The team performed valuation analyses on HBO to estimate its stand-alone enterprise value and equity value. Using discounted cash flow analysis, comparable companies analysis, and precedent transactions analysis, the team estimated HBO's enterprise value to be between $32,189.0 million and $38,630.5 million, and its equity value to be between $22,797.8 million and $29,239.3 million. The team based their final valuation conclusion solely on the discounted cash flow analysis results due to limitations in comparable the comparable companies and precedent transactions analyses for valuing the private company.

1. MEMORANDUM
TO: Mark Mondello and Arya Rahimian (Duff and Phelps) Prof. Steve
Moyer and Prof. Julia Plotts (USC Marshall)
FROM: Team One (Tingting Liu, Brian Wang, Claire Wu, and Dongyu Yu)
DATE: December 10, 2014
RE: Stand-Alone Value of HBO
Our team has been requested to perform valuation analysis on the stand-
alone value of HBO, a subsidiary company of Time Warner Cable, Inc. As a
rapidly growing company while seeking further business expansions, online
video streaming, for example, in a relatively competitive media and
entertainment industry. Our task was therefore to reasonably and
professionally value the enterprise as well as equity values of HBO, using
industry research insights, financial knowledge, and various valuation
techniques. We started with conducting extensive research on the industries,
trends, HBO company profiles, etc., followed by performing valuation
analysis using discounted cash flow (DCF) analysis, comparable companies
analysis, and precedent transactions analysis. After careful and detailed
deliberation, we are concluding the following result for HBO valuations (in
millions dollars):
Enterprise Value: $32189.0 - $38630.5
Equity Value: $22797.8 - $29239.3
In the following sections, we will explain in detail the methods used,
analysis, and rationales for concluding in such valuations.
I. Company and Industry Overview
HBO (Home Box Office) is a premium television cable and satellite station,
headquartered in New York, USA. Started in 1972, it streams movies,
exclusive television shows, music, documentaries, sports, and various other
entertainment programs. After 42 years of development, HBO, along with its
sister channel Cinemax, is encompassing almost 90% of US paid television
stations market. Some of well-known and popular HBO productions include
Sex and the City, Game of Thrones, Girls, The Newsroom, etc.

2. HBO is also a premium cable and satellite television network worldwide.
Owned by Home Box Office Inc., a private operating subsidiary of Time
Warner Cable, HBO generated $1.8 billion in operating profit last year,
which is as much as one quarter of the total profit of Time Warner Cable.
A. Business Model
HBO operates on a unique business model that it created 42 years ago: It
provides non stop streaming high-quality, and some unique entertainment
television programs 24/7 for paid subscribers of its 13 channels. Unlike the
majority of US broadcasting and cable television stations, HBO does not
have advertisement placement, which accounts for a huge part of profits for
its peers. The main driver for its income has always been the number of
subscribers, which generates about 80% of HBO’s income. The cost of this
programming varies from $15-$20 per month depending on which major
cable provider the customer uses. The subscription fee is high compared to
other cable stations; however, HBO, using high-quality and exclusivity as
selling points for its products and operating under TTS (total subscriber
satisfaction), profits more than the total of ABC, NBC, CBS, and FOX. In
addition, most companies will offer discounts or even free HBO for 6-12
months.
Next year, HBO is finally planning to start offering stand-alone, online-only
subscription plans, seeking another expansion of its business.
B. Porter’s Five Forces Model
l Buyer Power
In the media and entertainment industry, the bargaining power of buyers
(consumers) is high. This bargaining power is due in part to the economy in
that if low cost alternatives are available, more families are likely to choose
them. The availability of substitutes increases the bargaining power of
consumers, as the ultimate purchaser of entertainment products and services
increase. Consumers have a very wide selection of programming to choose
from and ease of access through increased online programming and sources
of entertainment. Increased globalization also adds to the bargaining power
of the consumer.
l Supplier Power
The bargaining power of suppliers varies by supplier type in the media and

