Guest Post: Where There’s Smoke, There’s a Smoke Machine – A Case for Movie Futures

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By Buzz Potamkin, former studio executive and producer, in the biz for 40+ years, now a consultant

Every investment in film is gambling.
Schuyler Moore, April 22, 2010, testimony before the House Agriculture Subcommittee on General Farm Commodities

Futures are a hedge against some event yet to come, representing the desire by a participant to cover its risk on the unknown.
Composite definition

Marley was dead: to begin with. There is no doubt whatever about that.
Charles Dickens, A Christmas Carol

Dramatis personæ
(per customary Billing Block order)

MPAA – Motion Picture Association of America
The distributors: a fraternity of the current six Majors. MGM is out.

NATO – National Association of Theater Owners
The exhibitors: members operate over 30,000 screens.

SAG – Screen Actors Guild
The actors’ union. Would rather have top billing.

IATSE – International Alliance of Theatrical Stage Employes, Moving Picture Technicians, Artists and Allied Crafts of the United States, Its Territories and Canada – commonly called the IA (pronounced I-A)
The union for the “below-the-line” film/TV workforce, including projectionists in signatory theaters. Some workers are represented by the Teamsters, the Painters and Allied Trades, and others.

Schuyler Moore – Tinseltown lawyer, author of “the” book on the biz, entertainment tax authority, well-respected adjunct professor at UCLA. As he said in Washington, it was his Entertainment Law Reporter article in 2003 that started serious consideration of film box office futures. (It’s no longer available on the web, except as a pdf attachment to his submitted testimony to the House Subcommittee http://agriculture.house.gov/testimony/111/h042210/Moore.pdf or to subscribers of Lexis/Nexis or Westlaw.)

WGA – Writers Guild of America, West
The writers’ union. Fought hard to get penultimate card.

DGA– Directors Guild of America
The union for directors and director’s team. Always gets the last card.

A few weeks ago our humble blogger ran a guest post by Gonzalo Lira regarding film exhibition (or “box office”) futures – an “ah ha” moment for me: a post on my business, one I don’t have to scratch my head to get. Lira wrote a nice rant, and I share his gut feelings for the biz – but I respectfully disagree with his opposition to futures.

Before I go on with that respect, a few data points, and of each it could be said “there is no doubt whatever about that.”

The MPAA is a rapacious, oligopolistic cartel. Its control of Washington has no equal, and puts the Securities Industry to shame.

NATO is its domestic partner, locked in longstanding sado-masochistic embrace.

And the IA is concerned that continuing film production remain under its bargaining agreements. (That is, when the president of a local isn’t being voted out by gun fire, as happened at Local 52 in 1969.)

Now back to the regularly scheduled respect.

Lira comes to the issue with fervent love for quality film; I won’t dispute that, and I love quality film too, but the biz is no longer a question of quality film, it’s a question of finance. He uses romantic comedies as a touchstone; today it’s more a question of tent-pole franchises:

Batman, Spider-Man, Iron Man, X-Men, Shrek, Star Wars, Star Trek, Toy Story, Ice Age, Nightmare on Elm Street, Pirates of the Caribbean, Chipmunks, Kung Fu Panda, Madagascar (Penguins of), High School Musical (TV, then feature), Twilight Saga, et cetera ad infinitum

The lead-time for a franchise feature film is daunting; forget setting one up for release next year – that ship has sailed (unless you’re frantic like Fox with X-Men). As of today, here’s a list of franchise films scheduled for release in 2012:

Star Trek 2 (actually #12)
American Pie 4
Spider-Man 4
Batman 3
Madagascar 3
Cars 2
Clash of the Titans 2
GI Joe 2
Hancock 2
The Hobbit 2
Monsters Inc 2
X-Men Origins: Magneto (replaced by rush-produced X-Men: First Class in 2011)
The Avengers (includes Iron Man and other Marvel characters)
Dr. Seuss (another book – probably Lorax)
Godzilla (again)
The NeverEnding Story (again)
Yellow Submarine (again)

While these franchises can return upwards of $100 million in film rentals (not theatrical gross), and that makes a nice start on recoupment, their real break-out value is across multiple consumer-facing platforms – many of which are not included in discussions of DVDs, premium TV, etc. For a hit franchise directed against a younger demographic (and nearly all are), the ancillary markets can be as/more profitable than the media markets, and with a far longer tail.

