naked capitalism

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