.

• The general partners receive 20% of the profits

685

20% of the profits


• Active involvement in the management of each of the portfolio companies

• Venture capitalists allocating more than 100 hours and

686

more than 100 hours and visiting each of their portfolio firms on average 19 times per year.


110

• During the later years of a fund’s life, much of the venture capitalist’s time is focused on “harvesting” portfolio firms.

i i i

687

• most attractive exit is typically through an IPO


• In general, only a minority of the firms in the fund’s portfolio will be successful enough to take public. The second best exit is by sale to another company. Alternatively if a portfolio firm

688

Alternatively, if a portfolio firm does not do well, it maybe put back to its original owners, or (in a worst-case scenario) liquidated.


• Venture Capital

689

“The Next IPOs,” SmartMoney. January 10, 2006. Last accessed July 11, 2007. http://www.smartmoney.com/barrons/index.cfm?story=20060110 689

The Life Cycle Venture Deal

Scherlis and Sahlman article, “A Method for Valuing High-risk, Long-term Investments – ‘Venture Capital Method” www.inventiontostartup.washington.edu/ppts/anderson.ppt

Venture Capital • Pros

-Operational guidance-Professional management

691

gexpertise

-Management involvement-Quick investment decisions

• Cons- Expensive form of financing (giving

up a big chunk of the firm)- Large number of VC investments

l i f d l f

692

means less time for development of any one company

- Impatient funding, VCs try to sell quickly

- Reduction of control

111

• VCs can be generalists, investing in various industrial sectors, or specialists- Industry sectors- In geographical locations

693

In geographical locations- Stages of company’s life

SeedEarly stageExpansion

Startup Financing Cycle

Source: http://en.wikipedia.org/wiki/Image:Startup_financing_cycle.JPG

• At every stage, the level of financing is very different in terms of the discount rate. Figuring out the exact discount rate to use is more art than science.

Junee, Ryan. “Startup Valuation-The VC Method.” 20 September 2006http://blog.ryanjunee.com/2006/09/startup-valuation-the-vc-method/

• Some approximate guidelines for discount rates based on the stage of the company are:

»Seed stage: 80%+ »Startup: 50-70%»Startup: 50 70% »First-Stage: 40-60% »Second-Stage: 30-50% »Bridge/Mezzanine: 20-35% »Public Expectations: 15-25%

Junee, Ryan. “Startup Valuation-The VC Method.” 20 September 2006http://blog.ryanjunee.com/2006/09/startup-valuation-the-vc-method/

Secondary VC funds• Secondary partnerships

emerged that purchase portfolios of existing venture

697

portfolios of existing venture firms and provide liquidity for original investors.

• Tertiary: “Fund of funds”

Also: Corporate VCs, by Large Companies• Deep pockets

• Seek to find investment opportunities that match

698

parent company’s strategy and provides synergy, new technology, people

112

Examples of corporate VCs include

• Intel: corporate development arm incubated startups and technologies. Intel’s portfolio included 200 companies worth $2 5 billion

699

companies worth $2.5 billion• Lucent: uses VC to scout for

cutting-edge technologies, targeting early stage companies in high-growth markets like wireless and data networking

• Corporate VC can introduce a more entrepreneurial spirit into the culture of the organization.

• Creates “half way” house for

7002000 Responsive Database Services, Inc, Industrial Research Institute, Inc.

• Creates half-way house for internal entrepreneurs to remain.

Desirable Factors to VC • Proprietary products, like patent • If product is not patentable,

first-to-market is advantage Hi h k t t ti l

701

• High market potential• Qualified, proven management

team • Ability to provide investor with

big returns

Venture Capital Stages• Funds are provided in stages,

-Seed - First Round - Second Round etc..

702

• More funds are provided only if performance objectives are met.

Venture Exit Strategy• Main goal is to see the portfolio

firm go public (IPO) be acquired or merged as soon as

703

possible

VC Exit• Once the stock is freely

tradable, VC distributes stock h h li i d

704

or cash to the limited partner investors.

113

Venture Capital Industry•Venture capital is a cyclical business, subject not only to internal dynamics, but to the

705

influence of external economic sources and to fluctuations in financial markets.

VC in media - MovieBeam• Movies are transmitted through

digital signals to a viewer's home

706

home • Walt Disney, Cisco Systems,

Intel and venture capital funds invested $48.5Mln

Source: Wall Street Journal 2006, The New York Times 2006

VC Investment Funds: Film •Not a major form of film financing

-VC film funds approve the budget, director, and lead actor

707

-Retains all rights, including theatrical, video and pay-per-view

-Not subordinate to any bank or lender

VC in media - ManiaTV• ManiaTV offers live free

programming including e.g. comedian’s Tom Green's live show

708

show• $12 Mln in its second round of

funding, for a total of $17 million

Source: Los Angeles Business Journal 2006, Newsletter of University of Texas at Dallas 2005

VC 2006• YouTube raised $11.5 million • Revver $17.3 million• Metacafe $15 million

709

Metacafe $15 million

Chris Gaither and Dawn C. Chmielewski.”Fears of Dot-Com Crash” Los Angeles Times. Los Angeles, Calif.: Jul 16, 2006. pg. A.1 at http://proquest.umi.com/pqdweb?did=1077578801&sid=2&Fmt=3&clientId=15403&RQT=309&VName=PQD 709 710

114

Impact of VC Finance on Media Content and

C d t

711

Conduct

Impact of VC Finance on Media Content and Conduct

• Significant monitoring by VC• Short term orientation

712

• Stress on patents

713












XI. CONCLUSIONS 714

VIII.6. Public Equity

715

Equity Types in the Life Cycle of a Firm


A l Fi V C i l

716


Angel Finance Venture Capital Public Equity

~25%

115

Why Issue Public Equity?• Present owners cannot or will not

increase capital contribution• Provide liquidity for present

stockholders

717

• Shift monitoring from private lenders to SEC

VIII.7. Initial Public Offerings

718

(IPOs)http://www.google.com/

A public offering:• The offer to sell

stock or bond securities to

719

securities to anyone who wants to buy them.

Advantages of an IPO• To raise capital as a source for

ongoing financing• Greater public exposure

G b i bili

*

720

• Greater borrowing capability• To retain staff, especially through

shock options• Prestige of being public

Source: www.meansbusiness.com

Disadvantages of going public

• Lack of operating confidentiality

i l f i

721

• Disclosure of remuneration packages and extensive company financial information


• High costs of going public- burdensome SEC reporting

requirements- legal fees- printing costs for prospectus

722

printing costs for prospectus- prestigious accounting firms and

investment bankers- Heckling by political groups and

pressure groups“The Business of Making Money,” The Economist. July 5, 2007. Last accessed July 5, 2007. http://www.economist.com/displaystory.cfm?story id=9440821

116

• Normally, management team/entrepreneur owns common stock disproportionately to the amount invested. E.g., might invest 10% of capital and perhaps receive

723

50%+ of common stock

Process of Going Public

724Vault.com Career Guide to Investment Banking

Aftermarket Trading• This begins after the new issue has

been sold to the original buyers, who purchased the shares at the

725

who purchased the shares at the issuing price


Private Placements of Securities

• Sometimes corporate issuer sells entire issue of securities di l

726

directly to one or more institutional buyers, such as insurance companies, without registering issue for public sale.