One more moment though, as we take a look at some finance:

Film rentals are what the Exhibitor (theatre operator, mostly chains) actually pays to the Distributor (overwhelmingly The Majors). Rentals in theory are a previously agreed percentage of admissions income (the famous “box office gross”), arrived at usually by bidding a complex formula with aggregates, sliding scales, floor payments and house nuts, and just as frequently post-fact recalculated in more arcane processes and acrimony – in other words, as the one holding the cash the exhibitor wants to keep it, while the distributor uses whatever threats possible to get it, and the process can be rather heated. After all is said and done, the exhibitor is left with a “gross profit on film admissions” in the range of 44-50%. Note that film exhibition cost (FEC) percentages appear to be trending up with the premiums tacked on for 3-D, leaving the exhibitors with gross profits percentage near the lower end. (This range is of the largest chains, and it varies across the year. Together they control over 45% of the total screens. )

All the popcorn and sticky drinks are another story. In Concessions, the exhibitor has no substantial supply chain problems, no “partner” demanding a recount, audit, or renegotiation, and the last time I looked popcorn was a true fungible commodity. So the gross profit margin on Concessions is about 85-90%.

Thus:

The gross profit per head from film admission (tickets) is around $3.85; it differs by market (can be under $3.00 in non-major markets), and will probably trend up with the new premiums for 3-D. (One chain is now over $4.00.)

The gross profit per head from concessions is around $2.80; it also differs by market, but can actually be higher, over $3.00, in non-major markets. (As to why, let’s leave that to the “fighting fat food” crowd.)

$6.65 gross profit per head; split ~60/40 film/food.

A non-major market exhibitor I knew called his multiplexes “junk food joints with entertainment.” He got very upset when the younger demographics were underserved, and he was known during the summer to run mature romantic comedies only at night, while during the day he double-screened youthful fare at deep discount ticket prices – without ever lowering the price of popcorn. Not that any of that was covered in his film rental agreements; if you wanted your film to track on his screens, tough luck.

While I was writing this, one of the larger chains (with a non-major market bias) announced Q1 results underscoring these economics of exhibition.

Said the CFO:

Carmike’s patrons spent $10.34 on average per visit during the first quarter of 2010, up 8.0 percent versus the comparable 2009 period. Average admissions advanced 7.4 percent to $6.85 as 3-D premiums of $2.50 and higher increased the average ticket price per attendee. Concessions and other revenue per patron increased 9.4 percent to $3.49, versus $3.19 in the prior year period. [My query: what’s the difference between a patron and an attendee?]

Dig a little deeper, and FEC is now 56%, with Concessions costs around 10%. Scribble out a few figures, and gross profit per patron/attendee is:

Film admissions $3.01
Concessions $3.14

That’s a 51/49 split in favor of junk food.

Now let’s return to ancillary markets.

In these markets there are significant non-insider (i.e., not part of nor controlled by the distributor) real world parties/industries who currently have no way of laying off their significant risk: Exhibition, Malls, Fast Food, Soft Drinks, Other foods, Video/computer Games, Toys, Books, Apps, Clothing, Collectors’ Art, Bedding, Kitchen Furnishings, it goes on forever.

Exhibition is obvious: empty theaters don’t make money and sell no popcorn. While NATO is now supporting the MPAA in opposition to futures, I wonder how long that will last. If I were running a business that relied upon the kindness of others to provide me with my meagre gruel, I would be seeking a way to cover my downside risk.

Malls are not so obvious. In this time of lighter consumer spending, mall operators are one of the main causes of Commercial Real Estate strain. Many multiplexes are co-located with malls, with movie traffic driving substantial added mall traffic – and the absence of movie traffic doing the reverse. Mall traffic falls, mall operator income falls. Mall operator income falls, mall operator faces default. Shouldn’t a mall operator be able to hedge the downside risk of lesser movie traffic?

Next up is Marketing Partnerships. Iron Man 2 is a good example:

Blue-chip marketers such as Burger King and Dr Pepper as well as smaller brands like Royal Purple motor oil are attached to a marketing bonanza valued at more than $100 million in media buys, retail tie-ins and giveaways.

Besides the three mentioned, other Partners include Audi, 7-Eleven, LG Electronics, Diesel, Oracle, Symantec, Hershey’s (Reese’s Peanut Butter Cups), and Sony Music. Looks like a $100 million one-weekend bet, not including their considerable internal costs. For only one movie. With the bet placed 18-24 months ago. As you read this, we’ll all know whether it’s paid off or not, but shouldn’t these guys be able to hedge the downside risk of lesser movie traffic?

