Monday, December 28, 2015

Intergalactic Finance: Valuing the Star Wars Franchise

I saw the newest Star Wars movie last week and it brought back memories that stretch back almost four decades. Watching Harrison Ford and Carrie Fisher on the screen reminded me of my age, though, once I learned how much Ford made for being in this episode, I understood the movie's story line much better. As I came out of the theater, though, I decided that it would be fun to update a valuation I did of the Star Wars franchise in 2012, when Disney acquired the rights from Lucas Films.

The Movies- Box Office Bonanza
If you are one of the few people on the face of the earth that has not followed the Star Wars story, it began in 1977 when George Lucas produced the first Star Wars movie, the fourth episode in what he saw as a six-episode series. That movie made history and remains one of the highest grossing movies of all time. It was followed in 1980 by the fifth episode, The Empire Strikes Back (my favorite), and in 1983 with the sixth in the series, The Return of the Jedi.  Those first three movies created an entire generation of Star Wars fans, who then had to wait 16 years for the first in the series, The Phantom Menace (my pick for the worst of the series), which was followed  by Attack of the Clones in 2002 and Revenge of the Sith in 2005. The six movies represent one of the most valuable movie franchises of all time, generating billions of dollars in box office receipts, with the appeal spreading globally.
The movies are shown in chronological order and the box receipts on the first three movies include the collections from their re-release in theaters in the 1990s.

The Add-Ons - Bigger than the Movies?
If you stopped just at box receipts, Star Wars might not be the most valuable franchise at all time, lagging the James Bond movies and perhaps even the Harry Potter and Lord of the Rings franchises. It is the magnitude of the add-ons to box receipts that make Star Wars unique and as someone who has partaken in all of them, I can attest to their power. I have owned the Star Wars tapes and DVDs, collected every Star Wars figure made, played Star Wars video games (very badly) and even used a GPS with a Yoda voice to drive from New York to Chicago (I love Yoda but he is a really bad navigator). The Star Wars empire stretches far and wide to include:
  1. VHS/DVD/Rentals: The additional revenue from this stream reflects as much the hold that Star Wars has had on our collective imaginations, as it does the changing of technologies for home video watching over the decades. Starting with video tapes (VHS) sales and rentals in the 1970s, morphing into DVD sales in the last decade and continuing into streaming in today's environment, this add-on has generated $7.7 billion (unadjusted for inflation) in revenues.
  2. Toys and Merchandise: This is the crown jewel of the franchise, as toy and merchandise sales have outstripped all other sources of revenue. The revenues from action figures sold by Kenner  (1978-1985) and Hasbro (1995-2011) amounted to almost $10 billion (unadjusted for inflation) and adding in other merchandise, the collective revenues from toys and merchandise over the history of the franchise is in excess of $12 billion. 
  3. Gaming: As with the video rentals, the Star Wars games track shifting technologies, starting with an unlicensed game for the Apple II on a cassette tape, followed by table-top game by Kenner and games for the Atari. Starting in 1992, the games shifted away from the films to the expanded Star Wars universe, first with the X-wing computer games and later with Dark Forces, a shooter game. In 2013, Disney revealed that Electronic Arts would retain the rights to produce games for PCs and consoles, while Disney would retain the rights for other platforms. The collective revenues from all of these games between 1977 and 2015 is $3.4 billion.
  4. Books: There have been almost 360 books, with 76 authors, in the Star Wars series and total sales have amounted to more than $1.8 billion. The staying power of the franchise is backed up by the fact that the first books were in print in 1978 and that there have been at least ten Star Wars novels a year, every year from 1991 to 2014.
  5. TV Series/Other: Given its success on so many dimensions, it is surprising that the Star Wars franchise has not spawned a higher profile TV series. The longest lived TV series, Clone Wars, has had seven seasons and a second one, Star War Rebels, produced by Disney, has had two seasons. There have been periodic rumors about other TV series in the works, with the latest one suggesting that Netflix is planning three live-action series
The collective revenues from these add-ons make the Star Wars revenue pie much larger than any competing movie franchise:

Note that the movie revenues in the table are not adjusted to 2015 $, since the revenues from the add-ons are not available in current dollars. In the table below, I scale the revenues from each of the add -ons to the box office receipts to get a measure of the value added from the rest of the Star Wars ecosystem:

In effect, for every dollar that Star Wars has made at the box office, it has generated four dollars in revenues from other sources. That number is a conservative estimate, since there have been undoubtedly others who have profited from the franchise unofficially (and illegally).