3. entertainment industry. The value chain of many of the production
companies is primarily handled in-house, but more companies are
outsourcing to cut costs in order to keep, or attain, a competitive advantage.
This strategy especially lowers the bargaining power of American suppliers
since suppliers overseas will provide the same services for a fraction of the
cost, with varying degrees of quality. The industry has also seen an increase
in the number of suppliers as a result of increased outsourcing, which also
results in lower bargaining power of supplies as competition at their level
increases.
As a result of this new decrease in draw, individual companies have
attempted to secure high-profile stars through multi-year or multi-show
contracts, and as a result reduce their future bargaining power.
l The Threat of the New Entrant
The threat of new entrants into any industry depends on the strength of the
barriers to entry, and the resulting response of existing competitors. The
threat of new entrants to the media and entertainment industry is relatively
low. This industry is seen to have established companies and conglomerates
with significant presence in media networks and television productions, thus
creating a significant barrier to entry.
The threat of new entrants is so low, in fact, that industry insiders are
concerned that new, independent producers are prevented from having their
voices heard and getting their new, innovative products into the market. The
evolution of Internet distribution channels is making this less of a concern
with its accessibility and immense distribution opportunities.
The high, ongoing financial outlay needed for movie production, or
television series production is also extremely high. For example, production
costs for Disney’s Pirates of the Caribbean movie hit nearly $300 million.
High sunk costs and capital requirements are also heavy entry barriers.
l The Threat of Substitute Product
The most detrimental impact on a corporation happens when there is a high
threat of substitute products or services that is both likely and probable. One
of the major threats of substitution for the media and entertainment industry
is facing the innovation in other industries. According to the PWC M&A
activities report for 2010, “technology giants such as Google Inc. and Apple
Inc. plan to continue to increase their pressure on the entertainment and

4. media industry by driving convergence.” Both Apple and Google have
become pioneers and market leaders in video distribution.
Netflix, in particular, has become a popular alternative to the expensive costs
of paid televisions resulting in some revenue loss for the entertainment
industry.
l The Rivalry among the Existing Firms in the Industry
All sectors of the media and entertainment industry face daunting challenges
from alternative delivery methods, which has increased the competition
among entertainment delivery platforms. Telecommunications companies
such as AT&T and Verizon are now delivering television programming to
the home via ultra high-speed Internet connections battling cable and
satellite TV firms for market share. Tough economic times often results in a
dog-eat-dog business environment but the opposite can also seen in the
industry.
A strategy being implemented across the industry is one of collaboration in
order to gain a larger market share and competitive advantage against other
industry leaders and collaborators. The goal of industry leaders is to be the
leading pioneer in digital entertainment and create entry barriers for new
entrants once growth becomes more obvious.
C. Current Market Position
For more than a decade, HBO has lavished good, smart product to its
viewers, and in the process of raising the entire industry's creative game. In
the late 1990s, HBO pioneered an intelligent, patient style of storytelling that
gloried in loose ends and morally ambiguous characters a style.
To keep relevant to television audiences, cable channel operators have
started spending huge amounts of money to create hit shows and
programming. Time Warner operates a few leading channels and says that
Home Box Place of work, or HBO for limited, is "majority of the nation’s
widely distributed multi-channel quality pay for television service.”
Furthermore, it competes on an overseas scale and boasts 93 trillion
worldwide subscribers, according to its owner.
The company is also taking steps to make its current competitive position
strong by focusing on its international strategy and strategic alliances. This
major subsidiary of Time Warner Incorporation had signed a deal with

5. Tencent Holdings Ltd. Through this deal HBO would distribute movies and
TV dramas through the giant online video site on the Chinese internet. In
this way, the US cable network would be expanded in the Chinese market.
This would allow HBO to take the advantage of the massive online user base
in China. HBO could also create an official distribution channel in a market
where the pirated videos are very much common and rampant.
Apart from this, another issue related to this matter is HBO’s new online
streaming serve, which would be basically add-on services on to the
broadband packages with the cable operators and through other technology
partners such as Amazon, Microsoft, and Apple Incorporation. Clearly a
business expansion plan and part of a strategy to deal of key competitors
such as Netflix and Hulu, the online streaming service will probably be a
great hit concerning the current trend.
II. Benchmarking Analysis
Due to the lack of publicly available data for privately owned companies, we
selected seven publicly traded companies that operate in the same industry
as the benchmarks to help determine the value of HBO. We compared
figures such as stock price, P/E, Return on Equity, Enterprise Value and Free
Cash Flow Yield, and narrowed down the comparable companies to four,
which included Twenty-First Century Fox, Inc., CBS Corporation,
DIRECTV, and Netflix, Inc. Moreover, considering the fact that HBO is a
private company, we relevered the beta for HBO based on the on the beta
and D/E ratio we found from these publicly traded companies.
III. Discounted Cash Flow Analysis
A. Key Assumptions
As a private company with limited access to its detailed financial statements,
some historical data from Time Warner’s 2013 financial statements was
used in estimating HBO’s key financials. As shown in Exhibit 1, current
assets, current liabilities, total debt, and cash flow used in investing activities
were all assumed based on average figure among 4 segments of the parent
company.
In addition, several other key assumptions were made based on HBO’s
historical performance and growth potential, potential online streaming
expansion, and global partnerships. Subscriber growth rate was assumed to
grow at a constant rate of 0.2% considering its business expansion, as well

