Over the past five years, securitizations of the future revenues from previously unreleased films have been a viable financing source for a number of movie studios. Including the two transactions that closed in 2000, Moody's has rated over $3.5 billion in the term and conduit markets.
These transactions have numerous benefits to the issuing studio. These include:
*The transfer of a portion of film performance risk to bondholders
*Access to an alternative and possibly lower cost of funding
*Earlier reimbursement of capital invested in the production of films
*Off-balance sheet accounting treatment
The ratings on these transactions have ranged from as high as Aaa to as low as Baa3. To determine these ratings Moody's has employed a comprehensive approach that focuses on the asset-quality, structural, and legal aspects of the transaction.
The approach places particular emphasis on the financial strength of the issuing studio because of its substantial ongoing obligations and the transfer of the assets is usually not a legal true sale. This analysis is layered on top of an evaluation of the historical performance of a studio's films and the likelihood that the studio will be able to achieve similar performance in the future. The structure of the transaction is also analyzed to gauge the potential benefits of structural features such as triggers. This article will describe in greater detail how the analysis is performed on each of these aspects of the deal.
Though future firm securitizations have been sold into both the term and asset-backed commercial paper markets, they have similar structures and economics. From the proceeds of the offering, a pool of cash is created for the purchase of films once they are completed ("in the can") and ready for release. Since the trust only purchases films when they are in the can, the trust does not take film completion risk. This risk is normally borne by the studio or by a third-party insurer who provides a completion bond.
It is customary that a studio's entire future slate of completed films, subject to a loose set of eligibility criteria, is sold into the trust in order to limit its ability to "cherry-pick" the films that have a greater chance of success. The cost to the trust to purchase the film is its negative (production) cost plus corporate overhead and capitalized interest allocated to the film, subject to limits. Caps are also placed on the cost of an individual film to prevent a concentration of the trust's funds in a small number of (expensive) films.
In exchange for the purchase price, the trust receives ownership of the film and is entitled to receive all revenues generated by the film. These revenues are then allocated according to a payment "waterfall" among debt service, distribution expenses, and other transaction costs. Most deals have a revolving structure through which revenues on earlier films are reinvested to purchase additional films for the trust until a specified date or until an early amortization trigger is hit.
The studio is also typically licensed back the marketing and distribution responsibilities for the film. Because of its past experience distributing films, the studio is generally best qualified to insure that the film is shown in the appropriate number of theaters and is promoted properly so that revenues generated are maximized. These obligations are equivalent to servicing responsibilities in traditional asset-backed deals.
Asset Quality Analysis
The asset quality analysis of a future film securitization focuses on two areas:
*Fundamental analysis of the studio
In contrast to most asset-backed transactions, the issuer (the studio) must continue to generate new assets following the closing date for future film securitizations. In addition to producing the films, the studio is also obligated to distribute and market the films in order to maximize their revenues. As a result, it is necessary to analyze the financial condition of the studio to determine the likelihood that it will be able to fulfill these responsibilities for the period it takes to create a diversified portfolio of films. The importance of generating a portfolio of sufficient size is explained in a later section.
For studios with a rating, Moody's view of the studio's financial condition is relatively easy to determine. For unrated studios it is necessary to perform a shadow rating analysis to assess this risk. All of the six major studios, which account for approximately two-thirds of 2000 to date domestic box office, are divisions of larger rated entities. Their ratings are as follows:
Studio Corporate Parent Rating
Columbia Sony Corp. Aa3
Warner BrothersTime Warner Baa3 Under review
for possible upgrade
Universal Vivendi Baa2 Under review
for possible downgrade
20th Century FoxNews Corp. Baa3
Buena Vista Disney A2
Paramount Viacom A3
The other U. S. film studios include so-called independents like Miramax (Buena Vista) and New Line Cinema (Warner Brothers), which are actually specialty divisions of the majors, as well as true independents such as DreamWorks SKG, Metro Goldwyn Mayer (MGM), Artisan, and Destination. None of the independents are currently rated, but it is believed that in most cases their ratings would be below investment grade. The credit quality of studios outside the U. S. generally are also below investment grade.
Because of their greater stability, well-developed film pipeline, and established distribution network, the major studios are best able to create future film securitizations that can achieve high ratings. It is not surprising that these companies were the first to enter this market and have issued the lion's share of the transactions. For unrated or lowly-rated studios it is possible to structure a future film transaction that can achieve ratings higher than that of the studio. See below for how a transaction can be structured to achieve ratings higher than that of the studio and factors that limit any ratings benefit.