Internet Direct Public Offerings (DPOs)

• Designed for small businesses to raise capital relatively easy and at a low cost fashionand at a low cost fashion

• DPOs allow companies to raise equity financing in markets dominated by venture capitalists and angel investors

727

• Biggest problem: lack of a secondary market to trade

iti i

Internet Direct Public Offerings (DPOs)

securities in- sales restrictions and lack of an

exchange - often deters potential investors

728

117

Internet Offering SEC Rules and Regulations

• Laws governing offerings are the same as the for the traditional offerings- must comply with state “Blue

Sky laws”

729

• 1995: Modifications regarding disclosures and disclaimers of Internet public offeringsofferings- Spring Street Brewing Co.

started trend

730

Advantages of Internet IPOs

• Speed of access to capital• Savings in legal andSavings in legal and

administrative costs• But restrictions on resale,

secondary markets731

• SCOR’s (Small Corporate Registrations, up to $1 mil)• SB-2’s (named after the actual f fil d ith th SEC li it

Internet IPOs

732

form filed with the SEC, no limit on the offering amount)• Regulation A’s (named after the 1992 Securities Act Amendment, up to $5 mil)

Internet IPOs

• SCOR, Regulation A, and SB-2 offerings are less expensive

no underwriters or high fees

733

- no underwriters or high fees• Also less time-consuming

- no preparation of a full-blown registration statement needed

SEC Concerns with Internet IPOs

• Fraud and manipulation is easy because the Internet offers an anonymous environmentanonymous environment

734

118

Google IPO 2004• 1. Method: Modified Dutch

Auction• 2. -Value of offering: $1.67

735

g $billion

-Initial market cap: $23.1 billion

Unsuccessful IPO: Vonage• Vonage is an internet

telephony company offering Voice-over-IP servicesSi f i i 2001


• Since formation in 2001, losses in every quarter

• $262M loss in 2005• IPO in 2006

Source: Brandweek 2006, PC Magazine 2006

Unsuccessful IPO: Vonage

• Brokerage firms helped their hedge fund clients to do g“naked short” selling

• Price lost 58% in first four month

737Eli M. Noam, Media Finance 737Source: Financial Times 2006, Yahoo Finance 2006

Media IPOs in China:Beijing Media

• Advertisement sales unit of Beijing Youth Daily, Beijing’s second biggest selling ne spaper ith a


biggest selling newspaper with a circulation of about 600,000

• Backed by the Communist Youth League (former member Hu Jintao)

Source: BBC Worldwide Monitoring 2005

Impact of IPOs on Media Content and

C d t

739

Conduct

• When a project is funded by public equity, the managers are held responsible by shareholders, and could

740

possibly be sued for irresponsible project management

740

119

Impact of IPOs on Media Content and Conduct

• Caution• Slower moving• Profit orientation and less

741

• Profit orientation and less willingness to educational or social content

• More middle-of-the-road activity• Short-term earnings orientation

For more details seeAppendix G:

Initial Public Offerings (IPOs)(IPOs)

also see Appendix H:Raising Capital on the

InternetEli M. Noam, Multichannel 742742

743

VIII.8. Secondary Stock

744

Secondary Stock Offerings

Secondary Offering• Any stock offering made after

an initial public offering (IPO)i b i f

745

• In its basic form, a company issuing more shares of stock

Why have 2nd Offerings• After IPO, secondary financing

is “easier”-Company is known-Public information for

746

Public information for valuation is available

• To increase the number of available shares to encourage institutional buyers

120

Dilution• More shares decrease the

earnings per share and voting power.

747

p• But if the new money raised is

used wisely, it could raise the long-term value of the shares

• A secondary offering can be the “sucker round”

• Companies may hold secondary offerings if they think their stock

748

g yprice is overvalued

Media Examples for Secondary

749

Offerings

Secondary Offering• Alaska Communications

- $327Mln revenue in 2005- Around 1,000 employees

750

- IPO in 2005- About $104 mil secondary

offering in 2006

Source: Alaska Communications 2006, Daily Deal 2006, M2 EquityBites 2006

Secondary OfferingDex Media

• Dex Media is publisher of the official White and Yellow

751

Pages directories for Qwest• Secondary offering delivers

about $419Mln

Source: Denver Business Journal 2005

• Google raised some $4 billion through its 2005 SEO. The reason for this secondary equity offering might have been that G l b li d it t k i i

752

Google believed its stock price is vastly overpriced, and wanted to “cash in” and get a lot more capital while the stock is overpriced

121

753

http://www.pomexport.com/O%20-%20Titanic%20Stock%20Certificate/POC%20-%20Titanic%20Stock%20Certificate_1x.jpg

For more details seeAppendix I:

Stock MarketsStock Markets, Investment Banking,

and ADRsEli M. Noam, Multichannel 754754

755 756












XI. CONCLUSIONS 757

IX. Capital Structure of

758

Structure of the Company

122

759

•We’ve now looked at all the various funding options.

760

-Which are the best?-What is the best mix? -Complex question

CAPITAL STRUCTURE

http://images.google.com/imgres?imgurl=http://www.bionicturtle.com

• The mix of various debt and equity capital of a firm

Capital Structure

762

equity capital of a firm

763

Measuring a firm’s financing structure

• Simplest measure of how much debt and equity a firm is using: the proportion of debt in the total financing called Debt to Capital Ratio

764

Capital Ratio= Debt / (Debt + Equity) • Other terms are “gearing” or “debt-to-

equity ratio”Damodaran, Aswath. “Finding the Right Financing Mix: The Capital Structure Decision”

Stern School of Business. 1 July 2004. <http://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/capstr.pdf>

123

• About 60% of capital structure for incumbent telecom firms is debt

765

Rob West, Competing for Capital, February 28, 2000

Capital Structure• Firms with no debt is called an

unlevered company• After the issuance of the debt,

the firm becomes levered

766

the firm becomes levered

767Brierley, P.G. and A Kearns, “The Financing Patterns of New and Old Economy Firms in the UK” Bank of England 2001

2006 Major Five Media Companies

Company Market Cap ($ in

billions)

Total Debt ($ in

millions)

Debt to Equity

768

billions) Time Warner 75.150 20,330 0.322 Walt Disney Co.

67.620 12,467 0.494

Vivendi Universal

42.590 8,000 0.360

Viacom 27.040 5,758 1.107 News Corporation

59.990 10,999 0.401 FIX!!

Comparison between Media & Communications Industry

d O h I d i

769

and Other Industries

IndustryTotal Debt

/EquityCurrent

RatioLT Debt/Equity

Media & CommunicationsBroadcasting & Cable TV 0.675 1.08 0.637Communication Services 0.923 0.99 0.800

Media & Communications Industry

770

Communication Services 0.923 0.99 0.800Audio & Video Equipment 0.248 2.61 0.133Printing & Publishing 0.517 1.51 0.456Communications Equipme 0.618 4.19 0.572Computer Networks 0.167 2.44 0.112Computer Services 0.211 4.86 0.177AVERAGE 0.480 2.526 0.412

124

IndustryTotal Debt

/EquityCurrentRatio

LT Debt/Equity

Basic Materials SectorAVERAGE 0.349 1.837 0.300Capital Goods SectorAVERAGE 0.172 1.666 0.143Consumer Cyclical SectorAVERAGE 0.230 1.803 0.192

Selected Other Industry Sectors

771

AVERAGE 0.230 1.803 0.192Healthcare SectorAVERAGE 0.101 0.867 0.084ConglomerateAVERAGE 2.317 1.62 1.419ServicesAVERAGE 0.280 1.120 0.217TechnologyAVERAGE 0.282 0.643 0.187UtilitiesAVERAGE 0.094 0.214 0.062

For Start-Ups•Little to no debt for start-up firms no access to debt

•Equity is therefore•Equity is therefore favored

772

Old Economy

773

P.G. Brierley, A. Kearns, “The Financing Patterns of New and Old Economy Firms in UK,” abstract, Bank of England, June 22, 2001.