The New Series: Disney takes over
In 2012, Disney acquired the Star Wars franchise for $4 billion, from George Lucas, with plans to produce three more Star Wars movies. At the time of the acquisition, I argued that it was a fair price, given Disney's history with developing, maintaining and merchandising franchises, but had to draw on the potential for synergy to justify the number. With the release of Star Wars: The Force Awakens just about ten days ago, Disney seems to be more than delivering on its promise, as the movie has broken box office records and is on its way to delivering a global box office of $2 billion or more.

To the extent that this movie, like its predecessors, will generate add-on revenues, there will be substantially more money to be made over the next few years. The next two movies are scheduled for 2017 and 2019, and there will be three spin offs in the intermediate years, with less ambitious budgets. After 2020, Disney's plans are not specific, but if the appetite remains, there will be undoubtedly more movies in the pipeline. More importantly, the movies will not only create a new base of younger fans but augment the sales of merchandise, toys and games in the coming decade. The revenues that would have come from DVDs and video rentals will be replaced with streaming revenues and there will undoubtedly be games and apps directed at smartphones, devices and gaming systems. 

Valuing the Franchise
To value the franchise, I started with my estimates of worldwide box office receipts for Star Wars: The Force Awakens and the subsequent movies in the series. Though, the first two weekends have blown away expectations (with the movie making $1 billion), I will estimate $2 billion in revenues, for each of the three main movies, and half those proceeds for the spin offs, with an inflation adjustment of 2%.

As with the prior movies, the bulk of the revenues from the franchise will come from add-ons, and in assessing the potential, here are some of my assumptions:
  1. Streaming: As viewers increasingly turn to watching streamed movies from services (Netflix, Amazon Prime) on their televisions and devices, the revenues from streaming are quickly catching up with box office receipts for movies, and by 2017, the total revenues from streaming are expected to exceed box office revenues. I will assume that each dollar in box office revenues from the new Star Wars movies will generate $1.20 in additional revenue in streaming, slightly higher than historical numbers (1.14).
  2. Toys/Merchandise: The Star Wars movies have historically generated $1.80 in revenues from toys/merchandise for every dollar in box office revenues. Given Disney's prowess at merchandising, I would not be surprised to see this number go up, and I will assume that each dollar at the box office will translate into two dollars in merchandising revenues, a little higher than the historical value of $1.80 per box office dollar. Keep in mind that this franchise is a merchandisers' dream, with an almost endless potential for new opportunities in the Expanded Universe.
  3. Books and eBooks: This is the stream that is perhaps most at risk, and I will assume that while a way will be found to adapt the publishing stream to changing tastes in reading, the revenues from this books/e-books will drop to $0.20 per box office dollar (from $0.27, the historical number).
  4. Gaming: In keeping with the history of Star War games, I am convinced that that games will be adapted not only to gaming platforms (Xbox, Playstation and Nintendo) but also to smartphones and tablets. I will leave the gaming revenues at $0.50 per dollar in box office receipts.
  5. TV Shows/Other: This is the one add-on where I will assume a significant improvement over historical numbers, as Disney, Netflix and others find ways to adapt the franchise to television viewers. I will assume that the revenues from TV shows will increase to $0.50 per dollar in box office receipts.
Download Spreadsheet
To estimate the franchise value, I used the operating margins of the movie (20.14%) and toy/merchandise businesses (15%) and netted out taxes (at a 30% tax rate), before discounting back at a 7.61% cost of capital, the entertainment sector average. (Disney will probably license most of the merchandise, passing of the risk to others, but settling for a share of the operating income.) At least based on my projections, the value of the Star Wars franchise, if it can maintain my estimated numbers (for add-ons) and deliver at the box office, is almost $10 billion. The value is obviously a function of movie revenues and the add-on dollar values:

Not only does that make Disney's $4 billion investment three years ago a very good one, but any synergies that Disney can gain in its other businesses (like this one) will create more upside. As always, you are welcome to make your own assumptions and revalue the franchise, using this spreadsheet.

An Acquisition Model that works?
I am not a fan of acquisition-driven growth, primarily because the process so often leads to over paying for growth, but Disney may have found an acquisition model (albeit a limited one) that works with its Star Wars and Marvel acquisitions. In both cases, the company bought established movie franchises and has used its merchandising machine to generate value. Those results have already borne fruit with Marvel, especially with the Avenger movies, and we may be be seeing the beginnings of the Star Wars dividends this week. 

