Sony Pictures Music Publishing Catalog

SONY PICTURES MUSIC PUBLISHING CATALOG

INTRODUCTION

Overview of the Catalog

Following two previous sales of its music publishing catalog, in 1993 Columbia (now SPE) begancreating new publishing entities to hold all musical works acquired for its productions, and SPE also entered into a worldwide publishing administration agreement with Sony/ATV Music Publishing. Currently, the Sony Pictures Music Publishing Catalog (“SPMPC”) consists of over 350,000 instrumental cues and portions of over 10,000 “songs” (titled score cues from albums, in which SPE owns 100% of the copyright as well as songs with lyrics, in which SPE owns smaller percentages of the copyrights), all derived from approximately 425 films and 320 television titles (including tens of thousands of individual episodes produced from 1993 to the present). Most of the instrumental cues are owned 100% by SPE, while SPE owns 50% or less of the copyrights in the songs.

Monetization Alternatives

Sony Pictures is currently evaluating a monetization of the SPMPC. This memo outlines the benefits and drawbacks of three alternatives structures:

• Sale of copyrights with no restrictions
• This structure is likely to generate the highest sale price. However, this structure would create several drawbacks for SPE
• Sale of copyrights with restrictions
• It may be possible to structure a deal to provide SPE ongoing access to works and protect SPE’s interest by placing some restrictions on the buyer. However, SPE’s interests are unlikely to be fully protected by contract and restrictions will negatively impact valuation
• Income stream sale
• This is SPE’s currently preferred structure as it would more effectively address the majority of drawbacks
• However, this approach is likely to lead to the lowest valuation

Evaluation Process

As part of a bake-off process, SPE will ask 2-3 investment banks to evaluate the proposed structure (under NDA). The bankers will be asked to address:

• Estimated value under each structure
• Any alternative structure that will provide SPE access and protections with limited impact on value
• Preliminary list of buyers
• Proposed auction process and timing

Before formally engaging a banker and proceeding with a sale, we will ensure that a sale under our preferred structure is compelling in light of the associated discount (if any).

REVENUE HISTORY

Over the last four years, the annual net publishers’ share of income (“NPS”) from the SPMPC has averaged about $13.9 million. Of that amount approximately 96.5% is a combination of Public Performance Income and Mechanical Income (collected by Sony/ATV) and the remaining 3.5% is Third-Party License Income collected directly by SPE.

Fiscal
Year / Sony/ATV Income
(Performance + Mechanical) / Third-Party Licenses / Total
2007 / $12,000,452 / $465,001 / $12,465,453
2008 / $13,467,159 / $642,843 / $14,110,002
2009 / $14,932,081 / $433,708 / $15,365,789
2010 / $13,412,207 / $429,562 / $13,841,769
Average / $13,452,975 / $492,779 / $13,945,753

Sony/ATV estimates that 90% of the income it collects on the SPMPC is from public performances and 10% is from mechanical licenses and other sources. So the breakdown of four year average NPS of the SPMPC is:

Income Source / Average NPS / Percent of Total
Public Performances / $12,107,677 / 86.82%
Mechanical Licenses/Other / $1,345,297 / 9.65%
Third-Party Licenses / $492,779 / 3.53%
Net Total / $13,945,753 / 100.00%

For a further historical view, the NPS derived from Public Performance Income and Mechanical Income for the SPMPC over the first 12 years that income was generated, as accounted by Sony/ATV, is as follows:

Fiscal
Year / Sony/ATV Income / Fiscal
Year / Sony/ATV Income / Fiscal
Year / Sony/ATV Income
1995 / $770,276 / 1999 / $5,657,009 / 2003 / $10,120,461
1996 / $1,803,858 / 2000 / $6,821,095 / 2004 / $10,768,526
1997 / $2,304,846 / 2001 / $8,120,989 / 2005 / $12,634,108
1998 / $3,453,333 / 2002 / $9,271,915 / 2006 / $11,690,355

Third-party license income is not included in the above charts, as that source of publishing income was lumped together with income from the licensing of master recordings during that period.

VALUE CONSIDERATIONS

Price and Valuation

The primary benefits derived from a sale of the SPMPC copyrights include lump sum cash payment and the recognition of the associated gain. Publishing catalogs are traditionally valued on a multiple of NPS with the multiple being influenced by the relative prominence of the music in the catalog, the estimated future performance of the catalog, and current economic market conditions in the music publishing industry. When Columbia Pictures last sold its music publishing catalog in 1988, the multiple was 10.5 times NPS. Income derived from the two prior sales of Columbia Pictures’ music publishing catalogs is as follows:

1976 EMI Sale - $23,500,000

1988 Filmtrax Sale - $52,000,000 + $10,000,000 for Futures (through 1992)

In addition to general economic factors, the multiple for any sale would also take into consideration any rights retained by SPE and the ongoing obligation to pay a portion of NPS back to SPE for contractual distribution to profit participants.

