Investing in Movies: Strategies for Investors and Producers [2 ed.] 0367721619, 9780367721619

Citation preview

INVESTING IN MOVIES

In this second edition of Investing in Movies, industry veteran Joseph N. Cohen provides investors and producers with an analytical framework to assess the opportunities and pitfalls of film investments. The book traces macroeconomic trends and the globalization of the business, including the rise of streamers, as well as the impact these have on potential returns. It offers a broad range of guidelines on how to source interesting projects and advice on what kinds of projects to avoid, as well as numerous ways to maximize risk-adjusted returns. While focusing primarily on investments in independent films, Cohen also provides valuable insights into the studio and independent slate deals that have been marketed to the institutional investment community. As well, this new edition has been updated to fully optimize the current film industry climate including brand new chapters on the Chinese film market, new media/ streaming services, and the effects of COVID-19 on the global film market. Written in a detailed and approachable manner, this book is essential for students and aspiring professionals looking to gain an insider perspective against the minefield of film investing. Joseph N. Cohen, a graduate of Yale and Oxford, held senior positions at Salomon Bros. and Lehman Brothers before he became president of Largo Entertainment, a joint venture between JVC and producer Lawrence Gordon, in 1989. During Cohen’s tenure, Largo produced such hits as Point Break and Malcolm X. Cohen founded American Entertainment Investors (AEI) in 1996, which is best known for advising independent production companies, including Alcon, River Road and Black Label. AEI advised Goldman Sachs and Assured Guaranty in restructuring the Weinstein Company in 2010. Cohen is a member of the Motion Picture Academy and has taught film finance at the Peter Stark Producing Program at the University of Southern California.

INVESTING IN MOVIES Strategies for Investors and Producers 2nd Edition Joseph N. Cohen

Cover image: © Shutterstock First published 2022 by Routledge 605 Third Avenue, New York, NY 10158 and by Routledge 2 Park Square, Milton Park, Abingdon, Oxon, OX14 4RN Routledge is an imprint of the Taylor & Francis Group, an informa business © 2022 Joseph N. Cohen The right of Joseph N. Cohen to be identified as author of this work has been asserted by him in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Library of Congress Cataloging-in-Publication Data Names: Cohen, Joseph N., author. Title: Investing in movies : strategies for investors and producers / Joseph N. Cohen. Description: 2nd edition. | New York, NY : Routledge, 2022. | Includes bibliographical references and index. | Identifiers: LCCN 2021022031 (print) | LCCN 2021022032 (ebook) | ISBN 9780367721619 (hardback) | ISBN 9780367721596 (paperback) | ISBN 9781003153702 (ebook) Subjects: LCSH: Motion pictures—Production and direction. | Motion picture industry—Finance. Classification: LCC PN1995.9.P7 C57 2022 (print) | LCC PN1995.9.P7 (ebook) | DDC 791.4302/32—dc23 LC record available at https://lccn.loc.gov/2021022031 LC ebook record available at https://lccn.loc.gov/2021022032 ISBN: 9780367721619 (hbk) ISBN: 9780367721596 (pbk) ISBN: 9781003153702 (ebk) DOI: 10.4324/9781003153702 Typeset in Bembo by codeMantra

To my late mother, Matilde, and the sweetest dog, Daisy, anyone could ever have, who together never let me get discouraged in the early years of American Entertainment Investors’ existence when I was struggling to turn the corner financially. And to my daughter Catriela, whom I can always rely on for some well-thought-out advice on new film projects.

CONTENTS

Acknowledgments

ix

Introduction

1

1 Pros and Cons of Motion Picture Investment

13

2 Macroeconomic Trends and Studio Co-Financing

33

3 Tax and Other “Soft Money” Benefits and Limited Partnerships

40

4 Welcome to the World of Independents

50

5 The Evolution of Revenue Streams

59

6 COVID and Post-COVID

68

7 The Rise of the Streamers

77

8 Cast of Characters

97

9 Globalization of the Business 10 How to Have Fun and Not Lose Your Shirt

120 137

viii

Contents

11 Managing Risk

154

12 Working the Banks and Non-Bank Lenders

167

13 How to Beat the Odds: Niche Strategies

188

14 Evaluating Projects and How to Pitch Them

200

15 Where You Should Be in the Food Chain: Distribution versus Production

213

16 The Sinkhole of Development

228

17 Exit Strategies: The Value of Film Libraries

234

18 New Directions: The Digital World

241

19 Art versus Commerce

249

Index

261

ACKNOWLEDGMENTS

I want to thank all my colleagues at American Entertainment Investors (AEI), present and past, for their strong support and willingness to search for data I directed them to. Past colleagues who assisted me on the first edition include Christopher Howland, Myriam Bocobza, David Chasmar and, in particular, I want to offer special thanks to my late colleague John Smith for his many valuable comments on the first edition and his invaluable collaboration in preparing the charts and graphs interspersed throughout the book. John was an exemplar of the adage, “The good die young”, and I greatly miss his presence. I continue to benefit from the counsel of my long-standing colleagues, my brother Charles, Andra Gordon, Luiz Tassi and a more recent addition to the team, Amelia Brain. I also want to thank my previous editor at Taylor & Francis, Emily McCloskey, and her editorial assistant, John Makowski and my current editor, Katherine Kadian Lowe, and her editorial assistant, Alyssa Turner, for their much-appreciated guidance in making both editions more accessible to the broadest possible readership. I want to thank Emily and John in particular for persuading me not to go with a “sexier” but less-Googleable title, So You Want to Walk the Red Carpet? I want to acknowledge Katherine and Alyssa’s sage advice in suggesting how the second edition would benefit from various updatings, including addressing the effects of COVID and changes in the industry post-COVID and the meteoric rise of the streamers. I want to especially thank my peer reviewer, Milena Grozeva-Levy, who clearly spent many hours reading my first edition draft and greatly contributed to reducing its opacity and reliance on technical jargon. Since the book was inspired by the course on film finance I taught for 16 years in the Peter Stark Producing Program at the USC Graduate School of Cinematic Arts, I would be remiss if I did not thank the longtime program director, Larry Turman, for his strong support of my teaching efforts during my tenure there. Finally, I want to thank all of AEI’s clients who kindly allowed me to comment on their business strategies in such a public forum.

INTRODUCTION

Summary—The introduction traces the career arc of the author from Wall Street to Hollywood via the UK and Canada. The author describes his seminal experience as president and chief operating officer of Largo Entertainment, one of the first of the well-capitalized independent production companies, and how he segued back into the financial advisory business, focusing on advising wealthy individuals who want to invest in the media space and incubating the companies they finance. There are lots of books about the job of the motion picture producer. Many of them focus on creative packaging and production issues, but some offer a broader insight into the financing process as well. What the market is lacking, in my opinion, is a book that is directed at prospective investors in the film industry—both institutional and individual. I have attempted to address that shortcoming with this book. While the structure of the book does not exactly mirror the lecture sequence of my course on film finance, which I taught (and modified to accommodate changes in the marketplace) for 16 years in the Peter Stark Producing Program at the USC Graduate Film School (I retired in 2010), most of the concepts, analysis, issues and, to a lesser extent, financial models that I have introduced to my students can be found herein. One warning: I write like I lecture—circuitously. That is, I tend to return to subjects I brought up previously for further clarification and amplification. Hopefully, I will not be too repetitious. While this book is directed at the broadest possible audience, I recognize that the universe of prospective investors in the film industry is relatively small. This is not surprising given the enormous capital requirements of most films. Yes, you can make movies utilizing your credit cards, but the likelihood of anyone ever viewing such films outside of film schools or obscure film festivals is minuscule, to say the least. DOI: 10.4324/9781003153702-1

2 Introduction

I must admit that I am conflicted in writing this book. Given that I advise high–net worth individuals in their investment adventures in motion pictures, it is obviously not in my interest to overemphasize the perils of investing in films. But the fact remains that most investors, particularly those who dabble in the space and don’t take it seriously, fail and lose money. I really believe you can make money on a systematic basis, but you have to be incredibly selective, incredibly careful and apply rigorous underwriting standards. Hopefully, this book will assist those interested investors in avoiding most of the pitfalls that abound. If I have one guiding maxim, it is “less is more.” You are lucky if you can find one or two or maybe three compelling projects a year that warrant an equity investment. The potential universe is larger with respect to mezzanine investment, which recoups ahead of equity, because the probability of loss is so much lower. I had one client several years ago who expressed an ambition to finance eight to ten films a year. I told him that made no sense: even the studios have difficulty finding eight to ten attractive projects to make in a given year if we strip out sequels and acquisitions from their schedule. Not surprisingly, this former client stretched on too many projects, either opting in on projects with questionable commercial appeal or accepting budgets that were too high relative to projections, resulting in an unfavorable breakeven analysis. He left a lot of money on the table before he imposed a more careful selection process, and, while he has not recouped anything close to his cumulative losses, he has probably recovered a meaningful portion of his overall investment—and he is still an active player in the space. Writing this book proved to be an invaluable exercise in compelling me to address many of the key challenges facing investors in the movie industry today. I retired from teaching the course on film finance at Peter Stark 11 years ago, and so much has changed in the industry since then. But I also had another reason for writing this book. As a young investment banker in London and New York, I was able to witness firsthand the great marketing skills (and admittedly also contacts) that certain “rainmakers” exhibited in winning mandates for their firms, but I also witnessed how many transactions represented “walk in” business that old-line firms benefitted from as a result of their quality reputations. I run a small boutique media financing, production and advisory firm, and we are referred business by producers, talent agencies, banks, law firms and accounting firms, but we are certainly not a household name when a hedge fund, family office or high–net worth individual is considering someone to seek advice from. To the extent this book gives such perspective clients a sense of the complexity of the issues they would face and the importance of soliciting objective advice (not that obtainable in Hollywood where feedback is so often tarnished by the threat of conflicts of interest), I believe it will serve as a valuable door opener for new business. Fair enough? Everyone has two businesses—their own and the movie business. This old saw is probably even more relevant today given the fact that virtually every

Introduction  3

local newspaper worth its salt publishes the weekend box office tallies. In addition, national newspapers like The New York Times and The Wall Street Journal frequently publish interesting business-related articles about the Biz. A little knowledge can be dangerous, and this little knowledge is compounded by greater access to databases related to film performance. One of my partners was once grilled by a hedge fund manager about prospective returns in the movie business. When he tried to weave a complex analysis on the trade-off of risk and return, the hedge fund manager cut him off with the simple explanation that “everyone knows studio films do three times their negative costs.” Oh, if it were only that easy! I was once an arrogant Wall Street investment banker too—primarily focused on the underwriting of sovereign debt and providing investment management services to central banks. Talk about a career shift: I started out as an academic in philosophy, teaching the paper on logic at Queen’s College Oxford to undergraduates in “Greats” and Politics, Philosophy and Economics. I had no knowledge of Hollywood and no interest in entering that world, although ironically one of the first deals I worked on as a young merchant banker at N.M. Rothschild was to handle the sale of the debentures that Paul McCartney received when the Beatles sold their music publishing operation Northern Songs to ATV. In those days the marginal tax rate on unearned income in the UK was 98%, so it didn’t make too much sense for McCartney to keep those debentures. My ex-wife can attest to the fact that my knowledge of contemporary music does not extend much beyond Motown of the 1960s, but I have had the privilege of working with some of the great musicians of our times to the extent they’ve been involved in the movie business. I handled the sale of George Harrison’s film company, Handmade Films. I executive-produced Bob Dylan’s cult classic Masked and Anonymous, I have been trying to put together a project for Mick Jagger’s film company, Jagged Films, for years (and I won’t give up because it is a great story set in China in the 1930s), and I advised Michael Jackson in an abortive venture in the movie business. When I woke up one morning and decided academics was not for me, I locked myself in a room and read Graham and Dodd on investment theory, and Samuelson on macroeconomics, and reinvented myself as an investment banker—first in London, then on Wall Street. When the economic debacle of the late 1970s–early 80s hit and short-term interest rates rose above 20%, I was running the London-based bond operation at Lehman Brothers under an ever-increasing stress level. What can you expect when your cost of carry on every position exceeded negative 800 basis points—in effect, I was virtually assured of losing on every bet if my trading desk held a position for longer than 10 minutes. Not surprisingly, I was drinking heavily. When my boss recalled me to New York to discuss shutting down the operation, I made a 3-hour presentation arguing that we could cut back dramatically and contain our losses without suffering the embarrassment of withdrawing from the market. My boss

4 Introduction

took it all in, and never spoke to me again. He did not fire me, but all future communications between him and me were via intermediaries (one of whom, Dick Fuld, achieved much greater prominence—and notoriety! long after I had left Wall Street). Needless to say, I saw the writing on the wall. My expected partnership was not to be. At the same time, the tax laws changed in the UK governing film amortization. The government in its beneficence now permitted a 100% write-off of a “qualified” film asset (one that met certain tests regarding UK content and labor contribution) in the year of its creation. An old buddy of mine from Oxford approached me to see if we could take advantage of this change in the tax laws. I researched the legislation and came up with the idea of creating a “sale and leaseback” structure to effectively transfer the tax benefits resulting from the creation of a film asset to tax-paying entities in the UK in exchange for a subsidized interest rate that we could monetize and convert into an up-front benefit to the production. In other words, we could “magically” generate cash to the production of between 10% and 20% of the budget. It was like buying a $100 suit for $80. To set the historical record straight, we came up with the idea at the same time that Barclays Bank did. But we had an advantage over Barclays. In those days, UK lessors demanded to be indemnified if they did not receive the anticipated capital allowances. Studios could issue such credible indemnities, but independent producers could not. My Oxford buddy and I managed to persuade a major UK insurance company to backstop such an indemnity. Thus, while the studios could bypass us, we were the only game in town for the independents. I left investment banking—actually I hedged my bets for a few years by joining another investment bank while continuing to finance films—to establish Albion Films with two partners. Albion became the “go-to” film financing company in the UK in the early 1980s. Not only did we close hundreds of millions of pounds worth of deals, but we also earned a significant windfall profit! Mrs. Thatcher reduced corporation tax during this period. Under the terms of the leases, we merely had to guarantee a certain after-tax rate of return to the lessor. These deals were all defeased (i.e., a certain percentage of the sale price was placed on deposit to secure the lease payments over the term). Since, with the reduction in corporation tax, we could reduce the cash flows required to the lessor and still deliver the same after-tax rate of return, we were able to retain a portion of the defeased amount for our own account. I personally earned a windfall profit of several million pounds. Then the Inland Revenue threw a spanner in the works. Tax bureaucrats in every country resent rich individuals and corporations being able to significantly reduce their tax bills. So, in 1984–85, the Inland Revenue attacked the sale and leaseback structure on technical legal grounds. The studios fought the Inland Revenue all the way up to the House of Lords and won. However, one of our main corporate investors did not wish to challenge the Inland

Introduction  5

Revenue—why should it since it had our insurance-backed indemnity? Therefore, it called our indemnity and while the insurance company paid up, we had issued a counter-indemnity to the insurance company. My windfall profit, which had miraculously appeared, just as miraculously disappeared. Ironically, the UK government and the Inland Revenue reintroduced the saleand-leaseback structure several years later to support the British film industry, and this financing mechanism—which we arguably introduced—became an enormous source of funding for studio and independent films, and generated enormous revenues for the intermediaries who arranged the deals. But I was long gone from the UK by then. I actually lost twice by the Inland Revenue’s action. At roughly the same time, I structured a convertible preferred offering for New Line Cinema, just before it went public. I also committed to take down a significant piece of the offering, using the windfall profit I had earned in the UK. But when my nest egg disappeared, I wasn’t able to take up my shares, so I lost out on the huge profit I would have earned when Ted Turner later bought the company. Having “bankrupted” one exchequer, I moved on to another. Canada in those days was the true Wild West when it came to film finance. There were tax benefits for Canadian qualifying films that could be accessed on both the federal and provincial level, but for the most part they were utilized for low-budget, obscure Canadian films. Tax shelter money was raised in small amounts privately, largely by medium-size accounting firms and individual promoters. In 1987, I launched the first-ever public offering for films in Canada. The C$21 million raise represented by far the largest single film financing ever achieved in Canada to that date. I followed this up with several subsequent limited partnership offerings, but I chose not to accept an offer from Alliance, the largest independent film company in Canada and my partner on those deals, to jointly establish a specialty film finance division. Tax shelter financing can be very lucrative for the promoters, but intellectually it is rather arid, and I wanted to become more involved in mainstream Hollywood activities. In hindsight, passing on the invitation to partner in Alliance Equicap was a huge mistake on my part, since it generated enormous revenues over the 15 or so years it was in existence. Arguably, it represented the vast bulk of Alliance’s profits over that period. But I had already made the decision to move to Los Angeles, where the real action was. By this time, my career shift from Wall Street to Hollywood was a fait accompli, and I was determined to become involved in the making of movies, albeit from a financial structuring point of view. The movie-making process was as close to creation ex nihilo as I could imagine, although, unlike God, we financial engineers have to rely on the creative vision of writers, directors and producers to assemble our universe. My first client after I moved to Los Angeles was a small, but highly regarded, independent production/distribution company, Alive Films, which was an offshoot of a successful management company/record label run by a charming

6 Introduction

guy, Shep Gordon, whose client list included Luther Vandross and Alice Cooper. After I closed a major financing several years later for a new production entity, Largo Entertainment, which was run by a high-profile producer, Larry Gordon, Shep sent me a note: “Congratulations, but you raised money for the wrong Gordon.” Shep is my hero; he now lives in an Edenic house on Maui and practices his culinary skills, which are considerable. I was delighted to see that a documentary Supermensch about Shep (who is the humblest guy in the industry regarding his success) was produced in 2013. I couldn’t agree more about the appropriateness of the title. Alive Films had a reputation as a tasteful art house producer/distributor (including such films as Choose Me, The Whales of August, The Moderns and Far North), but its greatest commercial coup was linking up with noted genre directors Wes Craven and John Carpenter to do a series of low-budget horror films. Shep recognized early on the appeal of the horror film genre for the teenage audience. He also realized that audiences were more director-driven than castdriven in this genre. Shep was not locked into studio precedents when it came to doing deals: he was able to attract Carpenter and Craven for what were after all low-budget films by offering them a true partnership position in profits. I believe that Wes made more money on his two films with Shep than he did on all the Nightmare on Elm Street films, which grossed infinitely more. To put things into perspective, Alive’s first horror film, They Live, did $13 million US box office on a budget of $4 million; the second film, Shocker, did $16.6 million on a budget of $5 million; and the third film, The People under the Stairs, did $24.2 million on a budget of $6 million.1 The key to Shep’s strategy was tight control of budgets, which is the first rule of success in the independent market. Largo for me represented an opportunity to segue from the financing area to becoming a full-fledged studio executive. In 1989, the prominent entertainment law firm of Bloom, Dekom & Hergott recommended me to the Japanese hardware company JVC to advise them on the creation of what would become the first Japanese-funded film company in Hollywood (we preceded Sony’s acquisition of Columbia Pictures by several months). I used to kid around that the reason I left Wall Street was that I would never have to deal with the Japanese again (I was in charge of Japan at Salomon Brothers, where I worked before Lehman—actually I joined Kuhn Loeb after Salomon and soon afterward KL merged with Lehman). In the mid-1970s, when I worked at Salomon, the Japanese brokerage firms, banks and trading companies were just beginning to become actively involved on Wall Street. They had an insatiable thirst for knowledge concerning the world’s biggest financial market. Because they gave me a lot of business and I guess also because of my professional demeanor, I became the go-to source for such information—it was very gratifying to be so lionized but it sure tired me out.

Introduction  7

Bloom, Dekom & Hergott had introduced Larry Gordon to JVC as a potential partner for the venture and chose to represent Larry in the negotiations. I represented JVC. The good news was it paid me my fee at closing; the bad news was I was the only acceptable candidate to both Larry and JVC to be chief operating officer of the new venture. Just kidding! I was delighted to be given this opportunity, because frankly, while I was an experienced investment banker and tax shelter film financier, I really had no hands-on experience in running a film company. My four-and-a-half years at Largo were an incredible learning experience. Business Affairs, Finance and International all reported to me. Larry retained full control over creative matters. I probably spent 2–3 hours every working day for 4 years in Larry’s office discussing corporate matters but also being regaled by Larry’s stories of his Hollywood experiences—and Larry is a great storyteller in the Southern and Jewish traditions. He grew up in Belzoni, Mississippi, the Catfish Capital of the world. I have worked with a lot of producers over the years, but Larry is as well-rounded as any I know. There are some good creative producers who don’t know a thing about financing movies. They have grown up in the studio environment and their job is to develop and package projects, which the studios will greenlight and finance, and then deliver a finished film to their studio masters. Larry started out with one of the original low-budget independents—American Independent Pictures—and while he went on to produce many big-budget action blockbusters, he never forgot his indie roots, which call for a careful assessment of revenue potential versus the cost of producing and marketing. Larry was the first producer who told me that he never started a film before he could envisage the movie poster (“the one sheet” in Hollywood parlance). Generally speaking, independent production companies, if they are to succeed, have to hit at least one “home run” within a reasonable period of time. “Grand slams”—like The Blair Witch Project or My Big Fat Greek Wedding—are even better, but without the significant profit cushion that a home run can deliver, most independents run out of money at some point. There are exceptions to that rule: if the indie is exceptionally well-capitalized, can maintain a very tight control over operating costs, avoid overspending on development and structure its deals so that even on unsuccessful films, it does not lose too much money, it can survive and maybe even prosper. My client, Alcon Entertainment, was an example of just such a successful independent production company that managed to generate an attractive rate of return for its investor over an initial 10-year period without ever having hit a home run. It did hit a number of singles and doubles, including P.S. I Love You, Sisterhood of the Traveling Pants, Insomnia and My Dog Skip. Alcon is very tightfisted when it comes to operating costs and development and is very careful on its higher-budget films to generate a meaningful percentage of budget out

8 Introduction

of foreign presales (i.e., the securing of minimum guarantees from territorial distributors irrespective of the film’s performance). Minimum guarantees represent non-refundable advances paid by distributors upon delivery of a film, which are applied against contractual net revenue entitlements, so Alcon never has too much money at risk predicated upon US and Canadian box office performance. One or two failures in a row would not break Alcon’s back. Success in the independent film world typically means being able to stay around long enough to hit that home run. In fact, after a 10-year run, Alcon did just that with the blockbuster hit The Blind Side, which frankly came out of left field. The industry pundits never saw it coming, but, thanks to its broad appeal to all audiences—in industry parlance we call it a “four quadrant film” (i.e., it appeals to males under 25, males over 25, females under 25 and females over 25)—the film wound up generating domestic box office in excess of $225 million (on a budget of around $30 million taking into account subsidies from the state of Georgia).2 In particular, The Blind Side brought out the evangelical audience in droves, because it was a “feel good” movie with an evangelical family as heroes—and it did not beat you over the head with an overtly religious message. Interestingly, Alcon has since modified its business plan to focus on higher-budget, star-driven and special effects-driven films with budgets of $100 million or more, particularly in response to the growing importance of the international market, which wants those kinds of films.3 The company released Transcendence starring Johnny Depp in April 2014, and Christmas-time 2015 released a rebooted version of the cult action film Point Break (which ironically was produced under my aegis at Largo)—both to disappointing results— and then launched its most ambitious project to date: a sequel to Ridley Scott’s dystopian sci-fi film Blade Runner, which despite disappointing box office (it achieved lifetime gross of less than $34 million4) has attained cult status over the years. Blade Runner 2049 dramatically underperformed at the box office, but I think Alcon will come out OK at the end because of future television spin-offs. Alcon has not totally forsaken its family film heritage. It released a sequel to its hit film Dolphin Tale in September 2014, which was profitable, although it underperformed the original by some 40%. Largo had a similar track record—i.e., a number of singles and doubles, including Point Break, Unlawful Entry and Time Cop—but no home runs. We mitigated our per-picture risk significantly by negotiating a substantial minimum guarantee for non-North American rights from our worldwide distributor— first Twentieth Century Fox, then Universal. Largo’s business plan called for us to produce five films per year on average. Our annual overhead and development budget was geared to that volume of production. For whatever reason, we produced only roughly two and a half films per year. Larry told me early on that temperamentally our industry is divided up between sellers and buyers. He clearly identified himself as a seller (he was one of the great pitchmen in the

Introduction  9

business), so I should have been forewarned that he would always be hesitant before pulling the trigger on greenlighting projects. Our margins were significantly impacted by the fact that our production slate had to bear roughly twice as much in amortized operating costs as we had planned. In the end, what sank Largo was not its performance history, which showed a meaningful, but not huge, overall loss on a fully amortized basis. What sank Largo was management’s failure to live up to its business plan, and JVC’s unwillingness to overlook that in the context of unexciting results. Ironically, the final nail in the coffin was Largo’s proposal to greenlight two big action films, which was precisely what JVC expected from the joint venture. I was not surprised that JVC passed on Waterworld—Larry told me that no one knows what Waterworld would cost given the difficulties of shooting on water— but I was surprised that JVC also passed on Die Hard With a Vengeance since that seemed like a no-brainer. But I guess that the confidence factor, which is a necessary element in the successful functioning of a joint venture, was irretrievably damaged. I learned a valuable lesson from that experience: Your business plan must be carefully constructed, and, once constructed, it must be scrupulously adhered to, subject to the ability to make needed changes in response to changing market conditions. When I joined Largo, I merged my financial consultancy company, InterMedia, with another consulting company, Film Equities, which was owned by a prominent boutique entertainment law firm, Sinclair Tenenbaum. When Largo dissolved (it actually was absorbed by JVC, which transformed it into a foreign sales company that promptly managed in the short span of 2–3 years to lose much more money than the production company ever did), I returned to InterMedia as co-chairman of InterMedia/Film Equities, which, among other things, advised the major music company Polygram on the creation of a motion picture subsidiary and the well-known directors Ridley and Tony Scott on a leveraged buyout of Shepperton Studios in the UK (a deal that turned out very profitable for the principals of InterMedia, since we had a small shareholding that was later monetized when Shepperton was merged with Pinewood). In 1996, Co-Chairman Nigel Sinclair informed me that he no longer wished to provide financial advisory services but wanted to segue into being a producer in his own right. Accordingly, I sold my interest in InterMedia to Nigel’s old friend and highly regarded foreign sales agent, Guy East, for a nominal amount, and established my current advisory firm, American Entertainment Investors. I mention this only because Nigel and Guy merged InterMedia with a major German tax shelter firm and, taking advantage of the huge inflows of German private capital into the movie business in the early 1990s, they and their German partners took the company public. For one millisecond, my shares in InterMedia, which I had sold for a pittance, were worth $100 million on the German Neuemarkt (the entire company had a market capitalization

10 Introduction

exceeding $1 billion!). But that was only for one millisecond since the German Tax Authorities killed the golden goose, and the principals did not have time to liquefy much of their holdings. I understand they did manage to sell some shares at a considerably lower valuation, and we are still talking about significant sums here. Yes, the film industry can generate enormous killings from time to time—but I am not promising any secret formulas for success. Over the last 20 years, Wall Street firms—primarily hedge funds—have plowed many billions of dollars into Hollywood, primarily in the form of equity and mezzanine investments in slates of studio and major independent companies’ films. Not surprisingly, this market dried up as a result of disappointing returns and the seizing up of the credit markets in 2008–09. Even during the 5-year love affair between the hedge fund community and Hollywood, you would have thought that Wall Street would also have attempted to create investment vehicles for the individual investor. It did not. Ironically, Wall Street did attempt to attract retail investors in the 1980s by marketing a series of motion picture limited partnerships that permitted smaller investors to participate in a slate of studio films with a minimum investment of only $5,000.5 Men (or women as the case may be) could now impress their dates when the lights dimmed in the cinema by casually informing them that this was their film. The only problem with these structures was that they generated unattractive returns for investors. Needless to say, Wall Street was more attentive to the investment considerations of the large studios sponsoring these funds. At that time, I was hired by a major Wall Street retail firm to educate it on the economics of these structures with a view to its possibly marketing similar partnerships. You have to realize that the executives I lectured to were predisposed to come up with structures they could sell to their clients. After all, that is how they make their money. But to the credit of the Wall Street firm in question, it could not justify getting into this business given the likely rates of return these partnerships offered. So, I never succeeded in becoming a general partner on a public motion picture limited partnership. Fashions on Wall Street tend to be cyclical. Fads fade out and come back into favor. So as I write this book, the older generation of hedge fund and private equity managers who pioneered the slate deals of the early 2000s are now enjoying their retirement on Nantucket or Naples, Florida and a new generation of money managers think they have figured out how to make money in the movie business—so a new series of slate deals have been launched over the past several years—embodying some improvements on the previous generations but with less leverage. Arguably, the kinds of returns required for this level of risk will be equally difficult to achieve this time around. My core consultancy is to advise wealthy individuals who wish to invest in the film and television industries, primarily by forming their own production companies. I am an incubator of such production vehicles. That is, I formulate the business plan, help organize the company, negotiate distribution

Introduction  11

relationships, assist in evaluating individual projects, negotiate deals with talent, organize the banking and other financing arrangements, and source subsidies, tax benefits and other “soft money” opportunities. When I am asked what I do for a living, I typically reply, “Do you remember Robert Duvall in The Godfather?” I am the consigliere. Most of my clients are on the Forbes 400 list, or in the case of some non-US clients, would qualify for that list if they were domiciled here. By definition, there are only so many prospective investors who can be culled from the Forbes roster. There is a much larger universe of investors in the $10–$100 million net worth range, who theoretically might be interested in exploring diversification into film and television investment. I have been seriously considering how to structure investment vehicles that could appeal to this group of investors, and I hope that this book will serve as a valuable guide to assessing such opportunities if and when they can be made available. If Wall Street has found ways to provide diversification through hedge funds, LBO funds, “vulture” funds, etc., the time is ripe to forego the poorly structured partnerships of the 1980s and come up with pooled investment strategies that can offer reasonably attractive projected rates of return. In fact, I have recently set up just such an investment vehicle with several entrepreneurial investors who have made a fortune in real estate investment. We are concentrating on the mezzanine space, as opposed to higher-risk equity investment. But more about that later. For those readers whose net worth is less than eight figures, I cannot promise to come up with viable investment opportunities, but if I can give you reasons for not participating in the funding of a film project with virtually no commercial potential, I will regard this book as having performed a valuable fiduciary function. Hopefully, the insights and anecdotes contained herein will prove entertaining, if not financially rewarding, for any reader, whatever his or her economic circumstances. In that regard, I kibitzed a few years ago at a cocktail party with a wealthy Russian pharmaceutical mogul who, when he heard I was an “expert” on film finance, told me about a proposal he had received to finance a relatively low-budget action film. I told him the concept was passé, the stars even more so, and the producers were not to be trusted. I advised him not to do the deal and then forgot about it. He invited me for drinks on his yacht several months later and thanked me for keeping him out of trouble. Not only did he thank me, but he brought out a gift box containing a beautiful Vacheron Constantin watch—Russians tend to be very generous in showing their gratitude. It was probably the best fee I have ever received for giving some gratuitous advice. Please do not be too disappointed, however, if this book does not contain multiple proprietary financial models that I have developed over the years, and that I am constantly updating to reflect changing economic conditions (I will refer to my models though throughout the book). That intellectual property is very valuable and is part of the reason my firm can command significant

12

Introduction

consulting fees to advise investors in the movie business. You cannot honestly expect to get the benefit of those models for the cost of this book. As I like to point out to prospective clients, I have CERT to sell—contacts, expertise, reputation and time—and probably the most valuable commodity is expertise. Recent changes in the securities laws, which will enable producers to reach out to a much broader range of “non-accredited” investors will likely lead to much greater activity in the crowdfunding arena, but I am extremely concerned that accompanying laxness in disclosure requirements and lack of discipline in enforcing anti-fraud provisions of the statutes will permit scam artists and naïve producers to raise money for projects that should never be funded. Unfortunately, I have little faith in the ability and willingness of government bureaucrats to protect the interests of “mom and pop” investors. Caveat emptor!

Notes 1 “They Live (1988) Box Office/Business,” Internet Movie Database, www.imdb.com/ title/tt0096256/business?ref_=tt_dt_bus; “Shocker (1989) Box Office/Business,” Internet Movie Database, www.imdb.com/title/tt0098320/business?ref_=tt_dt_bus; “The People under the Stairs (1991) Box Office/Business,” Internet Movie Database, www.imdb.com/title/tt0105121/business?ref_=tt_ql_dt_4. 2 “The Blind Side (2009) Box Office/Business,” Internet Movie Database, www.imdb. com/title/tt0878804/business?ref_=tt_dt_bus. 3 Anita Busch, “Alcon Entertainment, Warner Bros. Extend Deal to 2019, Arranges $200M in New Financing,” Deadline Hollywood, 5 Nov. 2015, http:// deadline.com/2015/11/alcon-entertainment-warner-bros-extend-deal-200million-financing-1201609157/; Dorothy Pomerantz, “Risk Managers,” Forbes, 22 Feb. 2012, www.forbes.com/forbes/2012/0312/strategies-kosove-broderickjohnson-film-alcon-risk-managers.html. 4 “Blade Runner (1982) Box Office/Business,” Internet Movie Database, www.imdb. com/title/tt0083658/business?ref_=tt_dt_bus. 5 L. M. Farrell, “Financial Guidelines for Investing in Motion Picture Limited Partnerships,” Loyola of Los Angeles Entertainment Law Review 12 (1992), 127.