New Economy

• Median New Economy firm even had negative net capital gearing in 90s- i.e., Deposits of cash exceeded

774

gross debt (negative gearing)• Basically no reliance on debt

financingP.G. Brierley, A. Kearns, “The Financing Patterns of New and Old Economy Firms in UK,” abstract, Bank of England, June 22, 2001.

775

Is there an “optimal” capital structure, i.e., an optimal mix between debt and equity?

776Lewellen, Katherina. “Capital Structure, cont.”MIT. 1 July 2004. <http://ocw.mit.edu/NR/rdonlyres/Sloan-School-of-Management/15-402Finance-Theory-IISpring2003/LectureNotes/>

X.2. “Optimal Capital Structure

125

A. The Modigliani-Miller Capital Structure

777

Capital Structure Theorem

1. The Modigliani-Miller Capital Structure Theorem

• Capital structure is irrelevant to the firm’s value

• Business value depends only on

778

p ythe asset side of the balance sheet, the PV of the firm’s cash flow stream

• Not on how the assets are financed

Modigliani-Miller Theorem• It also means:

-Financial transactions neither increase nor decrease firm

l

779

value-Long term vs. short term debt irrelevant

-Dividend policy irrelevant-Risk management irrelevant

Implications of Modigliani-Miller on Media Firm Content and

Conduct• Capital structure (financing

types) make no difference!

780

types) make no difference!• But is this realistic?

Modigliani-Miller Assumptions

• Assumptions: efficient market, no asymmetric information, no taxes no transaction no

781

taxes, no transaction, no bankruptcy costs

• This is a “textbook” view, not realistic

Problems With Modigliani-Miller Theorem

• As company issues more debt, the equity gets riskier, and thus requires a higher risk-adjusted rate of return

782

• Beyond some point more debt will reduce value of firm

• Value of company decreases when risk of bankruptcy as debt increases relative to cash flowSmith, Dr. J Herbert. “Analysis of Financial Statements.” University of New Brunswick. <http://www.unb.ca/web/jhsc/TME_courses/tme3013/ratios/index.htm>

126

For more details seeAppendix J:

Methods of Optimal Capital Structure

Eli M. Noam, Multichannel 783783 784

2. Optimal Capital Structure Method: O ti i i Fi

785

Optimizing Firm Value

Target Capital Structure Approach

786

DebtBrealey, Richard A.; Myers, Stewart C., Chapter 18 “How Much should a firm borrow?”, Principles of Corporate Finance. The McGraw-Hill Companies, Inc., 2003

• Firm balances benefits and costs at the margin, and operate at the top of the curve to maximize value.

787

Shyam-Sunder, Lakshmi; Myers, Stewart C., “Testing static tradeoff against pecking order models of capital structure.” in Journal of Financial Economics51 (1999) 219-244

• Implications: Firms should issue equity when leverage rises above the target level and buy back

788

g ystock (or pay dividends) when leverage falls below the target capital structure

Lewellen, Katherina. “Capital Structure, cont.”MIT. 1 July 2004. <http://ocw.mit.edu/NR/rdonlyres/Sloan-School-of-Management/15-402Finance-Theory-

IISpring2003/4ACF9E78-5C3A-42DD-A518-5D14ABFA2865/0/lec8bcapitalstructure3.pdf>

127

789 790

• Even though the institutional owners hold only a few percentages of any single company, they often have stakes in many firms.

If they act in concert they

791

- If they act in concert, they could exercise industry-wide power

-But little evidence for such activity aimed at content

• Inho: yeah, another “search” based ?? How that makes zero sense (refers to slide above)sense. (refers to slide above)

Does Institutional Ownership Result in Excessive Short-Term Profit Orientation?

• Conflicting evidence• In influencing management, institutional

investors tend to exercise “exit,” whereas large individual owners exercise “voice”

793

individual owners exercise voice• But some large institutional owners hold shares

for long time- Average holding time for CalPERS (California

Public Employees’ Retirement System, largest in US) is 8 years

• When there is low portfolio turnover of institutional investors, i.e. long term focus:- Institutional ownership serves to reduce

pressures on managers for myopic investment behavior

794

investment behavior- Empirical evidence: Managers are less

likely to cut R&D to reverse an earnings decline when institutional ownership is high

Bushee, Brian J. “The Influence of Institutional Investors on Myopic R&D Investment Behavior,” Accounting Review, Jul 1998, Vol. 73, Issue 3.

128

Palisade RiskOptimizerExample : XYZ Corp.

Optimization Software Models

795

• XYZ Corp has 24% debt in its capital structure

Asaf, Samir., “Executive Corporate Finance: The Business of Enhancing Shareholder Value.” Pearson Hall 2004. Edinburgh Gate, Harlow. Pp 50-70

Assumptions on Interest Rates

796


797Asaf, Samir., “Executive Corporate Finance: The Business of Enhancing Shareholder Value.”

Pearson Hall 2004. Edinburgh Gate, Harlow. Pp 50-70

OptimizationThe optimal financial leverage ratio is 39 %. If the

firm operated at this ratio it would be maximizing the total benefit from its current overall value.

798Asaf, Samir., “Executive Corporate Finance: The Business of Enhancing Shareholder Value.”

Pearson Hall 2004. Edinburgh Gate, Harlow. Pp 50-70

• Optimal leverage is 39%• At the existing 24% leverage, the WACC is

10.44%. The value of the company is $3,212 million, if one discounts the expected cash flow for Net Present Value

• At 39% leverage, XYZ value would be about [$3,450]

799

[$ , ]


Optimal Capital Structure• Case Study: British Telecom (BT)

- 1998-2001 BT increases debt level from £4.8bn to £31bn . This caused drastic

800

£4.8bn to £31bn . This caused drastic decrease in share price.

• What is correct proportion of debt to equity?

Fairchild, Richard, “An Investigation of the Determinants of Bt’s Debt Levels from 1998-2002: What does it tell us about the Optimal Capital Structure?” Working Paper Series, University of Bath School of Management, February 2003.

129

firm value

Optimal

801

equity

debt

Optimal

Fairchild, Richard, “An Investigation of the Determinants of Bt’s Debt Levels from 1998-2002: What does it tell us about the Optimal Capital Structure?” Working Paper Series, University of Bath School of Management, February 2003.

• Graph shows direct correlation between debt/equity and firm value for BT

• Displays that there is an i l i l

802

optimal capital structure - Different for each company /

industryFairchild, Richard, “An Investigation of the Determinants of Bt’s Debt Levels from 1998-2002: What does it tell us about the Optimal Capital Structure?” Working Paper Series, University of Bath School of Management, February 2003.

• 2005 BT capital structure lowest debt- 8 billion in long term debt

803

- 3.5 billion in equity- 27 billion in assets- 29.6% levered

LexisNexis Financial Reports

• As a firm increases debt relative to equity the average cost of capital initially decreases before increasing due to a higher cost of debt

• This is because eventually theThis is because eventually the higher cost of capital fully offsets the benefits of a tax shield, such as interest expense


805

• But where is that optimal level?• More practical, simpler: the

ki d h

806

“pecking order” approach

130

Alternative Approach: 3.

“Pecking Order” of

807

Pecking Order of Raising Capital

Pecking Order Theory:• No well-defined optimal debt

ratio• Debt ratios are driven by the

808

Debt ratios are driven by the need for external funds, not by any attempt to reach an optimal capital structure.

