Artisan Entertainment Inc, Case Study Example

Former Bain Capital employees Geoff Rehnert and Marc Wolpow are about to launch Audax Group that has been looking into a potential acquisition of 34 % stake in Artisan Entertainment Inc. for approximately $30 million from their former employees. Geoff and Marc have prepared a series of financial projections to help them secure financing for the acquisition of Artisan Entertainment Inc. They have developed three likely scenarios, i.e. an optimistic scenario, a pessimistic scenario, and the mostly likely scenario in their opinion. Below are the assumptions they took under each of the potential scenarios. They calculated the cost of equity to be 17.6% for this particular acquisition target. The corporate tax rate is assumed to be 35%. The analysis covered the years 1999 through 2003 i.e. 5 years. The sales revenue figure of $173.5 m for the year 1998 was chosen as the start point for income statement projections.

Pessimistic Scenario

The projected sales growth rate for the years 1999 through 2003 were 53%, 20%, 10%, 5%, and 5% respectively. The next step was to calculate net operating cash flows for the whole period which were then discounted at the rate of 20%. The sum of the PV of 5-years operating cash flows came out to be $112.63 million. The debt figure of $135.8 million exceeded the PV of operating cash flows, resulting in a negative equity of $23.2 million. This would put a 34 % stake in Artisan at negative $7.97 million. Under this scenario, the equity stake is non solvent and the value of the entire company is worth less than its debt obligations.

Optimistic Scenario

The projected sales growth rate for the years 1999 through 2003 were 100%, 20%, 10%, 10%, and 10% respectively. The net operating cash flows for the whole period were calculated and then discounted at the rate of 20%. The sum of the PV of 5-years operating cash flows came out to be $230.03 million. The debt figure of $135.8 million means the entire equity stake in Artisan is worth $94.2 million. This would give a 34 % stake in Artisan, a value of $32.42 million. Under this scenario, the purchase of 34% stake in Artisan from Bain Capital would net the investors of Audax Capital, an immediate profit of approximately $2.5 million.

Most Likely Scenario

Under the most likely scenario, the projected sales growth rate for the years 1999 through 2003 were estimated at 70%, 20%, 4%, 4%, and 4% respectively. The net operating cash flows for the whole period were calculated and then discounted at the rate of 20%. The sum of the PV of 5-years operating cash flows came out to be $186.19 million. The debt figure of $135.8 million means the entire equity stake in Artisan is worth $50.4 million. This would give a 34 % stake in Artisan, a value of $17.33 million. Under this scenario, the purchase of 34% stake in Artisan from Bain Capital would be an unattractive deal because Audax will be paying approximately $30 million for a stake that is worth only $17.33 million, resulting in a loss of over $12.5 million.

Conclusion/Recommendation

The multi-scenarios analysis shows that the Artisan deal would be profitable only under the optimistic scenario and even then the profit would be mere $ 2.5 million approximately or 8.33% of the purchase price. The stake is worthless under the pessimistic scenario and a loss incurring deal under the most likely scenario. Moreover, the motion picture industry is highly volatile and the success of small budget movies like ‘The Blair Witch Project’ is usually a rare occurrence than the norm. The probability of Artisan being an overvalued company at this time is a lot greater than being an undervalued company since the studio has been riding high on the recent success of ‘The Blair Witch Project’. Good news often result in optimistic projections and push up the equity valuation so much that the stock is not a good deal anymore.

Thus, the best course of action for Audax is to forego investment in Artisan in the light of the multi-scenario analysis. The stakes are stacked against an equity investment in Artisan at this time.