During the week, while I was in the city (New York), I saw at least three Stormtroopers and a Darth Vader on Times Square and every store that I went into had something related to Star Wars, on sale. If you are a Star Wars purist, appalled by the shameless merchandising of the movie, I am afraid that you ain't seen nothing yet. If you are a Star Wars collector, and think that you have the entire collection already (for you or your kids), here is something for you to ponder. If you are a Disney stockholder like me,  may the force be with you!

YouTube Video


Attachments
  1. Star Wars: Valuing the Franchise (Spreadsheet)
  2. Star Wars: Franchise Value Picture (jpg file)


20 comments:

Donza Worden said...

Professor,

I am interested in how you got to the operating margins of the movie. I would assume one could look at the budget of the movie as COGS, thus box office revenue less budget gets you to a gross profit. Thus, if TFA's budget of $200mm is accurate (meaning that is all it takes to generate the $2bn in box office revenue) and it ends up generating $2bn in sales its gross profit would be $1.8mm (90%) implying 70% or $1.4bn is SG&A...I don't see how that can be the case. Given this, I would surmise that the "budget" figure is not an accurate figure for COGS. Is that correct? If so, it brings me back to my question of how did you formulate the 20% for operating margins?

Thank you,
Donza

Donza Worden said...

As a follow-up to my comment, I noticed in your spreadsheet the note of "average margin for entertainment companies". However, I would contend that that is not a reliable metric given the Star Wars movies are far from average and it has the benefit of being able to leverage the value of its brand certainly more than average movie and possibly more than a premiere franchise. This brand in the marketplace (almost thinking of it as historical CapEx) I would think allows it significant operating leverage. For example, TFA could have spent $50mm less on advertising and their revenues would have dipped less than an average movie reducing its advertising spend by $50mm.

Aswath Damodaran said...

The 20 percent is the collective operating margin for movie companies. The question that you raise is an interesting one and there is no easy answer because it depends on (a) the cost of making the movie, (b) the advertising budget for the movie and (c) the profit sharing with others involved (producer, director, actors) in the movie. The rumored number for Disney to break even on this movie is already well above a billion, suggesting that the marketing costs are huge. There is a point (my guess is $1.5 billion) at which the margin not the additional revenues will be much higher. To be honest, the value is not that sensitive to movie margins, since it is more driven by the add-ons.

invicible said...

As there is growing demand for Hollywood movies in India, does the valuation model considers this additional factor? Some of the movies in the recent times like "Inception", "Avatar" have made more than INR 400-500 million which is significant achievement by Hollywood ...

Anonymous said...

In your perpetuity assumption for continuing income:
1) You have started with movie revenues for 2015 which is taken at 1514;
2) You have multiplied (1) with the factor of 1.82 which is total cumulative movies collections past and 2015 over past movie collections, i.e. (11473+9430)/11473;
3) Then you have considered the non-movie margin of 15%.
My question is, shouldn't you have considered non-movie numbers (past, 2015 and future) for estimating present value of perpetuity from continuing income?
Thanks
SP.

Aswath Damodaran said...

The $1.514 billion in 2015 was not movie but merchandise revenue, pre the new Star Wars movie. This ongoing stream is therefore only the merchandise stream, scaled up to reflect the higher demand created by adding a new generation of Star Wars fans after 2020. That is why the margin is only the margin on non-movie stuff.

Luis Espejo said...

Professor,

...and what about the pre-tax margin on non-movies ? does this also come from average margins for entertainment companies ?

Thanks

Anonymous said...

Additionally, what impact does the total decimation of the Republic Senate have on these numbers? Does this impact the intergalactic exchange rate? Will Rey’s quarter portions perhaps be increased to a .86 portion?

Anonymous said...

By this logic, there are a few other variables to the equation:
-Does Poe’s jacket become more valuable on Fynn?
-If she has been around for 1,000 years of inflation, why is Maz still so tiny?
-Can Chewbacca sell his crossbow at face value now that Han has touched it?
-Is Leia still hot?

Anonymous said...

When considering non-movie numbers for estimating present value, one is then also acknowledging the fact that the Force, indeed, has been awakened. This intangible asset has been valued at infinity.

We would also then have to consider fiscal impact of the Empire’s rise via the First Order. Now, the Death Star alone has been valued at $852,000,000,000,000,000 (http://www.forbes.com/sites/carolpinchefsky/2012/02/21/how-much-would-it-cost-to-build-the-death-star-from-star-wars/).

Ponder that for a moment. The First Order returns just three decades later with the Starkiller base, easily 9.64 times the size of the Death Star with 6 times the destructive power. Which assets are not factored here in funding the First Order since the destruction of the Empire? Could this imply resurgence by Lord Vader himself? Why can Supreme Leader Snoke afford such a luxury, but can’t fix his face?