My own favorite is Licensing and Merchandising (L&M). Except for Disney, L&M was mostly overlooked by Hollywood until toy-company-supported TV production showed the Majors how to do it. Until then, most Majors didn’t have large L&M groups, with many of the deals left to a small cadre of independent agents like “Honest Ed” Justin, who when representing The Flintstones always signed his minuscule NY Times display ads “Not Needy, Ju$t Greedy.” A man after my own heart. Now L&M is a major income stream for franchise pictures: everything from Toys, Mobile Apps, Games, and Books to Bedding and Condoms – and just about any other consumer product you care to name. All sold with royalties ~7% or so. Excepting maybe the condoms, these products also take 18-24 months to design and produce. Massive business from a hit, and disaster from a flop. Let’s look at Namco, a mobile app/games producer, who’s sold 23 million iPhone copies of Pac-Man:

[Namco] has hired Chris Lucero, formerly of United Talent Agency, to head up licensing for the company, and the company is kicking things off with the big … feature-film release The Wolfman from Universal Pictures.

(snip)

The licensing game has been tricky for many game developers that have promised certain returns, and then ended up with losses when the titles didn’t perform as well as they would have liked. Lucero would not quantify how many licenses the company will try to acquire this year. “It’s about what feels appropriate. There’s countless opportunities out there.” For him, the Wolfman game was a no-brainer. “The Universal monsters go back to the 30s. To be a part of this relaunch is an incredible honor.”

You all remember The Wolfman, right? February 12 of this year ring a bell? Depending on who you believe, the budget ran $85-150 million, plus P&A of let’s say $50 million, maybe more. Opening Weekend Gross a grand total of $31.5 million; total Worldwide Gross to date $138 million. (For your own amusement, do the math with a 50% rental number.) Wonder how many copies of the game Namco sold? They barely feature it on their own site now. Shouldn’t Namco and all other Licensees be able to hedge the downside risk of lesser movie traffic?

And so on to film production itself. Schuyler Moore has forgotten more about outside investment in film than I will ever know. He has skewered the anti-futures arguments from the MPAA, NATO, the DGA and the IA – and while it barely does him justice to excerpt those thoughts here, we in the biz are nothing if not copyists, so a few highlights (and “studios” = MPAA/Majors):

Only studios should be allowed to gamble on films! We need to save the public from themselves.

We also need to save the studios from themselves, because a studio might be tempted to manipulate the Exchange by going short on it then tanking its own film.

In the interest of preserving lawyers and legal fees, studios should be required to hedge film risk inefficiently, as they always have done, rather than doing it efficiently on the Exchange.

There would be wild, rampant “insider” trading because everyone at the studios is able to accurately predict box-office results.

(It really is worth a read on its own, but the end is in sight here, so finish first.)

I will just add a few points:

The DGA and the IA want to see production remain under the control of their full-price bargaining agreements; the Majors are much more likely to do so than smaller independent production entities.

There are dogs that haven’t barked: as far as I can see, neither the WGA nor SAG has uttered one peep against futures. Is it because their members will do better with the futures exchange fostering more independent production?

Independent production and distribution have long been the homes of “quality film” and the resuscitators of Hollywood creativity many times in the past 60 years. But they need investment sources beyond the usual suspects, and those alternative investors are naturally reticent when it comes to an opaque business that bets it all on one weekend. Don’t you think those investors might be interested in some way to hedge the downside risk of lesser movie traffic? (Although not right to the point, wouldn’t the Germans who invested $70 million in Battlefield Earth – with the ironically named Franchise Pictures – wouldn’t they have been delighted to be able to hedge the downside risk of lesser movie traffic?)

I am no fan of any unregulated OTC derivatives market; we have seen the damage done. I am a fan of a regulated box-office futures exchange, especially one that allows significant and substantial non-Hollywood participants to hedge their risk in a rather uncertain investment. The more comfortable these outsiders are, the more – and perhaps better – movies will be made.

For those wanting more biz background:

Schuyler Moore’s book
The Biz: The Basic Business, Legal and Financial Aspects of the Film Industry
Silman-James Press; 3rd Edition (Expanded and Updated)

Harold Vogel’s book – a former Merrill securities analyst
Entertainment Industry Economics: A Guide for Financial Analysis
Cambridge University Press; 7th Edition (Expanded and Updated)

Steven Bach’s book – financial company buys UA and comic tragedy ensues
Final Cut: Art, Money, and Ego in the Making of Heaven’s Gate, the Film That Sank United Artists
Newmarket Press; Revised Edition

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13 comments

  1. attempter

    (I admit that reading this twice I’m still not completely sure if it’s satire or not, some of the arguments are so ridiculous. But judging by the conclusion, I think it’s serious, so I’ll go with that.)