6. as the fact that HBO had seen the largest increase in subscriptions last year.
Therefore, we assumed the rate would increase. Also, cost of revenue % of
sales was seeing a continuous decrease shown in historical data in Exhibit 2,
we thus assumed that there would be a constant rate of decrease at 2% in
cost of revenue percentage.
Lastly, according to Ibbotson chart, we assumed a 0.8% size premium as
categorized 1⁄4 of Time Warner a large cap. Perpetuity growth rate was an
assumption between 2-3% inflation rate and a 4-5% GDP growth. Besides,
Beta was calculated from benchmarking analysis (Exhibit 6), and exit
multiple was assumed based on multiple range average determined in
comparable companies analysis (Exhibit 7).
B. Financial Statement Projections
Based on the HBO data that we found on Timer Warner Financial Statement,
we were able to project revenue of HBO at first. We calculated the growth
rate of number of subscribers from 2011 to 2013. We used the 2012-2013
growth rate as the base for projections, as the 2012 ratio of over 30% was a
bit abnormal probably due to new hit shows, such as Game of Thrones and
Girls on 2011. The growth rates in the projection period were thus
calculated, assuming the 0.2% increase every year. We then calculated the
subscribers as percentage of sales of 2012, 2013 for 2.5%, 2.6%. We
projected this figure in the projected period as the average 2.55%. The
projected revenue is calculated by dividing the projected subscribers by the
subscribers as percentage of sales.
Critical value such as net SG&A, depreciation & amortization, capital
expenditures, etc. based on percentage of revenues. We assumed 38% as the
tax rate to calculate tax expense. Then we concluded key financials such as
EBIT and Net Income.
With the lack of financial information of HBO, we projected the cash flow
from investing activities by dividing Time Warner’s total cash flow from
investing by 4 (HBO is one of the four segments of Time Warner). Thus,
after concluding three statement projections, we were able to get the net
change of working capital to proceed in the free cash flow calculation.
For one time adjustment, we also included a 1 billion dollar under “other
income” as Tencent announced a deal with HBO this year.

7. The detail is presented in Exhibit 2.
C. Estimating Enterprise and Equity Value
First, we calculated free cash flow based on the formula. After discounting
the sum into present value, we used both Exit Multiple Method (EMM) and
Perpetuity Growth Method (PGM) for calculating the terminal value. In the
process, we calculated WACC using some data given, and assumptions such
as 38% effective tax rate, and 0.8% Size Premium. We finally determined a
WACC of 8.5%. As for Perpetuity Growth Rate, we determined the growth
rate as 3.5% as explained earlier. After adding the PV of free cash flow and
PV of terminal value, we came to the enterprise values yielded by both
methods. Using Exit Multiple Method (EMM) and PGM, we were able to
estimate HBO’s equity value as $22,797.8 - $29,239.3 million and enterprise
value as $32,189.0 - $38,630.5 million shown in Exhibit 3.
D. Sensitivity Analysis
Then we performed a sensitivity analysis, adjusting variables such as exit
multiple, perpetuity growth rate, and WACC to test the change of enterprise
value and equity value as results. The detail is shown in Exhibit 4.
E. Scenario Analysis
To more accurately forecasting the valuation considering variabilities of
several key drivers, we performed scenario analysis. We determined that our
assumptions of the increase of subscribers’ growth, cost of revenue decrease,
as well as tax rate were all highly subject to change. Therefore, based on the
current case, we created best, moderate, and worst scenarios changing values
of the three key drivers to come up with valuation of target under different
circumstances. The result is shown in Exhibit 5.
IV. Comparable Companies Analysis
To come up with a list of comparable companies with HBO, we selected
four companies for their similarity in market position and company profiles
with HBO. To calculate multiples such as EV/EBITDA, EV/EBIT,
EV/Revenue, P/B and P/E ratio for all of the comparable companies, we
retrieved data such as EBITDA, EBIT, and Enterprise Value from Capital
IQ. We concluded our valuation of HBO’s enterprise value and equity value
based on multiple range estimated by the mean and median of the
comparable companies, we decided to exclude Netflix’s value as a result of