*Film Performance Analysis
In the 1990s, as home video and cable television have become more common throughout the world, the potential revenues that can be generated by a film have increased dramatically. Though domestic box office receipts, also referred to as theatrical rentals, are often considered the barometer of a film's success or failure, they usually equal only 15-20% of a film's lifetime revenues. The other 80-85% of total revenue generated by the exhibition of the film is composed of international rentals, domestic and international home video (including the new format of Digital Video Disk), pay television, and free television, and non-theatricals (see Figure 1). Further revenues can be earned through the sale of soundtrack albums, book adaptations, and various forms of merchandising.
Because of the variety of revenue sources available it has become less difficult in recent years for a studio to recover its production cost on a film. According to the data provided by the studios, the average film produced by the major studios in the 1990s has generated revenues that cover its negative costs by over 2.5x.
This high average coverage level is a key factor in lowering the risk of securitizations of future film revenues. Since the transaction finances only the film's production costs, average film performance would usually more than cover the securitization's debt service in most cases. Additional film expenses like prints and advertising (P & A) costs, which can reach over 50% of a film's negative costs, are typically funded by the studio and are generally repaid in a position that is subordinate to bondholders. This exposure to expenses and subordinated position in the cash flow structure aligns the studio's interest with that of the bondholders and provides them with a strong incentive to distribute the films properly.
Although average film performance is generally sufficient to more than cover debt service, individual film performance is highly variable, with coverage levels often falling below 1.0x. and sometimes reaching above 6-7x for major blockbusters (See Figure 2). To reduce this risk, future film securitizations cross-collateralize the revenues of a portfolio of films. The benefits of this are two-fold:
*to reduce the probability of a string of unsuccessful films with low coverage levels
*to increase the probability of producing a highly successful film that has the ability to cover the costs of the weaker films.
If a studio can demonstrate that it's performance can match the industry average, Moody's modeling of portfolios of films has found that a portfolio of approximately ten films can achieve a level of diversity that supports investment grade ratings. With smaller portfolios, there is a higher likelihood that limited number of films will all be weak performers, which increases the transaction's expected loss and pushes the deal outside of the investment grade category. This was determined by using a Monte Carlo simulation that randomly selected film revenues from a distribution created with historical data, for slates of different sizes. The revenues generated by these slates are then fed through the transaction waterfall to determine the expected loss for the pool. If the studio's performance is below average, the number of films needed to sufficiently lower film performance risk increases.
In most transactions, the portfolios of films at the start of the transaction are smaller than necessary to achieve sufficient diversification. However, in such cases Moody's will evaluate the financial stability and track record of the studio to assess the likelihood that the studio will be able to produce a sufficient number of films. Attention is also paid to the studio's production pipeline to determine the length of time it will take to create the portfolio.
Legal and Structural Analysis
Due to the obligation of the studio to continue to produce the films on an ongoing basis, as well as its exposure to film performance risk because of its investment in P & A costs, the transfer of the assets by the issuing studio is not deemed to be a legal "true sale." The trust does, however, receive a perfected security interest in the films and the revenues generated by them, which characterizes the transaction as a secured financing and not a securitization. In the traditional corporate finance context, the security pledge would normally enable the transaction to achieve a rating one notch above that of the issuer, but Moody's has determined that, through the use of structural enhancements in future film deals, it is possible to achieve a larger separation.
These structural protections normally take the form of a set of triggers related to both the financial condition of the studio and the performance of the included films. The triggers are designed to protect investors from a bankruptcy of the studio by increasing the likelihood that the bonds will be fully repaid prior to a potential filing. They are roughly equivalent to downgrade triggers in a transaction with a rated issuer.
Typical results of the triggers include early amortization events and reorderings of the priority of payments in the waterfall to reduce future payments to the studio. In addition, a clawback feature, which requires the studio to return funds paid to it in prior periods to cover principal and interest shortfalls, can also be included. This feature takes advantage of the cross-collateralization of film revenues by using revenues generated by earlier successful films to cover weaker films released later in the transaction's life.
In Moody's analysis of the transaction, the relative strength of the triggers is evaluated in combination with the film performance analysis discussed earlier to determine how much benefit they add to the final rating.
Despite the benefits that the triggers add to the credit profile of the transaction, Moody's does not believe that the risk of company bankruptcy can be completely eliminated. As a result, even with the strongest set of triggers, the rating of the transaction is still limited by the credit quality of the studio. In addition, the level of the triggers' benefit will tend to decline as the transaction moves up the rating scale.
Moody's approach to the rating of future film securitizations is a hybrid of both corporate and structured finance analysis. Through the use of asset-backed features like cross-collateralization and performance triggers, transactions have been structured to high rating levels in an industry where performance is thought to be highly unpredictable.