Shyam-Sunder, Lakshmi; Myers, Stewart C., “Testing static tradeoff against pecking order models of capital structure.” in Journal of Financial Economics51 (1999) 219-244

Pecking Order• Financing investment in this order:

- First, with internally generated funds

809

- Then, with debt- Lastly, with equity

• Rank of Priority Funding Source- 1 Retained earnings- 2 Straight debt- 3 Convertible debt

Pecking Order of Financing

810

3 Convertible debt- 4 External common equity- 5 Straight preferred stock- 6 Convertible preferred

• “Pecking orders” reflects CFO views

• According to a survey of 176 CFOs, 69% of respondents i di d f f

811

indicated a preference for a pecking order.


• Leverage improves the return on equity measure of financial performance

• Debt thus is an attractive funding f i d t

Debt Preference

812

source for companies, compared to equity

• However, the cost of debt increases as leverage increases and credit ratings consequently deteriorate

131

• Lenders will impose upper limits on debt by a potential borrower

813

Case Discussion:A. TWIT

F di P k f

815

Funding Package for $1B for Time Warner

Internet TV

Cost and Allocation of Funding

• In general: Match funding to life of asset• For this reason ST debt should be used

for content production projects, not for

816

p p j ,network upgrades

• Maximum for short term debt to finance a project is about $200M, (if not backed by TW)


• The cost of issuing secondary equity for TW, or an IPO for

817

q y ,TWIT, is considered to be 15%. Hence, Time Warner will first use public equity as a source of financing its projects

• Graphing these results yields the following curve, at which the minimum of WACC maximizes firm value

• In this case yields ~ 40% debt

818

In this case, yields 40% debt ratio is optimal

132

Leverage Optimization

13

14

15

16

CC

819

9

10

11

12

0 10 20 30 40 50 60 70 80 90 100

Debt Ratio (%)

WA

C Series1

• Applying to TW’s finance decision:–Maintain optimal debt ratio while using other cheaper financing

820

using other cheaper financing vehicles as they are available

–$400mil in debt–$600mil in non-debt

• Hence, equity funding needs to be increased from sub-optimal $200 to $350, and ST loans reduced by $150 to $80

• Lease Finance $10 mil• LT debt of $205 mil

821

• ST loans• Commercial paper $205

• Content Production ($400M)–Can also get state government subsidies of

15% if TW operates in those states reduces cost to 340MUse short term institutional commercial

822

–Use short term institutional commercial paper @ 5%, $200 mil debt @ market rate

–Remaining $140 mil: ST loans @ 8%

Source Amount Duration Interest

PV Cost of Interest*

Transaction Costs

Short Term Debt 200 3 years 5.0% 24.02 25Long Term Debt 395 5 years 7.7% 109.64 10Lease Finance 100 1 year 7.0% 6.25 3

$.20 per share

823

*12% Cost of Capital**Calculated to 10 years

Total Cost: 152.60 + 78 = $230.6

Equity 200 Indefinite** anually 12.70 40Subsidized Total: 895 152.60 78Total Subsidy: 105Total: 1000


• Time Warner had a total debt/equity ratio of 0.4 in 2006

824

• If Time Warner wants to keep its debt/equity ratio stable, it has to use $400M of secondary equity for the projects

Source: Yahoo Finance 2006

133


• The implicit interest rate for internal funding is 18% as this

825

internal funding is 18%, as this was Time Warner’s operating margin on its capital in 2006.

Source: Yahoo Finance 2006

Cost and Allocation of FundingKind of debt Ceiling

in $ MlnCost of Funding in %

Cost of Funding in $ Mln

Ceiling in %

Government 150 3% 4.5 15%

Short Term 200 5% 10 20%

826

Short Term Debt 200 5% 10 20%

Vendor Financing 50-60 7% 3.5 20% of cap

investmentLong Term Debt 200 7.7% 15.4 20%

Public Equity 400 15% 80%

Cost and Allocation of FundingSource Cost Max Funding Costs in $/yrGovernment 3% x $150 M = $4.5MShort Term Debt 5% x $200 M = $10M

827

Vendor Financing 7% x $50 M = $3.5MLong Term Debt 7.7% x $200 M = $15.4MPublic Equity 15% x $400 M = $60M

Total Amount $1,000M $93.4M/yr

Cost of Capital

• Time Warner has to pay $93.4M per year or 9.34%

828

• Only if the project has a higher return than 9.34%, can it be considered

Time Warner Optimal Capital

St t

829

Structure see Appendix J

830

134

Case DiscussionB. SNIT

Funding Package forFunding Package for Startup Network

Internet TV831

Source Vehicle and source of capital

Cost (est.)

Constraints

Govnmt. Grant/loans/taxrefunds

3% 15% of content production

Financing Source & Cost

costs, $6MInternal Funding

Founderresources + friends/family

5% $3M

Vendor Financing

Equipmentmakers

10% Mostly for infrastructure, $10-15M 832


Cost (est.)

Constraints

Venture C it l

Venture funds 25% $10-15M

Financing Source & Cost (cont.)

Capital

Angel Finance

Business Angels 25% $0.6M total

833


Constraints

LT financing Junk bonds Will likely have high cost,

Future Financing Sources (in order of availability)

not avail. 1st yrLT financing Bank Loans Not until firm has collateral

or cash flow to lend againstSecuritization 30%, only available after

content producedPublic Equity IPO, common

stockOnly available after several successful years 834

• If SNIT cannot raise the full $100M, it would have to make do with the amount it can raise

• If initially successful, it can y ,raise more funding through retained earnings or junk bonds

835

Source Amount Cost Cost / Year

Gvmt. $6illi

3% $0.18M

Cost of Funding

millionVendor Financing

$10 million

10% $1M

Internal Funding

$3million

5% $0.15M

836

135

• Although SNIT could get $19M through government subsidies, vendor financing, and internal funding, the rest of the funding is less certain

837

Source Amount Cost Cost / Year

Venture $15 25% $3.75 M

Cost of Funding (cont.)

capital millionTotal $34M $5.08 M

838

• With the assumptions we have made, SNIT would have an initial (5.08 / 34) =14.94% cost of capital to raise $34M

• In comparison, TWIT has a 9.34% cost of capital to raise $1B

839

• Much lower, provides significant advantage

• Also, TWIT has access to $1B in funding, whereas for SNIT g,the funding is uncertain above $34 mil.

840

• As calculated in the section on techniques to evaluate projects, assuming the revenue and costs of TWIT and SNIT scale linearly, IRR = 18.36%

841

• Therefore, given that for both TWIT and SNIT the cost of capital is less than the internal rate of return, both companies should invest in this project

• Both TWIT’s 9.34% and SNIT’s 14.94% < IRR of 18.36%

842

136

Leverage and Required Returns

843

Lewellen, Katherina. “Capital Structure.”MIT. 1 July 2004. <http://aka-ocw.mit.edu/NR/rdonlyres/Sloan-School-of-Management/15-

402Finance-Theory-IISpring2003/05F55F8E-5232-4B87-9E0B-BDF73F8BB307/0/lec4bcapitalstructure1.pdf > 844












XI. CONCLUSIONS 845

Startup Phase• Major Debt resources as part of

overall funding:- Commercial Banks ~ 16%- Trade Credits ~ 13.5% - Finance Companies ~ 8%- Principal Owner ~ 6%

846Allen N. Berger and Gregory F. Udell, “The Economics of Small Business Finance” Journal of Banking and Finance, Volume 22, 1998

Growth Phase• Major Debt resources:- Commercial Banks ~ 31%- Trade Credit ~ 13.5%- Principal Owner ~ 6%- Other Individuals ~ 3.3%

847Allen N. Berger and Gregory F. Udell, “The Economics of Small Business Finance” Journal of Banking and Finance, Volume 22, 1998

Changing financial needs of a firm

• Affected by cycles of1. The economy

i

848

2. The operation3. The product 4. The firm

137

Financing & The Stages of Maturity

• 1) Start-up phase- Little debt- Plenty of risk already no reasonPlenty of risk already, no reason to add more risk with leveraging

- Little taxable income, tax shield irrelevant

Asaf, Samir, “Executive Corporate Finance: The Business of Enhancing Shareholder Value.” Pearson Hall 2004 . Edinburgh Gate, Harlow. p 50-72.