Additionally, what impact does the total decimation of the Republic Senate have on these numbers? Does this effect the intergalactic exchange rate? Will Rey’s quarter portions perhaps be increased to a .86 portion?

By this logic, there are a few other variables to the equation:
-Does Poe’s jacket become more valuable on Fynn?
-If she has been around for 1,000 years of inflation, why is Maz still so tiny?
-Can Chewbacca sell his crossbow at face value now that Han has touched it?
-Is Leia still hot?

Chris Jefferson said...

Interesting discussion. A few thoughts that may impact how you think about the valuation:

1. The studio's take of the box office is 40-60% (50% domestically), so disney's revenue for the film will not be that reported in the newspapers. The balance goes to the exhibitor.

2. Does the "budget" for the movie include advertising & promotion costs? Those often exceed the actual cost of a big movie these days. The true cost of the movie may be 2x what the papers say.

3. The majority of the non-film revenue will be generated via third parties (i.e., Hasbro, EA, etc.), so the ancillary revenue to Disney will not be the headline revenue from these products. Disney also will not get the headline margins for a lot of these products either. Disney will benefit mostly via licensing and similar agreements with the actual producers of the toys, games, books. Will be lower revenue, but higher margin than you might be forecasting to Disney.

4. Most movies (big, popular movies being the exception) typically are not profitable during the cinema exhibition period. They only become profitable in later runs (DVD, TV, etc.). This will impact the valuation by pushing some profitability to later years. Additionally, now that we are in a new world of streaming video, it is unclear how the switch from the very profitable DVD business to streaming economics will affect mid-life profitability. Point is that historical norms may not apply as usual (this is one of the first big movies we have had under this new framework).

Just some thoughts for your consideration. I am interested in seeing how the next level of analysis looks.

Anonymous said...

Hi Mr.Damodaran,

Watched your appearance on CNBC during the December Holidays and it a great segment. Just wanted to ask whether you added "Chipotle" to your portfolio? (Video cutoff after Lukoil valuation)

Thanks,
Tim

Simon Warner said...

Prof D,

Didn't the Lucasfilm acquisition include the rights to Indiana Jones as well?

Using your number and assuming 3 Indy movies aa successful as the Star Wars spin-offs, including steaming and gaming but zero for books and merchandise, that would add another c$1.5bn to your valuation.

Jan Carl Rittaler said...

Excellent point Simon! And Bob Iger just confirmed there is an Indiana Jones movie coming! Harrison might get another one of those huge paychecks.

Aswath Damodaran said...

Simon and Jan,
I agree with you on the potential for the Indiana Jones sequels. The one difference is that the previous Indiana Jones movies rights reside with Paramount and Disney cannot use them. Also, the potential for merchandising on the Indiana Jones movies is much smaller than Star Wars.

Rohit Mahajan said...

Professor Damodaran,

What about incremental theme park sales?

All the best,
Stern Class of 2015

Aswath Damodaran said...

Rohit,
I did not value any synergies. To the extent that they exist (and I believe they do), that is icing on the cake for Disney but it should not be treated as part of the franchise value, since if Disney sells the franchise or spins it off as a stand alone enterprise, this synergy value would not accrue to the franchise.

Abhay Vig said...

Well This might seem off topic but, isn't movie business is riddled with uncertainty, sure the first few days click due to momentum, fan clubs etc. But for the two streams
(1) carryforward of a prior franchise: which can be modeled based on a prior revenue stream.
(2) New revenue from movies sequels: Isn't it a case of Real options. Can it be valued in some other way?

Anonymous said...

great analysis. I really don't get how you came across the $1514 that you use to calculate the perpetuity. Would someone mind to explain the assumption and the calculation behind? cheers, XG

Anonymous said...

Professor,

This is a very interesting analysis, thanks very much.

Chris Jefferson makes very important points, namely:

1) Box office is not representative of revenue to the studio. Exhibitors take a large share, especially in markets like China. Advertising & Promotion costs are usually at least 1x production costs, plus there are other costs

2) Consumer Products (Toys, Games, Books etc) are mostly licensed. Disney gets exceptionally high royalties on Star Wars but even so this is likely no more than 10 cents on every retail dollar after the retailers and licensees get their share.

3) The Disney Stores and Theme Parks likely saw huge increases in merchandise sales from Star Wars (physical and online) but not all is incremental as other brands e.g. Marvel were likely substituted. The same is true to lesser extent for general licensing.