1 PROS AND CONS OF MOTION PICTURE INVESTMENT

Summary—Investors in any business need accurate information in order to assess risk and project rewards. The movie business, however, does not provide the full panoply of publicly available information to make such judgments, so prospective investors have to seek other sources of information to augment their analysis. In particular, this chapter distinguishes between “budget” and “actual film cost” and points out the lack of transparency with regard to domestic and international distribution and marketing costs and the difficulty of determining accurate correlations between domestic box office and ancillary revenue streams, such as home video and free and pay television. The first challenge that prospective investors face, assuming they are looking at financing a single picture or a slate of studio films, is how budgetary discipline will be exercised. The chapter addresses a number of considerations that impact budgetary discipline. Finally, the chapter reviews historical expectations with regard to investing in a portfolio of studio films and why expectations and actual results did not always match. Invariably, whenever I tell someone that I advise very rich individuals with respect to their film and television investments, that person is skeptical about my clients’ intentions, “They really don’t expect to make money, do they?” For some reason, it’s really about hobnobbing with the stars, or getting their girlfriends (or boyfriends) in the movies, or impressing their cronies. I won’t deny that I have come across investors who have acted out of one or more of these questionable motives. But most of these “fringe” investors typically never show the color of their money. They make lots of promises, but rarely close. My clients are self-made multimillionaires or billionaires, for the most part. Some are scions of inherited wealth, but the scions of inherited wealth are usually surrounded by legions of legal and investment advisers who do their darnedest to keep their legatees out of the clutches of fast-talking producers. These fiduciaries are basically risk adverse. They aren’t knighted for generating DOI: 10.4324/9781003153702-2

14  Motion Picture Investment

above-average investment returns, but they face the danger of being axed if they invest in areas that are perceived to be exceptionally high risk—and the movie business certainly has the reputation of being not much better than the slot machines in Vegas. The self-made rich, however, are used to taking risks. That is why they have as much money as they do. But they tend to be extremely analytical in their approach to risk management. It’s all a matter of probabilities, and the fact that they have opted to play in this space is indicative of their belief that rational investment strategies are possible in the movie business. The bets are too large to simply act out of whimsy. That is not to say that their initial incursions into the motion picture industry were not somewhat capricious. Several major players I am aware of, including several of my clients, were, in fact, the “victims” of fast-talking producers. You have to realize that producers are some of the most persuasive salesmen around. They have to be, because they are dependent on their gift of gab for hooking studios or wealthy individuals to pony up significant sums of money on the basis of a “pitch,” a script or a package (director and stars). In the case of wealthy individuals, most instances of being taken to the cleaners did not involve major losses, because their basic reticence about the bona fides of film investment served as a natural drag to the contagious enthusiasm exhibited by the producers. In general, smart investors can be fleeced only once, maybe twice, and then they either leave the field or decide that they want to learn the rules of the game and apply the same set of rigorous investment strategies that they have employed in their primary businesses. The self-made rich do not like to be made fools of. Hence, their stubborn insistence on mastering the macroand microeconomic facts that underlie the motion picture business. Once this intellectual mastery has occurred, they can proceed to explore rigorous business strategies, culled from the experiences of the major studios and successful independent producers. Now they are in the world that business consultants are familiar with, throwing around concepts like market share, leverage, risk transfer, niche strategies, co-financings, return on investment (ROI) and tax shelter. They have gone beyond the perception of the business as a veritable crap shoot. Hollywood soaks up information, just like Wall Street, and while the quantum of information transmitted in Hollywood contains a far higher percentage of industry gossip than Wall Street, the information flow is also characterized by virtually instantaneous transmission. What books are available to be optioned, what films have fallen apart (so the director and actors are now available), what executives are about to be sacked (so do not waste your time pitching new projects to them)—all of that represents insider knowledge that is not generally available to the public at large. What is readily available to the general public is the latest box office data—at least the top ten grossing films for the weekend. Those box office numbers by themselves are not sufficient to determine the profitability of a film, or even whether the film is profitable at all. Arguably, it is

Motion Picture Investment  15

a fact that most of the key parameters that determine a film’s success are hidden below the water line, much like an iceberg, which discourages serious investors from dabbling in the movie business. The first impediment to investing in the movie business, therefore, is lack of concrete public information. This is particularly frustrating for Wall Street types who, in the Internet Age, are used to being able to extract any item of quantitative data they desire at the push of a button. If anything, stock and bond market analysis may be oversaturated with data, and one of the first tasks of analysts these days is to sift through the data to learn what they should take seriously and what they should ignore. The film industry is nowhere near as transparent. Let me try to be more precise. No totally reliable data is published regarding film budgets. Occasionally, you will see estimates in the press, but these are only estimates. No sources for these estimates are given, and I have seen vast discrepancies among estimates on the same film. There are many reasons for the lack of published data. Most important, there is no incentive for the producers or studios to reveal their hand. By doing so, they give away valuable information to competitors as well as to the creative participants (actors, directors and writers) who are profit participants in the film. Like sports franchise owners, it is in the studios’ interest to plead poverty. Since all the major studios are subsidiaries of large public conglomerates whose annual 10Ks are about as long as PhD theses, there is no way you can glean the profitability of individual films from SEC filings. The film operations are buried within larger divisions, which frequently include television programming, broadcasting, theme parks, video distribution and so on. Studio bragging rights are determined primarily by box office share, and generally only domestic box office share (“domestic” in the quaint parlance of the industry means both the United States and Canada). There is no definitive way to measure individual studios’ profit margins. Even box office share is not weighted for the number of releases in the studio’s release calendar for that year. In general, studios tend to understate budgets rather than hype them. There is an embarrassment factor at work here. Let’s face it—in an era of excess, where the mega-rich are buying $100 million homes and $10,000 pocketbooks (conspicuous consumption has returned after the economy has been boosted by continuous liquidity injections by the Federal Reserve)—it is a little obscene to make a movie that is more expensive than the GNP of half the countries in the world. In addition, the industry has a predilection for Schadenfreude, which is a German expression for taking pleasure in other people’s misfortune. Hollywood practically oozes Schadenfreude—not because its participants are more misanthropic than most, but because there is an abiding superstition that Hollywood is a zero-sum game. If you succeed, it means that there is less available success out there for me. Perhaps that principle makes sense when applied to competing films on the same weekend, but it clearly is wrongheaded when

16  Motion Picture Investment

applied on a macro basis. If you make a baseball movie that works, contrary to established opinion, that will increase the odds that my baseball movie may also get made (as long as mine isn’t the fifth film in the cycle, and the three previously produced baseball films didn’t tank). But, as we shall see later, given that there are few variables (I will suggest two, somewhat tongue in cheek) that show consistent positive correlations with box office success, repeating successful genres or themes is no guaranty of future success. Sequels to highly successful films, the so-called franchises, are a different matter, and there is definitely a reasonable positive correlation there. In fact, there used to be a rule of thumb (another one of those rules of thumb that are more industry wives’ tales than empirically grounded truths) that a sequel should do roughly 75% of the domestic box office achieved by its predecessor. Many sequels over the past 5 years have outperformed their predecessors, but studio executives are concerned that more recent experience has been much less positive. The very notion of “budget” is a shifty concept. Sometimes it refers to the projected cost of the film going in, and sometimes it refers to the actual cost of production, as determined when the film is delivered (“delivery” is a technical term that refers to the fact that all the elements needed to exploit the film have been completed and made available to the relevant distributors). As initially prepared, budgets represent best guesses regarding the ultimate cost of the film, prepared on a line-item basis and then tallied up. The responsibility for preparing such budgets falls on the so-called line producer and his staff. The line producer is the person who is the chief operating officer of the film. He or she is generally not the senior producer on the project. The senior producer is the person who typically acquired the rights to the project, developed the screenplay, hired the director and the key cast, brought in the studio to distribute the film and secured the necessary financing. In the old days, the senior producer function rested with one individual. Now that role has often been fragmented particularly with respect to putting together the financing and arranging distribution. Those tasks fall on individuals who frequently take “executive producer” rather than “producer” credit. The line producer answers to the producer, who, depending on the power and oversight of the financiers and distributors (who are often one and the same), may be the autocrat of the project or the factotum of the money guys, who are unaffectionately known as “suits.” Nevertheless, only the credited producers on a film get to ascend the podium to receive the Oscar for Best Picture. In Figure 1.1 you will find a sample “top sheet” for a film shot in New York that my company was an advisor on. The top sheet represents the first two pages of a standard film budget and includes an overview of all the major costs associated with the film. If you examine a complete budget, you will be reviewing 50–80 pages of numbers broken down into categories, like Art Department and Visual Effects, with a summary statement, the top sheet. The top sheet is broken down into

Motion Picture Investment  17

18  Motion Picture Investment

FIGURE 1.1

Sample Film Budget.

two sections: above-the-line and below-the-line. Above-the-line represents the cost of the rights (including development expenditure related to the screenplay), actors, director and producing group, while below-the-line represents the actual production costs, including crew, construction, locations, transportation, visual effects and film stock, as well as post-production expenditure, including editing, music and so on. Before these numbers can be calculated, the line producer has to “break down” the screenplay and figure out how many days it will realistically take to capture on film all of the action and dialogue contained in the screenplay. Typically, the line producer is given fairly free rein in coming up with this breakdown. Of course, this is done in the context of what kind of production the given project is likely to represent. If it is a big studio production with major stars and a prominent director, the line producer will approach the budgeting process with a certain bias, while if it is an independent film that clearly has limited capital available, he or she will approach the job with a radically different frame of mind. Enter the director. Frequently, the line producer has been selected by the director or is even the director’s own man (or woman). That is, many directors typically work with the same line producer time after time. There are advantages to the production in this cozy relationship. Given that the two are used to working together, there is a greater probability that the shoot will go more smoothly. The line producer knows the strengths and weaknesses of the director and is better able to support him or her. But this symbiosis is also fraught

Motion Picture Investment  19

with danger, particularly as far as the “suits” are concerned. When the line producer is effectively an arm of the director, when he or she clearly knows where his bread is buttered in the sense that he or she will continue to work with the director in the future but may never see the financiers on this project again, there is tremendous risk that there will be less than total financial conscientiousness displayed in the construction of the budget and less than total financial discipline exercised during the making of the film. One must remember that some directors, not all, are first and foremost artists. The French refer to these directors as auteurs. That does not mean that such directors do not exhibit financial discipline, but it does mean that their primary responsibility is to their artistic vision. If that vision requires reshooting scenes or expanding the scope of the production design or low-balling the true budget to entice the financiers to commit to the project, even the most ethical of directors will be sorely tempted—and not every director starts out with the highest ethical standards. There are some directors who are marvelous in terms of being able to create cinematic masterpieces whom I would never bankroll because they cannot be controlled. Some producers may con themselves into believing that they can control any director through sheer force of will, but for the most part, they are kidding themselves. On the set the director is basically king. Yes, you can fire him (subject to what I will discuss later as an “essential elements” clause), but then you really risk the film going totally out of control, both financially and creatively. Lack of budgetary discipline cannot always be laid at the foot of the director. Studios are often just as much to blame. Many studio executives who have responsibility for overseeing productions do not have a lot of physical production experience. After all, it’s not their money, and it’s not necessarily in their interest to keep the director on too tight a leash. Like the federal government, studios frequently attempt to solve problems by throwing more money at them. This is particularly true on the big action and special effects films, where there is a great deal of pressure to come up with state-of-the-art action and special effects. Granted, if you skimp on these sequences, you jeopardize the commercial prospects of the film—but all too often the studios acquiesce to a shooting schedule on a straightforward production that is far too accommodating. Clint Eastwood is not only a great director, but he is also the opposite of prodigal when it comes to the pace of his direction. As an example, Clint took only 36 days to shoot Million Dollar Baby. This can be compared with the 70-day-plus schedules that are not uncommon today even on studio dramas and comedies. Let’s confess to a not-well-kept secret that is relevant here: more and more, the studios are turning to younger, less-experienced directors who are considered hipper and more attuned to the youth audiences that are the primary demographics for a large percentage of the films the studios are making today. Many of these directors have honed their skills on commercials and music videos that are incredibly good-looking, but short on plot and characterization. To

20  Motion Picture Investment

a significant extent, these inexperienced feature directors are learning on the job, which often entails longer production schedules. Independently financed productions, because of tighter capital constraints, tend to be much more disciplined when it comes to budgets. But frequently this translates to a less-polished finished product. Just because an independent producer says that he can shoot a given film in 5 weeks on a budget of X doesn’t mean that the film will be roughly comparable to a studio version shot in 10 weeks on a budget of 2X. While capital constraints are incredibly important, they cannot succeed in placing a square peg in a round hole. While I have complained about excesses with respect to the number of days utilized for principal photography, there is the flip side of the coin that places a practical floor on the least number of shooting days that can accommodate a given script. There are only so many setups (individual scenes from a script breakdown point of view) that can be accomplished in a given day, irrespective of the number of takes that are required. Independent producers should always keep in mind the mantra of independent filmmaking—good, fast and cheap. Enter the completion guarantor. The completion guarantor is the entity that covers budgetary overages and guarantees that the film will be delivered by a specified date. Virtually all independent films, apart from ones with micro-budgets, as well as a growing number of studio films (although the vast majority still self-bond) utilize completion guarantors. To the extent a bank is involved in providing any portion of the financing, it is necessary that the film be “bonded” by a reputable completion guarantor. Similar requirements are often placed on the film by equity investors. There is a very good reason that banks do, and equity investors should, require such protection. With respect to project finance lending (that is, stand-alone single-picture financing), the banks are lending primarily against bankable contracts from distributors who commit to paying an advance upon delivery of the film. Entertainment banks may give some credit for the estimated value of unsold rights, the so-called gap lending, but in either case if the film is abandoned or if the film goes over budget and there is no source to provide the required additional capital, the value of those distributor advances is nil. In addition, distribution contracts stipulate outside delivery dates, and if for whatever reason the producer fails to make timely delivery, the distributor is no longer obligated to honor the contractual advance. Completion guarantors take on the burden of ensuring that such events do not happen, and, if they occur, the completion guarantors ensure that the named beneficiaries on the bond are made whole. In the case of an abandoned picture, for example, the completion guarantor will reimburse the financiers for any monies expended to date. There is obviously a cost associated with utilizing a completion bond company. First, the bond company will insist that a contingency be added to the budget. This contingency functions much like the deductible on your homeowner’s policy. The contingency is typically 10% of the budget, possibly with

Motion Picture Investment  21

certain exclusions, (but may be more in the case of complicated special effects films), and it must be fully expended to cover any budgetary overages before the completion guarantor kicks in. Second, the completion guarantor charges a fee, which is typically around 2–3% of the budget (more precisely, of the defined budget, which for completion bond purposes may exclude certain expenses) but volume users generally get a discount on that price. Studios usually function as their own completion guarantors because they fully expect to have to cough up whatever is required to deliver a film that they believe can be commercially successful. Why pay someone else to fulfill a role that you are prepared to play yourself—unless you are very worried for some reason about your ability to avoid excessive budgetary overages? If you are nervous about the fiscal discipline of your director, you can be sure that the completion guarantor is equally nervous. The well-capitalized independents recognize that you never really want to call on the bond. If you do, you may jeopardize your good standing with the bond company, and your future rates—as in automobile insurance— will surely rise. Thus, completion bonds in the eyes of the major players in the industry are a kind of catastrophe insurance. They should be called only if a major financial disaster is the alternative. Accordingly, when most films go over budget, and there is a bond in place, the producer will put up the budgetary overages if he or she has the financial wherewithal. That probably works if it does not happen too often. However, I know of one major indie that had great distribution output deals in place. The deals were so good, it was difficult to see how it could lose much money on any production—except the company went invariably over budget to the tune of 10–15%, which it covered, and this represented the imputed profit margin on its portfolio of films. So, after several years of not being able to exercise budgetary discipline, it closed up shop. There are very few completion bond companies that serve the industry. As of the writing of this book, there are only three major completion guarantors in the United States (there are several smaller bond companies elsewhere around the world) that can handle studio-level features. Thus, producers can’t afford to burn any bridges by getting a reputation of calling on bonds with any regularity. I was asked recently by a private equity guy who had invested in one film whether completion bonds were a good business. My response was equivocal. The good news is, as I said earlier, producers do not want to call on bonds except in a disaster scenario because it jeopardizes their ability to bond films in the future. The bad news is that the fees a bond company charges (typically 2–3% on one-off films and less if a well-capitalized indie commits to an overall relationship with the bond company) are, in my opinion, somewhat light given the risk bond companies bear. It must be noted that if a bond company takes over a given film, its investment is subordinated to the existing equity investors, plus the bond company does not enjoy any profit participation. The latter fact provides a strong motivation for the bond company to spend the minimum

22  Motion Picture Investment

amount of money to deliver the film, irrespective of its impact on the film’s commerciality. So, the completion bond business is about accumulating as many 2–3% commissions as possible to offset any underwriting losses. Thus, to succeed, a bond company must bulk up in volume—which led the largest bond company, Film Finances, to acquire the second largest bond company, International Film Guarantors (IFG), a few years ago. IFG was backed by Allianz, the huge insurance company, whose other subsidiary (Firemen’s Fund) was a leading provider of overall insurance to the film industry—cast and production insurance as well as errors and omissions insurance (a special form of insurance that protects a film’s rights holders from the potentially devastating impact of lawsuits for libel, slander, invasion of privacy, infringement of copyright and other specified torts, including improper handling of unsolicited scripts, failure to obtain appropriate rights for music and film clips, failure to obtain appropriate releases from individuals appearing in the production, and improper use of celebrity’s name or likeness). IFG/Fireman’s Fund benefitted from its ability to provide joint coverage for both general insurance and completion risk, but it came as no surprise to me that Allianz was a willing seller of its completion bond subsidiary. If a completion bond company can manage its risk properly and if it has a sufficient volume of business, I suspect it can achieve an acceptable return on capital particularly given that it can reinsure a large portion of its risk with mainline insurance companies and be left with a limited deductible. Thus, bond companies can play the leverage game as well. Completion bond companies serve another important purpose on productions. As it is clearly in their interest to do their homework on scripts and budgets presented to them, they employ experienced in-house physical production executives who go over these budgets with a fine-tooth comb. Bond companies are not hesitant about challenging budgets presented to them by producers, and they frequently insist that additional shooting days be added to the schedule or that various departmental sub-budgets be augmented. This, of course, has the consequence of increasing the budget. It should be pointed out that completion bonds are not in force until the producer has demonstrated that he or she can fund the film to the “strike price,” which is the fully loaded budget for bond company purposes. Because banks won’t lend a dime to the production until the completion bond is in place, producers frequently have to bridge required cash flow themselves, or find outside financiers who specialize in providing such bridge financing, until the bond and bank loan both close. Industry outsiders are flabbergasted when I tell them that it is not uncommon to close on the bank loan on an independently financed film after the start of principal photography. This is generally not a problem for my clients, who all have the financial capability of bridging the funds required for pre-production (and even the first couple of weeks, or more, of principal photography), but it is an enormous burden for production companies that are not well-capitalized. At the very least, it adds significantly to the financing costs, and thus to the overall budget.

Motion Picture Investment  23

It is not unusual for films to eat through their entire contingency (because, like Mount Everest, it is there!) as well as incur additional budgetary overages. Thus, there is great variability between the going-in budget of the film and the actual cost of completion. When you see the occasional budgetary numbers thrown around in the press, you can assume they are referring to actual final cost, but there can be no assurance that these numbers are accurate or that they include all the relevant costs. For example, financing costs are often ignored. By financing costs, I mean the fees the bank charges for making the loan as well as interest to delivery. Technically, the bank will provide for interest costs 2–4 months beyond delivery to give itself a cushion, but if there is anything left in this interest reserve at delivery (either because the film was delivered promptly or the bank’s projected interest rate during the course of production was excessive—the banks like to give themselves a cushion here as well), it reduces the amount that has to be paid back to the bank. The bank’s legal fees are also born by the producer, and these fees have tended to escalate as a result of the increasing complexity with respect to how films are financed. Fifty years ago, most mainstream films were either cash-flowed by the major studios or banks lending against studio contracts for worldwide rights (the socalled negative pickups). In the 1950s internationally sophisticated producers began to tap into the foreign markets by “preselling” titles to foreign distributors. These producers would then bank these contracts to provide a large chunk of the necessary financing for their films. Thus, the “bifurcated” film model was borne, whereby producers lay off domestic rights to the major studios or the so-called mini-majors and license foreign rights (i.e., outside-North America) on a territory-by-territory basis. Given the multiplicity of contracts now relevant to a single picture financing, the legal paperwork also increased exponentially as did the lawyers’ fees. Over the past few years, the so-called soft money benefits (governmental rebates and tax credits) and tax-incentivized investment structures have proliferated greatly to the extent that they have frequently become a necessary piece of the puzzle on independently financed and also studio films. On the one hand, the tax incentivized investment structures (the German and UK Equity Funds, the old Canadian tax shelters), in particular, added significant degrees of complexity to the financial package and dramatically increased the legal fees associated with such transactions. These structures also carried with them high levels of fees and commissions for the middlemen who sourced such funding, which either added directly to the financing costs that had to be financed as part of the budget or required disproportionate revenue participations for these funds in order to permit them to recoup the costs of their raise. Governmental subsidies, on the other hand, typically represent “freebies”— that is, they are outright cash rebates or they can be monetized by selling the tax credits to tax-paying entities in the jurisdiction—and don’t have to be repaid nor do they participate in the film’s profits. Such is the case with the benefits

24  Motion Picture Investment

provided by most US states (at time of writing, roughly 60% of the states had film subsidy programs in place) and all of the Canadian provinces. There is another important variable that affects the true cost of the film, which cannot even be quantified at the time the film is delivered. This variable is a function of the quantum of the so-called gross profit participations in the film. Many “A” level actors, directors and producers have negotiated gross profit participations that enable them to receive significant remuneration above and beyond their fees in the budget, irrespective of whether the film has recouped its negative cost for the financiers. These gross profit participations are couched as a percentage of gross receipts, and their fees in the budget are typically applied against their percentage entitlement of gross receipts. It works like this: let us assume that a given actor receives a $10 million fee in the budget (the so-called fixed compensation) against 10% of the gross. In fact, it’s not really 10% of the gross because certain off-the-top deductions—such as taxes, shipping costs and Motion Picture Association of America (MPAA) dues—apply. Hence, “gross” becomes “adjusted gross.” In addition, home video gross receipts that are included in the total revenue base do not represent true gross receipts, but are calculated on an artificial royalty basis, which typically is based on 20% of wholesale revenues (higher in the case of major stars). There are historical reasons for this (it is based on the traditional reporting model for the record industry, to which it bears some resemblance), and the guilds are constantly fighting for a redefinition of video residuals, which are also based on the same royalty definition. The studios have resisted these efforts for a very good reason: the traditional royalty definition represents a fraction of the studios’ share of video revenues, even after taking into account manufacturing and marketing costs. Not surprisingly, as digital distribution platforms replace physical video sales and rentals, this issue has become less relevant. In this case, the actor in question would not receive any additional compensation until adjusted gross revenue equaled $100 million (i.e., when he had earned out his $10 million fee based on 10% of the gross). When studios account to profit participants, they include gross participations in their calculation of budgets. Arguably, there is good justification for this if gross participations kick in prior to the studio’s having recouped, since they serve to push back the studio’s breakeven just like any other budgetary item. But if they kick in after recoupment, they simply function like any other profit participation, which simply reduces the profitability of the film for the studio. By including gross participations as a budgetary item, the studios can also charge interest on such sums as well as include them for purposes of calculating the overhead factor that they tack on to the budget of every film they produce. Thus, a budget is a rolling definition that increases over time, even after the film has been released. I should point out that as overall economics of the business have become more challenging, studios have cut back dramatically on their willingness to pay a share of gross, even to top stars. The mantra is now cash breakeven, whereby

Motion Picture Investment  25

actors do not receive additional compensation above and beyond their fee in the budget until the studio has recouped (typically before taking into account distribution fees). I think you get the message: “budget” and “film cost” are not synonymous. Even if you think you have a reasonable handle on the cost of making the film, you still have to address the cost of marketing and distributing it, which can frequently exceed the cost of production. The so-called prints and ads (P&A) costs have grown faster than production costs over the past 10 years. In 1998, according to MPAA statistics, average production cost of an MPAA member (primarily studios) film was $52.7 million.1 In 2007, it was $70.8 million— representing a per annum growth rate of 3%.2 In 1998, average marketing expenditure was $25.3 million.3 In 2007, it was $35.9 million—representing a per annum growth rate of 5%.4 These numbers don’t look too bad if you believe them; I don’t, at least not with respect to recent studio experience. It is interesting that the MPAA has not published average production and marketing expenditure numbers since 2007. A cynic might attribute this to the fact that one or both categories are out of control, and the MPAA does not want to fess up to that fact publicly. I suspect the culprit is more the “A” side of the equation (print costs are actually dramatically in decline as films are now distributed digitally for the most part). Based on the projects that I have knowledge of, I believe the studios now find it difficult to release a high-profile film—that is, a film that has one or more “A”-list actors and is released broadly on at least 2,500 screens—without spending north of $30–35 million in domestic marketing and distribution costs. Not only are they throwing more advertising dollars against the wall—for television and radio spots and Internet advertising—but they have also become more spendthrift than ever in crafting their creative campaigns. That is, the studios think nothing of hiring multiple vendors to create a multitude of trailers, finishing often more than 100 television spots, conducting vast research efforts related to testing the film and the marketing campaign. The cost of the creative campaign alone can run on the order of $10 million—and this is before the studio has spent a dime on advertising to create public awareness and want-to-see. Later in this chapter I highlight the disappointing experience that many institutional investors have experienced on the so-called studio slate deals. It is not unreasonable to assume that this may be due in large part to the lack of fiscal discipline the studios have exhibited in marketing their films. Ironically, as I indicated earlier, the studios have been showing greater discipline in controlling burgeoning production costs, particularly with respect to talent remuneration. By the way, the P&A numbers compiled by the MPAA refer to North American costs only. There is absolutely no public database that represents a comprehensive compilation of marketing and distribution costs outside of North America. One reason for this is that many films distributed by the studios in North America are handled differently in the foreign marketplace. The

26  Motion Picture Investment

good news about foreign, though, is that marketing expenditure has historically trailed domestic spend, mainly because television spots are less expensive; plus, some countries, like France, do not even permit television advertising for films. But, over the last few years, P&A spending internationally has accelerated dramatically. In my course on film finance in the Peter Stark Producing Program in the USC Graduate Film School, each student was required to construct a financial model analyzing the profitability of individual film projects. The model is based on a set of correlations relating revenues and costs. The key performance variable in these models is domestic box office. Thus, all revenue streams are keyed to domestic box office: home video, free and pay television, pay-per-view, video on demand (transactional, subscription and advertising), non-theatrical (airlines, universities, military bases, etc.), merchandising, music publishing and sound track, both domestic and foreign. While the database represents generic correlations, I make it very clear to my students that for the model to be effective it must permit them to override any specific revenue stream or expense item, depending upon the characteristics of the film being modeled. Thus, you cannot come up with a generic multiplier that relates overall film revenues (in particular, key ancillary revenue streams such as home video, which also includes video on demand and free and pay television) to domestic box office—notwithstanding the glib assurances of the hedge fund manager I referred to in the introduction. Profitability data is extremely hard to come by in the film industry, unless you have privileged access to studio data. But why would the studios open their kimonos? Well, they would and have under a rather obvious set of circumstances; to the extent they were trying to attract major institutional investment, they understood that they would have to disclose precise revenue and cost information to prospective investors in order to enable those sophisticated investors to run Monte Carlo simulations to quantify risk and assess projected returns. Monte Carlo methodology is based on computer-generated random number techniques that are used in business to calculate risk, but also have widespread use in science and engineering to study systems with significant uncertainty in inputs. In fact, the methodology was invented at Los Alamos in the 1940s to predict the likelihood of nuclear fission being accomplished based on various assumptions regarding radioactive processes. In the case of motion picture analysis, you generate thousands of likely portfolio results based on historical data to generate a bell curve measuring probability of loss and projected returns. Institutional investors—primarily hedge funds—were initially attracted to Hollywood because they recognized that movies were a pre-eminent asset class that was totally non-correlated to the stock market. Thus, they were a perfect addition to portfolios that were seeking to diversify beyond stocks and bonds. Portfolio diversification by itself, of course, is not a sufficient determinant of risk mitigation. A portfolio also has to consist of asset classes whose

Motion Picture Investment  27

performances are relatively independent of one another. As an example, if we assume that utility stock performance is correlated with the bond market, a portfolio manager would not be accomplishing much in terms of risk management by diversifying his bond portfolio into utility common shares. It did not take much in the way of research to recognize the relative independence of film performance versus the stock market. Everyone can cite the fact that people still went to the movies during the Depression. As I will argue later, profit margin trends in the movie business are more a function of technological innovation within the industry than macroeconomic trends. Now I would like to introduce the term “moral hazard.” Moral hazard occurs when one person takes more risk because someone else bears the burden of that risk. While moral hazard is a feature of all insurance policies, the interests of policy holders and insurers are usually somewhat aligned. That was not the case when insurance companies dipped their toe in the water in the mid-1990s by providing shortfall guarantees on several packages of films. It goes without saying that the producer who was in the deal primarily for his fee could care less how the insurance company made out. That is what goes to the root of moral hazard. The first such deal was initiated in 1995 by the well-known producer Mike Medavoy, who was looking for financing for a five-picture package including The People vs. Larry Flynt and The Mirror Has Two Faces. Chase Manhattan agreed to act as lead bank for a loan syndicate and a group of insurers underwrote part of the financing package. The People vs. Larry Flynt bombed at the box office and while The Mirror Has Two Faces did reasonably well theatrically, the picture still showed a loss because the star, Barbara Streisand, pressured the distributor (Sony) to overspend on P&A. The insurance syndicate balked at compensating Medavoy’s production company, Phoenix Pictures, for the tens of millions of dollars in losses and sued Chase and Heath Insurance Brokers, the broker that placed the Phoenix policies. In full disclosure, I acted as an advisor to Heath’s counsel in the litigation. The plaintiffs claimed that they had relied on the “principle of utmost good faith” (which is a principle in British tort law) but had been misled by misrepresentation and non-disclosure.5 The defendants countered that such a principle did not apply under US law and that the insurers could not unilaterally void their contracts. After prolonged litigation, Chase and Heath prevailed, which caused other insurance companies that were involved in other unsuccessful deals to cut their losses and run. Today, banks generally run the other way when someone brings up the notion of an insurance-backed guarantee, although savvy insurance underwriters can point to several flaws in the shortfall guarantee structure that were embodied in the Phoenix deal and then replicated in other transactions. First, the insurers did not fully understand the notion of diversification (five or fewer films in a package implies too much volatility). Second, the insurers had too much risk on a per-picture basis. Several analysts suggested that a significantly lower percentage of the budget should have been covered to lower the risk of

28  Motion Picture Investment

moral hazard. Finally, the insurers should have written into the contract a more protracted period before they paid up (the makeup payments were required in as little as 2 years after the theatrical release of the last film in the package, after which the insurance companies would step into the shoes of the banks and collect future revenues to make themselves whole). I might mention that an old partner of mine, Harris Maslansky, and I have recently come up with a new insurance structure that is quite dissimilar from the shortfall guarantee structure promulgated in the Phoenix and other deals. I don’t want to disclose the structure because we have not yet tested it in the market, but we are confident that at least the lending banks should be satisfied that payments under the policies are reasonably bulletproof. Wall Street learned from the bad experience of the insurance structures, and—always on the lookout for new investment products that can be sold to their clients—banks and brokerage firms soon glommed on to the idea of “securitizing” slates of studio films by creating various tiers of risk that could appeal to more than one class of investors. In addition, they trumpeted the importance of achieving a diversified portfolio by investing in a studio’s entire output (with some notable exceptions) over an entire year, and sometimes longer. These studio slate deals were typically comprised of three separate tiers. The senior pieces, which historically represented the first 55% or so of the overall slate, were provided almost entirely by commercial banks. The mezzanine pieces, which historically represented 25% or so of the overall slate, were largely provided by hedge funds, many of whom also participated in the equity slice as well. Wall Street houses and insurance companies have also participated in the mezz loans. The final equity investments, representing 20% or so of the slate, were entirely provided by hedge funds. As more hedge funds caught the fever, some deals were done with equity pieces representing as little as 15% of the overall slate (remember, leverage is a two-way street—in success, it can jack up your ROI, but in failure it magnifies losses). But as senior and mezzanine lenders perceived that there was greater risk in structures than they originally thought, they demanded greater equity cushion beneath them. Over a period of roughly 5 years up to the financial meltdown of 2008, more than $13 billion of slate financing (including slate financings for independent production companies) was raised.6 The jury is still out as to overall rates of return, but I think it is fair to say that, except for some notable exceptions, investors’ experiences have significantly underperformed expectations (which may have been too high in the first place). On several deals, the entire mezzanine pieces have been wiped out or largely wiped out. All of the studios climbed on the slate bandwagons as well as many of their specialty film divisions. Interestingly, the most successful specialty film division, Fox Searchlight, which has been responsible for such crossover successes as Juno, Little Miss Sunshine and Slumdog Millionaire, refused to participate. The

Motion Picture Investment  29

reason given to me was quite simple: the division was too profitable, and the cost of capital on these slates was too high. When the slate financing structure was first introduced, the pricing on the senior and mezzanine pieces was quite attractive from the studios’ point of view, with the senior interest rate in the area of LIBOR + 1.75–2.50% and the mezzanine coupon in the area of 10–12%. As the spreads on less than investment grade securities widened overall, the pricing on the mezzanine pieces also deteriorated with the market quoting 16–18% on the mezz.7 But then everything imploded, and the market for slate financing came to an abrupt standstill in 2008–09, although the structure re-emerged to a limited extent thereafter. It should be pointed out that the analysis that senior and mezzanine lenders engage in is fundamentally different from the approach taken by equity investors, although the Monte Carlo simulations they run are based on the same database. As I indicated earlier, Monte Carlo techniques as applied to film investment are designed to compute probability of loss as well as projected returns. Senior and mezzanine lenders are more focused on the probability of loss calculation. In particular, they set acceptable probability of loss parameters, and if the parameters are exceeded, a prospective investment is automatically rejected. Clearly, mezzanine lenders are prepared to accept higher loss potential than senior lenders because they charge a significantly higher cost of capital to justify the higher degree of risk assumed. Once it is determined what the likely probability of loss is, the senior and mezzanine lenders can determine the pricing of their respective tiers, taking into account as well their own internal guidelines as to benchmark returns. Equity investors, in contrast, tend to be more fixated on probable upside. Not surprisingly, given the projected equity returns they expect in the private equity and LBO markets, hedge funds wanted some degree of comfort that 20% plus internal rates of return (IRRs) were achievable on these slate deals. The studios would not give them such comfort because of the risk of legal liability, although they would provide historical data and let the hedge-fund boffins crunch their own numbers. The promoters who married institutional investors with the studios had fewer qualms. Halfway through my course at Peter Stark, I attempted to quantify studio returns while standing on one foot—it was a fairly down-and-dirty analysis since I quickly got tired in that pose. In a very brief analysis, I projected single digit (maybe low doubledigit) type returns. Even first-year graduate students can understand that it is tough to transform such base IRRs into 20% plus returns, even through the use of substantial leverage (remember, the studios will still charge the slate distribution fees off the top, albeit on a reduced basis). I have a slate presentation that just crossed my desk (provided confidentially by presenter) that shows a projected IRR on committed capital of 15% (27% on drawn capital) predicated on a base-case cash on cash return of 1.18×—not bad, but I believe the model embodies an accelerated time-line for receipt of revenues, and I do not know if

30  Motion Picture Investment

it factors in management carry and administrative costs. I suspect the targeted IRR is inflated and will require much better than median performance to achieve. Please keep in mind that IRR reflects the time value of money (the idea that a dollar today is worth more than a dollar in the future), unlike ROI, which simply represents profit as a percentage of investment, irrespective of whether it takes 1 year, 5 years or 50 years to achieve that return. IRR is the proper way to assess an investment because it represents the compound interest rate at which an investment has to grow to generate certain proceeds over time. The question immediately comes to mind as to the cause of the divergence between results and expectations. After all, institutional investors who were given complete performance histories by the studios soliciting their investment were in a much better position to construct financial models than my students at Peter Stark who have to research their correlations. The investors had complete breakdowns of historical costs and revenues. Accordingly, five possible explanations come to mind. The first I dismiss out of hand—namely that the historical data the investors received was inaccurate. The potential legal liability associated with providing false information is enormous, and these studios are all parts of much larger publicly traded conglomerates. No, that is a game we associate with individual shysters. The second explanation is that the data was incomplete or misleading. I have reviewed some of the worksheets provided, and I have not found any sign of incompleteness, but in one sense the data may be misleading if not analyzed properly. Most of those slate deals do not encompass all of the films produced by the studio from a point in time going forward until the funds are fully expended. The studios in general have excluded sequels and animated films from the slates funded by outside investors. They have done this for a very good reason: sequels are invariably sequels to extremely profitable films. You do not make a sequel to a box-office bomb or even a mediocre performer. Thus, it might rightly be concluded that ROI in sequels exceed overall returns on the studio’s entire slate of films. It does not take a rocket scientist to make the necessary adjustments to the historical data to exclude sequels or potential sequels, assuming, of course, that the historical data provided actually identify the specific films produced by the studio or the studio itself excludes such films in the overall database. In some cases I have examined, this was done, or could have been done by the investors if the actual films were identified in the worksheets they were provided. I wonder, however, if the necessary adjustments were always made. Similar comments apply to animated films, which also tend to outperform studio averages, not surprisingly since they typically demonstrate four quadrant appeal. The third possible explanation is that the future did not resemble the past for whatever reason. I stress “for whatever reason” because this discrepancy with regard to future versus past performance may be a result of changing macroeconomic conditions or industry-specific conditions, or it may be a result of

Motion Picture Investment  31

changing studio behavior. It is the latter charge that lies at the root of some of the litigation that percolated over disappointing slate results. The fourth possible explanation is that investors underestimated the underlying variability of film portfolios—as a result of not having sufficiently many films in the slate. In the beginning, investors insisted on having 25–30 films or more in the slate, but as money piled into the sector, underwriting standards weakened and investors were prepared to accept 20 films and sometimes as low as 15 within the slate.8 Since the movie business is a hit-driven business, the probability of hitting a home run in a diminished slate, I would argue, was dramatically reduced. I haven’t compared key probability metrics for slates with different film samples, but I am confident my gut feeling is correct. The fifth possible explanation, and the most likely in my opinion, is that the deck was stacked against the investors. This explanation can be broken down into a number of possible categories. To begin with, perhaps the studios charged too-high distribution fees—in fact, the studios over time have reduced the level of distribution fees they have charged slate deals considerably below what they charge on single-picture deals. The real problem, as I indicated earlier, was that sequels (and animated films) were typically excluded from the slates. Sequels tend to be concentrated in the upper echelon of studio budgets. Several years ago, one investment firm did extensive Monte Carlo analysis of studio results as a function of budgets. Interestingly, the firm found that studio films in the under $25 million budget category generated very positive returns, while above that returns declined dramatically in a straight line to zero until budgets hit $100 million, where the returns spiked and even exceeded the performance of the under $25 million budgets.9 But you shouldn’t be surprised—that is why studios today are concentrating on large tentpole films and why they excluded generally bigger budget sequels and animated films from these slates. While I can’t prove it, I also suspect that studios took advantage of this huge influx of capital to drive up marketing budgets. Since they recoup P&A off the top, such aggressive tactics didn’t raise the studios’ risk profile that significantly and enabled them to buy “gross.” That refers to the fact that studios calculate distribution fees off gross, not net, revenues so it is in their interest to hype gross receipts given that the slates’ typically bore 50% of the risk related to the financing of the budget (with the studios bearing the remaining 50%). The MPAA for years published detailed statistics on theatrical costs for its members—studios, mini-majors and large independents—as well as marketing expenditure. But, as I mentioned earlier, it stopped doing so in 2008 on the excuse that the increasingly complex nature of film financing and distribution made it difficult to obtain reliable data. Cynics, however, suggested that the reversal came about as a result of studio pressure. The MPAA chairman and CEO, Dan Glickman, a former congressman from Kansas and a former Secretary of Agriculture, was probably not in a mood to push back on his studio bosses, especially in light of his inability to lobby successfully for tax breaks for Hollywood in the federal

32

Motion Picture Investment

stimulus package that was passed to preserve US jobs after the economic debacle of 2008–09. The same studio bosses were probably not keen to reveal how much they were spending on making and marketing their films during a time of severe recession and massive layoffs. Needless to say, Glickman’s contract was not renewed in 2010.