849

2) Growth Phase• Adds debt as output expands• Company still risky, debt still

k t lkept low• Tax shield may still have little

valueAsaf, Samir, “Executive Corporate Finance: The Business of Enhancing Shareholder Value.” Pearson Hall 2004 . Edinburgh Gate, Harlow. p 50-72.

850

3) Maturity

• Tax shield benefits rise• Less profitable NPV projects

Di ib h h h ld• Distributes cash to shareholders• Increasing proportion of capital

structure in form of debtAsaf, Samir, “Executive Corporate Finance: The Business of Enhancing Shareholder Value.” Pearson Hall 2004 . Edinburgh Gate, Harlow. p 50-72.851

4) Decline• Must incur substantial debt• Creditors bear risk of default• Harder to obtain loans

Asaf, Samir, “Executive Corporate Finance: The Business of Enhancing Shareholder Value.” Pearson Hall 2004 . Edinburgh Gate, Harlow. p 50-72.

852

• Smaller/younger/more opaque firms lie near the left end of the continuum they must rely on initial insidermust rely on initial insider finance, trade credit, or angel finances


853

• As firms grow, they gain access to intermediated finance on the equity side (venture capital) and on the(venture capital) and on the debt side (banks, finance companies, etc.).


854

138

• If the firms remain in existence and continue to grow, they may gain access to public equity and debt p q ymarkets.


855

• Distinction “insider” and “debt” financing early stage is not bright. “Intertwining.”

• Most small business loans are personally guaranteed by inside ownersowners.

• Personal assets of the insiders are also explicitly pledged as collateral to back the loans.


856

• Small businesses are often organized as proprietorships and partnerships not protected by limited liability that govern corporations and maygovern corporations, and may have their personal wealth at stake.


857

For more details seeAppendix K:

Life Cycle of Capital Structure

Eli M. Noam, Multichannel 858858

859

IX. Sources of Media

860

Media Financing

139

• Financing means- Ownership

i i i i i k

861

- Participation in risk

Major Types of Media Ownership

• Family• Entrepreneurs and Managers

862

• Entrepreneurs and Managers (insiders)

• Public• Institutions

1. Family Ownership of

863

Ownership of Media

• Newspapers were traditionally owned by individuals and

864

owned by individuals and families

• Closely held (non-public) by special voting stock

Murdoch Family (News Corp)

865

http://www.abc.net.au/canberra/stories/The_Murdoc_m424960.jpg

Media Moguls of early 20th Century

Hearst Castle

140

Media Empires Around the World

• Germany– Bertelsmann

• Italy: BerlusconiMohn

BerlusconiItaly: Berlusconi• France: Vivendi• Sweden: Bonnier• UK, Australia, US: Murdoch Murdoch

•Mexico: Televisa •Brazil: Globo media

- James Knight Estate 11% of Knight-Ridder before selling out

- Sulzberger family has a combined voting interest in the New York Times Co of over

868

New York Times Co. of over 60%

- McCormick family 20% of the Tribune Company, with Chandler family with another major share Graham family for Washington Post.http://www.ur.ku.edu/oread/Oread03/Jan31/Jan31images/sulzberger.jpg

Viacom: Sumner Redstone controls company with 18.8%

869 870

871

2. Entrepreneur and Management

872

(Inside) Ownership

141

Insider Ownership in Major Mass Media Companies (2005)

Company %InsidersTime Warner 3.3Comcast 16.5Disney 6.6News Corp 27.4Viacom I 11 8

Mass MediaBertelsmann** 75Vivendi* 3Hearst 47.8Barnes & Noble 19.8McGraw-Hill 1Advance^^ 75

Mass Media

873

Source For Mass Media 2005: MSN Money;

Book: Eli Noam, Media Ownership and Concentration in America (forthcoming 2007, Oxford University Press)

*Estimate, **Most of Company is owned by the family-controlled Bertelsmann Foundation, ^2 Classes of stock consolidated, we assume that both classes are of equal weight, ^Âdvance is private, owned mostly by the Newhouse family

Viacom I 11.8CBS 13.3General Electric 0.1Gannett 2Cox* 66Sony* 1Tribune 27Charter 11.8

Advance 75Knight Ridder 0.6Clear Channel 7.1Blockbuster 3.1Reed Elsevier* 0.5Border/Walden 1.2Washington Post^ 35.4New York Times* 35

Company %InsidersVerizon 0SBC/AT&T 0.1Sprint 0.1IBM 0.1HP 10 1

IT/Telecom

Insider Ownership in IT/Telecom Companies (2005)

Lucent 0.2Xerox 0.3Oracle 43.3Toshiba* 1Cisco 0.1Apple 0.6

IT/Telecom

874

HP 10.1Microsoft 23.6Bell South 0.1Dell 9.5Motorola 0.4Sony* 1Qwest 17.4Intel 5.9

Source For IT/Telecom 2005: "Compact D - SEC," Compact Disclosure Inc., 2005


*Estimate, **Most of Company is owned by the family-controlled Bertelsmann Foundation, ''Estimate based on industry, ^Âdvance is private, owned mostly by the Newhouse family

Samsung'' 10.7Gateway 38.7Matsushita* 1Sun 2Avaya 0.7EDS 0.4Unisys 0.1NCR 0.2

• IT industry had high insider investment- Declined over the years because

f th l f i

875

of growth cycle of companies- Microsoft: insiders owned over

66% in 1988; down to 37.7% in 1998

• In 2000, 99 (almost one-fourth) of Forbes 400 wealthiest individuals in America had earned their wealth

876

in America had earned their wealth in the media and communication fields

Forbes 30 Wealthiest Americans2006

Rank Individual Net Worth (in Billions of $)

Industry / Firm

1 William Gates III 53 Microsoft Corp.2 Warren E. Buffett 46 Berkshire Hathaway3 Sheldon Adelson 20.5 Casinos, hotels

877

3 Sheldon Adelson 20.5 Casinos, hotels4 Lawrence J. Ellison 19.5 Oracle Corp.5 Paul Gardner Allen 16 Microsoft Investments6 Jim C. Walton 15.7 Wal-Mart Stores7 Christy Walton & family 15.6 Wal-Mart Inheritance7 S. Robson Walton 15.6 Wal-Mart Stores9 Michael Dell 15.5 Dell

1 "400 List," Forbes 2006. The names in bolds represent individuals who earned their fortunes in pure media and/or communications ventures.

Rank

Individual Net Worth (in Billions of $)

Industry / Firm

9 Alice L. Walton 15.5 Wal-Mart Stores11 Helen R. Walton 15.3 Wal-Mart Stores12 Sergei Brin 14.1 Google


878

Se ge g13 Larry E. Page 14 Google14 Jack Crawford T. & family 13.9 Enterprise Rent-a-car15 Steven Anthony Ballmer 13.6 Microsoft16 Abigail Johnson 13 Fidelity Investments17 Barbara Cox Anthony 12.6 Cox Enterprises17 Anne Cox Chambers 12.6 Cox Enterprises19 Charles De Ganahl Koch 120 Oil, comodities

142

Rank Individual Net Worth (in Billions of $)

Industry / Firm

19 David Hamilton Koch 12 Oil, comodities21 Forrest Edward Mars Jr. 10.5 Candy21 Jacqueline Mars 10.5 Candy21 J h F kl M 10 C d


879

21 John Franklyn Mars 10.5 Candy24 Carl Icahn 9.7 Leverage buyouts25 John Werner Kluge 9.1 Metromedia26 Kirk Kerkorian 9 Investments, casinos27 Donald L. Bren 8.5 Real Estate27 George B. Kaiser 8.5 Oil, gas, banking27 George Soros 8.5 Hedge funds30 Philip H. Knight 7.9 Nike

3. Institutional Investors in Media

881

Main Categories of Institutional Investors

• Mutual funds • Pension funds

882

• Hedge funds • Insurance companies• Endowments• Trust departments of banks

•Pension fund assets increased from $260 billion in 1975 to $1.7 trillion in 1990 to more than $7 trillion by 1998

883

trillion by 1998.