SALE OF COPYRIGHTS WITH NO RESTRICTIONS

Benefits

A sale of the copyrights with no restrictions is likely to yield the highest valuation. It opens the sale process to strategic buyers. It also increases the likelihood that financial buyers are able to use the copyrights as collateral when securing leverage for a purchase.

Drawbacks

Any sale of the SPMPC would result in the loss of an annual income stream that has been in the range of $13 to $14 million in the last three years and the loss of potential breakout income earned by hit songs contained in the SPMPC. A sale of copyrights without restrictions would also result in:

• Potential Loss of Master Recording Income on Masters Retained by SPE

A sale of SPE’s publishing interests will also affect SPE’s ability to license its master recordings, because the new owner of publishing rights can create its own new masters of these compositions to exploit in lieu of the originals still owned by SPE.

• Loss of Control over Music Usage

A transfer of SPMPC ownership results in loss of control over how the music associated with SPE’s films and television productions can be used.

• Strained Relationships with Separate Pot Income Participants

Historically the buyers of Columbia Pictures’ music publishing catalogs have not provided accurate accountings, potentially straining SPE’s relationships with the highest level profit participants.

• Non-Contractual Relationship Issues

Non-contractual considerations and restrictions are not likely to be honored by a third-party buyer. SPE’s interest in maintaining a close relationship with John Williams, for example, may lead to seeking his consent for uses of his music even where it is not required under any agreement.

• Future Audits and Lawsuits

Major music publishers who are potential buyers for the SPMPC tend to focus on acquisitions and collections, not on overseeing third-party responsibilities.Under past sales agreements, SPE has filed two separate lawsuits (both settled) against EMI resulting from audits due to EMI’s failure to properly account to SPE for payments due to third-party royalty participants.

• Potential Corporate Consequences

The SPMPC is an asset affecting the overall valuation of SPE, and its sale may have unforeseen consequences in a corporate sale or merger.

• Restrictions on Future Use of Music by SPE

Once the SPMPC is sold, obtaining licenses from the buyer for the re-use of that music in future types of productions, for ancillary uses and for new media is difficult and expensive.

SALE OF COPYRIGHTS WITH RESTRICTIONS

Drafting Considerations for Sales Agreements

If copyrights are sold outright, past experience has twice shown that it is highly unlikely for any sales agreement to allow SPE to retain all the rights or enforce all the restrictions that may be needed or desired in the future. Nonetheless, some of the negative impact of selling the SPMPC can be reduced by careful drafting of the sales agreement.

Specific Rights for SPE to Retain

A sale agreement could allow for SPE to retain the following rights in the SPMPC compositions:

• Use in all SPE productions, distributed products and acquisitions in all media, worldwide in perpetuity

• Use in all forms of advertisements and promotions for all SPE productions, distributed products and acquisitions in all media, worldwide in perpetuity, both in-context and out-of-context

• Use in featurettes and making-of’s, both in-context and out-of-context, in all media, worldwide in perpetuity

• Use on DVD/Blu-Ray menus and extras, both in-context and out-of-context, worldwide in perpetuity

• Use in film clips, whether by SPE or licensed to any third parties, in all media, worldwide in perpetuity

• Use in all co-promotions and commercial tie-ins, both in-context and out-of-context, in all media, worldwide in perpetuity

• Use in all merchandise and in ringtones, mastertones and videotones in connection with SPE productions, distributed products and acquisitions in all media, worldwide in perpetuity

Specific Obligations and Restrictions on SPMPC Buyers

Any sales agreement would also provide that:

• The buyer will be responsible for payment of the appropriate percentage of SPMPC income to SPE for distribution to profit participants.

• The buyer will abide by all restrictions, consents, etc. contained in all applicable talent agreements.

• The buyer will not make any use of SPMPC compositions that competes with SPE productions or with co-promotion partners.

INCOME STREAM SALE

Benefits to SPE

For SPE, a sale of income stream from publishing assets (“ISPA”) rather than the publishing copyrights themselves eliminates issues related to SPE’s continued control of musical compositions and the use of those compositions in connection with SPE’s own productions, while still providing the same influx of cash as a sale of the SPMPC itself. Additional benefits to SPE of structuring a deal in this manner include:

• The buyer is a 100% net income participant, but has no right to dictate or limit SPE’s usage of the music.