Notes 1 Welkos, Robert W. “Movie Production Spending Dips, but Marketing Costs Rise, Valenti Says,” Los Angeles Times, 10 Mar. 1999, www.articles.latimes.com/1999/ mar/10/business/fi-15740. 2 McClintock, Pamela. “MPAA: Specialty Films See Rising Costs,” Variety, 8 Mar. 2008, www.variety.com/2008/film/markets-festivals/mpaa-specialty-films-seerising-costs-1117981882/. 3 Welkos, Richard. “Movie Production Spending Dips.” Los Angeles Times, 10 Mar. 1999, www.latimes.com/archives/la-xpm-1999-mar-10-fi-15740-story.html. 4 McClintock, Pamela. “MPAA: Specialty Films See Rising Costs.” Variety, 5 Mar. 2008, www.variety.com/2008/film/markets-festivals/mpaa-specialty-films-seerising-costs-1117981882/. 5 “A Fine Romance,” The Economist, 29 Mar. 2001, www.economist.com/ node/554490. 6 Owczarski, Kimberly. “Becoming Legendary: Slate Financing and Hollywood Studio Partnership in Contemporary Filmmaking,” Spectator 32, no. 2 (Fall 2012): 50–59, https://cinema.usc.edu/archivedassets/32_2/6_Owczarski.pdf. 7 According to author experience. 8 According to author experience. 9 Confidential internal company analysis (American Entertainment Investors).

2 MACROECONOMIC TRENDS AND STUDIO CO-FINANCING

Summary—The chapter discusses the impact of technological change and other macroeconomic factors on industry profit margins. It focuses on the historical introduction of new distribution platforms—i.e., free television, pay television, video on demand and home video—and how they contributed to studios’ profit margins as opposed to cannibalizing them. It highlights Warner Bros.’ penchant early on for nurturing satellite production companies that served as valuable contributors of independently produced and financed films to the studio’s distribution pipeline. From a macro point of view, film company profitability is much more variable than other industrial sectors. This is a result of creative variability: some years, the industry just seems to do a better job of producing films the public wants to see; other years, it seems the industry cannot buy hits on a consistent basis. But it is also a result of technological changes. If we could develop accurate statistics as to overall industry profit margins over a meaningful span of time— which we cannot—I am confident that we would see a graph containing a series of profit margin jumps, looking like a step or saw-tooth graph, which coincide with new distribution platform introductions, following which profit margins level off and actually decline as studios, flush with cash, tend to overspend going forward and face increasing cost pressures from both talent and union workers who want their fair share of the goodies. Ironically, when television took off in America in the early 1950s, some pundits predicted television would cannibalize the box office and dramatically reduce Hollywood’s profitability. The opposite was the case, however, as network television became a significant licensor of feature films that it showcased as “movies of the week” and independent broadcasters acquired a high volume of feature films that they aired in a newly created syndication window following the network window. Thus, the movie business got an enormous fillip when pay television was introduced in the early 1970s DOI: 10.4324/9781003153702-3

34  Macroeconomic Trends and Studio Co-Financing

with the advent of HBO, then again in the late 1970s when VHS technology trumped a probably superior Betamax system, then again in the mid-1990s when DVD was introduced and the public went on a buying spree to stock DVD libraries, which were much more efficient to store than bulkier videocassettes and had enormous competitive advantages in terms of image quality and ease of viewing. Arguably, the data the institutional investors originally received were derived from a period of rising profit margins related to strong DVD sales, which caused them to invest in film slates with murkier prospects, particularly in light of the peaking of the DVD sell-through market. DVD sales on new titles declined dramatically at the end of the first decade of the new millennium as a result of weakness in overall consumer spending in a steep recessionary environment as well as a shift in consumer buying patterns toward streaming and other download technologies. DVD sales showed signs of stabilizing at the end of the recession as the economy improved and the introduction of Blu-Ray technology at higher price points gained increased public acceptance. But then streaming and other downloading technologies took off and started to rival home video as a major secondary window for theatrically released films. Not all new distribution platforms have the same impact on the industry’s bottom line since there are meaningful differences as to what share of the revenue pie the studios retain in each medium. Not surprisingly, the studios have sought to protect at all cost their DVD franchise because they retain a much higher percentage of the retail price on video sell-throughs than they do, for example, in pay-television broadcasts where they have to share subscriber fees with both cable and satellite companies and the four premium pay services: HBO, Showtime, Starz and Epix. To put this into perspective, studios’ pay television license fees typically represent on the order of 25% of gross pay television subscriptions allocated to feature films (with the premium pay service retaining 25% and the cable or satellite carrier the other remaining 50%), while it is more on the order of 45% on DVD sales even after taking into account the retailer’s margin and manufacturing and marketing costs.1 The situation was much different with respect to the DVD rental market, where there were complex revenue sharing arrangements with major video outlets like Blockbuster, but it is clear that the studios’ margins on rental did not approach what they were able to achieve on sell-through. That notwithstanding, revenue sharing was still a preferred model for the studios than what existed pre-revenue sharing when Blockbuster and others paid a very high price per videocassette—roughly 3× what a DVD sells for at retail outlets today—but then they kept all of the rental income generated by the videocassette, which could represent several times the price they bought it for. Revenue sharing sought to allocate the stream of rental income more fairly between the retail outlets and the video distributors (i.e., the studios and some independent distributors). The emergence of streaming as a meaningful revenue stream has complicated the economic equation even further since in many cases streaming represents a

Macroeconomic Trends and Studio Co-Financing  35

replacement of “windows.” Thus, several majors and mini-majors have entered into output deals with Netflix in lieu of their traditional pay-television window. In certain cases, these deals are non-exclusive, so the distributor is free to negotiate multiple streaming deals, which makes it very difficult to compare the overall impact on the bottom line with the classical video/pay-television/ network television/syndication sequence. It seems fair to say, therefore, that much of the blame for poor slate performance can be attributed to a secular downturn in profit margins as a result of declining DVD sales. There is another possible explanation that is much more in the control of the studios: for whatever reason, the studios spent significantly greater marketing dollars on the films in the slates to achieve the same level of box office revenues than what they did historically. But why should we be surprised? The whole point of these studio slate deals was to shift a meaningful percentage of production risk to third parties while at the same time permitting the studios to earn distribution fees. The investment bankers who negotiated these structures spent too much time, in my opinion, negotiating the studios down on their distribution fees and not enough time on capping marketing expenditure, which, after all, is recouped prior to any investment in negative cost. Yes, cutting distribution fees by several percentage points can be helpful in bolstering returns, but this has a piddling effect compared with extravagant advertising spending (or excluding sequels from the slate). The investment bankers naively thought that fiscal discipline would be shown by the studios given that they were funding the other half of the budgets of the films in the slates (the slate funds typically funded 50% of budgets, although recently several deals have been done with the slate only providing 25% of budgets).2 Only late in the cycle did the investment bankers wake up and try to impose spending caps on P&A (to the extent the studios chose to spend over the negotiated caps, they could only recoup that excess spending after the production costs had been fully recouped). Any efforts to cap P&A expenditure or require the studios to defer recoupment of expenditure beyond a certain cap have been largely unsuccessful, in my experience. I do not know if these charges about excessive P&A spending are warranted, or whether most of the blame can be attributed to secular industry trends, but the fact remains that a combination of disappointing results and an overall meltdown in structured finance across all industrial sectors dried up institutional interest in this portfolio approach to studio co-financing for a time. However, institutional memories are short. As the economy and stock market have improved, new slate deals, albeit with more conservative leverage structures, have emerged. Today, only Disney, among the studios, avoids slate co-financing. The experience of co-financing with the studios has not been a uniformly bad experience. Several entities remain committed to the business, presumably because their experience to date has been relatively rewarding. I am thinking here primarily of Legendary Pictures and Village Roadshow. Founded in

36  Macroeconomic Trends and Studio Co-Financing

2000, Legendary was one of the first assemblages of hedge fund and private equity capital to co-finance studio films. Legendary almost went bust in its early years, but was bailed out by Warner Bros., who let it co-finance the rebooted Batman franchise in 2005 as well as Superman Returns. Village Roadshow is an Australian public company whose core businesses consist of exhibition, distribution and theme parks. Roadshow was the first to climb on the co-financing bandwagon in 1997. Roadshow remains mainly attached to Warner Bros., but Legendary pulled up stakes in 2013 and moved to Universal, primarily because it wanted to concentrate more on in-house production. But Legendary’s first two in-house produced films through Universal, Blackhat and Seventh Son, were both clunkers and Universal put Legendary’s take on King Kong, Kong: Skull Island, in turnaround, ostensibly because of a budget that was reputed to be north of $125 million. Warner Bros., Legendary’s old studio partner, immediately stepped in with a three-picture deal, including Kong, followed by a sequel to Godzilla (the biggest Warner Bros. hit initiated by Legendary), followed by a huge extravaganza pitting the ape against Godzilla, which was released in 2021 to outstanding box office results—the first film released during the pandemic which indicated a return to normalcy. After that three picture deal, Warner Bros. did not re-up with Legendary for slate financing because it negotiated an overall deal with an investment group which was a joint venture between billionaire James Packer and Brett Ratner’s RatPac Entertainment and Steven Mnuchin’s (yes, that Steven Mnuchin) Dune Entertainment. Warner Bros. bought out the investors when Mnuchin went off to run the Treasury for Donald Trump and Ratner was accused of multiple cases of sexual assault and harassment, which caused Warner Bros. to sever all ties with the director. Thomas Tull, Legendary’s founder and CEO, was also desperate to show that he could produce successful films in his own right, not simply co-finance studio fodder. But the jury is out, and industry insiders weren’t overly impressed when Tull took credit for the Batman films on which he had no real producing role and simply benefited from Warner Bros.’ generosity in letting him cofinance. Perhaps because it mistakenly thought Legendary produced Batman, the Chinese conglomerate Dalian Wanda Group, which owns the AMC theater chain, acquired a majority stake in Legendary in 2016 at a valuation of $3.5 billion.3 That number is flabbergasting and if true (which I don’t believe for a second—I suspect $3.5 billion represents a potential earn-out number, while the base price is much, much lower), it is not surprising that Legendary’s institutional shareholders rushed to cash out. Wanda clearly wanted to beef up its media subsidiary with the acquisition of Legendary in order to float it on the Hong Kong Stock Exchange at some astronomical multiple of earnings. As part of that strategy, Wanda took a huge $550 million write-off on Legendary to ensure that post-IPO profits would look extremely good.4 That said, it should be pointed out that while Legendary’s Warcraft, based on the best-selling game (50% of the subscribers are Chinese) set an opening day box office record in

Macroeconomic Trends and Studio Co-Financing  37

China—generating $156 million in the first 5 days of release—the film petered out at only $221 million in total Chinese box office and was considered a major flop in the United States, where it grossed less than $25 million on the opening weekend and only $47 million in its entire run.5 For these big-budget action films, particularly those that are based on highly popular games or comic books, the economics will continue to be driven by international metrics—but, ironically, Wanda pulled Legendary out of its media subsidiary IPO at the last minute with the excuse that it wanted to give the company more time to demonstrate to investors that it could deliver meaningful and consistent profits. Not surprisingly, Tull departed from the company the next year. While Warner Bros. has jealously guarded its Harry Potter franchise, not permitting co-financiers access, it has been the most forthright studio in sharing the financing burden and potential rewards on most of its tentpole films. Warner Bros., in my opinion, has been the savviest studio in terms of cultivating outside investment in general. It has always been the leader in bringing on board the so-called satellite production companies—well-capitalized producers that can feed Warner Bros.’ distribution pipeline with their own productions which they are in a position to partially or fully finance. Thus, they relieve Warner Bros. of the obligation of fully funding these films while at the same time enabling Warner Bros. to earn distribution fees on a limited-risk basis (i.e., by only having to take P&A risk) or on a non-risk basis (i.e., if the satellite company is willing to guarantee the P&A, which Warner Bros. cash flows). Some of the satellite companies that Warner Bros. has nurtured include New Regency (now in partnership with Fox because News Corp, Fox’s parent, was prepared to make a substantial investment in New Regency when Warner Bros. demurred), and Alcon (which remains in a quasi-exclusive distribution arrangement with Warner Bros.). Warner Bros. recognized early on that these kinds of relationships do not have to be zero-sum games. If the satellite company prospers, the studio benefits by having access to a greater distribution pipeline, from which it can earn a greater quantum of distribution fees. Warner Bros. was probably the first studio that shifted its strategy from a broad mix of various genres and budgets to an emphasis on tentpole films that, if successful, could morph into a franchise, churning out successful sequel after sequel. Warner Bros.’ management was shrewd to recognize that a successful tentpole strategy would deliver significantly higher profit margins than the hodgepodge strategy of simply greenlighting films on a case-by-case basis, hoping that the creative executives are in tune with the public’s variable taste. The only problem with this strategy is that it requires a great deal of capital since those tentpole films cost a lot of money to produce. They are tentpole films precisely because they have enormous production costs: they feature big action scenes, are heavy on special effects, and often feature the most expensive talent. One way to augment this strategy and not break the bank is to reduce the annual production slate. But Warner Bros.

38  Macroeconomic Trends and Studio Co-Financing

wanted to have its cake and eat it too. Not only did it not want to reduce its annual production slate, but the studio also wanted to increase the same relative to its competitors because it realized that its distribution operations, both domestically and abroad, could handle a greater annual throughput than its inhouse production people could deliver. There was another reason that Warner Bros. revved up its production: the DVD market. The DVD market took off in the late 1990s and in less than 10 years domestic DVD revenues even outstripped what the studios could generate out of domestic box office, except for theatrical blockbusters. In addition, the studios have to share each dollar at the box office with exhibitors—with the exhibitors, on average, keeping roughly 50 cents of each dollar. The retention rate for the studios on DVD sales was much higher and, even more important, box office’s contribution to the bottom line was continually being eroded as the cost of marketing rose at a breakneck pace. In the last few years, the number of studio-released films that fully recouped their P&A out of box office alone could be counted on the fingers of one hand—maybe two or three hands, but that’s still no more than around 10% of total studio releases in a given year. Warren Lieberfarb, the Warner Bros. executive who ran the home video division for many years, had the prescience to champion the new technology at its inception, and the business got to the point where you could argue that the theatrical marketing spend on a film was as much designed to promote DVD sales as it was to drive the public into the theaters. As I indicated earlier, profit margins in the movie business tend to expand or contract largely as a function of where you are in the technology cycle. When Warner Bros. adopted this emphasis on a tentpole strategy, we were in an upswing in the cycle thanks to the burgeoning DVD market. Warner Bros. wanted more throughput, not less—so it sought out potential satellite companies who had the creative chops to deliver high-caliber films to feed the Warner Bros. pipeline as well as having the capital resources to fund all, or a significant portion, of their budgets. Warner Bros.’ tentpole strategy has survived the decline in DVD revenues, largely as a result of the strong growth in international box office, which is particularly receptive to big special effects–driven films. Fifteen years ago, international probably represented 30% of worldwide box office and domestic 70%, while today it’s probably closer to 70/30 in favor of international.6 All of these percentages, of course, are pre-COVID. Warner Bros. helped these satellite production companies gear up their output by opening up its own development coffers to supply them with attractive commercial scripts that these companies could finance and produce but that would automatically be distributed by Warner Bros. in all media—at a minimum in the United States and Canada. Sometimes, particularly if the budget was high enough, the satellite company would choose to presell the film outside of North America because it could bank those presale contracts and thereby

Macroeconomic Trends and Studio Co-Financing

39

minimize the percentage of budget it was required to fund. On one hand, Warner Bros. typically didn’t participate in the profits of those films (or only marginally), but on the other hand, it didn’t bear any of the production risk, and if it had to put up the P&A, it got to recoup it before the satellite company recovered one dime of its production spend (unless Warner Bros. was prepared to carve out some gross corridor for the satellite company, which would ensure some recoupment for the satellite irrespective of box office performance). Warner Bros. was also proactive in providing partial financing on many of those satellite projects if the budgets were too steep for the satellite company to finance on its own. But Warner Bros. was not being overly charitable here. When it contributed to the production funding on satellite company projects, it frequently insisted on a preferred recoupment position after higher distribution fees and, invariably, an appropriate piece of the back end.

Notes 1 According to author experience. 2 Pressberg, Matt. “Paramount Inks Slate Financing, Strategic Partnership With China’s Shanghai Film Group and Huahua Media,” The Wrap, 19 Jan. 2017, www. thewrap.com/paramount-inks-slate-f inancing-strategic-partnership-chinasshanghai-film-huahua-media/. 3 Fritz, Ben and Burkitt, Laurie. “China’s Dalian Wanda Buys Legendary Entertainment for $3.5 Billion,” Wall Street Journal, 12 Jan. 2016, www.wsj.com/articles/ chinas-dalian-wanda-buys-legendary-entertainment-for-3-5-billion-1452567251. 4 Ingram, Mathew. “This Chinese Billionaire Has His Sights Set on Buying Hollywood,” Fortune, 4 Nov. 2016, http://fortune.com/2016/11/04/china-billionairehollywood/. 5 “China’s Love Affair with Online Game World of Warcraft,” BBC, 5 May 2016, www. bbc.com/news/world-asia-china-36209913; “Warcraft (2016),” Box Office Mojo, www.boxofficemojo.com/movies/?page=intl&country=CH&id=warcraft.htm. 6 Brooke, Tom. “How the Global Box Office Is Changing Hollywood,” BBC, 21 Oct. 2014, www.bbc.com/culture/story/20130620-is-china-hollywoods-future; Goldsberry, Kirk. “All the World’s a Stage: How International Box Office Is Changing the American Blockbuster Economy,” Grantland, 25 Apr. 2014, http://grantland.com/ hollywood-prospectus/all-the-worlds-a-stage-how-international-box-office-ischanging-the-american-blockbuster-economy/; Levine, Sydney. “MPAA Report on the Growth of the Global Box Office,” Indie Wire, 31 Mar. 2014, www.indiewire.com/2014/03/mpaa-report-on-the-growth-of-the-global-box-office-168810/.

3 TAX AND OTHER “SOFT MONEY” BENEFITS AND LIMITED PARTNERSHIPS

Summary—The chapter discusses the strategies that the studios have used to supplement their investment in a slate and reduce their cost of capital—in particular, various tax shelters, and other incentive structures, employed in the United States, the UK, Canada and now in many US states. Finally, the chapter focuses on limited partnership offerings, particularly Disney’s Silver Screen Partners and offers a critique of why the odds were stacked against the individual investors who participated in those offerings. The satellite production companies linked to specific studios and the special purpose entities set up for the studio’s slate deals are not the only sources of outside production financing for the major studios. All of the studios have aggressively pursued the so-called soft money benefits, either in the form of cash rebates, transferable tax credits or tax-incentivized structures like the UK sale and leaseback, which was replaced several years ago by a cash rebate program. Tax deals spoiled the studios because they typically carried a low, or even negative cost of capital. In effect, governments subsidized these programs by giving investors tax write-offs, which—assuming there were no applicable “at risk” rules in effect—permitted investors to pass on a portion of their tax benefits in the form of a low cost of capital to the studios. Probably, the most egregious tax shelter was the old US leveraged non-recourse deal, which permitted investors to take advantage of the federal Investment Tax Credit (ITC) on a leveraged basis. Investors could put down as little as 15–20% of the purchase price of a film (i.e., the value of the ITC) and borrow the remainder on a non-recourse (i.e., the investors were not personally liable for the loan) basis from the studio. The government eventually quashed these deals by first imposing “at risk” rules whereby investors could not claim write-offs if they could not show they were actually at risk if the underlying film assets did not perform. The final DOI: 10.4324/9781003153702-4

Soft Money Benefits  41

nail in the coffin was driven by the Tax Reform Act of 1986, which eliminated the ITC and barred investors from offsetting losses against non-passive income. The studios were spoiled by these tax shelters, which often represented a negative cost of capital; that is, rather than being able to borrow at a lower cost of capital than they could through their banks or parent companies, the studios actually received a net benefit that effectively reduced their cost of production. The amount of the benefit was a function of the parameters of the specific tax shelter, the key parameters being the quantum and timing of the write-offs available to investors, the investors’ marginal tax rates, investor hurdle rates and overall level of interest rates. If the studios had maintained fiscal discipline, such tax shelters would have enhanced profit margins—but not surprisingly, the studios often relaxed their fiscal discipline by greenlighting more films, at higher budgets and with greater profit participations to talent in response to the tax shelter largesse. Many tax shelters carried with them a variable cost of capital given that they included profit participations to investors. But it was frequently the case that these profit participations were more theoretical than real. They were often driven by tax regulations in the specific venue that required some form of profit motive—that is, investors had to demonstrate they were entering into the tax shelters with the expectation that if the films performed, they would actually earn a cash-on-cash profit on the deal. The key word here was “possibly,” not “likely” or even “reasonably.” The revenue allocation among the various parties, which is called the “waterfall” in industry parlance, could be structured in such a way—utilizing high distribution fees, high overhead allocations, etc.—that the films would have to be virtual blockbusters in order for profit participations to be paid. Investors in tax shelters would have to be satisfied with the base after-tax returns they got up front, without any benefit from profit participations down the road. The ultimate tax shelter, as opposed to rebates or transferable tax credits, in my opinion was the UK sale and leaseback. Not only did it not carry with it any profit participation, however ephemeral, but it also permitted US studios to “double dip” on the benefits. What do I mean by “double dipping”? Under the sale and leaseback structure, the producer would sell the film (i.e., the copyright and accompanying distribution rights) to a UK lessor—either a corporation or a partnership of individual investors. Technically, what was conveyed was the master negative, which is largely a legal fiction. I have on the wall of my office a plaque indicating that the group of lessors who entered into a sale and leaseback on the James Bond film Never Say Never Again took possession of an empty beer can evidencing constructive delivery of the master negative. The lessor would then lease the distribution rights back to the producer, and there would be an agreed mechanism for the producer to reacquire copyright after a certain number of years for a specified amount. A little aside here: my company was finalizing a sale and leaseback deal on Paul McCartney’s film Give My Regards to Broad

42  Soft Money Benefits

Street, when McCartney’s lawyer and brother-in-law, John Eastman, brought him to the closing as a courtesy. John explained to Paul the key terms of the deal and mentioned that Paul would have to transfer his copyright for a few years to the lessor, but he would automatically get it back. Paul was outraged: “I will never give up my copyrights,” he said. I should have remembered his terrible experience when the Beatles, against their better judgment, sold their music publishing company, Northern Songs, to Associated Television. Eastman never even got a chance to explain to Paul that ownership of “naked copyright” is more about having the right to produce derivative works—remakes, sequels and television spin-offs—while the ability to exploit a film is more about controlling the distribution rights. The lessor was prepared to enter into such leases because the lease payments made by the producer, which were typically over a 15–20-year period, were sufficient to generate an attractive after-tax rate of return to the lessor. Under the UK tax code, if a film was a qualified UK production (there was a set of objective rules determining this), the lessor could write off 100% of the purchase price in the year of acquisition. Given 100% first year allowances, the lessor could charge a lower imbedded interest rate on the lease payments than could be earned on deposits (we were in a much higher interest rate environment then). So, producers could “defease” these transactions (i.e., they could take a certain percentage of the purchase price and put it on deposit to make the lease payments over time and pocket the difference). How much of the purchase price would have to be defeased was a function of the key parameters mentioned earlier (i.e., marginal tax rates, interest rates and what after-tax rate of return investors required). Independent producers had to enter into defeased transactions because they were not sufficiently creditworthy to enter into 15–20-year lease commitments on their own, but the studios (or at least those with good credit ratings) could opt to either defease a transaction or effectively assume a low interest rate obligation over the life of the lease. The “double dipping” aspect of the deal refers to the fact that both the studio and the UK lessor amortized the same asset. They were able to do this because they were operating in different venues: the studio offset depreciation of the negative against its US tax bill and the lessor applied the capital allowances against its UK tax bill. The studio was able to justify this because it took a “substance over form” approach to the transaction. That is, while on paper the studio sold the asset to a UK investor, because it licensed back the distribution rights, it took the position that it was really a loan rather than a bona fide sale. Thus, the studio retained as its basis for the leased film its original cost less the up-front benefit of the lease transaction (if it defeased it), which it then amortized on the traditional income forecast basis mandated by Generally Accepted Accounting Principles (more about such accounting rules later). While the sale and leaseback structure has been nullified in the UK, there is another tax shelter structure that can be utilized for film finance. Enter the

Soft Money Benefits  43

Enterprise Investment Scheme (EIS), which was introduced in 1994 and which applies to unquoted companies carrying on a qualified trade in the UK. Companies formed to invest in feature films qualify under this structure. Under this structure, if a UK individual taxpayer invests £100 in an EIS company, he or she is entitled to claim tax relief equal to 30% of his or her share subscription. In addition, the investor can defer capital gains tax on other assets, when disposal of the asset is less than 12 months before the EIS investment or less than 36 months after it. Such relief is limited to the amount being invested in the EIS. Finally, if the investment in the EIS is successful, no capital gains tax is payable on disposal of EIS shares, provided such shares are not sold within 3 years of the investment. Some EIS deals I have seen are structured so that investors are effectively at risk only to the extent of their tax savings; other deals are straightforward equity punts, with obviously much greater upside, but the investor is at risk for his entire investment less his tax break. There is one major misconception about film EIS companies that I would like to clear up: many people believe that the EIS benefits are restricted to films produced in the UK. In fact, the criterion for qualifying under the EIS rubric is that the EIS company be domiciled and managed in the UK. Any films that an EIS company produces and finances can be shot anywhere. There is a variation on the EIS structure that offers even greater tax benefits: the Seed Enterprise Investment Scheme (SEIS), which was launched by the UK government in 2012 in order to encourage investors to finance start-ups. The SEIS structure is particularly suited to investment in film development because it is limited to a £150,000 capitalization per each SEIS company (the cap on EIS companies is £5 million).1 In the case of SEIS companies, investors can obtain 50% relief for income tax on the cost of shares, on a maximum annual investment of £100,000. If an investor sells his shares any time after 3 years at a price above his basis (i.e., 50% of his initial investment), there is no capital gains tax to be paid. In addition, investors can claim exemption on up to half of capital gains owed in a given tax year (up to the SEIS limit of £100,000) provided this amount is reinvested in an SEIS company. One final benefit: if the SEIS company fails, the investor can claim loss relief equal to 50% of his investment times his marginal tax rate.2 “Soft money” benefits in the form of cash rebates were pioneered by the Canadians—both on the federal and the provincial level. These benefits are available based on eligible labor expenditure in Canada, and despite a relatively strong currency versus the US dollar until 2014 (the Canadian dollar has weakened by around 15% since then, which has further strengthened the country’s competitiveness), this has enabled Canada to attract a lot of production that otherwise would have remained in the United States. Hence, the term “runaway production.” To put these benefits in perspective, current rules authorize rebates on the federal level equal to 16% of eligible Canada labor expenditure (increasing to 25% in the case of the so-called qualified Canadian productions, which have to meet certain objective tests regarding Canadian creative

44  Soft Money Benefits

participation—writer, director, actors and key heads of departments as well as minimum percentages of production and post-production spend in Canada), and on the provincial level they can be as high as 50% of approved provincial labor expenditure, subject to certain caps regarding benefits as a percentage of total production costs.3 Ontario has taken advantage of the very weak Canadian dollar to cut its film tax credit from 25% to 21.5%.4 Given the cutthroat competition among all the Canadian provinces, we will see how much future production Ontario will lose. These benefits have nurtured the Canadian film industry, which has built up an extensive crew base to service film and television productions. Let’s face it: if your film takes place in an unnamed North American city, what’s the difference if you shoot it in Toronto or Chicago? The surge in production north of the border has even prompted a number of American producers, directors, actors and crew to pull up stakes and apply for “landed immigrant” status in Canada, which means they qualify under the Canadian spend requirement. The qualifying Canadian production test has been a bonanza for Canadian actors like Donald Sutherland. Needless to say, it hasn’t hurt the careers of certain Canadian directors either. US states have fought back over the last few years by introducing their own form of incentives: either direct cash rebates like the Canadians, or transferable tax credits, which, assuming the producer cannot use them, can be sold to tax-paying entities, typically corporations, in that state. The two most long-standing state programs are New Mexico, which offers a 25–30% fully refundable tax credit on qualified expenses (with additional bonuses if certain facilities are used or if rural locations are employed), and Louisiana, which offers transferable tax credits (25% base credit with additional bonuses), which used to be monetizable at a 10–15% discount with a corporate or individual taxpayer in Louisiana, typically oil and gas companies, but now the state itself repurchases the credits at 88 cents on the dollar.5 However, after a series of well-publicized frauds, where some producers submitted inflated expense reports, Louisiana withdrew such buy-back commitments for a 1-year period, but subsequently reinstated the program. It has also capped aggregate annual incentives at $180 million, which is well below what aggregate production in the state was in 2014.6 To give you some sense of the success of some incentive programs, film and television production in Louisiana totaled only $1.5 million in 2004, but after introduction of the tax credit program, it jumped to $231 million by 2012.7 Louisiana had been the leading destination for feature film production after California, but it has been greatly surpassed by Georgia, which introduced an aggressive incentive program of its own, which saw total incentives grow from $141 million in 2010 to $870 million in 2019. Some 60% of states now offer some form of incentive program.8 New York recently re-upped after running through $685 million in incentives, but Michigan, which had the most aggressive incentive program of any state—rebating

Soft Money Benefits  45

40% of qualifying production expenditures (42% if you were prepared to shoot in Detroit or other “core communities”) has wound down its rebate program given the sorry state of the Michigan economy.9 The argument for granting incentives, of course, is they generate local jobs and more than pay for themselves in terms of an economic multiplier effect: for every dollar of rebate, the state economy benefits by a multiplier effect of that dollar in terms of local expenditure that otherwise would not have come there. I should point out that a number of prominent economists have challenged the claim that these rebate programs more than pay for themselves.10 As a result, North Carolina rescinded its rebate program, and I understand several other states are reviewing their incentives. The success of the various state incentives has even led California to enter the game, after affirming for years that the facilities, crews and talent base in California were so superior to what was available elsewhere that the state did not have to compete by offering “soft money” incentives. Accordingly, California introduced a transferable tax credit (transferable in the case of independent production companies) that was set at a base 20% of qualifying expenditure. However, the aggregate amount of tax credits was initially capped at $160 million on an annual basis, which is not all that exciting given that producers have to enter a queue with no guarantee they would qualify for the largesse.11 In September, 2014, however, Governor Jerry Brown signed an increase in the annual allocation to $330 million and replaced the lottery system with a merit-assessment scheme. The $330 million annual commitment has since been extended to 2025. Interestingly, the new bill also favored television production over feature films in terms of allocations. In particular, $44 million is set aside (going up to $66 million in fiscal 2016) for television shows that have been shooting in other venues and move to California. Also, in order to show that the legislature is not entirely in Hollywood’s pocket, an additional deduction of 5% was made available for productions not shooting in Southern California.12 Congress recently reinstated retroactively Section 181 of the Tax Code, which permits a 100% write-off for the first $15 million of the cost of producing a film in the United States if the film commenced principal photography before the end of 2014.13 The Section now extends through the 2025 tax year. One of the first questions I am asked—or should be asked—by a wealthy prospective investor, either individual or institutional, is whether you should consider co-investing alongside a studio or independent production company (i.e., the passive investment approach) or whether you should adopt a more “hands on” approach by setting up your own production company. Before I answer that question, it is worth examining the pitfalls of the passive investment approach by reviewing how the studios roped in retail investors in the 1980s. The most successful limited partnership in terms of dollars raised was Silver Screen Partners, which was marketed by E.F. Hutton. The first partnership was established in 1983 to finance films produced by HBO and was followed by