•By 2002, Pension fund assets increased $2.5 trillion since 1998.Bureau of Economic Analysis. “Table 6.11D: Employer Contributions for Employee Pension and Insurance Funds by Industry and by Type.” Survey of Current Business, April 2004.

Largest Pension FundsCompany Assets (bn)California Public Employees' Retirement System 133.5New York State Common Retirement Fund 99.7General Motors Investment Management 87California State Teachers' Retirement System 82.6

884

California State Teachers Retirement SystemFlorida State Board of Administration 77.5New York State Teachers' Retirement System 71.1Texas Teacher Retirement System 69.5Federal Retirement Thrift Board 64.5New Jersey Division of Investment 63.3General Electric 58.7

143

Institutional Investors• Generally do not have interests

greater than 10% in more than a few companies at one time

S k di ifi i f h i

885

- Seek diversification of their portfolios

- subject to a variety of legal limitations and reporting requirements

Institutional Ownership in Major Mass Media Companies (2005)

Company % InstitutionsTime Warner 74.7Comcast 47.3Disney 66.3News Corp 48.1Viacom 68 4

886




Viacom 68.4CBS 74.3General Electric 55.2Gannet 84.3Cox* 20Sony* 47.9Tribune 54.6Charter 54

Institutional Ownership in Major Mass Media Companies (2005)

Company % InstitutionsBertelsmann** 25Vivendi* 13.5Hearst 25Barnes and Noble 73.6McGraw-Hill 77.4

887




Advance^^ 25Knight Ridder 92.1Clear Channel 87.5Blockbuster 96.5Reed Elsevier* 17.4Border/Walden 98Washington Post^ 64.2New York Times*^ 40

Institutional Ownership in Major IT/Telecom Companies (2005)

Company % InstitutionsVerizon 55.4SBC/AT&T 76.2Sprint 83.3IBM 46.9HP 72 7

888


Book: Eli Noam, Media Ownership and Concentration in America (forthcoming 2007, Oxford University Press) *Estimate, **Most of Company is owned by the family-controlled Bertelsmann Foundation, ^2 Classes of stock consolidated, we assume that both classes are of equal weight, ^Âdvance is private, owned mostly by the Newhouse family

HP 72.7Microsoft 55.9Bell South 59.8Dell 64.6Motorola 71.1Sony* 47.9Qwest 72.4Intel 55.8

Institutional Ownership in Major IT/Telecom Companies (2005)

Company % InstitutionsLucent 36.7Xerox 86Oracle 48.3Toshiba* 37.7Cisco 58.7

889


Book: Eli Noam, Media Ownership and Concentration in America (forthcoming 2007, Oxford University Press) *Estimate, **Most of Company is owned by the family-controlled Bertelsmann Foundation, ^2 Classes of stock consolidated, we assume that both classes are of equal weight, ^Âdvance is private, owned mostly by the Newhouse family

Apple 71.8Samsung* 40Gateway 56.1Matsushita* 36.3Sun 54.2Avaya 71.3EDS 92Unisys 71.7NCR 75.5

• Largest owners of some of the major telecommunications firms companies were institutional investors.

• In contrast, the major mass media

890

In contrast, the major mass media companies such as Disney, Time Warner, and Viacom have individual owners as the largest shareholder.

144

• Major Financial Institutional Investors In the Information Sector Companies 2005 (mil $)

891

( $)

Largest Institutional investors in media each with over $300 Bil in media ownership in 2000 (CRM)- Capital Research & Management- FMR (Fidelity) - Putnam Investments

892

- Credit Suisse- New York Bankers Trust- JP Morgan

IT/Telecom Ownership by Fidelity (FMR) (2005) ($MIL)

Fidelity Management &

Research$ %

893

$ %Verizon 4,115 6.8Hewlett Packard 5,302 3.5Qwest 3,085 4.7Cisco 2,744 3.9Apple 2,960 3.1IT/Telecom Total 33,103Eli. M. Noam, Media Ownership and Concentration in America

Capital Research and ManagementIT/Telecom Companies $ %Bellsouth 3,279 3.1Q t 3 301 5 0

IT/Telecom Ownership by Capital Research and Management Funds

(2005) ($MIL)

894

Qwest 3,301 5.0Intel 4,137 2.8Apple 7,549 7.9Gateway 3,469 4.3Avaya 5,939 12.0NCR 3,174 5.0IT/Telecom Total 37,761

State Street Global InvestorsIT/Telecom Companies $ %AT&T 3,252 3.4IBM 6,488 4.3

IT/Telecom Ownership by State Street Funds (2005) ($MIL)

895

Hewlett Packard 3,564 4.4Microsoft 7,263 2.6Intel 4,788 3.2Cisco 3,243 3.1IT/Telecom Total 47,006

BarclaysIT/Telecom Companies $ %Verizon 3,609 6.0Hewlett Packard 7 580 5 0

IT/Telecom Ownership by Barclays (2005) ($MIL)

896

Hewlett Packard 7,580 5.0Bellsouth 5,564 5.3Intel 4,405 3.0Apple 3,649 3.8Unisys 4,739 5.7IT/Telecom Total 46,044

145

Mass Media Companies

% Public Stock Owned By 14 Major Institutions

Time Warner 28.0Comcast 26.8Disney 21.9News Corp 23.2Viacom 20.4

897

General Electric 22.8Gannett 20.1Tribune 0.5Charter 13.8

Hearst 4.7Barnes & Noble 26.2McGraw Hill 22.3Knight Ridder 18.2Clear Channel 38.7Blockbuster 18.7Borders Group 1.0

898

Post 26.0New York Times 6.5

IT/Telecom Companies

% Public Stock Owned By 14 Major Institutions

Verizon 32.8AT&T 33.7Sprint 31.6

IBM 25.0

899

Hewlett Packard 24.0Microsoft 26.9Bellsouth 26.4Dell 29.8Motorola 42.3Qwest 29.5

Intel 18.2Lucent 4.0Xerox 24.0Oracle 39.2Cisco 20.8Apple 25.6

900

Gateway 23.5Sun 18.1Avaya 27.2

EDS 24.8Unisys 24.2NCR 21.1

901

4. Other Types of Ownership

902

Ownership

146

• There are several major alternative models to

i l di Th fi tcommercial media. The first model is public media such as public broadcasting.

Other Types of Ownership

• Employee-ownership• Foundations

904

• Foundations• Churches• Communities• Universities

Union-Owned Newspapers• 200 Labor-owned papers in

1920s

905Dennis Herrick, Media Management in the Age of Giants, Iowa State Press

Employee-Owned Newspapers: • Omaha World-Herald • The Daily News-Miner in Fairbanks,

Alaska • The Evening News in Monroe,

Mich

906

Mich. • Milwaukee Journal Sentinel.

Dennis Herrick, Media Management in the Age of Giants, Iowa State Press

• Community Newspaper Holdings Inc. (CNHI), controlled and financed by the $22 billion Alabama public employees pension fund.