• SPE retains all control and flexibility necessary to allow for the exploitation of the SPMPC while maintaining its relationships with both film/tv participants and talent.

• All collection procedures remain in place, including Sony/ATV’s administration agreement, allowing SPE’s sister company to continue to profit from the SPMPC.

• No need to audit the buyer for payments due on behalf of third-party participants, as SPE would continue to make those payments directly.

• A sale of the ISPA rather than the SPMPC itself obviates the need for extensive negotiation and predictive drafting of complex rights retention provisions in the sales agreement.

Benefits to the ISPA Buyer

Beyond having the same flow of income as would result from an outright purchase of the SPMPC, the buyer of the ISPA would enjoy some additional benefits as well:

• SPE’s current 10% worldwide administration fee with Sony/ATV would remain in place. If the buyer is not a worldwide publishing entity, the 10% fee may be a better administration deal than the buyer can obtain from any other publishing administrator.

• The buyer of the ISPA is removed from all obligations and liabilities with respect to composers and third-party participants.

Potential Concerns of the ISPA Buyer / Potential to Negatively Impact Valuation

A sale of the ISPA is a different model from more conventional publishing catalog sales, and potential buyers will require assurances that there are not any significant disadvantages to allowing SPE to retain control and ownership of the SPMPC. Some concerns that might be raised:

• SPE might not have an incentive to obtain maximum exploitation of the SPMPC, since the buyer is entitled to all of the profits.

The following chart sets forth the reasons for SPE’s continued incentives to maximize income from Performing Rights, Mechanical Rights and Third-Party Licenses.

Income Source / % of ISPA / SPE Incentive to Maximize
Performance / 87% / This income is generated automatically from SPE’s exploitation of audiovisual productions in all broadcast and streaming media. As this kind of exploitation is essential to the core business of SPE, there is every incentive to maximize performance rights income.
Mechanical / 10% / Virtually all of this income derives from the distribution of soundtrack albums on which SPE also receives an override royalty (for use of key art and the title of the applicable production). SPE has both a marketing and a financial interest in promoting sales of soundtracks, and accordingly SPE is incentivized to maximize mechanical rights income derived from the SPMPC.
Third-Party Licenses / 3% / Even though SPE will not be retaining income from musical compositions in the SPMPC, SPE will continue to own and retain income from the master recordings of those compositions which are licensed to third parties. Licenses for the compositions are necessary in order for the masters to be licensed, so SPE’s interests are aligned with those of the ISPA buyer.

• SPE might not have the incentive to obtain the most favorable administration agreement.

After the sale, SPE will again begin to accumulate new copyrights, generating their own income to SPE, which will still require the services of an administrator for the lowest fee that SPE is able to obtain. While SPE will have an ongoing corporate interest in working with its sister company, as well as the Michael Jackson estate (which has a stake in Sony/ATV), it should be noted that the fees payable under SPE’s administration agreements are exceptionally low, and there is no reason to believe that SPE would not continue to negotiate for such low fees in the future.

• SPE will not license compositions in every instance where the buyer would want to issue a license.

Generally, as discussed above, the incentives of SPE are squarely aligned with the income maximizing concerns of the buyer. However, there are some instances where SPE will have overriding concerns focused around SPE’s core film and television production businesses. So, for example, SPE will not license a song being used in a Coca-Cola co-promotion for a Pepsi commercial. However, SPE is unlikely to agree to an outright copyright sale with no restrictions. Assuming such competing licenses would also included in an agreement for the sale of the SPMPC as well, the sale of the ISPA only does not very from a sale of copyright with restrictions.

• SPE will license compositions in the SPMPC for its own uses on sweetheart terms.

SPE’s licensing practices already require arm’s length, industry standard transactions for uses of music by internal entities not connected to the original production for which the music was written. The reasons are (1) SPE’s fiduciary obligation to the composers and lyricists as the publisher of their compositions and (2) SPE’s additional fiduciary obligation with respect to all profit participants in the film or program from which the music is derived.

• The ISPA value might decrease over time, as the assets become stale and are used less.

