Up to $275,000,000 New Films Facility, currently rated A2 (sf)
$250,000,000 Class A-1 Ultimate Facility, currently rated A2 (sf)
$600,000,000 Class A-2 Ultimate Facility, currently rated A2 (sf)
The Amendment will provide the Borrower's film production division, Village Roadshow Pictures Group ("VRPG"), additional capacity to co-produce and co-finance additional films with major studios. The collateral for the Facility are the international film rights and resulting cash flows from a library of 72 existing films and from future films which may be co-financed under the Facility. The existing films were produced and co-financed primarily with Warner Bros. ("WB", subsidiary of Time Warner Inc. -- Baa2), with 68 of the 72 films to date.
The Borrower is amending and restating the Film Finance Credit Facility, rated A2 (sf), to, inter alia, upsize the aggregate amount from $1.0 billion up to $1.125 billion, to extend by one year the revolving period of the New Films Facility (to four years), the revolving period of Class A-1 Ultimate Facility (to five years), and to reset the scheduled and legal final maturity dates to five years and fifteen years respectively from the closing date of the Amendment.
The Company requested that Moody's provide its opinion to them as to whether its ratings on the Moody's-rated debt issued in the affected transaction would be downgraded or withdrawn as a result of the execution of the amendments. Moody's believed that the amendments did not have a significant effect on the credit quality of the debt such that the Moody's ratings were impacted. Moody's did not express an opinion as to whether the amendments could have other, non credit-related effects.
In assessing the credit impact of the amendments, Moody's analysis is primarily based on: (i) substantial equity both contributed and internally accumulated through the performance of the current film slate (as reflected by current film library valuation); (ii) the substantial role of WB in the operations of the Borrower and in the Facility including agreements for sub-distribution, back-up distribution, and, under certain circumstances, advancing; (iii) structural features within the transaction to protect lenders such as a dynamic borrowing base, minimum equity requirements, and subordination of some repayment for prints and advertising cost advances; (iv) alignment of interests of all transaction parties supported by structural features whereby the potential for cash leakage or other distributions out of the Facility to the sponsor prior to repayment is extremely limited; and (v) performance to date of the Borrower and its accumulating library of films for over fourteen years.
The main risks to this Facility are the potential for investment in future films which perform poorly and possible performance volatility of the existing library. As the Facility is expected to fund future new films during its four-year revolving period, it is exposed to the potentially varying performance of these new films. For instance, individual performance of films already owned by the Borrower as compared to initial projections has widely ranged from a loss of over 80% of the initial investment to above 300% return on investment. Thus any single new film investment would pose some risk due to this unpredictability of performance. A lower advance rate for new films, currently capped at 50% of cost when without a valuation, is intended to mitigate this risk. For the existing films already owned by the Borrower and financed by the Facility, there is a dynamic borrowing base determined as a maximum advance rate against an independent third party valuation which is regularly updated. The valuations are discounted present values of cash flow projections for international revenues of each film, including box office, television licensing, DVD sales and other merchandising. As macro-economic conditions, among many other factors, change, these projected cash flows remain somewhat exposed to fluctuation.
PRINCIPAL METHODOLOGY
Moody's methodology used for rating this Facility can be split into two different parts, as follows: (i) a qualitative assessment, focusing on structural features and the contractual obligations of the transaction parties, including VREG, its affiliates and WB, and (ii) a quantitative cash flow analysis of the expected cash flow from existing films and potential new film investments. Together, these items formed the basis for the Facility ratings.
Qualitative Assessment of Structural Features and Contractual Obligations
Film rights will be acquired by VRPG (or already have been acquired for existing films) and subsequently transferred to the Borrower. VRPG represents and warrants that no non-permitted liens exist on the international film rights and that this transfer constitutes a true sale of assets to the Borrower. As such, the Borrower will own the legal title to the international distribution rights and a security interest in all proceeds generated from exploitation of these rights.
Structural protections in the transaction have not changed which include a dynamic borrowing base to limit debt, a minimum equity test, net receipts test, and a minimum production investment credit all of which must be met to fund new film investments. Together these measures are found to be highly effective at limiting exposure to unprofitable new films. We note that the New Films Facility and the Ultimate Facility are cross-collateralized insofar as excess cash flows from one facility are available to repay the other facility.
The involvement of WB is important in our analysis as WB is the main distributor for the co-financed films. WB is a major subsidiary of Time Warner (Baa2) and is one of the major Hollywood studios with a long and successful track record of major film production. Our qualitative analysis further focused on their requirements to meet a minimum and maximum release costs to support a film's release as well as their obligation to advance one year after scheduled maturity upon request from the Borrower or the Facility lenders. VRPG's ability to select profitable films was also an element as shown by the success of the financed films to date, along with the ability of Australia-based Village Roadshow Ltd to distribute in select regions. When taking into account the structural features and roles of VRPG and WB, the alignment of all parties to the success of the film slate is a distinct strength for this transaction.
Quantitative Cash Flow Analysis
The cash flow analysis for this transaction was split into two parts: (i) projected cash flow of existing films in the slate and (ii) expected cash flow for any new films financed. For the projected cash flow of the existing slate, an analysis was conducted using annual historical projections versus collection on a per film basis. The detailed analysis looked at aggregate trends in collections for the films per year and also variability of these projections. Collections have historically been on average more than 10% higher than the projected cash flow for the films in the slate. However annual collections per film have a high degree of variability. As the advance rate for the Ultimate Facility is limited to 75% of the present value of the projected cash flows, the actual collections would have to decline substantially from the current level to incur a loss.
Monte Carlo simulation analysis was conducted to assess the performance of the Facility given new film investments. Future new film revenues were projected by sampling film performance data for current film slate using the cost-coverage-ratio ("CCR", defined as the projected cash flows divided by the investment amount) as a proxy. The entire data set of 72 films was reduced by excluding all films with a CCR above 1.0x (only 35 of 72 seasoned films included in this data set). The average CCR for the new data set is approximately 0.65x which implies an undiscounted 35% loss on any new film investment. At an assumed investment rate of one film per quarter if financing is sufficient to meet the minimum film budget requirement, each new film was sampled using the 35 film dataset to determine a CCR as a proxy of the projected cash flows for the new film. During simulation, the cash flows through the waterfall and the Facility's performance was measured. Additional stress were run to haircut first cycle and subsequent cycle cash flows from existing films ranging from 5% to 20% with various credit to the terminal value of the film library. The Monte Carlo simulation results for all scenarios showed that the new film investment was cut back as the haircut increases thus reducing exposure to new unprofitable film investments.
Other methodologies and factors that may have been considered in the process of providing this opinion can also be found at www.moodys.com in the Credit Policy & Methodologies directory, in the Ratings Methodologies subdirectory.
Xiaochao Wang Vice President - Senior Analyst Structured Finance Group Moody'sInvestors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653Michael McDermitt VP - Senior Credit Officer Structured Finance Group JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653 Releasing Office: Moody's Investors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653(C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.
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