8. abnormal multiples. As we found out, in substance, Netflix is an Internet &
Computer Company which has much less cost than a Broadcasting & Cable
Company. Therefore Netflix has better operating leverage. Our estimation
was equity value range of being $ 10,775.5 - $23,881.6 and enterprise value
range being $20,166.7 - $33,272.8. The detailed comparable companies
analysis is shown in Exhibit 7.
V. Precedent Transactions Analysis
To create a list of precedent transaction companies, we used transaction
screening on Capital IQ. Narrowing down the list based on criteria such as
industries (TV Broadcasting Stations, Television Production Companies,
Video Production Companies), US geographical location, private target,
mergers & acquisition transaction type, etc., we generated a list of precedent
transactions in the past 5 years. We then further screened the results for
available and reasonable financial multiples. With limited information
provided for private transactions, we tried to create a list of comparable
precedent transactions, focusing in TV Broadcasting industry (with one in
TV Production), as it is the sector that generates most revenue to HBO. This
method yielded an equity value range of $10755.4 - $22536.1 and an
enterprise value range of $17690.0 - $32927.3. The result of precedent
transaction analysis is shown in Exhibit 8.
IV. Valuation Conclusions
Analyzing the results yielded by all three valuation methods, we decided to
conclude our final valuation based solely on DCF result. One obvious
rationale was that both comparable companies analysis and precedent
transactions analyses were based on publicly traded companies, which
apparently differentiates largely from HBO. In addition, HBO’s unique
business model of operating both cable satellite service and the potential
online streaming service separates it from peers, adding the difficulties of
accurate comparable and precedent valuations. The results yielded by this
two methods also proved to be moderately off from the DCF results, due to
the difficulties of finding similar companies or transactions.
Overall, the DCF valuation result was reasonable considering the fact that
the performance of HBO in 2014 was outstanding. HBO had achieved $ 1.8
billion in operating profits over the last year which is equal to about one-
quarter of the Time Warner’s$ 4.9 billion of its annual revenues. Also, the
market and investors are looking at HBO as a profitable and rapidly growing

9. target with is active business strategy and expansion plan. The impact of
cash flows for future forecasting for HBO stand-alone 2015 program is
positive and it generates positive cash flows during five year forecasting.
The net present values for five year forecasting was positive and this
indicated a healthy enterprise value. HBO therefore should definitely
proceed its planning for standalone streaming in 2015 because they have a
positive net present value and also they can made some solid strategy
regarding financing other project in the future.
HBO can expand their projects in the future as well where they can earn
more profits and get their position according to their mission and vision.
Maximizing Current Valuation
Since the subscribers growth is stagnating in United States of America, the
pay television market was shook up by HBO in an announcement that in the
year 2015 under which the customers would be able to access HBO without
paying any pay television subscription. The new price of the HBO will be
influenced by many factors. First of all, the initial target of HBO being 10
million broadband customers will probably contribute to more sales growth.
Secondly, HBO competes with Netflix, not on the basis of price but content,
providing a more stable and promising future. Thirdly, HBO is not very
likely to have too big of a downfall which affects its current profits.
To further maximize its valuation, the company should spend more efforts
on its promotional activities to keep its incumbent subscribers. Apart from
this, HBO should take steps to expand in the international markets. The
company is examining its options to expand the tactics of the company for
programming distribution such as the cooperation this year with Tencent.
The news was published in the Wall Street Journal, in which it was stated
that it was looking forward to launch Netflix-like services in those countries
that had broadband infrastructure. Some of the choices for HBO to expand
are Japan and Turkey based on its market position. HBO needs to think over
its international expansion strategy before the saturation mark is reached.

10. Exhibit
1:
Key
Assumptions
Exhibit
2:
Financial
Statements
Projections

11. Exhibit
3:
Discounted
Cash
Flow
Analysis

12. Exhibit
4:
Sensitivity
Analysis

13. Exhibit
5:
Scenario
Analysis
Exhibit
6:
Benchmarking
Analysis

14. Exhibit
7:
Comparable
Companies
Analysis
Exhibit
8:
Precedent
Transactions
Analysis