This assertion, if it were true, would be equally a concern for a purchaser of the SPMPC as for a buyer of the ISPA. However, in actuality, although the greatest performance income is generally from an initial release in foreign theaters and on television, after the initial exploitation income fluctuates from year to year. While exploitation of some compositions may decrease, others may increase over time. For example, performance income may increase, as new streaming media (licensed by the PROs) are used to exhibit existing catalogs of films and television programs. Older film scores by A-list composers that have not been recently used in third-party trailers and advertisements can be freshly marketed. And music by relatively unknown new composers can become more popular as those composers gain notoriety in their careers (older film music by James Horner before TITANIC, for example, became highly marketable after TITANIC was released). The following is a chart showing the total annual music publishing income over the last twelve years derived from each of 16 films released over the last 16 years:

Fiscal
Year / Film Title / ANNUAL NPS BY FISCAL YEAR (IN THOUSANDS OF DOLLARS)
1999 / 2000 / 2001 / 2002 / 2003 / 2004 / 2005 / 2006 / 2007 / 2008 / 2009 / 2010
1993 / RUDY / 17 / 29 / 69 / 44 / 47 / 52 / 16 / 103 / 15 / 35 / 29 / 45
1994 / LEGENDS OF THE FALL / 85 / 39 / 43 / 64 / 60 / 92 / 48 / 43 / 64 / 72 / 64 / 42
1995 / SENSE AND SENSIBILITY / 91 / 41 / 15 / 12 / 12 / 21 / 33 / 17 / 42 / 48 / 24 / 23
1996 / CABLE GUY / 26 / 15 / 8 / 2 / 5 / 17 / 13 / 25 / 13 / 12 / 14 / 12
1996 / MEN IN BLACK / 172 / 476 / 122 / 85 / 48 / 86 / 179 / 106 / 75 / 68 / 67 / 71
1998 / MASK OF ZORRO / 0 / 78 / 301 / 137 / 88 / 85 / 126 / 100 / 127 / 82 / 118 / 109
1999 / GIRL, INTERRUPTED / 0 / 0 / 0 / 13 / 15 / 35 / 36 / 195 / 111 / 258 / 218 / 306
2000 / CHARLIE'S ANGELS / n/a / 0 / 0 / 215 / 494 / 194 / 145 / 147 / 135 / 166 / 67 / 38
2001 / A KNIGHT'S TALE / n/a / n/a / 0 / 1 / 38 / 113 / 44 / 83 / 32 / 59 / 41 / 35
2002 / PANIC ROOM / n/a / n/a / n/a / 0 / 0 / 105 / 158 / 74 / 52 / 54 / 29 / 44
2003 / PETER PAN / n/a / n/a / n/a / n/a / 0 / 0 / 30 / 61 / 213 / 158 / 44 / 40
2004 / SPANGLISH / n/a / n/a / n/a / n/a / n/a / 0 / 0 / 2 / 52 / 29 / 39 / 21
2005 / FUN WITH DICK AND JANE / n/a / n/a / n/a / n/a / n/a / n/a / 0 / 0 / 11 / 104 / 48 / 61
2006 / PURSUIT OF HAPPYNESS / n/a / n/a / n/a / n/a / n/a / n/a / n/a / 0 / 1 / 26 / 234 / 78
2007 / GHOST RIDER / n/a / n/a / n/a / n/a / n/a / n/a / n/a / n/a / 0 / 1 / 140 / 108
2008 / 21 / n/a / n/a / n/a / n/a / n/a / n/a / n/a / n/a / n/a / 0 / 44 / 47

• Unlike the actual copyrights, the ISPA is not an asset on the books of the buyer and may not be able to be levered by a buyer

Copyright itself is not a tangible asset, and the ISPA can be assigned, sold and licensed no less than the copyrights themselves.

Structuring an ISPA Sale

A sale of the ISPA is simpler than a publishing catalog sale, in that it does not require the same sort of reserved rights for the seller and restrictions on the buyer. However, a general accounting procedure must be established, and some other issues should be addressed before moving forward.

Payment of Participants / Valuation

Past music catalog sales have required the buyer to pay a fixed percentage (20% for most films, 25% for Embassy productions) back to SPE to allow for distribution to film participants. This arrangement has some advantages for SPE, because the 20% or 25% is poured into the gross for each motion picture, but participants are paid only a percentage of that gross – so the remainder is profit to SPE. However, placing the payment obligation on the buyers has been unsatisfactory and opened up SPE to potential accounting liabilities, because the buyers (now all under the umbrella of EMI Music Publishing) have not provided the required accountings on a regular basis, and only after extensive audits have payments been made. If the ISPA, rather than the SPMPC itself is sold, then the division of income can be handled by Sony/ATV, which would pay the participants’ share into gross, then pay the ISPA buyer the remainder of net income. In order to account for the need to pay participants, the evaluation of the ISPA should be based on 80% of NPS. Any separate pot music publishing participants (e.g., Jerry Bruckheimer and Brian Grazer) could also be paid directly by Sony/ATV, but they must be disclosed to any potential buyer.