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- Don D., California
Show Me the Money!
The American film industry is often aligned with fantastic wealth and glamorous opulence, as so-called “A-list” actors don the status of “movie star” with all the glitz and salacious hype that is to be expected of those who live in that limelight. Though somewhat less exposed to the public eye, movie producers and production executives carry a stigma of being shrewd and unabashed businessmen in relentless pursuit of the next obscenely lucrative venture. However, from a financial standpoint, the reality facing some pure-play movie production studios is that it has become increasingly difficult to sustain profitability in the traditional sense.
Taking a closer look at the film production landscape, it becomes apparent that there are very few pure-play, stand-alone movie production companies. Indeed, most of the film studios are owned by media/entertainment behemoths like News Corp. (NWS), which owns 20th Century Fox of Avatar and Star Wars fame, and Viacom (VIAB), which owns Paramount Pictures, responsible for recent blockbuster hits such as, Mission Impossible: Ghost Protocol and Transformers: Dark of the Moon. Other major, publicly traded competitors in the movie production space include, Time Warner (TWX), Disney (DIS - Free Disney Stock Report), CBS Corp. (CBS), Sony (SNE), Lions Gate (LGF), and DreamWorks Animation (DWA). However, only Lions Gate and DreamWorks Animation (not to be confused with privately owned DreamWorks Films) focus the larger share of their operations on the production of full-length feature films, and the latter primarily produces computer generated animation films.
To be fair, one has to consider the vast imbalances of scale when comparing these companies. For example, Sony Pictures Entertainment (Sony Corp.’s movie arm) is a relatively small piece of Sony Corp.’s overall business. In fact, Sony’s entire movies segment generated more revenue (about 18% total revenue) in 2011 than the combined revenue of Lions Gate and DreamWorks for that year. In fact, the average cash balance of those previously listed aforementioned major outfits also dwarfs the combined revenue of Lions Gate and DreamWorks.
Traditionally, the returns on a film production investment are somewhat disappointing. The cost of producing a film has grown considerably and the revenue split is often less favorable for the production company. Indeed, the “box-office revenues” that are often sensationalized in the media are generated by the independently-owned movie theaters, the larger share of which stays with those movie theater companies that sometimes remit as little as a third of those revenues to the production company. Yet, the production companies are responsible for footing the entire advertising and marketing bill that is expected to entice ticket buyers. Hence, quite often the advertising budget exceeds the net proceeds from a film, as Disney learned all too well with the recent disappointing release of John Carter. Still, considering that Disney’s studio entertainment segment accounts for less than one-fifth of its overall business (16% of 2011 revenue), it is better positioned to weather a blow like the unsuccessful release of a major film investment than a company like Lions Gate.
In the information age, margins have been further strained by the rise of myriad entertainment viewing options, particularly with the technological and creative advances in television broadcasting and Internet streaming, as well as the black market or “bootlegging” scourge. In fact, most major movie production companies have come to the realization over the past two decades that there is considerably more profit to be made from the home entertainment industry than in actual theater releases, especially from television licensing deals. DVD sales, Video-on-demand/Pay-per-view, merchandising, and broadcast television licensing, aptly dubbed the “back-end” revenue stream, have helped most film production outfits to recoup sizable losses from theater releases. In fact, some companies may even invest in a movie they expect to lose money on at the box-office because they are confident that the back-end will more than offset the initial deficit. Notably, television licensing deals are favorable for the production companies because once the film rights are licensed for a hefty fee, the cost of advertising and airing the feature falls on the licensee. In most cases, by the time a film has been licensed for network television, the production has already broken even and, therefore, the licensing fees and/or residuals are virtually pure profit for all beneficiaries (production companies, actors, guilds, unions, etc.). In this instance the largest share of the proceeds go to the production studios (typically as much as 90%).
Consequently, this offers another example of how the larger conglomerates have an advantage over the smaller pure-production outfits. When the FCC reversed its Financial-Syndication rule in 1995, which banned television networks from benefiting financially from proprietary programming through local syndication, many large film studios (who were not affected by the ban) began gobbling up television networks (e.g., Disney bought ABC and ESPN, and News Corp. started the Fox Network). This proved to be a highly profitable strategy, hence the dawn of the media conglomerate. For instance, a company like Viacom, which owns several television networks, can therefore air its Paramount films on these networks, thereby capitalizing on this additional source of advertising revenue. Furthermore, Viacom’s very scale provides a considerable advantage in terms of distribution costs. However, the other side of that coin is that Viacom is then still left with the expense of marketing the movies that air on their networks. Still, the benefit of the advertising revenue often substantially offsets those costs, making for a handsome net profit when all is said and done.
On another note, the film industry has evolved in the way it finances productions. The movie business’ reputation of being a potentially lucrative enterprise, but typically a bad investment has prompted studios to increase their film budgets, while decreasing the number of films they produce. The larger ticket productions, which now average about $100 million to make and market, are increasingly being financed by sources outside the movie realm, including German corporations seeking tax shelters and private equity investors. Greater transparency into the business models of film companies has enticed Wall Street firms, who now often purchase slates or bundles of several productions over the course of a year, creating a hedge of sorts (like an MBS or Movie Backed Security). In addition, private equity firms have taken it a step further by entering into partnerships with major studios like Sony Corp. in the buyout of MGM back in 2005 (Providence Equity Partners, et al.), as well as funding smaller outfits like The Weinstein Company, which was backed by Goldman Sachs (GS) following the founders’ departure from Disney that same year.
All told, when analyzing these businesses, it is apparent that the legacy titans of the industry, such as Time Warner, Viacom, Disney, and News Corp. have fared better than the smaller outfits, mainly because of their scale. DreamWorks’ business strategy offers a key advantage to the small fry, as its emphasis on computer generated animation helps to limit its production costs, though marketing remains a hefty expense. On the other hand, another upstart, Lions Gate, has struggled. Despite a few successful projects, including the release of renowned cult favorites like the Saw series and American Psycho, along with the critically acclaimed Monster’s Ball and the most recent box-office smash The Hunger Games, the company has had a tough time staying out of the red. Lions Gate’s most profitable venture at present is its Studio 3 partnership with Viacom and Sony (via MGM). Together, these companies own and operate Epix, which is an up and coming television network that primarily airs films produced by all three studios, along other content. This is a testament to the aforementioned benefits of owning networks that can generate additional ad revenue. Still, looking at Lions Gate specifically, there is no doubt that after three consecutive years of profits from 2004 to 2006, the onset of the most recent economic downturn was probably instrumental in the much weaker results of the years that followed. Nonetheless, it is left to be seen whether or not the company can reemerge as a profitable player in this fiercely competitive business.
In conclusion, film production, not unlike many other business ventures, can be rife with risk, but also abundant in reward. Too, like most other product launches, there is typically a large initial capital outlay and often a period of nail-biting suspense in anticipation of a respectable return. However, it is apparent that the golden goose mentality that surrounds box-office numbers does not necessarily correlate with the financial success of a project. Rather, the longevity of a film’s appeal is the key factor in generating the most profits, as the “back-end” deal appears to be where the most attractive margins are realized. Lastly, it is apparent that the big dogs have not only the loudest bark, but the biggest bite, as the Viacoms and Time Warners of the world seem to be the more sound and attractive investments.
At the time of this articles composition, the author had no positions in any of the companies mentioned.