46  Soft Money Benefits

three further partnerships in 1985, 1987 and 1988 to finance films produced by the Walt Disney Company.14 Silver Screen II and III did reasonably well, each generating a ROI in excess of 10%.15 But Silver Screen IV became a disaster when Disney decided to take advantage of the increased capital resources Silver Screen Partners represented to dramatically increase its annual production output. The excuse proffered for not doing a Silver Screen V was ostensibly the Tax Reform Act of 1986, which barred offsetting losses from business activity in which a taxpayer did not materially participate (“passive losses”) against other taxable income, including salaries, active business income and portfolio income. But the Tax Reform Act of 1986 applied equally to Silver Screen III and IV. No, the real reason was Disney’s strategic decision to invest in a series of lower-budget films that departed from the traditional Disney model of family entertainment. Since the investors in Silver Screen IV fully financed those films, enabling Disney to earn significant distribution fees without having to take production risk, it was a traditional win/lose Hollywood scenario: the studio wins irrespective of whether the investors lose, and they lost big. Look at the disappointing domestic box office results of Disney films in Silver Screen IV that were released in 1990–91, and you will get a sense of the magnitude of that loss (Table 3.1). Remember, however, that a big marketing ploy on the Silver Screen Partners was a Revenue Shortfall Payment clause, which provided that if the revenues on any film in the portfolio did not equal 100% of production cost, Disney would make up the difference out of the distribution fees it earned on the film—but only to the extent of aggregate distribution fees earned. Thus, investors effectively provided Disney with an interest-free loan for more than 5 years (because the determination date was 5 years after the theatrical release of the films, as opposed to when the partnership cash-flowed production). It should be noted that even under those circumstances the investors would not have fully recouped their principal because the Revenue Shortfall Payment did not take into account selling commissions and expenses of the offering (which represented 10.4% of the price to the public).16 In my opinion, the real disconnect in the Silver Screen structure was how much investors had to compensate Disney in the form of higher-thanappropriate distribution fees in exchange for having the Revenue Shortfall Payment backstop. Notwithstanding the fact that the investors funded 100% of production costs, subject to certain cost overrun obligations on Disney’s part, Disney charged the distribution fees shown in Table 3.2. These fees were well above market, even taking into account the benefit of the Revenue Shortfall Payment. One-off deals where the studio has P&A risk only would typically command average fees on the order of 17.5% (with video on a gross rather than a royalty basis—we will compare the two video computation formulas later), and recent studio slate deals, where the special purpose investment vehicles typically funded 50% of production costs, with the studio

Soft Money Benefits  47 TABLE 3.1 Disney Films Released in 1990–91

Title

$ millions

V.I. Warshawski, Detective in High Heels The Doctor The Rocketeer Deceived Blame It on the Bellboy One Good Cop Wild Hearts Can’t Be Broken Oscar The Marrying Man Scenes from a Mall Run White Fang Three Men and a Little Lady The Rescuers Down Under Mr. Destiny Taking Care of Business Betsy’s Wedding

11.1 38.1 46.7 28.7 3.1 11.3 7.3 23.6 12.5 9.6 4.4 34.8 71.6 27.9 15.4 20.0 19.7

Source: All data found on specific film pages at Box Office Mojo, www.boxofficemojo.com.

funding the other 50% and P&A, had overall fees as low as 10% or less, which still did not help many of the equity investors in those deals. By the way, Disney also was entitled to 25% of profits in addition to those distribution fees—plus, there was a lot of “vig” in the budgets for both Disney and the managing partner, Silver Screen Management, Inc. (whose board of directors included George W. Bush—yes that George W. Bush).17 Each budget had a 17.5% overhead on the budgeted film cost, which was allocated 13.5% to Disney and 4% to the managing partner, and an additional development fee, above and beyond the development costs incurred by Disney on that film, of $500,000.18 It is truly amazing that investors in Silver Screen ever saw any positive returns—it is a tribute to the inherent profitability of the classic Disney family film model. Each Silver Screen partnership funded all of Disney’s films sequentially until it ran out of money. Nothing says, of course, that even a passive investment approach has to entail taking all of the producer’s output over a given span of time. The studios, particularly Warner Bros., have been amenable to allowing co-financiers to actually select which studio films they wish to co-finance apart from sequels and animated films, which are typically excluded, subject to a pre-negotiated set of terms. Ironically, there are several instances where investors have taken films they did not have much belief in to obtain positions in films that they expected to be blockbusters, when it was the unheralded film

48  Soft Money Benefits TABLE 3.2 Disney’s Distribution Fees on Silver Screen Partner’s Films

Revenue Stream

Disney’s Distribution Fees

Theatrical (in the United States and Canada and in foreign territories where Disney distributed directly) Home video

Initially 75%, ratcheting down to 50% (after aggregate revenues in excess of $25 million) To investors, royalty of 20% of the wholesale price if retail price is $39.95 or less, to a ceiling of 25% if retail price is $79.95 or more 30% 35% 20%, escalating to 25% 20%, escalating to 25%

US network television US syndication US cable/pay-per-view Foreign free television (including Canada) Foreign non-standard television (cable/ pay-per-view) (including Canada)

20%

that turned out to be the “sleeper” hit. As William Goldman is fond of saying, when it comes to the movie business “nobody knows anything.”19 What you should try to avoid, of course, is to let the studio cherry-pick for you (i.e., by excluding certain films, typically franchises, as an investor option). I represented a strategic investor—a European distributor that was interested in co-financing a portfolio of studio films if it could obtain distribution rights to those films in its territory. We were rebuffed by all the studios because our approach was made during the heyday of hedge funds’ infatuation with Hollywood. Since hedge funds were purely financial investors (they were simply interested in overall returns, as opposed to also furthering any other business interests), studios could obtain ample capital for their slates without having to relinquish any distribution rights. The Weinstein Company expressed interest in our proposal, but midway during the negotiations it revealed that the films produced by its Dimension division, which specialized in genre films, would be excluded from the deal. Remember what I said about getting cherry-picked. The problem with that was it had already given us historical performance numbers on the company’s films, and a cursory look at those numbers clearly revealed that the Dimension division was significantly more profitable than the arty fare that the company primarily was known for. It wasn’t surprising, therefore that the Weinstein brothers would try to take the Dimension films off the table. Needless to say, my clients passed. In hindsight, given the fairly well-publicized financial problems The Weinstein Company later experienced, Harvey and Bob probably regret not having taken our offer. The Weinsteins did actually raise a fund to finance Asian films, which The Weinstein Company would produce and distribute, but that was small potatoes given their overall

Soft Money Benefits

49

capital requirements. In fact, only one film was produced under the Asian fund and it did not even command a US theatrical release.

Notes 1 HM Revenue and Customs, “Guidance Enterprise Investment Scheme,” 7 Oct. 2013, www.gov.uk/government/publications/the-enterprise-investment-schemeintroduction/enterprise-investment-scheme. 2 HM Revenue and Customs, “Seed Enterprise Investment Scheme,” 22 Oct. 2013, www.gov.uk/guidance/seed-enterprise-investment-scheme-background. 3 “Canadian Content Tax Credits,” Canada Film Capital, www.canadafilmcapital. com/TaxMapCC.aspx. 4 Ibid. 5 Tannewald, Robert. “State Film Subsidies: Not Much Bang for Too Many Bucks,” Center on Budget and Policy, 9 Dec. 2010, www.cbpp.org/research/state-film-subsidiesnot-much-bang-for-too-many-bucks; “Tax Credit FAQ,” New Mexico Film Office, www.nmfilm.com/Incentive_Frequently_Asked_Questions.aspx. 6 “Motion Picture Investor Tax Credit,” Louisiana Entertainment, http://louisianaentertainment.gov/film/motion-picture-investor-tax-credit. 7 Longwell, Todd. “The Biz’s Taxing Situation,” Variety, 5 Oct. 2012. 8 Sandberg, Bryn Elise. “Film and TV Tax Incentives: A State-by-State Guide,” Hollywood Reporter, 21 Apr. 2016, www.hollywoodreporter.com/news/film-tv-taxincentives-a-885699. 9 Ibid. 10 Povich, Elaine S. “Some States Yell ‘Cut!’ on Film Tax Credits,” The Huffington Post, 18 May 2015, www.huffingtonpost.com/2015/05/18/states-film-taxcredits_n_7306342.html; Verrier, “Are Film Tax Credits Cost Effective?”. 11 “California Film & Television Tax Credit Program 2.0,” California Film Commission, Feb. 2016, www.film.ca.gov/res/docs/pdf/Incentives%20Documents/CFCGuidelines%202%200%20January%20%20Revised%20Feb%201%202016.pdf. 12 Patton, Dominic. “Hooray for Hollywood! Gov. Brown Signs Film & TV Tax Credit Bill Extension,” Deadline Hollywood, 18 Sept. 2014, http://deadline.com/2014/09/ california-film-tv-tax-credit-bill-signed-jerry-brown-hollywood-836075/. 13 Macaulay, Scott. “Section 181, Film Production Tax Incentive, Reinstated (and Retroactive!) in 2016 Spending Bill,” Film Maker Magazine, 19 Dec. 2015, http:// f ilmmakermagazine.com/96723-section-181-f ilm-production-tax-incentivereinstated-and-retroactive-in-2016-spending-bill/. 14 “E. F. Hutton Raised $300 Million for Disney,” Los Angeles Times, 3 Feb. 1987, http://articles.latimes.com/1987-02-03/business/fi-796_1_e-f-hutton. 15 Fabrikant, Geraldine. “Market Place; Silver Screen’s Tie with Disney,” New York Times, 11 Sept. 1990, www.nytimes.com/1990/09/11/business/market-place-silverscreens-tie-with-disney.html?src=pm. 16 “Silver Screen Partners Prospectus,” Edgar Online, http://sec.edgar-online.com/ silver-screen-partners-iv-l-p/10-k-annual-report/1998/03/31/section2.aspx. 17 “Bush Has a Tie to Media ‘Depravity’,” Los Angeles Times, 15 Sept. 2000, http:// articles.latimes.com/2000/sep/15/news/mn-21553. 18 “Silver Screen Partners Prospectus.” 19 Goldman, William. Adventures in the Screen Trade: A Personal View of Hollywood and Screenwriting (Reissue ed.). New York: Grand Central Publishing, 1989.

4 WELCOME TO THE WORLD OF INDEPENDENTS

Summary—The chapter introduces the notion of an independent film and the benefits and disadvantages of adopting a selective approach to film investing as opposed to a portfolio approach via a slate transaction encompassing a number of films. The chapter focuses on what strategies an independent production company has to implement to be competitive and optimize returns. A case study of an independently financed film Wing Commander is presented. You can be a selective investor in films without ever setting foot in a studio. The independent film world is constantly starved of capital, and unless you are on the Forbes 400 list or just below it, you probably don’t have sufficient throwaway capital to play in the studio space. Today, it would be difficult to even scare up a meeting with a major studio unless you were prepared to write an equity check for at least $250 million. Most of the entities that co-finance with the studios on a regular basis are either corporations like Village Roadshow, or large hedge fund- and private equity-backed funds like Legendary. There are exceptions. The late Steve Bing, heir to a large family fortune, put up 50% of the budget on the Warner Bros. film The Polar Express, which was reputed to be $150 million. Independent production companies tend to produce films that range from budgets of a few hundred thousand dollars up to several tens of millions of dollars. I would distinguish true independent productions from what I call “studio lite,” which are clearly commercial films designed for broad national releases but that carry lower budgets than traditional studio in-house productions. “Studio lite” films are produced and financed by well-capitalized independents, typically the satellite production companies I referred to earlier that run their films through their studio output deals or through the so-called mini-majors (smaller integrated production and distribution companies). These companies, DOI: 10.4324/9781003153702-5

Welcome to the World of Independents  51

which include Lionsgate, Relativity pre-bankruptcy and The Weinstein Company, also pre-bankruptcy, not only function as theatrical distributors, but also they may or may not handle their own ancillary distribution—primarily home video and television. Satellites and mini-majors have substantial capital resources; but, of course, they are dwarfed by the resources studios can bring to bear. At least they don’t have to go out hat in hand every time they want to greenlight a film. True independent productions are put together by entrepreneurial producers who must cobble together the necessary funds for each picture by utilizing a combination of equity, debt and tax credits. I have the highest regard for independent producers because I know how hard their job is. Assembling the necessary financing is often as much or more work than actually producing the film. Every year I started my class at Peter Stark, which is the premier producing program among the nation’s film schools, discouraging my students from embarking on a producing career, unless (a) their parents are worth at least $500 million, (b) they have been the head of a studio or (c) they’re partnered with Tom Cruise and I said I wasn’t sure about (b) or (c). I am not being totally facetious: making it as a producer is an incredibly tough challenge. However, it must be said that there are a number of success stories that did not meet any of my criteria. By the way, I have had at least two students in my 16 years of teaching who did qualify under (a). I must say that many of the independent production companies are run by savvy business types who know how to cobble together creative financing packages, but that doesn’t mean they are competent creative producers in the classical sense. Because power has shifted over the years from dominant producers to auteur directors, I have seen too many examples of films that have suffered from the feckless guidance of producers who have resisted for whatever reason, probably as a result of a lack of confidence, from critiquing the creative vision of the director. Despite the myth of the egomaniacal instincts of the modern-day director, I can cite many examples of directors who would have appreciated more creative input from their producers. Being the sole arbiter of the creative vision of a film can be a heavy burden, and a savvy producer can certainly rein in a director’s misguided creative take. But if your producer has no credibility on that score, what can a director do? Where is David O. Selznick when we need him? David O. Selznick, of course, would not have waited to be asked. His films were as much a product of his imagination as the director’s—probably more so—and Selznick wasn’t the ultimate controller of the purse strings, so there is no excuse for the heads of the independent production companies who are financing a film to relegate their responsibility to oversee the director if they think he or she is going off kilter. With the studios increasingly reliant on outside capital to fund their slates, it is not surprising that Hollywood will seize every opportunity to genuflect before its benefactors, whether they are billionaires in their own right or have managed to cobble together sizable institutional funding. The praises bestowed

52  Welcome to the World of Independents

are so cloying that you don’t know whether to laugh or to cry. When a studio head is quoted as saying “On a creative level, we certainly have come to rely on so-and-so” and one of the top Hollywood producers added “so-and-so had really good story ideas,” translate that to mean “hey, the guy funded a quarter of our budget.” I am more in tune with Joe Roth, a consummate Hollywood insider, and a producer, director and former head of multiple studios. Joe basically dismissed most of these financiers as having too much ego and not enough skill to anticipate the zeitgeist. “They always come up with what they think is the right thing and it’s the wrong thing,” he said. “It’s yesterday’s news. They’re behind the audience.”1 Typically, investors choose a selective investment strategy either because they do not wish to commit sufficient equity resources to fund a slate transaction or an ongoing production company and/or they do not want to devote the time and energy such an ongoing production company requires. Another way to put it: setting up your own production company is equivalent to establishing a new business. Selective film investment, on a passive basis (i.e., investing in projects that other producers control), can remain a hobby. If you ask me, however, which strategy has the better chance of success, I would unequivocally opt for establishing your own production company, assuming you have the capital resources to do so. But as I indicated earlier, don’t think that because you are bankrolling the company, you either don’t have the ultimate responsibility for the creative vision of your films, or you can get along without a strong creative executive to help you run the show. The former mistake is pure naiveté, the latter pure hubris. If you adopt a selective investment strategy on a passive basis, you typically find yourself playing in the minor leagues; that is, you wind up financing smaller independent features, the vast majority of which never command theatrical releases or at best, limited theatrical releases. Without the potential upside the box office represents, I described this strategy in my Stark class as building a hotel where you need 98% capacity to break even. It’s possible—but why bother? Of course, the producer who enticed the financial investor to fund his picture can come up with doctored historical examples of low-budget films that generated stupendous returns for their financiers, but these represent an incredibly small sample of lower-budget films that somehow got theatrically released and did meaningful business. I would be surprised (although I don’t have statistics readily at hand) if more than 2% of films costing less than $5 million did as much as $5 million in United States and Canada box office. Hence, my hotel analogy. If I were a total cynic, I would also point out that a producer’s job is to cause as many of his or her projects to be made as possible— because he or she earns producer fees in the budget. Of course, if the producer loses too much money for the investors, he or she will probably have to find new investors. I know several glib producers who seem to have an unending stream of new investors, because they continually burn their existing partners.

Welcome to the World of Independents  53

They can always point to the one or two films they produced, sometimes in the primordial past, that worked out very well for their investors. They seem to be able to live off these past glories without having to own up to a string of more recent flops. One of my former clients did dabble in film investment on a selective basis over the years, but as a passive investor, and he did reasonably well at it. He had hits and misses, but the occasional hit more than made up for the misses. When he retired from his primary business, he decided he wanted to be much more involved in financing movies. Recognizing that being a selective investor meant relying on producers to bring him attractive projects, he chose to form his own production company, which enabled him to develop projects in-house as well as giving him greater visibility in the industry, which he hoped would result in a greater flow of credible projects. The venture was a total fiasco. He lost an enormous amount of money (although he persevered in the business and his more recent experience has been more satisfactory). This example notwithstanding, I continue to believe that forming your own production company is the way to go if capital is not an issue. The reason is CONTROL. If you are either a slate investor or passive investor in other producers’ projects, you are effectively relying on a studio or producer partners to deliver commercial films at a price. You may or may not have control over what films you invest in—in a slate deal you probably wouldn’t; when you fund independent or studio films on a selective basis, you would— but there is a lot more to the concept of control than simply picking projects. If I had a dollar for every independent film company business plan I have read that purports to be able to save a significant percentage of budget versus what studios would spend to produce the same film, I would be a very rich man. But it goes without saying that independents have to be more cost efficient than the studios, because they have to compensate for the distribution fees they pay the studio to release their pictures. If, ex hypothesi, the studios on average achieve a single-digit ROI on newly released in-house films (let’s be generous and assume low double-digit returns), and we assume that independent production companies pay on average 15% distribution fees across the board, then you do not have to be a mathematical genius to conclude that independents are hard-pressed to achieve positive returns unless they can either (a) be better film selectors than the studios (why should we believe this, particularly given the assumption that independents do not have the capital resources to participate in the big tentpole movie space, and it is precisely these large budget films that overperform for the studios) or (b) achieve significant cost savings vis-à-vis the studios. Of course, there are other factors at work as well. For example, independents frequently bifurcate domestic and international rights by preselling foreign, which permits them to mitigate risk and is also a risk-transference mechanism that enables the independent producer to shift a significant portion of production risk to foreign distributors (but this strategy also significantly reduces the producer’s upside on

54  Welcome to the World of Independents

successful films). It is controversial at best whether the independent producer is better off in the long run by adopting a split rights philosophy; remember, preselling is a financing tool as well as a risk mitigation/transference mechanism, and cash-strapped independents (even ones not so cash-strapped) may have no alternative. Whether the independent producer is better or worse off over a meaningful portfolio of films, it is true that preselling foreign rights should reduce losses on unsuccessful films and thus enable the independent to get up to the plate more times, utilizing the same amount of capital. The movie business, as I have stressed, is about achieving the occasional hit, and, since you cannot predict which project will achieve breakout status, being able to stretch your capital over a larger portfolio of films certainly looks like a preferential strategy. At a minimum, you want to be able to fully control your budgets. Optimally, you want to have approval rights on a line-item basis over P&A expenditure as well. This optimal strategy is easier said than done given the trade-offs between budgetary expenditure and production values. Films are not widgets on a production line. The same film can be made for various budgetary numbers, but it will not necessarily look the same nor will it have the same commercial prospects. This is why producers want to avoid having to call on the completion guarantor when the film goes over budget: the completion guarantor will spend the minimum amount necessary to complete and deliver the film based on the approved script. In the movie business, like most other businesses, you get what you pay for. This is particularly true in the area of special effects. A producer must carefully weigh on a cost/benefit analysis basis the various bids solicited from the special effects houses. Price must be weighed against quality of product. There is a good reason that Industrial Light and Magic—George Lucas’s effects company—gets a significant share of the business on big-budget studio pictures, even though it is probably the most expensive house in town. It delivers on a consistent basis special effects shots with high production values. I put together the financing on a sci-fi film, Wing Commander, some 15 years ago. The film cost in the low 20s, and it was probably one of the most complicated independent financings I have ever done, not least because the equity component in the capital structure was quite small. The overall financing structure included two different tax shelters, including one from a country that shall remain nameless and that had absolutely no involvement in the production—no money was spent there nor did any of its nationals work on the film. We had a reasonable level of foreign presales because the film was based on a best-selling video game and we supplemented those presales with a “gap” component (i.e., an unsecured loan against the estimated value of unsold territories). Finally, to close the circle, I negotiated an advance from Twentieth Century Fox against domestic rights only. The advance was a relatively puny 15% of budget, but that sum enabled me to complete the financing, so I took it—grudgingly. The budget was very tight. The easiest place to skimp was in the special effects category. There were approximately 300 special effects shots, a large

Welcome to the World of Independents  55

portion of which were handled by associates of the director. However, a certain number were farmed out to independent houses, and budgetary pressures made us sacrifice quality in exchange for lower cost. You get what you pay for. Special effects shots are generated after principal photography is completed and, if they are not up to snuff, you have two choices—live with them or bring in another shop. Unfortunately, we did not have sufficient contingency remaining in the budget to redo the faulty shots, and Fox refused to pony up more money. So, the director fudged a bit by limiting the presence of the alien soldiers, who looked more like amorphous blobs. Audiences even then expected special effects–driven films to have stellar production values. Bad word of mouth regarding some of the computer-generated imagery (CGI) certainly hurt us at the box office. I faced a similar dilemma several years later when I financed a supernatural thriller that was focused primarily on the ghost of an abusive husband who is pursuing his wife from the grave and required a fair amount of CGI. The original ghost images looked more like a man wearing a clown suit and the producers had to hire another special effects house to rectify the situation, but the result was only a slight improvement. Not surprisingly, this film—for which the producers and the equity investors (the fund I co-managed was a mezzanine lender—i.e., it took the risk between the banks in first position and the equity investors in last position) had high hopes in terms of being able to command a meaningful theatrical release—went straight to video. My fund recouped, but the equity investors were totally wiped out. When Fox informed us that it did not intend to theatrically release Wing Commander (the problem with taking such a low minimum guarantee relative to the budget is that distributors are not motivated to roll the dice on a meaningful theatrical release unless they really believe in the picture), Fox made it clear that it was going to bury the film. I forgot to mention that the studio had another sci-fi film slated for release that summer—the first in the new Star Wars trilogy—and it didn’t want to spend significant marketing dollars on a competitive film in the same genre. The producers and I fought back, enlisting our powerful lawyer to put pressure on Fox. The tactic worked, and Fox gave us a “get out of jail free” card, whereby we could buy it out, at a premium of course, if we could find another distributor to theatrically release the film. Enter Columbia Pictures, which had originally competed with Fox for the domestic distribution rights but had lost because it insisted on retaining certain non–United States rights as well, and our financing structure was predicated on our ability to presell foreign. Columbia indicated it would put up a minimum guarantee that would enable us to repay Fox with the required premium. I was sitting in the waiting room at Columbia waiting to finalize the deal when I got an urgent call from my lawyer. “Get out of there immediately,” he bellowed. “What do you mean?” I asked. “Fox is reneging—they now say they want to keep the film and they will theatrically release it.” I was incredulous, but it was clear to me what had happened to change Fox’s mind.

56  Welcome to the World of Independents

Wing Commander was not a star-driven film. The cast was headed by Freddie Prinze, Jr., who just happened to also star in a little teenage comedy—She’s All That—released by Miramax at the beginning of 1999, which turned out to be one of the sleeper hits of the year. It did more than $16 million on the opening weekend and ultimately grossed almost $64 million domestically. Given that the budget was only around $10 million, it was clearly enormously profitable. It became clear to me that Fox hoped to strike lightning in a bottle a second time around with Freddie Prinze, Jr. It certainly was not going to let Columbia steal its thunder. The problem was that it was still faced with the dilemma of not wanting to release another science fiction film too close to Star Wars: The Phantom Menace (which ultimately grossed $431 million domestically). So, it rushed Wing Commander into release without having sufficient lead time to attach trailers onto other films in order to create audience awareness and wantto-see. Wing Commander may have been the only film in recorded memory that had a wide national release (defined as more than 2,000 screens) without the benefit of a trailer campaign to promote the film. In order to compensate for this failure—and it cannot be overemphasized how important trailers are in creating audience awareness and want-to-see (possibly more important than even television spots because trailers are seen by a filmgoing audience that is already attending a similar film and television spots, if they are watched at all, are seen by a broader audience who may or may not be frequent filmgoers)— Fox overspent on television ads. Given that the film bombed—it did under $12 million at the box office, although it had a much better reception on home video—we did not see another dollar above and beyond the small advance. Arguably, we would have been better off if Fox had buried the film theatrically and relied primarily on home video revenue. One of the first budgetary items a completion bond company scrutinizes is the special effects budget, especially considering the visual-effects house that has been hired to do the CGI work: are they credible and creditworthy? Visual effects houses come and go; most of them are significantly undercapitalized and their ability to continue operating is very much a function of their ability to continue to attract assignments. Typically, they do not have the working capital cushion to survive prolonged periods of inactivity. Also, the business is so competitive, they are often forced to work at minimum or even nil margins in order to avoid having to lay off their workforce. CGI shops are “work-for­­ hire” operations, and their assets—namely, their work force—leave the office every night. If the special effects house fails to deliver satisfactory production values or fails to deliver shots at all because it has gone bust in the interim, the completion guarantor will have to replace the faulty shots on its own dime. Guarantors are very careful about whom they approve and the level of the special effects budget they approve. If they think the special effects budget is light, they will have no hesitation about requiring the producer to up that portion of the budget.

Welcome to the World of Independents  57

Two of the largest visual effects houses—Rhythm and Hues and Digital Domain—both declared bankruptcy in 2013. They were acquired by an Indian animation studio in the case of the former and a Chinese/Indian consortium in the case of the latter. This was despite a globalization strategy in the case of Rhythm and Hues, which employed artists in India, Malaysia, Taiwan and Canada, and an intellectual property ownership strategy on the part of Digital Domain, which sought to expand beyond simple “work for hire” by taking equity positions in films on which it generated special effects shots. Their first foray into equity investment was on Ender’s Game, which did a so-so domestic box office of $87 million in late 2013 (it had a reported budget of $110 million,2 but this number should be treated with caution as we do not know the specifics of Digital Domain’s investment), but the film was undoubtedly a big loser even though the international box office was more robust. Post-production is another area of the budget that is frequently undercapitalized on independent productions. Many producers think most of the hard work is accomplished when principal photography is completed. But many films have been ruined or saved in the editing room. Since the editing budget is basically a function of the number of editors on the job times the number of weeks they spend in the editing room, it is easy to underestimate the task and skimp on what is required. Music is another post-production item that is frequently underbudgeted. How many films can we remember where the music absolutely made the film? Chariots of Fire always comes to mind when I think of memorable film scores. Again, you get what you pay for. Not every film needs a score by John Williams or Hans Zimmer, nor can they afford them, but I have seen too many films whose playability was adversely impacted by the choice of composer. Also, I am sure that the Romanian National Orchestra is a reasonably accomplished group of musicians, but there is a difference between playing Mozart and recording a film score. Music is not necessarily a good place to try to save a buck. Recently, I was in the middle of assisting one of my producer clients in lobbying the domestic distributor on a psychosexual thriller she produced to replace what was really a fairly lame score with a proper score that would magnify the suspense. Unfortunately, the distributor probably intended only to do a nominal theatrical release and push the film on video on demand (VOD)—a score is really about improving the film’s box office prospects—and the studio seemed unwilling to gamble on theatrical success, which would have required meaningful P&A expenditure. Given the low advance it paid for distribution rights, it can probably recoup its investment and earn a decent profit just out of streaming, DVD and cable television revenue. I know of one prolific independent producer who made his name doing low-budget genre films. It made sense for this producer to channel his key production dollars into paying for a meaningful action star and providing sufficient explosions on-screen to keep his audience awake. Larry Gordon, my boss at Largo, used to draw up “whammo charts” for his action films, which

58 Welcome to the World of Independents

measured the time between key set action pieces—and you better not let too much time elapse. Since this indie producer worked with very tight budgets (for which his financiers, I am sure, applauded him), post-production invariably suffered. This does not matter too much on low-budget action films, but when the same producer graduated to bigger-budget films, he could not shake his habit of skimping on the post-production budget—and his bigger budget films, which were clearly “studio lite,” did not meet audience expectations in terms of quality control across the board. Editing and music on his films certainly never commanded Academy Award nominations. At the end of the day, an independent producer must conform his creative vision to the pot of money he or she has to work with. Producers working for the studios are less under the gun here, but even they have to be mindful of budgetary constraints—big tentpole films excluded to a large extent. Sometimes, the budget and the commercial potential of the project cannot be reconciled. Arguably, you should walk away from the project in such a case or find a way to reconfigure it. Insistence on rigorous financial discipline goes a long way to separating the winners from the losers (remember J. Paul Getty’s advice, however, that the best way to succeed is to work hard and strike oil), and why management is so important in determining whether an independent production or distribution company will succeed or fail. It may be tough to instill commercial taste—and I know several well-known producers who would not recognize a good script even if all of their hard-working but undercompensated “readers” applauded it—but at least I can try to persuade my clients to apply rigorous financial analysis. If I can just do that, I have probably paid for my services many times over.

Notes 1 Masters, Kim. “The Dangers When Financiers Think They Can Produce Movies, Too,” The Hollywood Reporter, 1 Oct. 2015, www.hollywoodreporter.com/news/ dangers-financiers-think-they-can-827843. 2 “Ender’s Game (2013),” Box Office Mojo, www.boxofficemojo.com/movies/?id= endersgame.htm.

5 THE EVOLUTION OF REVENUE STREAMS

Summary—The chapter introduces the various revenue streams that films participate in and how they have evolved over time. Particular attention is paid to new streaming platforms, including subscription video on demand (SVOD) and transactional video on demand (TVOD). Advertising video on demand (AVOD) is also considered, as is the future of premium video on demand (PVOD) given the changes in theatrical windows in light of COVID. The chapter wraps up by emphasizing the importance of theatrical revenues in terms of maximizing ancillary revenue streams and overall ROI. Some revenue streams have much more predictability than others. For example, pay television license fees are based on strict numerical formulas tied to theatrical rentals (rentals represent the portion of box office that is retained by distributors, as opposed to exhibitors). These formulas are not linear, and the percentages tend to decrease as rentals increase. The studios lobbied for this treatment, because it favors poorer performing films, and thus the studios could mitigate the losses they incurred on box office failures. However, each studio has negotiated a different formula with the premium pay service it has contracted with—either HBO (the industry leader), Showtime, Starz or Epix. Warner Bros., in particular, is known to have an especially favorable definition in its deal with HBO, which is not surprising since HBO is owned by Warner Bros.’ parent company, WarnerMedia. Other revenue streams vary all over the place relative to box office performance. While the rule of thumb used to be that international box office is roughly equal to domestic, (but this has been rendered anachronistic, particularly with respect to big tentpole films, by the major increase in several key international territories). A more applicable breakdown today is 65/35 in favor of international. Let’s face it: if a film can achieve international popularity, there are a lot more potential customers outside the United States and Canada DOI: 10.4324/9781003153702-6

60  The Evolution of Revenue Streams TABLE 5.1 High Performing Films Internationally

Title

International Gross (i.e., Outside of North America)

Percent of Worldwide

Frozen Iron Man 3 Skyfall Hobbit: Desolation of Smaug Les Miserables Oblivion

$867.10 million $803.70 million $804.33 million $692.10 million $293.23 million $195.56 million

68.39 66.27 72.55 72.82 66.34 68.70

Source: All data found on specific film pages at Box Office Mojo, www.boxofficemojo.com.

than there are within our borders. Many high-profile films have skewed even more in favor of international. Table 5.1 gives some examples of international overachievers in 2013. Home video revenues are even more difficult to predict as a function of domestic box office. This is primarily a result of technological changes in the industry—at first the eclipsing of VHS usage in favor of the much handier and information-richer DVD technology, which also provoked a dramatic shift in sell-through versus rentals. United States spending on VHS peaked at $12.2 billion in 1999 and virtually disappeared in 2006.1 Spending on DVD peaked at $20.2 billion in 2006 and has continued to decline since then— although this decline has been mitigated to some extent by the introduction of Blu-Ray technology.2 Because of the exponential growth in DVD sales from 2000 to 2006, it was extremely difficult to get a precise fix on actual sales revenues relative to box office. This is not surprising when we were faced with radical shifts in the business model, which has occurred at least three times before with respect to the home video market. In the early 1980s, at the onset of VHS, we had an explosion in the number of retail stores catering to the rental market. These stores had enormous stocking requirements, and it was possible to move a significant number of units of practically any feature film with recognizable stars. Home video became the driving force for a low-budget film model, which was best exploited by Cannon Entertainment, a dynamic new company run by two Israeli cousins, Yoram Globus and Menahem Golan. Cannon specialized in low-budget action films, and it was virtually guaranteed a significant profit on every title if it controlled its budgets, irrespective of whether or not the film succeeded at the box office. Home video revenues combined with international sales were sufficient to turn a meaningful profit. Cannon eventually went public, borrowed a lot of money from the junk bond market thanks to Drexel Burnham, even had a run at the once-mighty MGM, and then went bust when it violated the sacred canons of its business model and thought it could compete with the majors by producing higher budgeted fare that needed box office success to be profitable. I was intimately involved in Cannon’s roller coaster

The Evolution of Revenue Streams  61

ride since I arranged a number of tax-driven financings that drove its earnings, including a UK deal on the first film that represented a departure from their low-budget business model: Lifeforce aka Space Vampires. When the growth of retail stores slowed dramatically, the stores’ buying patterns also changed. Rather than waste shelf space on marginal titles with little audience recognition, the stores began to concentrate more and more on high-profile theatrical releases. This trend accelerated as a few chains, led by Blockbuster, gained significantly greater market share. The major chains prominently advertised that they would be able to provide rental tapes for any recently released major theatrical feature (video tended to lag theatrical release then by 6 or more months—today that delay has been reduced to 4 months, or even less). Accordingly, you could go into a local Blockbuster store and find 60 or more tapes of a high-profile film on hand. No longer could the Cannons of the world be assured that they could ship three to four units of a low-budget action film to every Blockbuster outlet. If they were lucky, they could ship one, and there was no guarantee even of that. The business model of the straight to video action/horror/sci-fi/thriller promptly imploded. That is not to say these films went away entirely, but the volume decreased dramatically, and the producers had to cut their budgets in response to lower video demand. Avi Lerner of Nu Image, who cut his teeth with the Cannon crowd and successfully emulated their model, moved his favorite venue for making films from South Africa to Romania, and then to Bulgaria in search of the lowest below-the-line cost. Initially, the video market was almost exclusively a rental market. Sellthrough was confined largely to the sale, at a significant discount, of previously viewed tapes on rental. The studios, however, who were the major content providers to the video market, historically participated in the revenues arising out of the retail stores’ purchase of the tapes. The studios did not share at all in the recurring rental income that the tapes generated. The pricing structure reflected this. Tapes were sold to middlemen who stocked the stores at a relatively high wholesale price that typically would exceed $50. The middlemen would take their cut and pass on the tapes to the stores at some premium to that—around $65. If the stores recycled each tape on average 50 times at an average price of, say, $3, you have an idea how profitable a successful rental could be—and this does not take into account the late fees the stores charged (rumor has it that late fees represented the overwhelming bulk of Blockbuster’s profits). The studios eventually lobbied for a more equitable revenue allocation in the rental market, and a new revenue sharing model was introduced. Under this model, the stores no longer paid for the tapes up front, thus saving a meaningful upfront cash commitment. Instead, they shared each dollar of rental income with the distributors on an agreed-formula basis, which further caused the market to bifurcate between high-profile theatrical releases that commanded high rental turnover and more obscure films that had limited and often no theatrical release and typically had limited rental interest.