    So this establishes that the studio system is a sausage factory that no longer produces anything worthwhile.

    It should be needless to say that bringing more financial “products” into the equation will not create any new value but only leave us with greater and more ramified risks while the finance gangsters extract yet more rents and become yet more powerful. Yet evidently the bounds of people’s inability to digest the evidence and learn a lesson is infinite.

    Even if it were believable that adding more derivatives to the cesspool could do some good (but we all know that’s impossible), there’s nothing worth further empowering Wall Street.

    So if it really were true that this rotten business can’t function without opening yet another casino, then let it perish and good riddance.

    As for the violins on behalf of the financial risks faced by the junk food pushers, I’ll treat that with all the respect it deserves…

    1. buzzp

      I’m using this space to correct a typo – L&M paragraph scrambled, parts left out – Yves, please remove this comment after typo fixed –

      readers: please note links are left out here – will be back in when typo fixed

      My own favorite is Licensing and Merchandising (L&M). Except for Disney, L&M was mostly overlooked by Hollywood until toy-company-supported TV production showed the Majors how to do it. Until then, most Majors didn’t have large L&M groups, with many of the deals left to a small cadre of independent agents like “Honest Ed” Justin, who when representing The Flintstones always signed his minuscule NY Times display ads “Not Needy, Ju$t Greedy.” A man after my own heart. Now L&M is a major income stream for franchise pictures: everything from Toys, Mobile Apps, Games, and Books to Bedding and Condoms – and just about any other consumer product you care to name. All sold with royalties ~7% or so. Excepting maybe the condoms, these products also take 18-24 months to design and produce. Massive business from a hit, and disaster from a flop. Let’s look at Namco, a mobile app/games producer, who’s sold 23 million iPhone copies of Pac-Man:

  2. fresno dan

    “The more comfortable these outsiders are, the more – and perhaps better – movies will be made.”

    I think both conclusions are unlikely. I don’t have the figures handy, but there are a tremendous number of “major” American films produced each year (I believe on the order of 500 or so). If one includes non “major” filmes and foreign movies, the number is in the thousands.
    So the arguement is almost like during the housing boom – we need to have everyone own their own home, and maybe a couple of vacation houses as well – everyone needs to see a movie twice a week, or maybe 7 times a week, or 4 times a day – are far more movies than anyone can or should see.

    “You all remember The Wolfman, right? February 12 of this year ring a bell?”
    I can’t think of a better arguement for less movies being made, or a better arguement that more money available to studios will actually result in more crappy movies.

    My libertarian self says let people freely engage. Future exist for hedging economic endeavors that have uncertain future returns. But my “deal with things as they really are, and not according to how my ideology says they should be” says, “are not enough movies really a problem?” Must we have more financial “inovation” so that Wolfman II gets made?

    1. buzzp

      The Majors released 111 films in 2009; of the other 447, most never played outside the top cities and college towns.

      The number of indie (-14%) and specialty (-21%) films dropped sharply from 2008.

      Indie and specialty films tend to be more intellectually stimulating; also while they opened it was not necessarily in wide release. They also include foreign films.

  3. Dan Duncan

    “Ohm…Ohm…Ohm…”

    Meditate after me:

    You are a calm, open-minded, clear-thinking individual. Yes, you hate the greedy blood-suckers on Wall Street and you hate the incessant need for constant financial innovation.

    BUT, you are calm and relaxed now. And you feel good about yourself.

    Therefore, you will allow yourself a moment of temporary cognitive dissonance…because you know that the open-minded consideration of an opposing view is the path to wisdom.

    Therefore, even though you HATE Financialization, you’ll consider Potamkin’s post with an open-mind. [Unless you’re Attempter, who is only “at home” with one of George Washington’s pandering, infantile tantrums.]
    ________
    Serenity Now.

    OK….

    Potamkin seems to be saying that major studios are akin to TBTF Banks.

    If movie-making is a currency, then the big boys are holding all the chips. Like the TBTF banks, who have morphed garden-variety banking into something perverse, the major studios have done the same with films.