• In less than five years, CNHI became America’s 13th largest

907

gnewspaper chain, owning 95 dailies in 2003.

• Fired many employees, cut cost just like a regular business owner.Dennis Herrick, Media Management in the Age of Giants, Iowa State Press

Impact• St. Petersburg Times follow what

they call “permissible moderation in the pursuit of profits,” with an

i i h h ld b

908

executive saying that they would be concerned if operating profits were below 10 percent, but they also would be concerned if operating profits were over 20 percent.

147

• The Washington Times, (Unification Church)

Church-Owned Newspapers

909

(Unification Church)• Desert Morning News, (Church

of Latter-Day Saints in Salt Lake City)

• Christian Science MonitorDennis Herrick, Media Management in the Age of Giants, Iowa State Press

• Radio stations• weekly Navajo Times, etc.

Tribe-Owned Media

910

y j ,


• 1,300 newspapers (75 of dailies), 1,000 radio stations and 700 television stations on campuses

Non-Profit: College Media

911

• 2006: college paper in [ ] sold to for-profit company

• The Public Welfare Foundation, own the Spartanburg (S.C.)

ld l l

Foundations

912

Herald-Journal, Tuscaloosa (Ala.), and Gadsen (Ala.) Times.


• Few media critics would consider the last two as models for balance, even though they are not profit-driven.

• Other nonprofit media are owned by foundations or charitable trusts St. Petersburg Times (owned by the nonprofit Poynter Institute.)

• Usually, this model is based on bequests by an original owner to a foundation.

• In other cases, the placing of media properties into a nonprofit entity does not greatly diminish the family control.

148

• Germany’s largest media firm, Bertelsmann, is fully owned by th B t l F d tithe Bertelsmann Foundation, which in turn is controlled by the Mohn family.

• A fourth alternative to commercial media ownership is community media, including the intriguing model of a “media commons” in which The Koreancommons in which The Korean Ohmynews and the WikiNews are major examples most feasible for relatively low-cost media such as radio, periodicals, and Web sites.

• Once one moves video and multimedia, individualized

t ib ti bcontributions become technically and economically difficult and mostly national rather than local.

918

5. Impact of Ownership on

919

Type of Content

• Ben Bagdikian, Pulitzer Prize winner and Dean of Berkely Journalism School, writes “The fifty men and woman who head these corporations would fit in a large room. They constitute a new Private Ministry of Information and Culture”.

149

• Prof Lawrence Lessig argues: “This narrowing has an effect on what is producedwhat is produced.

• The product of such large and concentrated networks is increasingly homogenous.

• “Increasingly safe. Increasingly sterile. . . . This i h iis not the communist party, though from the inside, it must feel a bit like the communist party.

• No one can question without risk of consequence – not

il b i hnecessarily banishment to Siberia, but punishment nonetheless.

• Independent, critical, different views are quashed. Thi i h iThis is not the environment for democrats” (pp. 165–166).

• Commercial firms, whether large or small, will operate in

fi i i i f hia profit-maximizing fashion, which generally include cost-cutting and audience maximization.

• Regardless of size, media firms may provide some

bli i i i ipublic-interest activities as an investment in goodwill and credibility.

150

• They may at times move away from pure profit maximization and in favor of socialand in favor of social responsibility, but it must yet be shown that small media firms have more of that attitude.

• Some of the socially most benign firms were those with

l ka near monopoly market position, and consequent high profits and lower cost pressures.

• Examples are AT&T, Xerox, and IBM in their peak days; or CBS, NBC and ABC when theyNBC, and ABC when they accounted for most of the TV audience; or local newspapers with near monopoly.

• Conversely, small or medium-sized media firms

b i ibl dcan be irresponsible and profit-driven.

• Medium-sized media companies, for example, h l l d hi lhave cut legal and ethical corners.

• Just in the year 2005, Adelphia Cable’s 80-year-old owner John Rigas was sentenced to 20 yearsRigas was sentenced to 20 years in prison for skimming corporate money for personal investments and cooking the corporate books.

151

• The A. H. Belo newspaper chain acknowledged inflating circulation numbers i ecirculation numbers, i.e., cheating its advertising.

• And Lord Conrad Black, the owner of the Hollinger I i l GInternational Group, was charged with diverting $80 million from the company for his own use.

• In the ranking of American media firms in 2001, Ad l hi #15 B l # 33Adelphia was #15, Belo # 33, and Hollinger #45.

• Commercial pressures have led even nonconformist

di b h i hmedia to behave in the same anticompetitive spirit as established ones.

• The two leading chains of “alternative” papers have been News Times Media (11 papersNews Times Media (11 papers, circulation 1.1 million) and Village Voice Media (seven papers, circulation 800,000).

• In 2002, the two companies contracted to close down their respective papers in Cleveland and Los Angeles, the Cleveland Free Times and the Times Los Angeles, so that they would not compete with the other company’s paper in that city.

152

• It took the U.S. Justice Department’s intervention to reverse this anticompetitive behavior, forcing the two publishing firms to pay a fine and to make some of their assets available to new entrants.

• What ownership model might lead to a different conduct by a commercial media firm? Is itcommercial media firm? Is it individual owners, institutional ownership, control by employee-managers, or nonprofit ownership?

• If individual owners are in control (whether Rupert Murdoch, Silvio Berlusconi, or William Paley), their personal

d i b ildipower and empire-building tendencies are a problem. And their heirs may well be the kind of dilettantes.

• Does the size of the firm make the difference? It is unclear why the dynamics of profit maximizationof profit maximization would affect huge media firms more than small or medium-sized ones.

• Is a $10 billion company more interested in profits h $1 illi fi ? Othan a $1 million firm? One

could argue this three ways.

• Geneva Overholser, the respected editor and ombudsman of the Washington Post wrote:of the Washington Post, wrote:

153

• “Too often by far, being an editor in America today feels like holding up an avalanche ofholding up an avalanche of pressure to do away with this piece of excellence, that piece of quality, so as to squeeze out just a little bit more money.”

• But the profit orientation of media is not a new problem, i b k lit goes back at least a century.

• Tension between journalism and commerce, between content creators and bean counterscreators and bean-counters, between agents and principals, is endemic to all commercial media.

• In 1897, muckraker Lincoln Steffens wrote: “The magnitude of financial operations ofof financial operations of the newspaper is turning journalism upside down.

• It therefore becomes necessary to postulate a change in the nature of capitalism to explain whyof capitalism to explain why media firms in the past were less aggressive in pursuing profits and efficiencies.

• That argument is usually that institutional ownership is

f d imore performance driven than direct shareholder ownership of the past.

154

• The pressures of fund managers on media managers for profits are often said to be a majorare often said to be a major factor in changing the nature of media behavior and quality.

• It forces cost-cutting that lowers quality,

i li isensationalism to gain audiences, and a pandering to advertisers that reduces courage.

• But this causality is not clear at all. • It requires us to believe that

individual owners, especially large ones with a big and undiversifiedones with a big and undiversified stake, care less about a firm’s return than today’s fractional beneficiaries of a mutual fund, in which a media firm is only a small component.

• The investor in such a fund seeks diversification, and reasonably assumes that some shares will perform better than

thothers. • Some fund managers will

quickly sell a poorly performing stock.

• But other funds are in for the long haul.

• Still others invest in risky firms, for the upside potential.

• Still others prefer “pure plays” of specialized firms over conglomerates and will exertconglomerates and will exert direct or indirect pressures for such firms to streamline themselves rather than grow.

155

• It is possible that such ownership exerts greater pressure than that of individuals.

• Again the opposite case can• Again, the opposite case can also be made, that individuals with a large stake and exposure will keep management much more on its toes.