62  The Evolution of Revenue Streams

Rental has virtually disappeared over the past few years—particularly brick and mortar rental and physical subscriptions—although kiosk-delivered DVDs (largely through the cut-rate offerings of Redbox) have been relatively stable.3 Overall, rental expenditure now represents only about 25% of total consumer home video expenditure in the United States (based on 2016 numbers).4 The rapid contraction of the rental market precipitated the virtual disappearance of retail chains like Blockbuster. Instead, mega-retailers like Walmart and Best Buy began to dominate the sell-through DVD market. Walmart today is responsible for approximately 40% of all DVD sales in the United States, which permits it to dictate the terms of doing business vis-à-vis the video distributors.5 Walmart’s clout permits it to basically take DVDs on consignment and return any unsold units at no cost to it. Ship 100,000 units to Walmart and you might find yourself having to take back 90,000 at a later date. Not surprisingly, virtually all the independent distributors find themselves staring into the financial abyss these days, and most, if not all, are looking for buyers for themselves as well as their product. But even Walmart feels threatened by the shift in consumer preferences to streaming (which, by the way, carries lower margins, at least for the time being, than physical discs.) As a result, even Walmart entered the streaming game. It first acquired Vudu, a digital video store and streaming service and then announced a deal with Ultraviolet that would permit customers to upload the DVDs they already own to a cloud-based platform for as little as $2 to $5.6 But Walmart chose to back away from what has become a very competitive market when it sold Vudu in 2020 to Fandango, a majority owned subsidiary of NBCUniversal. Electronic delivery has grown at an astronomical pace over the last few years and now represents more than 50% of total US home entertainment spending.7 PricewaterhouseCoopers estimated that electronic delivery actually overtook domestic box office in 2017/2018.8 VOD has even become a preferred release window, in lieu of theatrical, for many smaller films. VOD distributors will typically release a new title in a small number of theaters to create audience awareness, but this is primarily a marketing ploy to drive VOD revenue. More and more new releases are being done “day-and-date”—i.e., simultaneous releases in theaters and on VOD, and in some cases, transactional VOD (TVOD) revenue has even outstripped theatrical—as can be seen in Table 5.2. TVOD encompasses a number of platforms including iTunes and Amazon (which also offers a subscription VOD service). It includes both electronic sellthrough (EST), in which the consumer downloads to own, and download to rent, where the consumer can watch the film for a limited period of time in exchange for a transactional fee. Subscription video on demand (SVOD) pioneered by Netflix, which is now challenged by a number of domestic competitors such as Amazon and Hulu and foreign players such as Canal Plus, is a market that is many times the size of TVOD and in some cases has even replaced the

The Evolution of Revenue Streams  63 TABLE 5.2 High Performing Films on TVOD

Title

Box Office

TVOD

All Good Things Arbitrage Margin Call The Bachelorette Only God Forgives Black Death

$582,000 $7.9 million $5.4 million $500,000 $1 million $22,000

$6 million $14 million $5.4 million $8.3 million $2.4 million $4 million

Source: Bernstein, Paula. “Here Are All the VOD Numbers We Know So Far.” IndieWire, 30 Dec. 2014. www.indiewire.com/article/here-are-all-the-vod-numbers-we-have-so-far-20141230.

traditional pay television window, as witnessed by the now superseded Netflix deal with Disney. Disney replaced its deal with Netflix by introducing its own SVOD service Disney+, which in one year’s time gained an 18% market share, having reached a subscriber base of almost 87 million by the end of 2020. Over time, there has been increased pressure to shorten the release windows for feature films. J.P. Morgan’s research department published a controversial study several years ago arguing that a total collapse of the various release windows whereby consumers could choose on the initial release date whether they wished to view a film in the theater, on DVD, or on a streaming platform, would result in a dramatic improvement in industry margins.9 The rationale behind this thinking is that such a strategy would enable the distributors to eliminate a lot of duplicative marketing expenditure: there would be only one integrated marketing spend to create audience awareness and want-to-see, with no need to spend additional marketing dollars to support sequential release windows. A number of distributors over the past few years have expressed a desire to experiment with “day-and-date” release windows—i.e., simultaneous openings in theaters and either DVD releases, but more typically today VOD. They backed away from such experimentation, however, for one very good reason: the big exhibition chains wouldn’t permit it. They simply refused to play those films in their theaters if they had to compete with other platforms available contemporaneously. You have to remember that the three largest theater chains—AMC, Regal and Cinemark—control more than 40% of all the screens in the country.10 So we are talking about a lot of clout here. Theatrical is still the primary locomotive in driving success in the movie business, and distributors couldn’t afford to rock the boat. If anyone was going to rock the boat, it was Harvey Weinstein. The Weinstein Company released Snowpiercer, a critically acclaimed sci-fi film in late June 2014 initially on eight screens playing sold-out shows in New York and Los Angeles. It did $171,187 box office opening weekend for a respectable per-screen average of around $21,500.11 Typically, The Weinstein

64  The Evolution of Revenue Streams

Company would roll out a film with that level of opening gross on an escalating number of theaters in subsequent weeks. In fact, The Weinstein Company expanded the number of screens to 250 the second weekend, where it achieved a weekend gross of $1.007 million (per-screen average of $4,032).12 That’s OK, but not great. Depending on whom you believe, Harvey either blinked or decided the time was right to experiment. Thus, on the third weekend, The Weinstein Company expanded the number of screens to 356 but at the same time made the film available in 85 million homes on VOD, making it the widest-ever virtually simultaneous theatrical-VOD release.13 The per-screen average dropped to $1,785, but the film generated $2 million on VOD and iTunes at the same time.14Bloomberg estimates that this strategy will net The Weinstein Company on the order of $13 million over the theatrical window, while it also estimates that had Harvey screwed up his courage and simply expanded the release pattern as he typically does, The Weinstein Company would have netted $18 million.15 So by Bloomberg’s calculations, The Weinstein Company left $5 million on the table. That’s not chump change. But, at the same time, it’s only a guesstimate. To concretize that guesstimate, Harvey would probably have to have spent an additional $10–15 million in P&A. So, even if Bloomberg’s prognostications are relatively on the money, you can certainly see why Harvey was justified to lock in a much more predictable return that the simultaneous VOD release certainly provided. Risk-adjusted return! That’s a concept I learned as a young portfolio manager—and one that investors in the movie business should keep well in mind. Paramount then announced an interesting experiment in what I would describe as near-day-and-date release. The studio persuaded two major cinema chains—AMC in the United States and Cineplex in Canada—to play two Paramount-distributed horror films in their theaters while permitting Paramount to release them digitally 17 days following the point at which the number of theater locations playing the films drops to less than 300.16 This would permit the exhibitors to retain the bulk of the films’ box office revenues, which are typically generated in the first 3–4 weeks of release in any case. To induce the chains to play ball, Paramount was prepared to channel to them some of the money from digital distribution (but not DVDs) generated through 90 days after the theatrical release of the films. Not surprisingly, Paramount tried its experiment on two horror films, which typically have shorter lives in theaters than more mainstream fare—dramas, comedies and action/tentpole films— and certainly arthouse films that can play for months on more limited release. Then, COVID hit, and Universal broke the mold by negotiating a new model with AMC, whereby all upcoming Universal films, including its specialty affiliate, Focus Features, will be granted theatrical exclusivity for the film’s first 17 days (first three weekends) of release, and thereafter Universal has the option of making those films available on premium VOD for viewers at

The Evolution of Revenue Streams  65

home, who can also use AMC’s own on-demand platform. In order to persuade AMC to forego later box office revenues, Universal agreed to cut AMC into its PVOD revenues on a basis which was not disclosed.17 As COVID persisted, Warner Bros. pursued an even more radical strategy. They approached CAA and WME to agree on behalf of their clients, the film’s star Gal Gadot and director Patty Jenkins, to permit them to release the much-anticipated Wonder Woman 1984 simultaneously in theaters and on Warners new streaming service HBO Max on Christmas Day. To persuade the agencies to agree to that strategy on behalf of their clients, Warners had to agree to pay key talent what they most likely would have received had the sequel been released in a traditional manner (an exclusive run in theaters before arriving online). Ironically, the film significantly underperformed expectations, at the box office although it did become the most watched straight-to-streaming title in 2020. Warners then doubled down by announcing that every one of its 2021 films will debut in theaters and on HBO Max contemporaneously. Warners called the move a “strategic response to the coronavirus pandemic”, and they pointed out that the films will be available on HBO Max for only 1 month upon initial release, so Warners would still stand to make additional profits from anyone not wishing to subscribe to its SVOD service, and instead choosing to rent or buy digital copies later. Warners also stressed that this commitment only applied to 2021 releases, and they reserved the right to move back to more traditional windows once the effects of the pandemic had eased.18 However, industry experts believe that the genie has effectively been let out of the bottle, and even if Warners and other studios return to the more traditional theatrical release model, the windows will be collapsed with the exclusive theatrical window not lasting more than three or four weekends. Interestingly, Warners made their announcement without the benefit of concerted negotiations with talent’s representatives, and, not surprisingly, they received significant blowback. Accordingly, the studio is in the process of working out a deal whereby talent will be paid regardless of box office receipts, so box office bonuses will now be paid when half of the box office revenue that would usually be required to trigger the said bonus is reached. If more theaters are shut down, the box office threshold will drop even lower. Sean Parker, the Internet mogul best known for his roles in Napster, Facebook and Spotify, launched a new service, The Screening Room, in 2016 which proposed to offer consumers the ability to watch a new release in their homes at the same time it hits the theaters via an encrypted set-top box they can buy for $150. Despite the fact that he has offered to give theater owners $20 of the $50 spent to rent a film for 48 hours, the major exhibition chains, as well as several leading directors, strongly lobbied against it (to be fair, Peter Jackson and Ron Howard have come out in support of the initiative).19 The service did

66  The Evolution of Revenue Streams

not take off until COVID hit, and it was rechristened in 2020 as SR Labs with an equity infusion of $27.5 million. A final word on the importance of theatrical as a driving force in the Biz. Just as distributors are cutting back on the number of theatrical releases they undertake—because of the stratospheric cost of releasing a film on a broad, national basis (2,500 screens plus)—theatrical success has become even more important in determining ultimate profitability. As I mentioned earlier, most independent films are released on a bifurcated rights basis. Foreign rights are pre-sold on a territory-by-territory basis both to help finance the film—and reduce the amount of equity that has to be raised—and mitigate the risk. More and more, the presale value of a film in the international marketplace is very much a function of whether the film is perceived to be of sufficient quality to warrant a theatrical release. I am talking about a huge chasm between the value of a film that is deemed to have theatrical appeal and one that is considered “straight to video.” Some films are marketed to international distributors up front, on the basis of a script’s key elements—director and one or two lead actors—that is, before the film has been produced and frequently before domestic distribution rights have been set up. Thus, the local distributors must either take a leap of faith and commit before they know for certain what kind of theatrical release in the United States will occur and by whom, or they can wait until they can see the film, which is usually when the potential US distributors see it as well, and run the risk of being gazumped by a more aggressive competitor. Alternatively, they may propose two-tier pricing whereby they offer a higher minimum guarantee if the film gets a meaningful theatrical release in the United States and a lower price if it goes day-and-date or commands a smaller platform release. Fortune favors the brave, but not always. After the 2008 economic debacle, foreign distributors have become more cautious in committing, which entails producers having to find more equity to finance their films. When I tell my clients that you want to play in the major leagues as opposed to AA Reading (I’m a Phillies fan), I am basically saying that they should invest in films that have a shot at delivering at the box office. Of course, I can cite a number of low-budget films, even microbudget films (budgets of less than $1 million) that have had successful theatrical releases or even mega grosses (primarily horror films). But they are few and far between. Most low-budget independent films never see the light of day in theaters or fall far short of recouping their investment, even taking ancillary and international revenues into account. Films, if they are going to succeed at the box office, typically require a combination of star power and production values—which implies a certain level of budgets. Serious investors in the movie business soon discover that budgets and risk do not have a positive correlation: arguably, there is even a negative correlation between these two variables. But we will address that apparent contradiction in detail in Chapter 11 when we explore how risk can be properly managed.

The Evolution of Revenue Streams

67

Notes 1 “Consumer VHS/UMD Rental and Sell-Through Spending in the United States from 1999 to 2008,” Statista, https://www.statista.com/statistics/188911/ us-consumer-spendings-on-vhs-umd-since-1999/. 2 Pullen, John P. “5 Reasons Streaming Is Making DVDs Extinct,” Time.com, 15 June 2015, http://time.com/3921019/streaming-dvds/. 3 Bailey, Jason. “The Premature Death of the Video Store,” Flavor Wire, 3 Mar. 2016, http://f lavorwire.com/563171/the-premature-death-of-the-video-store-andwhyits-worth-saving. 4 McCourt, J. (2017, January 4). “U.S. Home Entertainment Spending.” Retrieved from http://degonline.org/wp-content/uploads/2017/01/2016-Q4-DEG-HomeEntertainment-Spending_Rev-3.0_01.04.17_-External_-Distribution_Final.pdf. 5 Horn, John. “DVD Sales Figures Turn Every Film into a Mystery,” Los Angeles Times, 17 Apr. 2005, http://articles.latimes.com/2005/apr/17/entertainment/etdvdmoney17. 6 Pepitone, Julianne. “Walmart Launches DVD ‘Disc to Digital’ Service,” CNN, 13 Mar. 2012, http://money.cnn.com/2012/03/13/technology/walmart-ultraviolet/. 7 McCourt, J. (2017, January 4). “U.S. Home Entertainment Spending.” Retrieved from http://degonline.org/wp-content/uploads/2017/01/2016-Q4-DEG-HomeEntertainment-Spending_Rev-3.0_01.04.17_-External_-Distribution_Final.pdf. 8 “PwC’s Entertainment & Media Outlook Forecasts U.S. Industry Spending to Reach $720 Billion by 2020,” PR Newswire, 8 June 2016, www.prnewswire.com/newsreleases/pwcs-entertainment--media-outlook-forecasts-us-industry-spendingto-reach-720-billion-by-2020-300281287.html. 9 According to author experience. 10 Ceply, Michael. “AMC Is Set to Become the Biggest Movie Theater Company in the U.S.,” The New York Times, 7 Mar. 2016, www.nytimes.com/interactive/2016/03/07/business/media/amc-biggest-movie-theater-chain.html; “Number of US Movie Screens,” National Association of Theater Owners, www.natoonline. org/data/us-movie-screens/. 11 “Snowpiercer (2014),” Box Office Mojo, www.boxofficemojo.com/movies/?id= snowpiercer.htm. 12 Ebiri, Bilge. “Can a Korean Sci-Fi Movie about a Train Reinvent Hollywood’s Distribution Model?” Bloomberg, 10 July 2014, www.bloomberg.com/news/articles/2014-07-10/snowpiercer-tries-to-reinvent-hollywoods-distribution-model. 13 Ibid. 14 Ibid. 15 Ibid. 16 Lang, Brent. “Paramount’s Shorter Movie Windows: Bold Move or a Bad Precedent?” Variety, 16 July 2015, http://variety.com/2015/film/news/what-is-behindshorter-movie-release-windows-1201541011/. 17 Zeitchik, Steven. “Universal Pictures’ Deal with AMC Doesn’t Necessarily Mean You Can Quickly See Big Movies at Home,” Washington Post, 29 July 2020. 18 Ray, Siladitya. “Warner Bros.’ 2021 Lineup Will Get Simultaneous Releases in Theaters and HBO Max”, Forbes, 3 Dec. 2020. 19 Guerrasio, Jason. “Billionaire Sean Parker Has a New Startup That Wants You to Pay $50 to Stream Movies Still in Theaters,” Business Insider, 10 Mar. 2016, www.businessinsider.com/sean-parker-streaming-rental-startup-the-screening-room-2016-3.

6 COVID AND POST-COVID

Summary – The chapter tracks the impact of the coronavirus on the international movie business, both with respect to theatrical box office and new production. It also analyzes the changes in viewing windows with particular emphasis on video on demand. While it is difficult to assess how long COVID will persist and its ongoing effect on the business, effort is made to make general prognostications on how the film-going experience will be influenced going forward and how the economics of the business will be affected. The coronavirus emerged in Wuhan, China at the end of 2019, but it did not spread its wings as a worldwide pandemic until 2020, when it dramatically affected social intercourse and economic activity. The film business, both the theatrical marketplace and new production, was devastated. To put the virus’ effects into perspective, North American box office hit a 40-year low, struggling to reach $2.2 billion, compared to $11.4 billion the previous year.1 International box office was almost equally affected with grosses outside of North America down almost 68% to $10.2 billion.2 It would have been even worse had not theatres started to reopen in China as the year progressed due to more stringent lockdown measures introduced by the Government. As a result, China overtook the United States as the world’s top moviegoing market. The major studios kept pushing back release dates for their blockbuster films, and when Warner Bros.’ valiant effort to release its much-awaited Tenet in September, 2020 failed miserably, only generating $58 million domestically, but a more respectable $365 million worldwide, the rest of the studios basically pushed all of their major releases to 2021, or alternatively chose to pass on theatrical releases by selling films to the streamers. Paramount was particularly aggressive in laying off risk to the streamers. It sold Aaron Sorkin’s Oscar contender The Trial of the Chicago 7 to Netflix, as well as Michael Showalter’s action/comedy The Lovebirds. In addition, it sold the rights to Tom Clancy’s DOI: 10.4324/9781003153702-7

COVID and Post-COVID  69

thriller Without Remorse, starring Michael B. Jordan, and the Eddie Murphy sequel Coming 2 America to Amazon. Paramount also laid off The United States vs. Billie Holiday to Hulu at the last minute. In each case, Paramount achieved a purchase price well in excess of its budgeted cost, so it managed to lock in a profit without having to risk substantial P&A. Nevertheless, Paramount resisted selling its high-profile Top Gun: Maverick sequel despite being offered an exceptionally high price by several streamers. There was even more intrigue surrounding MGM’s latest James Bond film No Time to Die. It was originally scheduled to be released in April 2020, but that was pushed until April 2021. According to insiders, this decision cost MGM between $30 and $50 million. 3 Rumor has it that MGM was shopping the film to streamers for an astronomical $600 million, but it is understood that no streamer would bite.4 In any case, any such deal would have been complicated by Universal’s ownership of international distribution rights and blocking rights by the film’s producers, Barbara Broccoli and Michael Wilson. To MGM’s further detriment, the release date has been pushed even later to October 8, 2021. In March 2020, the three largest US theater chains—AMC Entertainment, Cineworld’s Regal Cinemas and Cinemark closed their doors in response to guidance from health experts advising against large gatherings. Initially, AMC said it expected the closures to last at least 6–12 weeks, but that prediction was soon shown to be dramatically overoptimistic. When it became clear that some of the biggest titles that had been expected to debut in 2020—in particular Marvel’s Black Widow—would be indefinitely delayed plus the spread of COVID accelerated, the theatre chains shut down to a large extent. In particular, the two largest markets, New York and Los Angeles did not reopen until well into 2021, and the leading exhibition groups continued to hemorrhage money. AMC Entertainment, the largest chain, publicly warned that it faced imminent bankruptcy, but the company aggressively moved to raise capital and after it successfully raised $917 million of new equity and debt capital by the end of the year, it announced that any talk of imminent bankruptcy was completely off the table. Regal, the second largest chain, shut down all 536 locations in the United States in October, less than 2 months after it started to reopen selected US locations in late August to conserve cash. Regal’s parent company Cineworld, which commanded a share price of $275 a year previous, plummeted below $22 after that announcement before recovering somewhat. By the first quarter 2021, the stock market began to anticipate the inevitability of theatre openings and bid up the share prices of the exhibition chains. On March 18, 2021, the AMC share price had recovered to $14 from a low of $1.91 less than 12 months previously. Film production was just as seriously affected. Completion bond companies immediately made it clear that they would not cover COVID risk either with respect to temporary shutdowns on set, or, more seriously, civil authority

70  COVID and Post-COVID

actions, whereby a government might lockdown the country and cause indefinite postponement or even the need to abandon production. Studios, of course, which typically self-bond were in a position to assume COVID risk, but even they had to implement elaborate COVID protocols to meet guild requirements. At the height of the pandemic in mid-2020, home viewing became the main leisure activity for those who found themselves working remotely and unable to go out in their off hours. Initially, viewers binge-watched new seasons of The Crown and The Mandalorian and new programs such as Bridgerton and The Queen’s Gambit. But pandemic-related production delays, which all but shut down the filming of scripted TV shows and movies for much of 2020 started to have an effect. The number of premieres of American scripted shows nose-dived in the second half of 2020, and the trend has continued in the first half of 2021. To put that into perspective, the effect was most apparent in September 2020, a big month for debuts. In September 2019, 86 shows premiered in the United States. A year later, that number fell to 35.5 Several outlets filled their gap by turning to international programming. Netflix’s Lupin, a French thriller series, and Call My Agent, which I like to describe as the French Entourage but far better, both connected with American audiences. Their success was part of a larger lockdown trend. The viewing of non-English language titles by US Netflix subscribers shot up more than 50% in 2020.6 After a 5-month lockdown, the guilds and the studios set up detailed and complex protocols, which include routine screening and testing for the coronavirus, environmental sanitation, diligent use of personal protective equipment (PPE) and zone-based set access control. To ensure workers’ livelihoods are not burdened with added uncertainty during the pandemic, the multiparty agreement also provides for COVID-19 sick leave and quarantine pay. Data indicates that production sets have remained relatively safe environments despite the surge in community infection rates throughout the United States. Highlights of these protocols include: -

-

-

Every member of the cast and crew will be tested before their first day of work to ensure they are not actively infected with the virus. Cast and crew members in the production environment will subsequently undergo a regular testing protocol during the course of their work on the production. Lab-based PCR tests, the gold standards of COVID-19 testing accuracy, or rapid PCR tests used in conjunction with lab-based PCR tests, will be allowed. Antigen and antibody tests are not permissible. Crew in masks with limited contact to cast.

COVID and Post-COVID  71

-

-

-

-

In order to ensure the different sections of the production environment are tightly controlled, the agreement requires the implementation of a specialized “Zone” system laying out barriers within which those on set can flow based on proximity to cast, level of testing, PPE and the extent to which physical distancing can be observed in the performance of their work. Given that performers are uniquely vulnerable when cameras are rolling because they are not able to utilize PPE and physical distancing, the agreement requires more frequent testing—of at least three times a week—for performers as well as those with whom they come into close contact, referred to as “Zone A.” All other individuals in the production environment will utilize physical distancing and PPE at all times. Those who work on set, but not when performers are present without PPE (“Zone B”), must be tested at a minimum of once a week. Workers in production areas other than the set, such as the production office (“Zone C”), must be tested at a minimum of once every 2 weeks. Remote workers associated with the production, but nor working in the production environment (“Zone D”), will be tested prior to their first day of employment.

- Dedicated COVID-19 Safety Monitoring and Enforcement -

Each production must have a designated COVID-19 compliance supervisor responsible for safety compliance and enforcement, who will be accessible to cast and crew at all times during working hours. To ensure that safety protocols are being followed, the compliance supervisor or a member of their compliance team with training and authority will be physically present on the production from crew call to wrap. The production may hire additional staff to work under the compliance supervisor to assist in carrying out the safety duties.

Sick Pay -

-

All employees will receive 10 days of COVID-19 paid sick leave. The leave can be used for any of the eligible COVID-19 events, including testing positive, exhibiting symptoms, isolation or self-quarantine, or when a member of their household tests positive for COVID -19. Employees who go on COVID-19 sick leave will be reinstated once they have been cleared to return to work as long as their position continues to exist.

72  COVID and Post-COVID

Quarantine Pay -

With certain limited exceptions, employees who are required to quarantine or isolate at the request of an employer, or as required by local law, will receive quarantine pay.

Implementing these COVID protocols, including adding medical staff, enforcing social distancing, requiring periodic testing and controlling cast and crew interaction, has resulted in budgetary inflation. Depending on size of budget, it appears that average production costs have increased on the order of 10–12%. Producers have reacted to this budgetary uplift by trying to contain the number of locations and size of crews and setting up tiered “bubble” systems to isolate crew members to limit viral spread. Probably the most effective country in maintaining its level of production activity during the worst period of the virus was Hungary. What set Hungary apart from other European countries was the speed at which local studios became “COVID-19 conform” and the unfettered support they received from the national government. Origo Studios in Hungary installed a private COVID testing laboratory on location and contracted with a private local hospital to exclusively treat any infected crew members. Just as important, when the European Union in June 2020 banned non-EU citizens from traveling to the continent, the Hungarian government quickly introduced exemptions for US cast and crew. Recently, insurance companies active in the film business have started to offer COVID coverage, but it is very expensive, involving premiums of 8–10% of the coverage provided. For example, if an independent film with a budget of $10 million wants to take out coverage of, say, $5 million to cover long-lasting, but temporary shutdowns as a result of COVID outbreaks among talent and crew, that would entail a premium of $400,000–500,000. In addition, implementation of the full protocols, in terms of additional staffing, controlled shooting bubbles and longer shooting schedules, as I mentioned, will typically increase budgets on the order of 10–12%, or more. As the virus has come under better control in certain venues, it would appear that insurance premiums might be coming down to the 6–8% range. Countries who are also very active in providing production services, such as England, Canada and Australia have also implemented COVID insurance structures, but these are only available to indigenous production companies and they are capped at relatively low coverage amounts. The most dramatic event affecting the traditional theatrical release model occurred when Warner Bros. made a shock announcement in December 2020 that it would stream all of its 2021 releases through its affiliated SVOD service, HBO Max, at the same time they hit theatres. The films included Matrix 4,

COVID and Post-COVID  73

Dune, Mortal Kombat, Judas and the Black Messiah, Space Jam: A New Legacy, The Suicide Squad, Tom and Jerry, Godzilla vs. Kong and the film adaptation of In the Heights, among others. Shares of movie theatre operators fell more than 15% on the news. Warner Bros. blamed their decision on the likelihood that most theatres in the United States will likely operate at reduced capacity throughout 2021. At the same time, Warner Bros. held open the possibility that they would return to a more traditional distribution model in 2022, when it is presumed that the effects of the coronavirus will largely have dissipated. Whether that will happen or not, the genie has been let out of the bottle, and it is virtually a given that traditional windows will be a thing of the past. Despite the lip service the studios may pay to the traditional moviegoing experience, it is clear that the studios now recognize that their future is largely digital. Bob Bakish, ViacomCBS President and CEO, recently announced that Paramount films will now have a theatrical window of 45 days, which will be shortened to 30 days for smaller films from the studio, before heading to the studio’s new SVOD platform, Paramount+. Given that the traditional theatrical window was 90 days, Paramount’s new strategy amounts to cutting that by one-half to two-thirds. Even more significant given the studio’s strong number one ranking, Disney CEO Bob Chapek at the Morgan Stanley Technology, Media and Telecommunications Conference was quite explicit that there’s no “going back” to the traditional theatrical release format prior to the pandemic.7 Chapek pointed to the “impatient” consumer as the driving force for the new reality. The films that Warner Bros. planned to release in 2021 will now be available to HBO Max subscribers for 31 days. After the 1-month mark, those films will only play in theatres until they reach the traditional home entertainment window. From there, people can rent through online platforms like Amazon, iTunes or Fandango. Warner Bros.’ announcement was so rushed that its business affairs department did not even have time to negotiate modifications on talent deals to accommodate this new distribution model. The result, sources say, was that it cost Warner Bros. big time. The first film released in 2021 was The Little Things, starring Denzel Washington, who is one of the highest paid actors in the business. Rumor has it that Warner Bros., in addition to protecting Denzel on his up-front fee, also had to guarantee him a defined profit element, which was calculated on an imputed level of box office performance which would have been the case if the film had commanded a traditional theatrical release. But even Denzel does not always generate hits, and, in this case, Warner Bros. had to pay him a profit participation which assumed the film would have been profitable. At the time I am writing this chapter, it seems that no general formula has been adopted by the studio, but, according to sources, Warner Bros. has a draft proposal out to agents whereby talent making less than $4 million will be paid an additional 25% of their salary upon the release of the film as an advance

74  COVID and Post-COVID

against box office bonuses. Anyone making $4 million and over would receive an advance profit participation equal to 40% of their salary. Moreover, the box office performance thresholds would be halved, and, regardless of the film’s run at the global box office, all previously negotiated deferments would be honored upon the film’s release. Talent agents may have concluded that their clients would be better off at a 50% threshold, but given the dramatic fall-off of theatrical revenue in 2020, that assumption may prove to be significantly too optimistic. While a number of cineaste directors and movie reviewers are looking forward to massive vaccination of the general public, which they expect to lead to significant reopening of theatres and a return to the movie going habit which was so important for freeing us from our humdrum existence, there are conspiracy theorists who posit that COVID presented a wonderful excuse for the media giants, as The Nation commentator Jeet Heer described it, to disguise their planned “murder of the moviegoing experience as death by natural causes.”8 A more extreme conspiracy theorist might even suggest that it is the long-term project of companies like Disney or Warner Bros. to drive movie chains out of business and then set up their own exhibition sites where they don’t have to split the profits. This is theoretically possible since the Paramount consent decrees of 1948, which forced the studios to divest their exhibition chains, were abrogated in 2020. I don’t take such suggestions seriously, but I do believe that the fantastic success of Netflix, duplicated to a lesser extent by Amazon, has persuaded the studios that streaming represents an equally valid means of satisfying people’s insatiable thirst for new cinematic content, and the future will require them to place a comparable value in being able to offer such content on a home entertainment system, a laptop, or even a cell phone. But streaming will not replace watching a film in theatres, which offers a fundamentally more social and immersive experience than streaming can ever provide. Watching movies in theatres can scare us, make us laugh and make us cry in ways that can never be replicated by watching a film on the Netflix platform, and even if the popcorn is stale or people are chatting in the row behind you, there is a palpable excitement when the lights are dimmed that cannot be matched by the streamers. Throughout this book I have emphasized the need to examine the individual profit margins which are embedded in the various revenue streams that make up the distribution life cycle of an individual film in order to explain executive decisions of the distribution companies. For example, Disney Plus is available for $6.99 a month or an annual rate of $69.99 a year. In March 2021, the monthly price was increased to $7.99 and the yearly cost to $79.99. In early February 2021 Disney announced that its subscriber base had grown from 14 million at the beginning of the previous year to 95 million at year end (and over 100 million in early 2021). What is most impressive, is that Disney had originally expected to hit 60–90 million paying subscribers by 2024. It has now

COVID and Post-COVID  75

changed its targets to 230–260 million worldwide subscribers by 2024. If we assume conservatively that the annual subscription rate at that time is $90, that means that Disney Plus will generate annual revenues on the order of $20–24 billion. To put that into perspective, Disney’s entire revenue from its domestic studio entertainment division in 2019 was less than $10 billion. Arguably as well, profit margins on Disney Plus are more robust than in its theatrical division, which requires substantial marketing expenditure to drive traffic to the theatres, where Disney must split box office around 50/50 with the exhibitors. Clearly Disney’s big tent pole offerings will continue to command major theatrical releases, but there is no question that Disney will adopt a selective strategy with respect to theatrical releases on its more run of the mill product, using the limited theatrical release approach as a marketing tool to rev up its subscriber base on its streaming platform. Actually, I should refer to streaming platforms, since Disney also controls Hulu, which presumably will be used to present more adult fare. In a post-COVID era, movie production will undoubtedly see some significant changes. It’s likely, for example, that many jobs won’t be returning. The goal will be to minimize crew as much as possible while cast is on the set, and crews will be limited to essential production personnel only. We will also see greater reliance on VFX. In this regard, the latest technological developments in digital effects have not been perfected in feature films but in television where the many alien worlds the series The Mandalorian featured were not filmed in deserts and tundras around the world, but were instead realized by George Lucas’ Industrial Light and Magic (ILM) on just one stage in Los Angeles, nicknamed “the Volume.” This cavernous set is surrounded by LED panels on its walls and ceiling. Instead of shooting actors against green screens and adding a virtual background later, environments are projected onto the walls during filming, blending seamlessly with practical props. The tremendous advantage this offers is that the Volume accurately lights a scene while it is being filmed, so complicated manipulation of lighting and reflections in post-production can be avoided. Not only does this save a lot of money, effects-driven productions can be much more contained, which will become increasingly important in a post-COVID world. It will be interesting to see how animation will fare in a post-COVID world. Since animation can largely be done in remote locations, where there is no danger of temporary shutdowns as a result of infection, there will clearly be great temptation for producers to turn their attention to adult animation productions, and, of course, there has been a lot of prognostication about the possibility of replacing human actors with digital simulations. I think we are still many years away from delivering credible complete digital “live-action” motion pictures, including fully realized humans, but the advent of the virus will undoubtedly spur the industry’s efforts to marshal the necessary computational resources to achieve that goal.