    Additional sources of REGULATED investment may foster more independence—and better movies—as some movie-makers will be able to demonstrate that focusing on the quality of the movie, as opposed to the quantity of popcorn, is a viable model.

    Additional sources of REGULATED investment are not forthcoming because its an opaque industry, impenetrable to outsiders…unless you are Chili Palmer.

    If you had difficulty with Potamkin’s post after 2 readings, then just re-read the part after Potamkin writes, “I will just add a few points:” It’s all there, and succinctly stated, too.

    Even if one disagrees with Potamkin’s thesis, it was an excellent post and quite informative.

  4. MindtheGAAP

    “Looks like a $100 million one-weekend bet, not including their considerable internal costs. For only one movie. With the bet placed 18-24 months ago. As you read this, we’ll all know whether it’s paid off or not, but shouldn’t these guys be able to hedge the downside risk of lesser movie traffic?”

    I have no problem with the gist of your argument, but this point, I think, is a little off. If “these guys” could hedge the downside risk, the $100m they are currently risking will just go up to $1billion.

    This should be great for the studios, I think. IT will also ensure more sequels, prequels, remakes, and, no doubt, more crappy George Lucas releases.

  5. John F. Opie

    Hi –

    Long-time lurker, first time commenter. :-)

    Of course the industry doesn’t want anyone taking a serious look at the downsides of the business: this would be information that takes away leverage from the film studios. After all, the downstream folks, now, are dependent on the studio’s assessments of how the films are going to do. Give them an additional input – the pricing of the futures – and you’ll see a shift in information away from the studios, resulting in their having less leverage in getting favorable rates for their “next blockbuster”.

    There’s a concept in the industry called “Stupid German Money”, based on (now changed) arcane German tax laws that led folks with substantial earned incomes to invest heavily in film fund in order to take their profits immediately via tax write-offs. Given the high marginal rates in Germany, this could bring an almost immediate 35% return for very high income level folks, since they were purportedly in a limited partnership with the intention of making movies (like I said, arcane German tax laws, which is almost an oxymoron…): while this led to the financing of some fairly successful films (almost by accident), it led to more “someone is actually giving us money to make this, can you believe that?”-films, which ended up appearing to be designed to flop (premise of The Producers), which ran afoul of German tax authorities.

    Film futures would have saved several thousand fund investors serious problems with the tax authorities, since hedging their down-side risks as investors would have been part of any decent due diligence…

  6. Pepe

    Hilarious, unless it was serious, and then, well, still hilarious, but in a different way.

    May I call you “Bubble”?

  7. abelenkpe

    Wall Street should go leech off something else. Everything they turn their attention to dies. I love the comments complaining that Hollywood doesn’t create anything new and just uses franchises to skirt by on. If you want more original content why champion increasing the influence of business? You want more cookie cutter productions and really strangle the little life and art out of the industry? Then go ahead and involve more dopey uncreative businessmen who think they know more about art and film than writers, directors and artists.

  8. Dave

    Cities take on huge risks by helping to fund their sports teams. The New Orleans Saints’ Super Bowl win drove massive foot traffic for their parade through the city, a huge influx of interest in Saints and New Orleans merchandise and had a major impact on future ticket sales. That’s a lot riding on the outcome of a single football game. Should not the City of New Orleans and the Saints organization have been able to hedge some of that risk?

    Why stop there? Local businesses in New Orleans had a huge interest in the Saints’ success. More future ticket sales and more future fans interested in the Saints means more business for local sports bars and other eateries and entertainment establishments in the New Orleans area and especially around the Superdome. Should not these local businesses have been able to hedge their massive exposure they had on the outcome of a single football game?

    Players on the Super Bowl winning team saw their salaries increase more than if they had not won the game and there was also a large bonus due to Saints players for winning the Super Bowl. Their future net worth rode on a few bounces of a prolate spheroid. Should these players have been able to hedge some of the risk that they have that could significantly affect their future livelihood and have a massive impact on their net worth?

    Saints season ticket holders saw the value of their seats rise dramatically when the team won the Super Bowl. There are a fixed number of good tickets in a given stadium in a given year. The value of those season tickets could rise dramatically if the team were to start a dynasty. Some season ticket holders could easily make multiples of their money by selling the seats individually. These people should have been able to hedge the outcome.

  9. ChrisPacific

    Yes, I’m sure it would stimulate investment in movie making just like mortage-backed securities stimulated investment in housing. What could go wrong?

Comments are closed.