• Disney management (Michael Eisner) was challenged in 2003 and 2004 by large shareholdersand 2004 by large shareholders, among other things, for squandering profit opportunities.

• The opposition was led by Roy Disney, Jr., the firm’s largest shareholder, on the grounds that managementgrounds that management had been wasteful and that profits were lower than before.

• There seems to be no model of ownership, control, or size h d blthat does not create problems

of a priority of profit over public interest concern.

• The key factor for media behavior—aside from a few small family papers or radiosmall family papers or radio stations run more as a vocation than a business—is a media firm’s business orientation, not its size.

A. Inside-Financing

962

156

Inside-financing:

Owner is in clear control• Can reflect own opinions and

h i

963

aesthetics

• Divergence from audience maximisation (ceteris paribus) will be at expense of profitability- Family-owned local

h d

964

newspapers have done so, both in the direction of more, or less, community responsibility

B. Outside

965

Financing?

• Less autonomy of owner to diverge from profit maximization- In public stock company, financial

obligation to shareholdersAlso shareholders might have

966

- Also, shareholders might have different views, and object to their money used for politics or aesthetics they do not support

Debt Financing and Content• Lenders do not usually require

profit maximization, only soundness and will therefore give

967

soundness, and will therefore give management more autonomy, unless company is in financial trouble

Short Term vs. Long Term Debt, and Content?

• A media company that must seek frequent re-financing is under greater performance

968

under greater performance pressure and greater need to be non- controversial

157

• Increasing pressure by profit-oriented owners or editors. - “The new marketing-oriented editor” - concept of as “Total Newspaper,”

where newspaper executives coordinate the news and business

969

departments (including circulation, advertising and financial) and work together to market the newspaper as a total product.”


• Jack Fuller, president of the Chicago Tribune (2001–2004) and thus a publishing business insider, observes: “The basic argument critical journalists make against the corporate form is that corporations have taken money out at a rate far higher than private owners did . . .but in the 1920s during the Tribune’s heyday under the proprietorship of Colonel Robert R. McCormick . . .

• “the operating margin reached almost 29.8%in 1929, compared with 24.6% at its highest afterwards.”

• In 2005, not a bad year, it was 21.69%.

C. Institutional

972

Ownership?

• Generally, institutional investors’ ownership much larger than those of the individuals

973

• But individual holdings are more concentrated in one firm,

• Institutional investors assets are more scattered among various companies

974

p- For this reason, individual owners

are usually much more involved in the day-to-day running of the firm than institutional investors

158

Institutional Investors and Corporate Activism

Exit and Voice• Institutional investors are more

concerned with short term gain

975

concerned with short term gain• If “exit” for an investor is easy,

as it is in the equities markets, then they will have less interest in exercising their “voice”

• Institutional investment in the growing number of media companies has increased

• Consequently, ownership of the US media has become fragmented

976

fragmented- Includes a large number of stakeholders with a few percentage ownership and usually without a dominant shareholder

• Where there is high portfolio turnover of institutional investors and engagement in momentum trading, i.e. short term focus:- Empirical evidence: significantly increases

the probability that managers reduce R&D to reverse an earnings decline

977

g- High turnover and momentum trading by

institutional investors encourages myopic investment behavior when such institutional investors have extremely high levels of ownership in a firm

THE INFLUENCE OF INSTITUTIONAL INVESTORS ON MYOPIC R&D INVESTMENT BEHAVIOR, By: Bushee, Brian J., Accounting Review, 00014826, Jul98, Vol. 73, Issue 3.

• Institutional outside ownership tends to be “hands-off” on content directly

• But strong orientation to short-term profitability

• This, when it has been challenged, leads management to cost cutting and audience

978

management to cost-cutting and audience-pandering beyond that of individual ownership

• Media: more business (i.e.: public service)

Institutional Ownership• Individual Shareholders Actions

- Gordon Crawford, Capital ResearchManagement, Challenges

AO

979

»AOL TW»CBS

- Disney challenged by funds- Hollinger (Lord Conrad Black) challenged by

Tweedy Browne, institutional investor, ousted

• One comparison of publicly (i.e., traded) and privately held newspapers shows that the count of full-time newsroom employees is 51.7 in publicly held (i.e., investor-owned) dailies, versus 45.2 in privately (closely) held newspapers.

159

• Probably the worst way to approach this question is by anecdote.

• At any given moment there are j li i ijournalists, participants, creators, and artists who can tell a compelling story of bias, restriction, and failure of imagination.

• But one needs to move beyond individual cases.

• At any moment, a huge number of creative projects and talents p jare competing with each other to be selected for funding, distribution, or jobs.

• Statistically speaking, most projects would be turned down under any conceivable system, because of limited resources and limited attention relative to the continuously rising information productivity of society.

• It has been said that 90% of all scientists who ever lived, live today.

• The same is likely to be true for aspiring screenwriters, novelists, or directors. The result is inevitable disappointment for most participants.

• Such rejections can be rationalized as systemic, b d th t l f dibased on the control of media by a few firms.

• True, a different ownership system might lead to the

l f i lapproval of some previously rejected projects and artists, but at the expense of others who would be rejected.

160

• The overall number of productions or employment either would not change much in the aggregate or it might rise for some media, such as music, and drop for others, such as expensive special effects and animation.

• Subjective rejection of worthy projects is inherent to

di tany media system.

• “free TV,” makes programs dependent on advertisers and Ni l tNielsen nose-counts.

• This leads to an under-financing of quality programs that appeal to taste minorities.

• Where markets do not provide the desirable results, social noneconomicsocial noneconomic objectives must be accomplished through social policy and the allocation of public funds.

• For media, this means, in particular, public support

h i fmechanisms for noncommercial content and distribution.

• The notion that one could do so on the cheap, through

hi ili iownership ceilings, is appealingly hopeful but bound to disappoint.

161

994












XI. CONCLUSIONS 995

XI. C l i

996

Conclusions

Tools Covered

997

Finance Tools Covered• Capital budgeting• NPV, DCF, IRR• Optimal capital structure• Life cycle of financing• WAAC

998

WAAC• EBIT-EPS approach• Portfolio diversification• Asset pricing• Entrepreneur negotiating with

Venture Capitalist

162

Issues Covered

999

Issues Covered• Capital investment in high risk

industries and projects• Choice of funding sources

1000

g• Capital structure• Short-term vs long term• Life cycle of financing

Issues covered• Irrelevance theory of capital• Pecking order• Internal financing

1001

Internal financing• Gap financing• Mezzanine financing• Junk bonds

Issues covered• Securitization• Vendor financing; PFD deals• Negative pick up deals

1002

Negative pick up deals• Government financing• Operating and financial leases• Limited partnerships• Private equity; venture finance

Issues Covered• IPOs and secondaries• Media ownership

1003

Rising Demand for Funding• Increasing production of media content• Growing number and power of

distribution networks

1004

• Greater technological sophistication and R&D complexity

• Greater expense of materials and production

163

• Media Finance is inherently risky, because the business of producing of producing media is itself risky – 80% of films,

1005

books, and music do not become profitable

• Most potential investors have no expertise in predicting the success of media, and cannot invest wisely

1006

• Intermediary firms are more likely to have specialized knowledge of the industry, can better pick “winning” investments

Rising Demand of Funding

• The financing of media is

1007

therefore becoming an even more central function

• Requires institutions and practices to channel funds from investors to firms and projects

1008

investors to firms and projects

These Financial Intermediaries for funding

• Activities of screening, contracting, and monitoringT h i f i k d ti• Techniques of risk reduction, control, maturity matching

1009

• Financing techniques and practices for American media projects and new media

1010

projects and new media industries are arguably major factor for their strength

164

End of L

1011

Lecture

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