76 COVID and Post-COVID

Notes 1 McClintock, Pamela. “It’s Official: 2020 Domestic Box Office Fell 80 Percent to $2.3B Behind China’s $2.7B,” The Hollywood Reporter, 1 Jan. 2021, https://www. hollywoodreporter.com/movies/movie-news/its-off icial-2020-domestic-boxoffice-fell-80-percent-to-2-3b-behind-chinas-2-7b-4110745/. 2 Tartaglione, Nancy. “2020 Worldwide Box Office Slumps 71% To $12.4B Amid Covid Impact: Strength of International, Piracy Concerns & Hope Dominate 2021 Chatter – Global Studio Rankings Chart,” Deadline, 6 Jan. 2021, https:// deadline.com/2021/01/hollywood-movie-studio-global-rankings-2020-globalinternational-box-office-analysis-2021-outlook-1234665561/. 3 Gelman, Samuel. “James Bond: No Time To Die Date Shift Hits MGM’s Bottom Line Hard,” CBR.com, 5 Mar. 2020, https://www.cbr.com/james-bond-no-timeto-die-date-shift-mgms-lose-money/. 4 Dean, Grace. “MGM Reportedly Asked Netflix and Apple for $600 million to Bring James Bond Film ‘No Time To Die’ Straight to Streaming,” Business Insider, 28 Oct. 2020, https://www.businessinsider.com/no-time-to-die-streamjames-bond-netflix-apple-mgm-2020-10. 5 Koblin, John. “How the Pandemic Stalled Peak TV,” The New York Times, 28 Feb. 2021, https://www.nytimes.com/2021/02/28/business/media/pandemic-streamingtv-shows.html. 6 Ibid. 7 Martinez, Jose. “Disney CEO Bob Chapek on Shortened Theatrical Windows: ‘I’m Not Sure There’s Going Back,’” Complex, 2 Mar. 2021, https://www.complex.com/pop-culture/disney-ceo-bob-chapek-impatient-moviegoers-shortenedtheatrical-window-not-sure-theres-going-back. 8 Heer, Jeet. “Movie Theaters Aren’t Dying—They’re Being Murdered,” The Nation, 4 Dec. 2020, https://www.thenation.com/article/culture/movies-streaming-covidtheatres/.

7 THE RISE OF THE STREAMERS

Summary—The origin of Netflix is discussed and how the studios thoroughly misjudged its potential by simply viewing it as another revenue stream for their own films. The pivot to original programming is revealed as the key to Netflix’s exponential growth, and Netflix’s model for working with producers is analyzed. A comparison is made between the traditional studio profit model and how the streamers make their greenlighting decisions. Preferred genres and budgetary ranges are discussed. The approaches of Netflix’s streaming competitors are reviewed, and an attempt is made to project who will succeed and who will fail. The importance of global initiatives for the streamers is debated, including the move to local language production. Some tips for producers are presented which should enable them to successfully pitch streamers, including at what point in the development process should the dialogue be initiated. Netflix was founded in 1997, and its initial business model focused on DVD sales and rentals by mail. Marc Randolph and Reed Hastings founded the company after Hastings sold his previous company Pure Atria to Rational Software Company for $700 million in what was then the biggest acquisition in Silicon Valley history. Randolph admired the fledgling e-commerce company Amazon and wanted to identify a large category of easily handleable personal goods which could be sold over the Internet utilizing a similar model. The partners rejected VHS tapes as too unwieldy to ship, but when DVDs were introduced in 1997, they realized they were eminently suited for shipments by mail. Netflix launched as the world’s first online DVD-rental store with 925 titles available, which they licensed from studios and independent distributors. Its pricing model tracked its brick and mortar competitor—Blockbuster—using a pay-per-rent model, with similar rates and due dates. Netflix introduced the monthly subscription concept in 1999 and moved to a business model of flat-fee unlimited rentals without due dates, late fees, shipping and handling fees, or DOI: 10.4324/9781003153702-8

78  The Rise of the Streamers

per-title rental fees. Ironically, Netflix had only 300,000 subscribers in 2000 and had accumulated $57 million of losses, when it approached Blockbuster to be acquired for $50 million.1 The proposal was that Netflix would be renamed Blockbuster.com and would handle the online business while Blockbuster would handle DVD shipments, making the company less dependent on the US Postal Service. The offer was declined, which was probably one of the most stupid decisions in American corporate history. Netflix’s initial success can be largely attributed to the exponential growth in sales of DVD players based on dramatically lower price points. DVD players became available at around $200 in 2001 and became one of the year’s most popular Christmas gifts. By 2002, Netflix saw a huge increase in its subscription business. The company went public in May 2002 selling 5.5 million shares of common stock at $15 per share. Netflix posted its first profit in fiscal 2003, and by 2005, its library consisted of 35,000 different films and the company was shipping out 1 million DVDs every day. Of course, none of this would have been possible if it didn’t have the full co-operation of the studios and independent distributors who made their content available on the Netflix platform. For some time, the company had considered offering movies online, but it was only in the mid-2000s that data speeds and bandwidth costs had improved sufficiently to allow customers to download movies from the net. Netflix at first wanted to introduce a hardware box to accomplish that, but the streaming success of YouTube persuaded the company to shift to a streaming model, a project that was completed in 2007. By that time, Netflix had delivered its billionth DVD, but it was already beginning to move away from its original core business model to a subscription video on demand model via the Internet. The challenge Netflix faced with this new model was that when it began to offer streaming content for a simple monthly subscription rate, it could only offer about 1,000 movies and TV shows in comparison with its more than 100,000 DVD titles. But as its SVOD platform began to grow in popularity, its library grew commensurately and reached 12,000 titles by 2009. In 2010, Netflix and Relativity announced a then groundbreaking deal whereby Netflix acquired Relativity’s future output of theatrical releases on an exclusive basis. The window of availability coincided with the traditional pay television window, which is roughly 1 year after theatrical release, and alleviated the need for Relativity to go through the pay television output deals its studio releasing partners had with the premium pay-television channels. While the terms of the Netflix deal have never been released publicly, Relativity was quite open that Netflix’s license payments were very competitive with what HBO and Starz were paying for major studio product. That means they were tied to actual box office performance and presumably were also skewed in favor of poorer performing films. Undoubtedly, Relativity’s Netflix deal underpinned CEO Ryan Kavanaugh’s claim that its Netflix deal together with its favorable international output deals put an effective floor on how much

The Rise of the Streamers  79

money Relativity could lose on any of its films. That said, the company has filed Chapter 11 bankruptcy on several occasions. How could this be if Kavanaugh was correct in his assertion? Because the company shouldered an enormous overhead, and while it may not have shown significant losses on its film slate, neither did it have many winners, certainly not enough to absorb that tremendous overhead. Netflix soon recognized, however, that it could no longer rely simply on third-party product if it were to achieve its ambitious expansion goals. Accordingly, it opted to make its own original programming, initially television episodic series. In 2011, it acquired the hour-long political drama House of Cards in an aggressive bidding contest in which it outbid HBO, Showtime and AMC.2 The series debuted in February 2013. The show was well-received, but the real success of Netflix’s new endeavor was Orange is the New Black, which was renewed for a total of seven seasons. The costs of high-profile episodic series are extremely daunting. Netflix spent a reported $100 million to produce two 13-episode seasons of House of Cards. At a $7.99 monthly subscription, it needed more than 500,000 new subscribers to sign up for 2 years to break even. Given that Netflix was targeting five new shows per year (now, of course, it is looking to introduce a significant multiple of that number), that translated into a need for 2.6 million incremental subscribers. But Netflix’s growth in subscribers vastly eclipsed that number and has continued to more than compensate for Netflix’s expenditure on original programming. Netflix has also outperformed HBO in this regard. HBO gets about $7.50/month per US subscriber. With the average charge for HBO on a cable bill being around $15/ month, HBO splits that fee 50/50 or so with the cable operator, so HBO’s net is roughly on par with Netflix. HBO’s much stronger profitability, however, permitted it to fund the most expensive television series, even outpacing the four main US networks. The debut show of Boardwalk Empire cost approximately $20 million while the final season of Game of Thrones reportedly cost on average $15 million.3 HBO is still a significant licensee of first-run feature films, having re-upped its output deals with Fox (through 2022) and Universal (through 2023) in addition to its ongoing output arrangement with Warner Bros., its sister company. Paramount set up its own premium pay television service, Epix, with MGM and Lionsgate in 2009, but MGM bought out its partners in 2017 after Lionsgate acquired a pay television competitor, Starz, which came with its own output deal with Sony. In 2014 Netflix dipped its toe into the feature film waters when it announced a four-movie deal with Adam Sandler and his Happy Madison Productions. Netflix justified its decision to get into business with Sandler on the basis that he had broad appeal with Netflix’s audiences, both in the United States and abroad. More cynically minded observers opined that Sandler was happy to sign the Netflix deal because his recent films performed underwhelmingly at

80  The Rise of the Streamers

the box office. Netflix has been quite happy with the relationship based on the number of eyeballs Sandler’s films have attracted for the service. At the same time the company started to internally self-produce its original content, and by 2017 it released 1,000 hours of original content. This enabled Netflix to cope with the inevitable decision of leading content creators like Walt Disney and Comcast owned NBC/Universal to pull more and more of their own titles from Netflix to put on their own streaming services. Netflix made the whole industry stand up and take notice when it announced in June 2015 that it would fully finance a $60 million film, War Machine, about General Stanley McChrystal, the commander of US troops in Afghanistan, starring Brad Pitt. The evolution of the project is interesting, and it offers excellent insight into Netflix’s competitive strategy with the studios. The project had been set up at one of the leading independent production companies, New Regency, which made 12 Years a Slave with Pitt’s production company Plan B (to be precise, New Regency came into the film late by putting up an advance for domestic rights—most of the initial risk on the project was shouldered by my client, River Road Entertainment) in conjunction with RatPac, a relatively new company funded by the Australian billionaire James Packer and run by the director/producer Brett Ratner. But New Regency and RatPac balked at the $60 million budget, so when the project was put into turnaround, Netflix swooped in. Industry insiders pointed to the director’s take on the material— which apparently was more in the vein of a satirical comedy than a dramatic biopic. A $60 million film that might turn off most of mainstream America and would appear to have limited international appeal could be considered a major commercial risk, but Netflix doesn’t have the same economic model as the studios. If it believes that a specific original program can attract a significant number of new subscribers, even a $60 million investment can be explained away. Undoubtedly, there was also the PR coup of attracting one of the top actors in the world to star in a Netflix original film. Once Pitt committed, all the key talent agents in town started to take Netflix seriously as a possible home for their clients. Netflix can thank John Malone, who controls Charter Communications, the second-largest cable company in the United States, because if it weren’t for the deal which Malone consummated with Netflix in 2008, whereby Malone’s premium pay-television service Starz agreed to stream 2,500 films and television shows on Netflix, Netflix might never have transformed from a disc mailer to a streaming service. Netflix’s growth exploded, single-handedly creating the streaming market that Malone tried to short circuit by terminating the Starz deal with Netflix in 2012.4 Had he re-upped, he could probably have negotiated a big stake in Netflix for himself. Losing Starz, Netflix was forced to rely on cheap, easy to license television libraries, which turned out to be more popular than feature films. The rest is history. Now Malone and the other cable carriers face the challenge of persuading cable subscribers to stick with more

The Rise of the Streamers  81

expensive cable packages and not flee to over-the-top (OTT) distributors like Netflix, a battle they are gradually losing as the so-called cord-cutting becomes a more prevalent phenomenon. The movement from cable channels to OTT platforms will undoubtedly have an adverse impact over the long term for the economics of theatrically released feature films, since the contribution of premium pay television license fees is a significant risk mitigator for the major studios as well as for the independents that distribute through the major studios. Pay television license fees are tied to the quantum of theatrical film rentals, but, most importantly, they are based on formulas that de-escalate the better the box office results. That is, the percentages are higher on the lower end of theatrical performance and decrease as performance improves. Plus, they are capped at a maximum license payment per film. The combination of a monotonically decreasing license payment and a cap has the effect of overcontributing on unsuccessful films, where the distributor needs the help, and undercontributing on successful films, where the distributor has the benefit of higher theatrical rentals and, more likely, higher home video revenue, which is positively correlated with box office performance. Even more than comparative box office results, international streaming revenues are growing significantly faster than those in the US market. The number of Netflix’s domestic subscribers nearly doubled from 2013 to 2018, going from 33 million to 58 million, but international subscriptions increased more than sevenfold during the same time frame, going from just 11 million to 80 million. This explains why Netflix’s international streaming revenue topped domestic streaming revenue for the first time in 2018, despite the fact that average monthly revenue from international subscribers ($9.43) was lower than average monthly revenue from domestic subscribers ($11.40). Wall Street has continually focused on subscriber growth as opposed to bottom line when it comes to valuing Netflix’s stock, which currently trades at a whopping 85 times earnings. To put Netflix’s business strategy into perspective, Netflix had virtually identical revenue with HBO in 2014, but Netflix generated only $266 million in annual profit, compared with HBO’s $1.8 billion. There was also a big gap in the subscriber bases: HBO ended 2014 with 138 million worldwide subscribers, versus 57.4 for Netflix. Since then, Netflix has demonstrated much faster growth than HBO. HBO’s worldwide subscriber base peaked at 142 million in 2017. At the beginning of 2021, Netflix surpassed 200 million worldwide subscribers. The discrepancy in market valuations can be seen by the fact that Netflix’s market capitalization today, even given that the stock price is extremely volatile, exceeds $230 billion, while all of WarnerMedia, including HBO, which arguably is the company’s crown jewel, was sold to AT&T for $85.4 billion. Why have Netflix’s margins been so much slimmer than HBO’s? Primarily because Netflix has been spending so heavily for content to foster international

82  The Rise of the Streamers

growth. Clearly Netflix has recognized that the US market may be reaching a point of saturation. But HBO too has had its challenges. Given its very healthy profit margins, it has resisted breaking its bond with cable television and only went whole-hog into streaming with the introduction of HBO Max in 2020. HBO’s streaming service, HBO Max, provides consumers an a la carte way to watch each of the network’s shows, film and television, as they come out without paying for a costly cable package. Canal Plus, which is the HBO of France, faced a similar challenge with regard to whether it should embrace a streaming platform. It resisted that strategy until 2015, when it bit the bullet and purchased Orange’s OTT platform Dailymotion. The French government had blocked (or threatened to block) previous overtures from Yahoo to acquire the site and from Hong Kong-based PCCW to acquire a 49% interest. Dailymotion is an interesting example of the lack of competitiveness of European challengers to US content aggregators. Dailymotion preceded Netflix, Amazon Prime and Hulu into the market. It was founded in 2005, and in 2009 the French government invested in it. Orange acquired a 49% stake in 2011 for Euros 62 million and bought the remaining 51% for Euros 61 million in 2013. In 2015, Vivendi, the owner of Canal Plus as well as Universal Music, purchased an 80% stake in Dailymotion from Orange and increased its ownership to 90% later that year. In September 2020, Dailymotion partnered with Mi Video, the global app developed by Xiaomi in China, which will help Mi Video to continue its growth momentum by giving it access to Dailymotion’s global and regional music, entertainment, sports and news catalogues. Dailymotion is one of the biggest OTT platforms in the world, with content available in 18 different languages and in 35 localized versions, featuring local home pages and local content. But it has been blown out of the water by the US upstarts. You can get a sense of its failure to generate competitive metrics, particularly its inability to generate meaningful profits, by the fact that the entire company was valued at only Euros 120 million when Orange bought out the other shareholders in 2013.5 Vivendi has built up a huge war chest of some Euros 15 billion by selling off its non-media assets, including various telecom companies around the world, including Global Village Telecom in Brazil to Telefonica for GBP 7.5 billion, after having first spun off its original water and waste companies, along with in other public service sectors, into a new company, Veolia, which was IPO’d in Paris and New York in 2000–01. While Vivendi has expressed a desire to continue to expand in digital entertainment, it has not made any major acquisitions recently. However, the company announced in February 2021 that it aims to distribute 60% of subsidiary Universal Music Group’s share capital to shareholders and list the music label in Amsterdam by the end of the year. It has set a minimum target of Euros 30 billion for the subsidiary’s enterprise value. The decision to spin off its music label was undoubtedly a result of continuing

The Rise of the Streamers  83

pressure by Vivendi’s leading institutional shareholders for such a distribution to reduce Vivendi’s conglomerate discount. Vivendi did make a move to expand its European television footprint when it announced in 2016 that it had agreed to acquire Italian media giant Mediaset’s pay television unit. The transaction was to include a 3.5% share swap between the two companies. The deal was to be an important step in Vivendi’s ambitions to build a pan-European group strong enough to challenge Netflix and Rupert Murdoch’s Sky group, but Vivendi changed its mind and revised its terms to involve only a 20% minority interest plus 15% of Mediaset itself in 3 years. A senior Vivendi executive said the company thought it was buying a Ferrari, but it turned out it was only a Fiat! Mediaset, smelling a creeping takeover, sued (indeed Vivendi built up a 29% stake in the company over time). The litigation continues even today. The watchdog agency which regulates competition in the communications industries in Italy, AGCOM, commenced an investigation in December 2020 aimed at assessing whether Vivendi’s holdings were in breach of national rules granting media plurality, which could help Mediaset, controlled by the family of former Italian Prime Minister Silvio Berlusconi, in its bitter battle against Vivendi, its second-largest shareholder. Original content is clearly more cost-efficient for Netflix in the long run than licensed content. There are fewer royalties to pay, and the company can obtain worldwide rights in perpetuity, so there are no bidding wars to engage in after an old contract expires. However, it is important to note that Netflix users are calculated to watch 63% licensed content and 37% Netflix originals, so licensed content remains very important in the service’s value proposition. As Netflix’s streaming competitors, which have now expanded beyond Amazon to include Disney+, Apple, Hulu and recently HBO Max, NBC/Universal’s Peacock, and CBS All Access which is due to morph into Paramount+ in March 2021, have moved or are moving into original programming, Netflix will clearly face growing competition in coming up with attractive new content. In effect, the old competitive studio rat race has transferred over to a streamers’ survival of the fittest. In the beginning of 2021 84% of Netflix subscribers also subscribed to Amazon Prime Video, and over 50% also subscribed to Hulu, which is controlled by Disney.6 Compared to cable subscriptions, which are suffering from growing cancellations (the so-called “cord-cutting”), streaming services offer lower prices and an expansive library of shows, but with the average household now having three or four subscriptions to streaming services, it won’t be too long before subscription VOD will hit the wall, and lower rated services will find it difficult to compete. Netflix’s efforts to produce new content, secure the rights for third-party produced content and expand its platform over 190 countries, with the only major exception being China where the Government blocks sole or majority ownership by non-resident companies, has resulted in Netflix’s taking on significant debt. The company borrowed over $16 billion in less than a decade,

84  The Rise of the Streamers

which prompted criticism that this capital structure was unsustainable. The stock market, however, was prepared to give Netflix a pass as long as its rate of subscriber growth continued on a significant positive upward arc. Accordingly, the stock price at the beginning of 2017 was $127.49, while at the beginning of 2021, it had reached $522.86. And the company reached a significant financial milestone at the beginning of 2021, when it announced that it would no longer need to raise external financing for its day-to-day operations. The aggressive borrowing strategy seems to have worked as its current worldwide subscriber base in excess of 203 million is generating sufficient ongoing revenue to service a debt level on the order of $10–15 billion and still be able to maintain its immense content budget, which topped $17 billion in 2020. To put that number into perspective, Amazon probably spent around $7 billion over the same period and HBO more on the order of $4.5 billion.7 Getting to over 200 million subscribers has permitted Netflix’s operating profit to expand significantly, increasing 76% over its 2019 number. The company apparently feels sufficiently flush to even contemplate stock buy backs. Netflix’s enormous spending on content will permit it to release 70 new films in 2021, more than one new film every week. The lineup features a collection of stars, including Leonardo DiCaprio, Meryl Streep, Dwayne Johnson, Jennifer Lawrence, Gal Gadot, Idris Elba, Zendaya, Naomi Watts and Octavia Spencer, which make it the envy of any studio. And with respect to episodic television, Netflix is achieving record views on its most popular shows. The Crown, by its fourth season, has drawn more than 100 households, while its largest film for the period, The Midnight Sky, which was helmed by George Clooney, was watched by 72 million households. As I indicated earlier, the growing competition in the streaming space raises the risk level for Netflix, which now has the second highest market capitalization in the industry after Walt Disney. The emergence of new VOD platforms has encouraged a phenomenon much like “cord cutting” with respect to cable—consumers are indulging in “switching” whereby, after watching their favorite shows on one service, more people are cancelling and then subscribing to a different service. A survey by the consulting firm Deloitte found in January 2020 that 20% of those who paid for a streaming service had cancelled it within the previous year, and, by October, as new services came to life, 46% had cancelled at least one of their services in the last 6 months. New competitors like HBO Max and NBCU’s Peacock are already eating into Netflix’s lead in the streaming wars. While Netflix still dominates the streaming universe in the United States, new data shared by Ampere Analysis with TheWrap shows that Netflix’s market share has shrunk from 29% to 20%, a drop of nearly one-third, as more services enter the market. The same can be said for Amazon Prime Video. A year ago, Amazon Prime Video claimed 21% of the US streaming market, but that has eroded to 16%, a drop of nearly 24%. Amazon Prime Video is a bit trickier for analysts to project. Anyone who pays

The Rise of the Streamers  85

for an Amazon Prime subscription gets access to Prime Video, but that doesn’t necessarily mean every Prime subscriber is watching content online. Some may be signing up for free shipping on goods. Amazon hasn’t given an update on its total Prime memberships since early 2020, when it announced it had passed 150 million paying customers. Ampere’s data indicates nearly 54 million Prime members use their Prime Video app in the United States.8 Disney-owned Hulu sits in third place, but that includes both its Hulu streaming service and its live TV streaming service. Surprisingly, Disney+ trails HBO Max in fifth place despite the uneven rollout of HBO Max last year. Disney+ skews very much international. Of its 94 million subscriber base at the end of 2020, slightly less than 40 million were American. While HBO’s numbers are impressive, its reported 41 million US subscribers represents a misleading number, because HBO already had existing streaming customers across both its HBO Go and HBO Now services prior to HBO Max. The biggest gainers, in terms of market share, were Peacock, which went from 0% of the market to 5% by the end of 2020, and HBO, which only claimed 3% of the streaming market at the same time last year. That share has now quadrupled in size, as HBO is aggressively promoting its linchpin service, HBO Max, which is benefitting significantly from Warner Bros.’ decision to release all 17 of its 2021 films on HBO Max at the same time they hit the theaters. Amazon has pursued a somewhat different strategy to Netflix. Amazon’s Prime Video is a subscription video on demand service via over-the-top streaming combined with a rental service. It is offered as a standalone service or as part of Amazon’s Prime subscription. Like Netflix, it primarily distributes film and television series produced by Amazon Studios or licensed from third parties, but unlike Netflix, it also hosts content from other providers, content add-ons, live sporting events and video rental and purchasing services. In addition to video streaming the subscription includes music and free two-day (or faster) shipping. At the end of 2019, it had 112 million members in the United States, which is substantially greater than Netflix, whose subscriber base in the United States was roughly 74 million at the end of 2020. Amazon’s international footprint is somewhat less than Netflix’s, while it is worth mentioning that both companies are currently blocked in China. It is also worth pointing out that Amazon has been much slower than Netflix in rolling out original film and television productions. In 2019, Amazon spent $6 billion on original programming, while Netflix spent $15 billion. You can imagine therefore who gets the first call from producers and agents. At the start, veteran independent producer, Ted Hope, steered Amazon Studios’ founder Roy Price toward more artistic fare, greenlighting Spike Lee’s ChiRaq as well as the Woody Allen films Café Society and Wonder Wheel. Sadly, the Amazon/Allen relationship turned out not to be a match made in heaven. It was originally intended to be a six-picture deal, but Amazon backed out after

86  The Rise of the Streamers

the first two films after Woody became embroiled in a spate of unfavorable publicity related to the #MeToo movement. Allen filed a $68 million breach of contract law suit, but the law suit was settled before the case came to court. In terms of full disclosure, I served as an expert witness in the case, but I won’t reveal on which side. Amazon started out as a friend to old Hollywood, being more willing to commit to traditional theatrical windows, unlike Netflix, which favored delivering films to its subscribers quickly, consistently foregoing any theatrical release. Amazon became known for its artistic taste having acquired two-time Oscar winner Manchester by the Sea and the acclaimed 2017 comedy The Big Sick. Then, in 2019, it performed a volte-face. Its expensive adventure film The Aeronauts, which was supposed to play exclusively on IMAX screens for a 1-week engagement before a full theatrical run, instead never played on IMAX and only had a 2-week run in a limited number of theaters before it became available for streaming on Amazon Prime Video. Amazon also has a challenge which Netflix does not face. Initially, Amazon was focused on domestic rights, which means that producers looking to monetize foreign rights to help fully finance budgets would typically have to find a way to pre-sell international. But without a meaningful theatrical commitment up front, which Amazon would not necessarily commit to, the film would find it difficult to command a sufficiently large foreign presale to close the financing circle, unless the producer could access sufficiently large “soft money” benefits or find investors who were prepared to take what I regard as excessive risk on the quantum of ultimate foreign revenues. International distributors are not terribly interested in films that aren’t going to command meaningful US theatrical releases—defined on the order of at least 1,000–1,500 screens. In fact, international distributors today frequently require a contractual commitment of that magnitude. I had long discussions with Amazon about structuring a slate deal to underwrite the required value of incentives and foreign minimum guarantees to top up Amazon’s domestic license fee, but I indicated that there was too much uncertainty as to the foreign value of those films when the extent of Amazon’s domestic release commitment could not be quantified in advance. Not surprisingly, Amazon responded to this challenge by expanding its international footprint over time, so, while it is not as geographically diversified as Netflix, it is rapidly making up that gap. Sundance 2016 represented the first real “flexing of the muscles” by the two largest streamers against the specialty distributors, both studio-controlled and independents. To borrow Tennyson’s poignant language, they descended “like the wolf on the fold,” and like Sennacherib’s cohorts, they were “gleaming in purple and gold,” referring to the size of their pocketbooks. Amazon paid $10 million for all domestic rights on Kenneth Lonergan’s Manchester by the Sea (it subsequently brought in Roadside Attractions, a specialty theatrical distributor, to handle theatrical rights for an awards-season run). Netflix paid nearly

The Rise of the Streamers  87

$7 million for SVOD rights to Paul Rudd’s The Fundamentals of Caring and $5 million for worldwide streaming rights on the Ellen Page drama Tallulah. Interestingly, Netflix apparently offered $2.5 million more than Fox Searchlight, which won the bidding contest on The Birth of a Nation (which represented the highest price ever paid at a film festival at the time—$17.5 million for worldwide rights) because of its proven ability to generate Oscar awards on its theatrical releases, while Netflix was prepared to commit only to a day-and-date simultaneous streaming/theatrical release, like it did with Beasts of No Nation.9 This bidding contest revealed an inherent advantage the streamers have versus the traditional studios and the specialty distributors. The streamers can justify the price they offer based on the impact the title would have in helping to grow their subscriber base. They are thus looking for product which is deemed to appeal to their current and potential audience. How else can you justify Amazon’s spending $10 million for Manchester by the Sea when no Lonergan film has ever grossed $10 million at the domestic box office, or it paying $14 million for domestic rights on Woody Allen’s Café Society when his previous two films, Irrational Man and Magic in the Moonlight, tanked at the box office. Amazon supported the film’s platform release with an aggressive P&A spend, but it wound up doing a disappointing $11 million at the domestic box office. The studios and the specialty distributors, on the other hand, have to be able to justify the price they pay based on actual performance at the box office plus ancillary revenues. In addition, they have to factor in the cost of P&A, which can exceed the actual budget of the film at times. Specialty distributors can control their P&A expenditure by indulging in a “platform” release, but such controlled releases typically cannot generate anything like the grosses a broad national release on 2,000–3,000 screens can accomplish. Netflix, on the other hand, could have buried its purchase price in its overall P&L, but Fox Searchlight was “murdered” by the controversy which surrounded the producer, director, writer and star Nate Parker (how could any auteur be more important to the movie he created?). The controversy involved an alleged rape many years ago when Parker was in college and also implicated Parker’s collaborator on the film, Sean Celestin. Parker was acquitted of the charge; Celestin was found guilty, although the sentence was thrown out on appeal. No second trial occurred because the accuser refused to testify. The facts would probably not have caused the public outcry which the film generated (although public sensitivity today is undoubtedly much more of an issue), except the accuser later committed suicide, and Parker has refused to apologize. The cloud which surrounded the film’s release unquestionably caused the film to “tank” even though the subject matter was so relevant to the current dialogue about race relations in America. It only generated $16 million at the domestic box office. Amazon’s success in producing original content has always been largely in episodic television, including such popular series as The Marvelous Mrs. Maisel, The Man in the High Castle, Bosch and Tom Clancy’s Jack Ryan, but for the first

88  The Rise of the Streamers

time in 2021 Amazon Studios reversed the equation by receiving seven Golden Globe nominations in film and three in television. Not surprisingly, given its preeminent market share in the theatrical marketplace, where it accounted for nearly 40% of the 2019 US box office, Disney has catapulted to being a major player in the subscription VOD market as well. Disney+ was only launched in November 2019 in the United States, Canada and the Netherlands, and expanded to Australia, New Zealand and Puerto Rico a week later. It became available in select European countries in March 2020 and in India in April. Additional European countries received the service in September 2020, with the service expanding to Latin America in November 2020. Despite the gradual roll-out, Disney+ had 100 million worldwide subscribers by the beginning of 2021, way ahead of its target which only projected this level by 2024. Given the breadth of content available on the service, which includes Walt Disney’s extensive film and television library, both live action and animation, and the content provided by its affiliated studios, including Pixar, Lucasfilm and Marvel and Disney’s prescient decision to aggressively price its monthly subscription at $6.99, it is not surprising that Disney has hit these subscriber numbers so quickly. It should also be kept in mind that Disney+ has access to Twentieth Century Fox’s large library since Disney acquired Fox in 2019. Disney also controls and majority owns the fourth largest American subscription video on demand Service, Hulu, which it is positioning to show more adult-oriented fare to complement Disney’s emphasis on family programming. Disney also offers the largest sports-oriented streaming service, ESPN+. Disney+ has jumped into original programming, primarily using the resources of its Lucasfilm and Marvel subsidiaries. Its first live-action series in the Star Wars franchise was the highly acclaimed The Mandalorian, created by Jon Favreau. The series was nominated for Outstanding Drama Series at the 72nd Primetime Emmy Awards, and won seven Primetime Creative Arts Emmy Awards. A second season premiered in October 2020, and a third season is in pre-production. As I mentioned in the last chapter, the importance of The Mandalorian for special effects-oriented film and television programming is the StageCraft technology developed by Industrial Light and Magic, which uses virtual sets and a 360-degree video wall to create the series’ environments. This technology has since been adopted by other shows and has particular value in addressing COVID production issues. Then there is the most highly valued company in the world, Apple. In 2007, Apple introduced its prototype Apple TV, which is a digital media player and micro-console that can receive digital data for visual and audio content such as music, video, video games and play it on a connected television set or other video display. To support this platform, Apple introduced its own streaming service Apple+ in November 2019 that offers originally produced film and television content from Apple. However, the industry is still unclear as to what Apple’s creative approach to original programming really is. The company has

The Rise of the Streamers  89

indicated that it intends to produce high-level original scripted programming in an effort to compete with Netflix, Amazon and Hulu, In August 2019 it was reported that Apple had already spent over $6 billion on original programming, and on November 1, 2019, the service launched in over 100 countries through the Apple TV app. But it will be a tough uphill climb for the technology giant because Netflix, Amazon and Disney have way more original content coming online than Apple, and HBO Max has all of the Warner Bros. theatrical releases in 2021. Apple appreciates the challenge because they have priced their monthly subscription at the bottom end of the range for SVOD services, plus from February until June 2021 Apple is giving a $4.99 credit each month subscribers keep their Apple+ subscriptions. The laggards in this race are NBCUniversal and ViacomCBS. NBCUniversal’s OTT service represents a hybrid approach combining a free tier whereby about two-thirds of the library can be viewed with ads at no cost, a premium tier where the entire library can be viewed with ads at a monthly subscription of $5 and a premium-plus tier which is a true SVOD platform without ads for $10 per month. Some promos can cut that cost. Customers of Comcast Xfinity, NBCUniversal’s parent, and Cox are eligible for a $5 discount, and Spectrum video or broadband customers are eligible for an extended free trial on Peacock premium-plus. Because of the pandemic, filming of original programming largely shut down in March 2020 and plans to piggyback Peacock’s national launch on NBC’s live coverage of the summer Olympics became moot when the games were pushed back to July 2021. One ace in the hole that Peacock has is that it is the exclusive streaming home to WWE Network, which is the leading distributor of professional wrestling events. The service will widen to include more than 17,000 hours of new, original and library WWE Network programming on demand and on a 24/7 channel on Peacock. That includes live pay-per-view events available to stream at no added cost. Peacock subscribers also have exclusive access to more than 175 English Premier League soccer matches. ViacomCBS is the last major studio/network in the game in the sense that CBS All Access, which is an existing SVOD service with 8 million subscribers as of November 2020, will be rebranded as Paramount+ on March 4, 2021 in the United States, expanding to Latin America and the Nordic countries at the same time and Australia in mid-2021. CBS All Access’ primary attraction was the Star Trek programming and the Sponge Bob films, but it also offered UEFA Champions League and Europa League soccer matches, replacing Turner Sports. CBS All Access provides complete back catalogues of most of CBS’ current series with certain exceptions, as well as a wide selection of episodes of classic series from the CBS Media Ventures program library, including such popular shows as Star Trek, Cheers, MacGyver, Twin Peaks and CSI: Miami. It will be interesting to see how aggressive the service will now be in commissioning original programming to compete with the bigger players on the block.

90  The Rise of the Streamers

It should be noted that when people refer to OTT (“Over the Top”), they are referring to a subset of video on demand. OTT means transmission to the viewer via the Internet without requiring users to subscribe to a traditional cable or satellite pay-television service. The broad VOD market is divided into four subcategories: premium VOD (PVOD), transactional VOD (TVOD), subscription VOD (SVOD) and advertising VOD (AVOD). Premium VOD is a new development as a result of changing windows, which I referred to earlier. PVOD is an evolving streaming service which permits consumers to watch blockbuster movies at home on the same day as their theatrical release, or close to it, so consumers, by paying $30–50 per movie, can see films at home for which they would normally have to wait 3 to 6 months. For a group of 3–6 or more, PVOD pricing is very competitive with the cost of going to a theater. Warner Bros.’ decision to make all their 2021 releases available on HBO Max at the same time they are released in theaters effectively jump started the new premium VOD window. Transactional VOD has existed in the marketplace for a number of years. Originally it was offered via set-top boxes, but it has now migrated to OTT services. TVOD is a straightforward service where the consumer pays a set fee based on the content he or she watches. It is basically a value-for-money experience for the audience. TVOD services will normally try to retain customers by offering attractive pricing on selective pieces of content, thereby hoping that users will come back to the service repeatedly for their general video entertainment needs. The leading TVOD services emphasize more recent releases because that is what the consumer primarily demands, although a number of TVOD platforms have been established with specific genre concentration. If there is a good demand for a particular film online, content owners and producers can generate significant profit through TVOD. The most prominent TVOD platforms include YouTube, iTunes and Google Play. Despite the much lower cost of setting up a TVOD platform, SVOD clearly represents the most moneymaking VOD model. According to Business Insider, 55% of Americans use Netflix, where more than 1 billion hours of video is streamed each week, and 31% use Amazon’s Prime Video service. The SVOD model works so well because of something which is called the membership economy. The Membership Economy is the title of a book by Robbie Kellman Baxter, a leading consultant to the VOD industry. The membership economy, she explains is all about finding your super-users, establishing and growing the “forever” transaction, and building recurring revenue off of something you created once. The question is, “Would you rather have a subscriber pay $10 for one video once, or $10 a month for unlimited access to your entire library for years?” You will probably have to think long and hard before you answer, but trust me, SVOD is definitely the more profitable way to go. As Disney, Apple, Warner Bros., NBCUniversal and ViacomCBS begin to do battle with Netflix and Amazon for the global SVOD market, the fight for

The Rise of the Streamers  91

online advertising is opening up a new front in the streaming wars. Welcome to the introduction of advertising-backed video on demand (AVOD). On January13, 2020 Fox Corp TV stations debuted a new AVOD service, Fox Soul, to stream ad-backed free content targeting African-American audiences in the United States. On January 16, 2021 NBCUniversal laid out the details how its new streaming service, Peacock, would be structured. Peacock will be available in three different tiers, differentiated by pricing and advertising. Peacock Free will offer 7,500 hours of ad-supported programming, including next-day access to current seasons of first-year NBC shows. Peacock Free will also include complete seasons of classic shows, but specifics on that content remain to be given. Peacock Premium will be available in two tiers—$4.99 per month with advertisements and $9.99 per month with no ads. Both tiers of Peacock Premium will provide additional content that will not be available to Peacock Free users, including early access to late-night shows and sports. As an inducement for its ad-driven services, Peacock will include a maximum of 5 minutes of ads per hour. In total, Peacock Premium will have over 15,000 hours of content including 600 movies and 400 TV series. The highly acclaimed The Office will move over from Netflix to Peacock in 2021. At the Consumer Electronics Show in January 2020 NBCUniversal introduced One Platform, which aims to create a single ad technology and sales infrastructure across all of its TV and digital properties. NBCUniversal says One Platform will reach more than 210 million adults ages 18 and up per month and offer the kind of micro-targeting and real-time feedback advertisers have come to expect with commercials placed alongside videos on Facebook and YouTube. A lack of this kind of targeted ad placement is one reason why AVOD has lagged behind SVOD. Traditional TV ad booking, where networks use broad demographics such as age and gender to sell viewers to brands, have less appeal online where the audience is increasingly fragmented. But as more studios move to a hybrid SVOD/AVOD model, AVOD is expected to take off. Ampere Analysis, a digital research group, expects revenue from the global AVOD market to top $62 billion by 2024, nearly double the $33.8 billion it generated in 2018.10 With this prospect in mind, it was not surprising that Viacom paid $340 million for AVOD start-up Pluto TV in 2019. Many observers think an SVOD industry of dozens of services asking for $5 a month or more is unsustainable. Several analysts have predicted a wave of consolidation among the midlevel streamers and media and entertainment companies. The counterargument is that the stocks of companies launching streaming services right now are up significantly, including ViacomCBS and Discovery, and they will want to give these new services sufficient breathing room before they do anything rash. I think it’s safe to predict that Netflix and Disney+ will continue to dominate the streaming field. Digital TV Research analyst Simon Murray even

92  The Rise of the Streamers

predicted in February 2021 that Disney+ would overtake Netflix’s global subscriber base by 2026 (294 million versus 286 million by then). In trying to guesstimate who will occupy the other top-tier slots, it should be appreciated that the sheer capital weight of the parent companies to AppleTV+ and Amazon Prime Video (which are worth $3.7 trillion combined) put them in a different league to their competitors. As someone described them, they are like sports teams without salary caps. Of course, the streaming services of the other major studios, not including Sony—HBO Max, Peacock and now Paramount+ (although its predecessor company CBS All Access has been around since 2014)— have extensive libraries to milk and have or will show aggressive spending plans for original programming, so it is premature to write off their ability to compete. However, the prospects for the niche services, like the Criterion Channel, Britbox and Shudder, are much cloudier. One of the major factors in the competition will be the “churn” rate. Analyst Matthew Ball of data company Antenna has prepared churn charts to attempt to quantify the impact of the “churn” phenomenon. He points out that some services churn rates spike or dip depending upon when key shows, like Game of Thrones and The Mandalorian, end or return, and depending on what promotional pricing is available. Hulu’s churn line, for example, slowly rose as more competitors entered the market, after dipping when it was wrapped into Disney’s streaming bundle. It has also been pointed out that households signed up for Disney+ are less likely to drop Netflix than HBO Max or CBS All Access, soon to be Paramount+. Consumers generally are willing to subscribe to both of the leading SVOD services. Most importantly, of the two key factors, price and content, a new survey from software company Amdocs suggests that the amount and quality of content on a platform is more important than the pricing of the service. When asked what drives their loyalty to video streaming services, 49% said the amount of content, 45% said the quality of content and 38% said pricing.11 Amdocs also shared data on how much people are spending: 42% of respondents said they spend more than $25 a month on video streaming, 10% spend $50–100 a month, which seems a tolerable range, 6% spend $100–150 and 2% spend more than $150. In another recent study, just over half those surveyed said they didn’t want to spend more than $20 a month on streaming services, which represents about the combined cost of Netflix and Disney+, not a good harbinger for the middle-tier services.12 Other recent studies have found that the average household has between three and four subscription services. Spending resistance by a large share of the market bodes well for the future of AVOD services. A study commissioned by The Trade Desk, a Ventura, CA adtech company found that 72% of those surveyed preferred free or low-cost adsupported TV over ad-free and more expensive options, with 14% preferring the ad-free alternative.13

The Rise of the Streamers  93

In a period dominated by the pandemic when new production has largely shut down, although it is now picking up again, streaming services have demonstrated increasing demand for exclusive programming, which means that the streamers’ parent companies are becoming more protective of their library content than in the past. Not only does this entail the hoarding of library assets, but the companies are aggressively buying back individual library assets previously licensed to others for use on their own new streaming platforms. At the same time, dollar commitments for original programming are increasing exponentially, which implies a potential windfall for aggressive producers. We should examine the economics of both licensing to and producing for the streamers from the producer’s point of view versus the historic financing model of being a studio producer-for-hire and the independent producing model. Let’s start with Netflix, since it is both the largest licensor of existing film and television content as well as the largest commissioner of original programming. Unlike some of its competitors, such as Hulu whose basic plan combines advertising with subscription fees but who also offers ad-free viewing for higher fees, Netflix’s business model relies solely on subscription revenue. It offers three tiers of pricing that gives customers access to exclusive and nonexclusive TV shows and movies which the company has either produced itself or acquired from the content owner. For example, the owner of a TV show could allow Netflix to stream all seasons of its show for 1, 3 or 5 years. The licensing agreement may limit Netflix to, or exclude it from, specified territories. When the licensing agreement ends, both parties can negotiate a renewal, or Netflix could drop the show from its content menu if viewer interest doesn’t warrant the cost. Such licensing arrangements may be exclusive to one service or nonexclusive, which permits the content owner to license the programming to multiple streaming platforms. Not surprisingly, non-exclusive licenses are generally less expensive because the non-exclusivity diminishes the content’s value. Exclusive licenses have become more important over time as various streaming services compete for subscribers. Netflix has continued to lose popular series, such as The Office and Friends as the studios have pulled many of those shows back to drive their own SVOD platforms. In the short term, that strategy has proved very expensive for the commissioning studios. AT&T, the parent company of WarnerMedia, is paying $85 million per year for the US rights to Friends for 5 years. Netflix was paying $80 million for global rights to the show but wasn’t in a position to re-bid given WarnerMedia’s contractual options with regard to streaming rights. Accordingly, Netflix has doubled down on its commitment to original programming, both TV episodic series and feature films. Original content accounted for 37% of Netflix’s US streams in October 2018 versus 24% a year earlier and just 14% in January 2017. That implies, of course, that the majority

94  The Rise of the Streamers

of Netflix’s viewing is still from licensed content, which is more expensive than original content in terms of bang for the bucks it delivers because of rising content licensing costs (when Netflix produces its own shows, it locks in its cost in perpetuity). While that trendline was temporarily interrupted due to the pandemic, original programming in 2022 should be on a par with licensed content. When Netflix commissions an original program or acquires an independently financed project, either TV or feature film, it retains worldwide rights in perpetuity, and it does not pay profit participations. In exchange, though, it will initiate a buyout which typically will be on the order of 115–130% of the budget, and even more if the content is subject to an aggressive bidding war. This is above and beyond the fee which Netflix will permit the producer to take as a budgetary item. As one producer commented, “What’s not to like?” especially since it eliminates the huge risk of having to support broad theatrical releases with significant P&A budgets, which can easily reach $30–40 million or more even before the film has opened, without any assurance that the film will recoup its total cost—budget plus P&A. Since most films do not report net profits, there is a great temptation for producers to take the money and run. However, for those auteur directors who want viewers to have the privilege of watching their films in theaters, the Netflix model is not persuasive. Arguably for mid-level fare, a successful launch on Netflix will result in more eyeballs seeing the film than would be the case on a moderately performing theatrical film. Keep in mind that fewer producers and A-list talent benefit from any sort of gross position these days, so a built-in profit margin, rather than gambling on net profits, has a lot to recommend for itself. It goes without saying that a producer has more leverage with the streamers if he or she is in a position to finance his/her film and then put it up for the bid, just as is the case in dealing with the studios. If you make a really good film, you are likely to command a much larger premium in terms of the pickup price. If you approach the streamers to finance your film up front, you are much more likely to persuade one to come onboard if you have a package to present— preferably a “hot” director and marketable cast. Let’s face it. The Netflix’s of the world have dozens of producers knocking on their door at any one time. You’re obviously in a much better position when you have a completed film that is receiving a fair amount of buzz, and Netflix is knocking on your door, rather than vice versa. If you have sufficient equity resources to make your movies, which gives you two shots at success—either utilizing the traditional bifurcated rights model, laying off international rights territory by territory and licensing your film to a domestic distributor or laying off the film, preferably on a worldwide basis, to a streamer—your options are greatly enhanced. And if you don’t have sufficient equity resources to adopt such a two-tiered approach, you can substitute the possibility of “gap” financing or domestic backstops to supplement your equity availability. You have to be prepared to pay the

The Rise of the Streamers

95

backstop provider a “kill” fee if you don’t use them because you have a better offer, either through a streamer or another domestic distributor, but it is well worthwhile given the significantly greater advance you are likely to receive. Initially, Netflix relied heavily on a deferred payment model to pay for all this content it was acquiring. Often, it stretched out its payment schedule over as long a period as 5 years. It was able to accomplish that because the commercial banks were prepared to lend against Netflix paper, albeit typically at a 10% discount, although the banks have become more aggressive as Netflix’s record of profitability has improved, and it is not uncommon now for them to lend at no discount. I thought that the banks would get nervous at some point, but they never did, and recently Netflix moved off a deferred payment model more and more as the company’s cash flow generation significantly improved. With a partner, I developed an insurance backstop for Netflix paper, which I thought would be eminently marketable given the relatively long average life of the paper, but we were never able to compete with the banks on pricing. Amazon also used a deferred payment model, but it had the advantage over Netflix in that the banks were prepared to lend 100 cents on the dollar against Amazon paper because of the high creditworthiness of the parent. I can’t leave the topic of the streamers without some comments on how the streamers, particularly Netflix, utilize in-house algorithms and big data to assess content creation. The New York Times went so far as to claim: “Netflix is commissioning original content because it knows what people want before they do.” Traditional TV networks use standard demographic ratings such as age, race or location for their market segmentation, but Netflix instead has tracked viewing habits of its subscriber base to create the so-called taste communities, which permits the company to make recommendations to individual subscribers which increasingly drive consumer choices. These recommendations are powered by algorithms that are based on the assumption that similar viewing patterns represent similar user tastes. Netflix’s reliance on AI-generated algorithms hasn’t totally replaced human decision making, but it has eliminated much of the subjectivity which goes into individual executives’ appraisal of how well a show will play.

Notes 1 Randolph, Marc. “He ‘Was Struggling Not To Laugh’: Inside Netflix’s Crazy, Doomed Meeting With Blockbuster,” Vanity Fair, 17 Sept. 2019, www.vanityfair. com/news/2019/09/netflixs-crazy-doomed-meeting-with-blockbuster. 2 Blackburn, Bradley. “Netflix Reportedly Acquires Original TV Series ‘House of Cards,’” ABC News, 16 Mar. 2011, www.abcnews.go.com/Technology/ netflix-reportedly-acquires-original-tv-series-house-cards/story?id=13149473. 3 Clark, Travis. “How Much Money ‘Game of Thrones’ Episodes Cost to Make in the Final Season, and throughout the Series,” Business Insider, 15 Apr. 2019, www.businessinsider.com/how-much-game-of-thrones-episodes-cost-for-production-2019-4.

96 The Rise of the Streamers

4 Nelson Jr., Keith. “Big Red Mistake: Starz CEO Calls 2008 Deal with Netflix ‘Terrible,’” Digital Trends, 10 Dec. 2014, https://www.digitaltrends.com/movies/ starz-ceo-netflix-terrible/. 5 Dillett, Romain. “Orange Acquired Dailymotion for $168 Million by Buying Out Remaining 51% Stake,” Tech Crunch, 22 Feb. 2013, www.techcrunch. com/2013/02/22/orange-acquired-dailymotion-for-168-million-by-buying-outthe-remaining-51-stake/. 6 Stoll, Julia. “SVoD Service Multiple Subscriptions in the U.S. 2020,” Statista, 20 Apr. 2021, www.statista.com/statistics/778912/video-streaming-service-multiplesubscriptions/#statisticContainer. 7 Spangler, Todd. “Netflix Projected to Spend More Than $17 Billion on Content in 2020,” Variety, 16 Jan. 2020, www.variety.com/2020/digital/news/netflix2020-content-spending-17-billion-1203469237/. 8 Burch, Sean. “Netflix Lost 31% of Market Share in the Last Year as Streaming Rivals Gained Ground,” Yahoo Entertainment, 5 Apr. 2021, www.yahoo.com/entertainment/netflix-lost-31-market-share-130058085.html. 9 Siegel, Tatiana. “Sundance: How Netflix Is Spending Huge and Annoying Studios,” The Hollywood Reporter, 20 Jan. 2016, www.hollywoodreporter.com/news/ general-news/sundance-how-netflix-is-spending-857104/. 10 Moulding, John. “SVOD, AVOD and Pay TV Market Trajectories: The Latest Analyst Figures,” Videonet, 23 Apr. 2021, www.v-net.tv/2021/04/23/svod-avod-andpay-tv-market-trajectories-the-latest-analyst-figures/. 11 Antonellis, Darcy. “Research: What the New Streamer Really Wants,” Amdocs, 17 Feb. 2021, www.amdocs.com/blog/amdocs-voices/research-what-new-streamerreally-wants. 12 Ibid. 13 Spangler, Todd. “Netflix Original Series Viewing Climbs, but Licensed Content Remains Majority.” Retrieved from www.variety.com/2018/digital/news/ netflix-original-series-licensed-viewing-friends-the-office-1203085230/.

8 CAST OF CHARACTERS

Summary—The chapter introduces all the participants involved in developing, financing, producing, marketing and distributing a film, beginning with the role of the producer. Attention is paid to compensation packages, particularly new kinds of partnership arrangements. Good films begin with good scripts; the role of writers and the rights they command, including the importance of copyright and chain of title, are discussed in detail. The roles of agents and managers are contrasted, and an effort is made to describe the ethos of the leading talent agencies. When asked about the intricacies of the movie business, I respond in all candor that it is more complicated than anything I ever worked on as an investment banker. Consider the cast of characters who are likely to be involved in an independent film, listed in Table 8.1 (I divide the group into creative and business, and I do not intend either group to be complete). Now, do you have a sense of how many balls have to be juggled? With so many players involved in any transaction, there is clearly the risk of multiple conflicts of interest emerging. A well-known entertainment attorney once told me though, “You only have a conflict of interest in Hollywood if you represent more than three people around the table.” When investors ask me what is the first thing I look at when assessing a prospective film investment, I do not say “the script,” or “the cast,” or “the director,” or “the budget”—I say “the producer” and I mean it. I take producing very seriously; that’s why I’m not a producer. Being a producer is very hard work, assuming you are taking on all of the responsibilities that ultimately fall on the producer’s shoulders—as opposed to phoning it in and taking all of the credit. If you are a passive investor—not the production company that is producing the film—you are basically reliant on the producer to deliver a commercially viable product on time and hopefully on budget. You are placing your trust in DOI: 10.4324/9781003153702-9

98  Cast of Characters TABLE 8.1 Key Individual Participants in a Film

Creative

Business

Producer(s) Executive producer(s) Director Lead cast Line producer Composer Casting agent Publicity staff Cinematographer Production designer Costume Designer Editor Sound Department Special Effects Supervisor Art director

Equity investor(s) Senior lender(s) Gap lender(s) Bridge lender(s) Completion guarantor Talent Agents—representing creative elements Managers for the creative elements Lawyers for the various financiers Lawyers for the various creative elements Domestic distributor(s)—possibly one handling all rights, United States and Canada (or a separate distributor for Canada), possibly several distributors handling different rights

Post-production supervisors Hair and makeup Wardrobe Stunts Music supervisor Vendors for trailer/one sheet/television spots Research executives (testing the film and marketing materials)

Foreign sales agent—or one or more studios distributing directly internationally Laboratory executives (preparing delivery elements)

his fulfilling his financial obligations. So, my first concern on a given film is whether the producer is both competent and a trustworthy partner. Some people place more emphasis on the competence of the producer—i.e., they would rather deal with a competent crook than an honest incompetent. But I place equal emphasis on both qualities. Honesty for me may not be a sufficient condition for working with a given producer, but it is certainly a necessary condition. Sam Spiegel, the great producer, is credited with telling a young assistant on a certain film that there was a Rolls Royce in the budget for Sam himself and he defied the kid to find it. This was probably apocryphal—but not ridiculous. Budgets are complicated financial structures. They run up to 80 pages or more of individual line items of expenses; I don’t care if you have the sharpest accountant vetting the numbers on your behalf, you will never have the same grasp of the numbers as an experienced producer will. Even if the numbers are

Cast of Characters  99

absolutely accurate, you will never know if the producer has received kickbacks from one or more vendors. So, there are a number of successful producers whom I would never work with—I simply don’t trust them. I like to say there are two types of criminals in Hollywood: genetic criminals (like the scorpion in the scorpion and the frog story, who stings the frog and they both drown because he can’t help himself ) and those who do shady things they wouldn’t normally do if they weren’t painted into a corner financially. I got a call after the 2008 financial debacle from a well-known producer whom I knew slightly and who asked to come in to see me. I was intrigued by what he wanted to discuss, so I readily agreed. He pitched me a concept for a film. Not only did he want me to finance a script, he wanted me to pay him an advance to develop the project! He must have been pretty desperate to practically beg for money. Let me put his plea into context: this was a guy with two Academy Award-nominated films. He lived in a house in Bel-Air that must have been worth at least $5 million, and he drove a Bentley (in hindsight, probably leased). But he hadn’t produced a film in 6 years, and he confessed to me that he couldn’t make his car payments. I commiserated with him, but of course I didn’t give him a dime. I read in the trades 6 months later that he got a producing assignment on a studio film, which probably meant that he called in some old chits from a studio head who owed him a favor. He died shortly thereafter. A much more interesting category are the rogues in our business, and I am sufficiently romantic to enjoy their company although I am careful to make sure our interests are aligned before I do a deal with them, and I definitely make sure my agreement is bulletproof to ensure I will get paid if we get into business together. The good old days were never as good as we remember them, but I interfaced with several of those larger-than-life producers in my early years as a film financier—and I remember them fondly, especially those who had great taste as producers and were responsible for some great films. While he never produced a great film in my opinion, Alexander Salkind, a second-generation Russian émigré producer, ranks at the top of my list of those legendary international independent film producers who cared more about movies than about money. He probably made ten times as much money in his lifetime than I will (after all, he was responsible for the Superman franchise, which has already spawned six sequels, including Batman v Superman, and was probably the most profitable film franchise in the history of Warner Bros.) but he spent it as fast as he made it. The mere fact that he was responsible for the “Salkind Clause,” which is now standard in actor’s contracts, which prevents producers from cutting two films back to back while only paying the actors for one (Salkind had so much footage on The Three Musketeers, he used the excess footage to release The Four Musketeers the following year), is sufficient reason to idolize the guy. I did several UK tax incentivized deals for Salkind in the early 1980s, including Supergirl and Santa Claus—The

100  Cast of Characters

Movie. We had to close the deals in Switzerland because Salkind refused to travel and he was resident there; I was never sure whether he was afraid to fly or whether he didn’t want to be served by process servers on behalf of the many people he was accused of stiffing. Salkind pioneered the use of multiple offshore companies to avoid paying taxes on film profits, which made the documentation process in these deals incredibly cumbersome. Rights had to be conveyed through a complicated chain of companies, which always ended up in a tax haven where Salkind paid little or no tax. We closed the deals in Salkind’s suite at the Dolder Grand Hotel in Zürich (he booked the Shah’s former suite, which was the size of a football field). Salkind never had his name on any of these companies: the president of each was an unemployed Russian hippie whom Salkind found, I am convinced, on the streets of Paris. Since each of these closings were a multi-day affair, the Russian hippies camped out in sleeping beds on the floor of the suite, only to be awakened when we needed them to sign the relevant closing documents. I was recently reminded by Pierre Spengler, Salkind’s producer, that the biggest deal, on Santa Claus—The Movie, had to be signed hurriedly in London because the Inland Revenue was about to close the window on the deal. Salkind wanted us to sign the agreements in a helicopter hovering over London because he didn’t want the contracts to be physically executed in the UK, but on the advice of counsel we decided that didn’t offer any real protection. Salkind was an impresario in the tradition of that other great Russian impresario Sergei Diaghilev. Before he locked in a deal with Warner Bros. to finance Superman, Salkind wowed Cannes by hiring a fleet of airplanes to buzz the Croisette with trailing banners headlining the as-yet-uncast movie. I understand Salkind wanted Robert Redford to play the Man of Steel, but he couldn’t reach a deal with him, then Paul Newman passed, following which he approached Ryan O’Neal, Burt Reynolds, Sylvester Stallone, Steve McQueen and even Clint Eastwood. But Salkind’s ultimate choice of a then stage actor, Christopher Reeve, proved an ideal selection. I take producing very seriously—that’s why I have never pursued it as a full-time job (I do have a few producing credits, but more executive producing credits, which reflects my role as a financier/packager). Ironically, I am more inclined to pursue producing in my twilight years because it’s easier and takes less time than writing novels. A producer’s life used to be a lot easier when virtually all producers operated within the studio system. Even then, of course, there were exceptions. Probably the most famous was Orson Welles, who once quipped, “I look back on my life and it’s 95 percent running around trying to raise money to make movies and five percent actually making them. It’s no way to live.”1 Today, even very high-profile producers who earn multi-million dollar fees when they produce a film for a studio also work on independent projects; i.e., they have to cobble together the financing and international sales as well as creatively produce the film.

Cast of Characters  101

There are a several reasons why big-name producers are prepared to work within the independent sector. First, the studios are producing fewer films these days. They are concentrating on the big tentpole films that permit multiplatform exploitation and hopefully spawn one or more sequels. In addition, the studios will also look for demographically targeted films that can be made at a reasonable price—lower budget thrillers that appeal to young males and romantic comedies (“chick flicks”) come to mind. As a result, the bottom has fallen out of the classical star-driven dramas and historical epics. I wonder where James Stewart, Cary Grant, Gary Cooper and Clark Gable would be today—maybe they would be following Liam Neeson’s example and reinventing themselves as action stars. I also dread to think whether Amadeus or Lawrence of Arabia could find the necessary studio support to be made today. Upon returning from Cannes in 2016, I watched In the Heart of the Sea on the plane. The film was a financial flop. It reportedly cost $100 million and did only $94 million in worldwide box office (only $25 million domestically).2 Nevertheless, I enjoyed it—but I am a Herman Melville devotee. Putting on my critic’s hat, I have to say the characterizations left something to be desired and, unlike Moby Dick, there was no satanic figure at the core of the story. The film’s disappointing results depressed me, because I felt it represented another nail in the coffin (forgive the pun—Henry Coffin is a sailor on the doomed ship Essex, who commits suicide rather than being forced to shoot his cousin, George Pollard, the vessel’s captain who draws the shortest straw in a tragic lottery) for being able to mount big period dramas. I have been working with a producer friend of mine to put together a film based on a great Joseph Conrad novel, Nostromo. At one time, David Lean was going to direct the film based on a Robert Bolt (A Man for All Seasons, Ryan’s Daughter) script, but he died before the film could be greenlit. Later, Marty Scorsese was briefly attached and another script by an Oscar-winning screenwriter Christopher Hampton (Dangerous Liaisons, Atonement) commissioned. I know how difficult the challenge will be to assemble the financing for such a project—which will require an iconic director, a major international cast and equally important, significant governmental incentives (we are exploring Colombia and Australia at the moment). I doubt whether I can go to a studio for one-stop shopping. To put this studio production shrinkage into perspective, the six MPAA studios (Disney, Paramount, Fox, Universal, Warner Bros. and Sony) released 124 films in 2006, but only 91 in 2019.3 This includes acquisitions (the socalled pickups) as well as in-house productions, and I suspect that acquisitions represent a greater percentage today than they did in 2006, so the decline in inhouse productions is probably more marked than those statistics would suggest. Second, experienced producers are more and more put off by the oppressive oversight of relatively inexperienced studio executives. The independent sector allows them much greater freedom of action to make the film they want to make. Third, the studios are getting much tougher with producers. It used to be the case that practically any mid-level producer with a few credits could get

102  Cast of Characters

a so-called housekeeping deal with a studio. With such a housekeeping deal, the studios would provide overhead (typically including offices on the studio lot) and development monies. If you were a producer with real clout, you would even receive a discretionary development fund, where you had free rein to spend the studio’s money to acquire properties and commission screenplays— up to a certain annual cap, of course. Over the last few years the studios have cut back dramatically on these housekeeping deals as the value of such deals have come increasingly into question. On-lot deals have declined 65% since 2000,4 but this is somewhat misleading since the streamers have started to enter this space, albeit on a limited basis, and with greater concentration in television. At last count there were some 112 housekeeping deals currently in place among the major studios. There are some good reasons for the old dinosaur to keep on truckin’. Hollywood, like Tevye in Fiddler on the Roof, extols tradition—if you don’t believe that, then explain to me why Hollywood continues to follow the traditional advertising model for feature films, despite the burgeoning costs the concentration on network television buys entails (a 30-second spot on the Super Bowl cost on average $5.6 million in 2021, compared to $4 million in 2014, $2.8 million in 2007 and $1.5 million in 1997.)5 Talk about a market that only goes up! The real reason, of course, for the existence of housekeeping deals is that studio executives rarely exit gracefully; like baseball managers, they expect to be fired eventually and replaced by former producers who hopefully will remember the favors the studio executive doled out to them when the roles were reversed. Also, more and more “A” list actors have formed their own production companies—most of these are vanity efforts, Brad Pitt’s Plan B is a notable exception. All studio executives like to keep close relationships with “A” list talent. What better way than to offer housekeeping deals to the talent’s production company? In an effort to preserve profit margins, the studios are also much tougher when it comes to producer compensation—both in terms of up-front fees in the budget, particularly on the enormously expensive tentpole films where there is tremendous pressure on studio executives to control costs, and back-end profit participations. In particular, producers who traditionally benefited from the socalled first dollar gross participations are increasingly being asked to defer their profit participations, like talent, until the studio has reached cash breakeven (or another “breakeven” definition more favorable to the studio). As a result, producers are more and more inclined to consider setting up their projects with the streamers because of the attractiveness of a windfall payment up front as opposed to taking a gamble on a back end which is likely to be worth much less than was the case historically. Let me tell you about the so-called quote. A quote is a bona fide offer of compensation that a credible producing entity (normally a studio) has made in the past to a piece of talent. Contrary to what some people think, a quote can

Cast of Characters  103

be established whether or not the film to which the talent is attached is actually made. If the offer is “pay or play”—in other words, the producer is contractually bound to pay the talent whether or not the film goes—then a genuine precedent has been established and the talent’s agent and lawyers on both sides of the table will use that precedent as a starting point in a negotiation. I stress “as a starting point,” since quotes historically have been a one-way street. An agent will always resist accepting a deal lower than his client’s quote even if his client’s last film tanked, and you can be sure the agent will not be hesitant in asking for a raise if his client’s last film did real business—whether or not his client was seen as contributing significantly to the film’s success. But times are changing: quotes for producers, directors, writers and actors are not the sacrosanct starting point of negotiations they once were. I mentioned earlier that studios are not shy in cutting back all above-the-line compensation when it comes to tentpole films where budgets are always threatening to escalate out of control. But studios are equally willing to insist on reductions in up-front compensation and adjustments in back-end compensation, usually in the form of pushing back on the point in the waterfall when the talent’s profit participation kicks in on projects that are considered “dicey” or “dangerous”—meaning the studio executives are nervous about the budget relative to the genre in question. This is shorthand for expensive dramas. I am sure that Sony and Fox, who co-financed The Monuments Men, did not pay George Clooney his normal quote for acting in the film. To be fair, Clooney directed, co-wrote and co-produced the film as well! The film featured a great ensemble cast—George Clooney, Matt Damon, John Goodman, Bill Murray, Jean Dujardin and Cate Blanchett—and I am sure none of the others earned their normal quote either. These overt savings notwithstanding, the film still cost a reported $70 million, which, given that it was a period drama, was probably the absolute highest budget that the two studios would have felt comfortable with. Even that much star power can’t trump the perceived unpredictability of the subject matter. In hindsight, it wasn’t such a bad bet since the film did $78 million in domestic box office and $155 million worldwide.6 In 1988 Arnold Schwarzenegger made a very prescient bet. He, Danny DeVito and the director Ivan Reitman persuaded Universal to greenlight a comedy—Twins—on the basis that none of them would take much of a salary on the film. Instead, they shared 45% of the profits.7 Since the film did $214 million worldwide box office and cost only $16.5 million, the trio made a killing.8 Schwarzenegger says that he made more money on Twins than on any action film he starred in—even the Terminator films.9 Universal was prepared to make Schwarzenegger, DeVito and Reitman their partners on the film because, let’s face it, at that point in his career Schwarzenegger was not an obvious choice to play in a broad comedy.

104  Cast of Characters

That deal has spurned a number of other “partnership” arrangements— normally not representing as extreme a gamble as the actors and directors took on Twins, whereby they took slightly above scale (scale today, for a theatrical film is approximately $65,000) in exchange for a big piece of the film. It is not uncommon today for talent to cut his or her rate in exchange for a significant piece of the profits—not only a significant percentage of profits but a more favorable definition than normal as to when their profit share kicks in. Typically, the studio at least wants to recoup its investment in the negative plus some deemed interest rate (equivalent to its cost of debt capital) before it starts splitting up profits, but talent is insisting upon getting a true cash-on-cash breakeven for purposes of calculating its profit participation—that means in some instances without permitting the studio to deduct any distribution fees before calculating breakeven. Independents have adopted this partnership approach more and more in order to attract “A” level talent to appear in more critically driven projects that would never get made if “A” level talent insisted on being paid at or near their quotes. I like that on a project because by lowering the budget we are lowering the point at which the film breaks even for all concerned, financiers as well as talent. If I am faced with a trade-off for an investor client whether he wishes to break even at a lower level of revenues in exchange for a lesser share of the back end, I invariably opt for the lower breakpoint. Let romantic investors dream of another Titanic, I know the movie business is more about singles and doubles, and I want to maximize my returns on the bulge part of the performance curve. I am reminded of the comments of Menahem Golan, who always told me with a straight face that his next film would gross $100 million. None ever did, but I don’t think he ever stopped believing that even after he left the United States, his go-go production company Cannon in bankruptcy shambles. Investors invariably ask me what’s a fair split of revenue between the money and the producer. There is no easy answer to that question. In the case of independently financed films, a typical deal calls for the investors to recoup their investment with a negotiated premium and then the profits are split 50/50, with the producer bearing talent profit participations out of his share. There may be variations on this theme involving the so-called soft and hard floors. On the one hand, a “soft” floor represents the point at which the participant (usually the producer) no longer fully absorbs other profit participants out of his share and begins to share additional profit participations on some negotiated basis with the studio. A “hard” floor, on the other hand, is a strict minimum below which a participant cannot be reduced. I have frequently been presented with proposals where the talent is “off the top”; i.e., the talent’s profit participation is deducted from gross profits, and then the producer and the investors split the remaining amount, typically on a 50/50 basis. As an advisor to the financiers, I resist such proposals adamantly, even if the investors are permitted to recoup with a “vig” before the film is

Cast of Characters  105

deemed to be in profit. I am generally willing to consider such a proposal only if I am dealing with any “A”-list producer who is willing to defer all, on a large part of his fee, in exchange for a big profit interest. What I want to stress here is that no deals are fixed in stone: deals should be crafted to suit the circumstances, and how those deals should be constructed must be evaluated based on careful risk-based analysis. My job is to ensure that my clients can look to an equitable projected return relative to the risk they are being asked to bear. A word here about credits: it is often the case that more time is spent in negotiations about credits than fees and profit participations. This is not simply a matter of ego. Credits, particularly on successful films, enhance a producer’s reputation, which can translate into greater dollars down the road. As film financing has become more fragmented over the past 10–20 years, with more and more financiers being involved on individual projects, producer credits per picture have also proliferated. It used to be the case that the producer credit was largely reserved for industry professionals who had an active producing role on a film, while the executive producer credit was largely reserved for financiers, principally equity investors. That has changed because money talks and if a financier (whether it is a high-net-worth individual or an independent production company that has a passive role in the production and is simply providing capital) has a reasonable amount of skin in the game, the financier will often seek to upgrade his credit to that of producer. The Academy has attempted to resist such credit inflation by permitting only up to three producers on a film to ascend the stairs to collect a Best Picture award. The Producers Guild of America (PGA), which represents professional producers, has also attempted to push back on this trend. You will notice that members of the Producers Guild of America now attach that distinction after their names on-screen and in print. In addition to the producer and executive producer credit, other people involved in the project may be awarded co-producer or associate producer credit (although co-producer is better). I have seen some recent films with more than 30 producer credits, including producer, executive producer, co-producer and associate producer credits (yes, that’s the pecking order). That’s a bit of a joke! By the way, the executive producer credit in television is much more important than in films, with the showrunner or principal producer responsible for putting together the series typically taking executive producer credit. To the extent that producers have benefitted from studio largesse for years in the form of housekeeping deals and development funds, such largesse comes at a price. The studios will typically require a “first look” at the producer’s projects whereby they have a first right of refusal to finance and distribute a film that has a locked script and has been packaged (meaning it has been budgeted with a director and lead actors set). If the studio passes, the producer can attempt to set up the project elsewhere, subject typically to a “changed elements” clause whereby if a new piece of talent becomes attached the producer has to go back

106  Cast of Characters

to the original studio to give it another shot at the project. In addition, the studio expects to recoup its investment in overhead and development out of the budgets of the producer’s films that the studio has financed but also out of the fees earned by the producer on future films that other studios have financed! As I indicated earlier, as the studios have reduced their in-house production slots, concentrating more on tentpole films, these on-the-lot deals have declined dramatically. Not surprisingly, producers have to spend more of their time running around searching for money to fund their ongoing operations as well as to fund projects where the major studios and mini-majors have passed. In absolute dollar terms, we are not talking about a lot of money—certainly compared with the capital required to fund production and P&A. Depending on how much a producer commits to annual development, typical overhead/ development expenditure may run from $2 million to $5 million or more depending on the development budget and size of staff. Studio largesse can also take another form for the so-called satellite companies or even companies with straightforward housekeeping deals. Studios are notoriously reticent about optioning properties they control to third parties (primarily because of the embarrassment factor of giving up a property that another studio turns into a huge hit), but they are often much more willing to option properties to production companies with whom they have an ongoing relationship, particularly if that company has the financial resources to finance the film and then bring it to the studio to distribute. While investment to fund overhead and development may not represent a lot of money in the scheme of things, I have never been able to come up with an attractive investment structure to attract such funds. We will get into that later in the book, but the problem is basically the low ratio of projects developed to projects actually produced. This ratio is below 10% for the studios, and even tight-fisted independents will find it hard to get the ratio much above 25%. It’s difficult to absorb the costs on the 75% or so of development projects that are ultimately abandoned (and not sold off to another studio or producer to let them have a crack at “licking the project”) out of the fees and profits earned on the much smaller number of projects that eventually go. So, if you are approached to invest in a development fund—I don’t care how successful the producer is behind the development fund—think twice, no three times, before you jump into the water. Many of you have heard the old joke about the naive actress who slept with the writer. While this probably reflects an accurate assessment of the writer’s position in the power hierarchy in Hollywood, I can’t feel too sorry for those top-tier writers—albeit a small percentage of the total members of the Writers Guild of America (WGA)—who can command multi-million dollar salaries for writing the tentpole scripts that studios more and more depend on to drive operating profits. I heard last week about a writer without that many high-

Cast of Characters  107

profile credits who was paid $5 million to write a script for a sequel to one of Hollywood’s highest grossing films, and the studio did not even use the script! (I’m not privy as to whether any of his work found its way into the screenplay that was actually shot.) The real aristocracy of the screenwriter profession is those writers who are called on to rescue or punch-up scripts. Such script “doctors” may specialize in punching up dialogue, deepening characterization, delivering better action scenes or coming up with better comedic situations. They can be paid several hundred thousand dollars a week for such services, and they may never be credited on-screen for their work. Credits are ultimately determined by the WGA, and precedent can often trump fairness in the award process. The WGA traditionally favors the original writer on a project, irrespective of how much of his work ultimately finds its way on-screen. One of the most famous script doctors, and the author of probably the most famous memoir about making it in Hollywood, Adventures in the Screen Trade (the title is a pun on the title Adventures in the Skin Trade, a collection of stories by Dylan Thomas), is William Goldman, who has won two Academy Awards for his screenplay Butch Cassidy and the Sundance Kid (1969) and again for All the President’s Men (1976). His credits also include such well-known films as The Princess Bride (which is based on his novel and is my number one choice for best dialogue ever written for the screen), Marathon Man (based on his own novel), Misery (based on the Stephen King novel that was considered to be unadaptable cinematically), Harper, The Stepford Wives, Chaplin, A Bridge Too Far and Absolute Power. But Goldman also “fixed” a number of other scripts for which he did not receive credit (but he did receive a lot of money), including A Few Good Men, Indecent Proposal, Malice and Good Will Hunting. I love most Goldman screenplays because they are witty without being erudite, imaginative without being inaccessible, and engaging without being lowbrow. One of my favorite moments in the business is when I come upon a young undiscovered writer who combines imagination with literary skills. Such writers don’t come along every day. Admittedly, I am somewhat of an Anglophile—not that I think British writers are inherently more talented than American writers, but I find that a lot of them cut their teeth on British television, which at its best is a marvelous incubator for young writers. But you should also appreciate that some of the worst tripe can also be found on the British telly. I have another reason I like to reach out to British writers: they generally are cheaper than their American counterparts. My company has very strict rules about accepting unsolicited screenplays. We accept them only from agents, lawyers, managers and producers—although I have to admit that I once accepted a submission from a waiter because he was very kind to my mother at her birthday dinner. There is a good reason for such hard-heartedness on my part. It has to do with legal liability. If I actually accept a screenplay from a writer that is about vampires (even if I never read it),

108  Cast of Characters

and I produce a film 10 years later that has vampires in it, I open myself up to a potential lawsuit for copyright infringement. Yes, the United States is a very litigious place! One of the reasons for the writer’s inferior status in the Hollywood pecking order is a particular exception in US Copyright Law. Typically, copyright becomes the property of the author who created the work, or those deriving rights from the author. However, if a work is specially commissioned, it is deemed a “work for hire,” and the author is considered an employee of the individual or corporate entity who commissioned the work. In that case, the entity that commissioned the work is deemed the author and has all the rights of an author in effecting changes in the literary property—and in the case of a screenplay, in determining what eventually shows up on screen. Other countries, particularly France, are much more protective of the writer. The principal of droit moral in French law protects artistic integrity and prevents others from altering the work of artists or taking the artist’s name off the work without his permission. “Moral” rights are retained by the author even if all the other rights granted by the Copyright Act are assigned to another. Moral rights cannot be assigned to anyone else by the author. This is a good reason, by the way, to be very careful when optioning or acquiring a property written by a French screenwriter. If a screenwriter has written an original script, under the WGA Master Bargaining Agreement, he or she can reacquire the script from the entity that acquired the property and can attempt to set up the material elsewhere for a 2-year period 5 years after the sale or completion of the writer’s services— provided the project is not still in active development.10 To do this, the writer must pay back what he or she received for the original material and must obligate a subsequent purchasing entity to pay back the balance of direct script costs (personal health costs, payments to other writers, etc.) but not production or overhead costs. Not surprisingly, this does not happen a lot. “Turnaround” is a different concept. A turnaround right is typically built into a producer’s contract with a studio, whereby if the studio chooses to abandon a given project, the producer is given the right to try to sell the property to another studio or production company. Turnaround rights are always for a finite period of time (if the turnaround is in perpetuity, it is called a “reversion”). If the producer fails to set up the property elsewhere, the rights revert to the original studio. The original studio typically wants to recover its sunk costs, plus interest and overhead, if the script is set up elsewhere, but this is subject to negotiation. In addition, the original studio may retain some financial interest in the property. Hollywood likes to think “what goes around comes around,” but there are plenty of shady characters who have had to wait for heaven’s judgment before they received their just rewards. However, there is a famous infringement of copyright lawsuit that prospective investors should review as an exemplary illustration of how important it is to be sure the underlying rights to a film

Cast of Characters  109

are properly secured. The lawsuit also gave immense satisfaction to fans who thought a certain studio had behaved abominably toward a certain writer. In this case, DC Comics, which is owned by Warner Bros., was believed to have screwed over the writer of Watchmen comics, Alan Moore, over a rights reversion clause to his comics. Rumor has it that Moore retaliated by placing a curse on any movie based on the comic book. Twentieth Century Fox had the project in development for a long time, but eventually put it into turnaround to Larry Gordon, my former boss. Larry set it up at Warner Bros. (after interim setups at Universal and Paramount). Warner Bros. went forward with the film, but before it could be released, it was hit with a copyright infringement lawsuit that threatened to derail or delay the release. The bugaboo was the changed elements clause, and Fox averred that this clause was violated by Larry’s not having gone back to Fox when the creative package had changed. Either Warner Bros. chose to ignore the validity of Fox’s claim or were not properly informed by Larry. Either way, the presiding judge made it abundantly clear that he intended to side with Fox, and Warner Bros., facing a potentially devastating write down of its $130 million investment (which it shared with its satellite fund Legendary Pictures) capitulated and agreed to pay Fox an 8.5% gross participation in the picture, a cash payment up front covering Fox’s development and legal costs, and a piece of everything going forward including any sequels or spin-offs (the high-ups at Warner Bros. were probably secretly delighted that the film failed to perform at the box office, so no sequel was likely on the cards).11 As an investor, or a creditor—banks lending to the film industry must be very careful on this point—you must absolutely do your homework that all the necessary rights are fully secured. This means doing your “chain of title” research. Chain of title involves the series of documentation that establishes proprietary rights to a film. This includes inter alia, option/acquisition agreements covering any literary properties or copyrighted stories on which is the screenplay is based, copyright clearances on music, trademark clearances, talent agreements, which should incorporate legal releases from talent—also directors, cinematographers, and others—to use their works, images, likenesses and other personality rights in the film, and proof of errors and omissions insurance. The so-called E&O issues can be particularly thorny when living persons are depicted in a film. You don’t have the same problems with the dead: the dead cannot be defamed under Common Law, because defamation whether it is libel or slander is a personal action that cannot be assigned or brought on someone’s behalf (except if the person subject to defamation is a minor, in which case a parent or guardian can bring the claim on his or her behalf ). One of my clients produced a film, Fur, an “imaginary” portrait of the famous photographer Diane Arbus (and the title specifically referred to the film as an imaginary portrait). Although Diane was long dead, her husband and children were very much alive and objected to their portrayal in the film. We had long discussions

110  Cast of Characters

with our copyright lawyers to ensure that a satisfactory E&O policy would be available, and the lawyers hung their hat on the fact that the Arbus family were “public” figures—plus it was clearly stated that the film was an imaginary retelling of Diane Arbus’s life containing some real persons and some totally imaginary. The film was trashed by the critics—rightfully so in my opinion. When we established Largo in 1989, we were at the beginning of the “spec” script boom. Just as the term indicates, these are screenplays that are noncommissioned, but that writers write in the hope that they can sell it in the future, hopefully generating a huge payday. The process began to be institutionalized when agents discovered they could frequently create a hot bidding war through an abbreviated auction process. Spec scripts were sent out on a Monday morning, and bids had to be received by the following Friday—and boy, did studios as well as large indies pay up in these bidding frenzies. I believe my hero William Goldman initiated the process in 1968 with his spec script Butch Cassidy and the Sundance Kid. Goldman’s agent, Everett Ziegler sent it out to the studios, and the price kept getting higher and higher until it reached $400,000—the highest price paid for an original screenplay at the time.12 The spec script boom really began in 1988 with the longest strike in WGA history—it lasted for 5 months and when it ended, a flood of original screenplays that writers had banged out in their spare time hit the market. This coincided with aggressive efforts by Walt Disney Pictures to dramatically ramp up its slate to compete with the other major studios: in 1988, Disney had released only two films, but by 1999 it was releasing 15 per annum.13 Also, several wellcapitalized independents were emerging and were looking to find high-profile commercial films to produce (they still had to go through the major studios to release their films in the United States and Canada, but the majors were happy to oblige given the significant distribution fees they could earn). Probably the most prominent of these new indies was Carolco, which took off on the back of the Rambo franchise, but the group also included my own company, Largo, as well as Arnon Milchan’s New Regency, which was originally based at Warner Bros. but is still an active producer today with a deal at Fox, now, of course, Disney. I am embarrassed to admit that Largo was the first to pay $1 million for a spec script, The Ticking Man, which, by the way, never got made. I like to think that our decision to pick up the project was because we liked the script and not because of a cute marketing ploy by the writers, Brian Helgeland and Manny Coto, who sent out ticking clocks to buyers in advance of the auction. In 1995, 173 spec scripts were sold. In 2010 the number was 55, in 2019 the number fell to 32.14 What killed the market? A combination of the Great Recession, but more importantly a shift in studio preferences to “develop from intellectual property”—i.e., emphasis on built-in branding, trolling books, comics, video games, television series, toys and so on as source material. As studio distribution output has shrunk and budgets continue to increase, there is a natural tendency to mitigate your risk by betting on “presold” properties.

Cast of Characters  111

The success of Marvel, which was on the verge of bankruptcy in the 1990s and was later sold to Disney for $4 billion, exemplifies the importance of this new business model.15 Studios want and need franchises, and what better way to generate franchises than to rely on comic book heroes who can be reinvented in new plot lines at will, or equally to take advantage of huge best-selling books, like Harry Potter where Warner Bros. could rely on a pre-existing series of seven novels that have sold more than 450 million copies worldwide. Spec scripts, in contrast, are predicated upon original ideas, and who knows if they will work on screen. There have been a number of prominent spec script sales that led to flops. Perhaps the most famous was Radio Flyer, a 1992 script that sold for $1.25 million, had a budget of $35 million and grossed only $4.65 million at the US box office.16 To a large extent, spec scripts are tailored for “A”-list actors—in their heyday, Arnold, Bruce or Sly come to mind. But audience tastes have changed, and the Marvel or Harry Potter movies are not reliant on the audience draw of several middle-aged, white male actors. Technology has also trumped the high-intensity auction process that underpinned the spec script model. Now scripts are emailed around town and there is no longer the sense of urgency that the auction process engendered. In addition, there is now the online tracking board, where almost everyone in Hollywood can follow the status of every movie project—from development through production. No longer can agents hype projects by creating artificial buzz. Even the lowliest assistant can click to see the actual status of a spec script: who has it, who doesn’t, who bid and who passed. That is not to say that every producer in town isn’t looking for the next American Hustle, The King’s Speech, Slumdog Millionaire or Argo. All of those scripts made the so-called Black List, which is a compilation of the most popular unproduced screenplays. It has been published by Franklin Leonard, a former development executive, since 2004.17 It does not necessarily represent the “best” unproduced screenplays, but the winners of a popularity contest voted on by studio and production company executives. You better believe the literary agents are in there aggressively lobbying for their clients. According to published statistics, approximately 30% of the scripts on the Black List have eventually been produced18 —a lot higher percentage than what the studios achieve out of their development programs (the success rate there is probably closer to 10%). The importance for writers of earning a coveted spot on the Black List is not just that it increases the odds significantly that their script will get made, but it also increases the writer’s marketability and makes it more likely someone will want to hire him for another project in the future. I think too many young producers make the mistake of primarily networking with agents and actors. If I were a young producer, I would spend much more of my time hanging out with young undiscovered writers. A young producer is not going to have access to best-selling novels—he or she can’t afford

112  Cast of Characters

it—nor is that producer going to have staff like Scott Rudin to track all the recently published works of fiction and nonfiction or have access to hot properties even before they are published. Young producers in general are not going to be attached to high-profile projects by the studios. Instead, they have to find good material by themselves. What better way to find good undiscovered material than to make friends with the writers who are most likely to produce such material? You can often option such screenplays for a pittance, and not infrequently you can enter into a “shopping agreement” with your writer buddy, who will let you run around trying to set up the project for free. Unlike a number of executives in town, I do not have an inherent bias against baby-boomer writers or against directors of my generation. After all, they have proven themselves under fire. It is amazing to me how often relatively unproven directors, on the basis of maybe one short film or a low-budget debut, can be given control of a high-budget studio feature that may require complicated special effects or action sequences or need the director to extract superlative performances from his actors. Just because a director has a number of films under his belt doesn’t mean he doesn’t still have fire in his belly—but I do understand the studio’s temptation, in a desire to achieve original filmmaking, to bet on a relatively unproven director who has shown a glimmer of talent. I have to admit that there are many directors—less so writers—whose best body of work is in the past and are basically living off their past reputations. “Hack” is an unfortunate term that is often applied to such auteurs. But in an era where a perceived “hot” director is so important to attract talent and support strong international sales, it is not surprising that extremely careful consideration has to be given to the choice of director on a project. Remember that when you attach a director to a project, particularly early on in the development process, it may be extremely difficult to un-attach that director, unless you are lucky enough to have him or her jump ship on to another project, at which point he or she becomes unavailable. By the way, even superb actors can “phone in” a performance, which means they went through the motions to collect their paycheck. Hollywood is pretty unforgiving in the sense that your value in town is a function of what you did for me last week, as opposed to last year. Memory is short-lived. Pamela Godfrey, a long-serving Hollywood executive and friend, told me she once saw Sir Lew Grade, who was probably the greatest UK film and television impresario of his generation eating lunch alone at the Hotel Du Cap during the Cannes Film Festival. He had lost control of his company, ITC, which later transformed into ATV, after several expensive box office failures. But God knows how much money he had put in the pockets of many of the industry players having lunch at the Du Cap at the same time. Yet no one reached out to invite him over to their table. The story of Mervyn Adelson, the co-founder of Lorimar, is even sadder. He was one of the most powerful moguls in Hollywood, but following some bad bets during the early dot-com era and some expensive divorce settlements (he married Barbara Walters not

Cast of Characters  113

once, but twice!), he declared bankruptcy in 2003. When he died in 2015 at age 85, he was living in a one-bedroom apartment in Santa Monica, virtually penniless. Apparently, no one reached out to him either. When he was asked what he missed most about his former lifestyle, he replied, “I miss my jet.”19 When I am asked what the difference is between an agent and a manager, I am always tempted to say “not much.” That is, they both seek out projects for their clients, but technically they operate under different statutory guidelines. On the one hand, agents are regulated by a state franchise, which permits them to negotiate employment contracts for their clients. Managers, on the other hand, are unregulated. That’s why you sometimes see an actor’s father or mother serving as his manager. Managers unlike agents, can produce movies and television shows. There is nothing more infuriating (that is probably an exaggeration) when I am told an actor’s manager expects to get a producer credit on a film I am packaging for simply delivering the actor. I do not mind paying the manager a producing fee, because that is simply part of the actor’s compensation in my eyes—but granting a gratuitous credit? That’s a different matter. This is not to say that some managers who receive producer credits do not actually perform valuable producer services—but they are few and far between. Managers present themselves as the big-picture strategists; they tend to have fewer clients and play a greater role in shaping a star’s career. They also find themselves playing babysitter more often, particularly given the volume pressures on agents who increasingly find themselves unable to give their clients the personal attention they need and crave. Most higher profile actors today have both an agent and a manager, but there are plenty of examples who have one but not the other. If an actor decides to forego agency representation however, he or she will need an experienced entertainment lawyer to negotiate contract terms on individual assignments. It may strike you that if a star’s manager is also a producer on a given film, he may find himself in certain conflicts of interest—representing his client’s interests while at the same time performing his fiduciary responsibilities as producer, like having to tell his client that he has to cut his fee in order to bring the budget under control. It helps to know in the case of individual stars whether the agent or the manager largely controls the shots. Frequently, the roles are fragmented. The manager may be more influential as to what roles an actor is willing to accept, while the agent may be much more involved in negotiating the terms of employment, particularly if “trick” deals are involved where the actor’s compensation is a complex amalgam of up-front fees and back-end bonuses. The actor will need to rely on the modelling skills that a large talent agency can bring to bear in order to assess the complicated deal terms a studio, or large indie, might propose. My producer clients rely on my company to help shape these proposals and evaluate various performance scenarios. We have a huge database that underpins such analysis, but so do the large agencies. Management companies, however, typically do not have the same analytical skills.

114  Cast of Characters

There are the “Big Three” talent agencies: Creative Artists Agency (CAA), William Morris Endeavor (WME) and United Talent Agency (UTA). Five years ago, the industry would definitely have regarded CAA as primus inter pares but arguably WME has crept up to a virtual tie. However, CAA still controls a plurality of the top directors—and that gives it greater power in packaging projects. Directors attract actors not vice versa. UTA would probably be ranked a level below CAA and WME, but it staged a midnight raid on CAA in 2015 and poached 11 agents—the core of CAA’s comedy department. So UTA arguably now has bragging rights to join the elite group. Ironically, the two leading conspirators—Jason Heyman and Martin Lesak—had switched from UTA to CAA a decade back. Rumor has it that the agents who jumped ship were miffed that the senior partners at CAA had reserved a big cash-out for themselves when the big private equity firm TPG acquired a controlling stake in 2014 (TPG originally bought a 35% equity interest in 2010).20 WME itself sold a controlling interest in two stages to the big private equity firm, Silver Lake, and then bulked up to be even larger than CAA (in terms of overall agents) when it acquired the leading sports talent and marketing agency, IMG—for 3× the amount WME was valued at when Silver Lake made its initial investment ($2.4 billion versus $800 million). WME must know something I don’t, because it paid 13× EBITDA for IMG, a company where the assets pack up and go home every night. WME has bulked up even further by acquiring UFC in partnership with Silver Lake, KKR and Michael Dell’s family office, the world’s premier professional mixed martial arts organization for the princely sum of $4 billion cash.21 Management clearly believed it could grow the business rapidly to justify such a price, although cynics saw the acquisition as part of a well-thought out plan to take Endeavor Group Holdings, the parent company of WME/IMG public to enable Silver Lake to monetize its significant investment in the group. Unfortunately, they cancelled the highly anticipated initial public offering the day before the stock was expected to begin trading on Wall Street, citing ‘hazardous market conditions”. Endeavor had anticipated raising as much as $619 million, so it found itself stuck with as much as $4.6 billion of long-term debt, which it had hoped to significantly reduce through the IPO. The pandemic has certainly not improved Endeavor’s liquidity problems. Endeavor recently refiled for an IPO and had the acumen to acquire the 49.9% of UFC which it did not own, which the market really appreciated. Quite incredibly, this enabled Endeavor to go public at a $6.25 billion market capitalization, despite the fact that it had accumulated losses in excess of $1.2 billion since it cancelled its original IPO. It remains to be seen how the two powerhouses (CAA and WME) will function now that they are controlled by large private equity firms, irrespective of the fact that Endeavor is now a public company. Already there are signs that the typical cost controls imposed by private equity firms when they acquire companies are being put in place at CAA. It is not surprising that Endeavor

Cast of Characters  115

relaunched its IPO since private equity’s investment horizon usually does not exceed 5 years (although Jim Coulter, the co-founder of TPG, who is on the board of CAA maintained in an interview in the 2016 published book about CAA, Powerhouse, that TPG was in no hurry to exit because it sees very longterm changes affecting the business22). I don’t see either agency being sold to a third party, so I suppose an IPO is the only viable exit strategy for the controlling private equity houses. UTA, which was founded in 1991 as the result of a merger between two mid-sized literary and talent agencies, Bauer-Benedek and Leading Artists, also received a significant capital infusion in 2015 from a leading private equity mogul, Jeffrey Ubben (a minority stake, however, and Ubben will become a non-voting member of the board).23 Interestingly, Ubben’s appetite for the entertainment space was presumably whetted by his co-founding in 2008 of Route One Entertainment, a film finance company that is segueing into a fullfledged production company. With their additional capital resources, both CAA and WME have stepped up their diversification efforts as well as their global expansion. CAA now has 11 offices worldwide, including Beijing and Mumbai, while WME trails with seven.24 UTA has offices in Los Angeles and New York only.25 CAA has aggressively pursued relationships with corporate brands to create “strategic content” and has built a dominating presence in the sports agency business. It also has a small affiliated merchant bank, Evolution Media, whose deal making activity has been primarily in advising on the purchase and sale of sports franchises. WME’s affiliated merchant bank, the Raine Group, is a large, full-service investment bank, with expertise in technology, media, sports and telecommunications. The focus on technology is not surprising since Silver Lake is known for its special expertise in the technology sector, with investments in Groupon, Zynga, Go Daddy, Alibaba and Skype. Raine also manages two private equity funds, a venture fund, and a hedge fund, with total assets under management of over $1.5 billion.26 Just below the elite three agencies is ICM Partners, which used to be one of the top-tier agencies but downsized after it acquired the literary agency Broder Webb Chervin Silbermann and bought out its major investor Rizvi Traverse Management. The firm, which now operates as a private partnership, concentrates on television, where packaging fees on network and cable series can be the most lucrative source of income for agencies, although such fees will soon be a thing of the past after the recent agreement with the guilds. Just below ICM are Paradigm Talent Agency and The Gersh Agency. Paradigm is particularly interesting because Sam Gores, the chairman and CEO, has two brothers (Tom and Alex) who both built a fortune on private equity and both appear on the Forbes 400 list. I have been waiting for Paradigm to bulk up by acquiring other agencies. To date, it has been aggressive in acquiring music agencies, but

116  Cast of Characters

has not made significant acquisitions in film and television. Unfortunately, with the virtual shutdown of live events during the pandemic, Paradigm’s cash cow totally dried up and they recently sold their music division to Casey Wasserman, Lew Wasserman of Universal fame’s grandson. This would appear to be a prelude to selling its film and television business to a second-tier competitor. Talent agencies, like Wall Street firms, have particular cultures. When I worked on Wall Street, Lehman Brothers was known for being a collection of personal fiefdoms ruled over by individual investment banking partners. Goldman Sachs and Morgan Stanley, in contrast, were distinguished by a more collective corporate demeanor where everyone pulled together. Needless to say, we know who won out in the end. I remember a meeting I had with a senior corporate finance partner at Lehman when I ran the Eurobond division. I was pitching the idea of underwriting a Eurobond for a leading corporate finance client of the firm, on which Lehman was the sole managing underwriter. When I explained to the partner that it was customary for Eurobond new issues to have five to eight lead underwriters who would share the management fee, he made it abundantly clear that he had no intention of recommending such an offering—not because it didn’t make sense for the client, but because it didn’t make sense for Lehman, and presumably for his partnership bonus for the year. On the one hand, CAA probably most resembles Goldman and Morgan Stanley in its button-down approach and team dynamics. WME, on the other hand, has a bit of the brashness of its senior partner, Ari Emmanuel, who was the inspiration for the character of Ari Gold in the television series Entourage. CAA was managed by a seven-person ruling council: Richard Lovett, Kevin Huvane, Bryan Lourd, Steve Lafferty, Rob Light, Michael Rubel and David “Doc” O’Connor (Doc left CAA to become CEO of Madison Square Garden in 2015, but he abruptly resigned 2 years later). This is not to say that both leading agencies don’t assign teams to handle their leading talent clients, which are typically headed by a high-profile agent while the middle-level agents on the team do most of the heavy lifting (not that dissimilar from how Wall Street operates). It just seems that lead WME agents are more front and center in beating up poor business affairs executives at the studios on behalf of their clients. I interface primarily with the independent packaging groups at the top agencies. The existence of these specialty teams of agents is a relatively recent phenomenon—not much more than 10 years old. They arose because the agencies realized that the best way to get work for their actor, director and writer clients was to help get films made. The establishment of such teams coincided with the rise of the well-capitalized indies. The number of buyers exploded in the 1990s and even more so in the first decade of the twenty-first century. While studios could rely to a large extent on their in-house development as a source for projects to greenlight, many of the indies—which by definition have finite capital—were loath or unable to spend much on internal development. They found it was much easier to rely on CAA, WME and UTA to

Cast of Characters  117

source projects for them, and even better if such submissions could come fully packaged, with a director and lead actors who were represented by the same agency. Some independent production companies even became retainer clients of an individual agency—that is, they paid the agency a monthly fee with the expectation that they would receive preferred treatment in being shown hot properties first. I know of one indie (it was more of a financier than a legitimate producer) that was known to be totally in the pocket of a leading agency. It practically took any project the agency gave it—no questions asked. Admittedly, I hedge my bets when I am asked by my clients and potential clients whether it makes sense to become a retainer client of a specific agency. In favor, I can point to the benefit of being the early recipient of attractive material, particularly in packaged form—if you believe that is really the case. Let’s face it, not every client can be first in line. However, why burn your bridges at other agencies? Generally, my advice is save the monthly retainer, but develop strong relationships with as many of the top independent packaging groups as possible. In the long run, if you actually write checks from time to time, respond promptly to submissions, negotiate rationally and produce films professionally, you will be on everyone’s shortlist in terms of being reasonably high up in the queue for submissions. Some of my clients are effectively tied to one agency, but they do not pay a retainer, nor is there ever any public admission of such a tie-up. That way, they avoid burning bridges with their agency’s competitors. A word about packaging fees here: while packaging fees are the norm when it comes to television shows, they are not unheard of when it comes to films, particularly when a given agency represents all of the key talent in a project. It helps as well if the agency also sourced the script. In the case of television, when the agencies are in a position to charge packaging fees, they typically waive their commissions with respect to showrunners—the people who are responsible for the day-to-day operations of a television series, including performing writing functions (if they don’t specifically write a certain episode, they will oversee the writer in question), script editing and producing. In episodic television, the showrunner outranks the director and can be identified as the one with executive producer, not producer, credit. As an aside, this peculiarity of credit nomenclature with respect to television makes it easier to structure international co-productions than in the case of films, because co-production treaties typically require everyone who receives producer credit be from one of the countries participating in the co-production (in some cases just being from one of the EU countries works). But such restrictions do not apply to executive producers. By the way, it may seem like manna from heaven for a showrunner to save the 10% commission he or she normally has to pay an agent when the agency charges a packaging fee until he or she realizes that the profit definition has been pushed way back as a result of the agent’s packaging fee. That fee is typically 3% of the network base license fee plus 3% deferred out of first profits plus a percentage of the profits (usually 10%). Since that fee is added to the

118 Cast of Characters

budget, against which interest and overhead are applied, you can begin to see how far breakeven, after which profit participations are paid, is pushed back. The Writers Guild of America has had a longstanding dispute with the talent agencies with respect to packaging fees as well as with the move by the agencies into production in their own right. Unable to resolve the matter, the WGA instructed all of its members to fire their agents in 2019, and the dispute was only settled with the big three agencies in 2021. As a result, packaging fees will be phased out by 2022 and the agencies will be limited to no more than a 20% interest in any one production company.27 Instead of a packaging fee in the case of feature films, the agency may instead charge a placement fee for setting up domestic distribution. Most producers, particularly those operating in the independent space, don’t have the contacts or the expertise to do that themselves, so they have to rely on the independent packaging groups at the agencies to do that for them. There are also entities outside the agencies who perform this function (I have also been known to place films with domestic distributors, but I do so typically on behalf of retainer clients, although I have also been active recently on some VOD-oriented releases because I want to expand my company’s profile in that space). It is not uncommon for multiple agencies—particularly if each has clients involved in the film—or a combination of an agency with a non-agency placement agent, to work together. The placement fees charged are negotiable; in fact, fierce competition among the agencies has pushed down the percentages (calculated out all domestic revenues received, including minimum guarantees and overages, or on all revenues if the deal is structured as a straight distribution arrangement with no advance). Recently, the leading agencies have been trying to hold fast at 10% in the case of lower-budget films. Is there the smell of collusion here? To be fair, when more than one placement agent is involved, it’s tough to incentivize them if they are splitting up much less than 10%.

Notes 1 Welles, Orson. “AZ Quotes.” Retrieved from www.azquotes.com/author/15479Orson_Welles. 2 “In the Heart of the Sea (2015) Box Office/Business,” Internet Movie Database, www.imdb.com/title/tt1390411/business?ref_=tt_ql_dt_4. 3 “The Numbers—Movies Releases in 2006,” The-Numbers, www.the-numbers. com/market/2006/summary; “The Numbers—Movies Releases in 2016,” The-Numbers, www.the-numbers.com/market/2016/summary. 4 McNary, D. (2014, March 18). “Facts on Pacts.” Retrieved from https://pmcvariety. files.wordpress.com/2014/03/facts-on-pacts-fixed.pdf. 5 Shwartz, Nick. “Stunning Infographic Charts the Skyrocketing Cost of a Super Bowl Ad,” USA Today, 6 Feb. 2016, http://ftw.usatoday.com/2016/02/ how-much-does-super-bowl-ad-cost. 6 “The Monuments Men (2014),” Box Office Mojo, www.boxofficemojo.com/ movies/?id=monumentsmen.htm. 7 “Arnold Schwarzenegger and Danny DeVito Made Twins for Free,” Express, 25 Jan. 2013, www.boxofficemojo.com/movies/?id=monumentsmen.htm.

Cast of Characters 119

8 “Twins (1988),” Box Office Mojo, www.boxofficemojo.com/movies/?id=twins.htm. 9 Hardwick, Chris and Schwarzenegger, Arnold. “Nerdist Podcast: Arnold Schwarzenegger,” The Nerdist, 24 Mar. 2014, http://nerdist.com/nerdist-podcastarnold-schwarzenegger/. 10 “Writers Guild of America 2014 Theatrical and Television Basic Agreement,” Writers Guild of America, 2 May 2016, www.wga.org/uploadedfiles/writers_ resources/contracts/MBA14.pdf. 11 Finke, Nikki. “Fox & Warner Settle ‘Watchmen’ Lawsuit: Warner Will Distribute; Fox Gets 8 1/2% Gross Cash Piece of Sequels/Spinoffs,” Deadline Hollywood, 15 Jan. 2009, http://deadline.com/2009/01/f inallyfox-warner-paramount-reach-watchmensettlement-8046/; Nikki Finke, “SAVE US! Warner’s ‘Watchmen’ in Legal Peril after Judge Won’t Dismiss Fox Suit,” Deadline Hollywood, 18 Aug. 2008, http:// deadline.com/2008/08/urgent-warners-watchmen-in-legal-peril-6734/. 12 Banks, Miranda J. The Writers: A History of American Screenwriters and Their Guild (New Brunswick, NJ: Rutgers University Press, 2015). 13 “Movies Released by Walt Disney,” The-Numbers, www.the-numbers.com/movies/ distributor/Walt-Disney. 14 Heidenry, Margaret. “When the Spec Script Was King,” Vanity Fair, 8 Feb. 2013, www.vanityfair.com/culture/2013/03/will-spec-script-screenwriters-rise-again. 15 Ingram, Mathew. “Six Years Later, Disney’s Acquisition of Marvel Looks Smarter than Ever,” Fortune, 8 Oct. 2015, http://fortune.com/2015/10/08/disney-marvel/. 16 Heidenry, “When the Spec Script Was King.” 17 “The Black List: About,” The Black List, https://blcklst.com/about/; “Black List Film Data,” The Black List, https://blcklst.com/lists/#films. 18 “Annual Black List Live Report,” The Black List, https://blcklst.com/lists/report. 19 “Former TV Macher Merv Adelson Talks about Financial Ruin and His Las Vegas–Mob Ties,” Vanity Fair, 31 Jan. 2013, www.vanityfair.com/news/2013/01/ merv-adelson-las-vegas-mob. 20 Fleming Jr., Mike. “TPG Spends $225 Million in Deal That Ups Stake in CAA to 53%,” Deadline Hollywood, 20 Oct. 2014, http://deadline.com/2014/10/ caa-sells-majority-stake-to-tpg-225-million-855694/. 21 Patten, Dominic. “Update: WME Brass Welcome IMG Staffers as Acquisition Deal Closes,” Deadline Hollywood, 7 May 2014, http://deadline.com/2014/05/ wme- silver-lake-acquire-img-worldwide-654232/; “Dana White on $4 billion UFC Sale: ‘Sport Is Going to the Next Level’,” ESPN.com, 11 July 2016, www. espn.com/m ma/stor y/_/id/16970360/ufc-sold-unprecedented- 4 -bi l l iondana-white-confirms; “William Morris Endeavor Entertainment and Silver Lake Announce Strategic Partnership,” PR Newswire, 2 May 2012, www.prnewswire. com/news-releases/william-morris-endeavor-entertainment-and-silver-lakeannounce-strategic-partnership-149861875.html. 22 Miller, James A. Powerhouse: The Untold Story of Hollywood’s Creative Artists Agency (New York: Custom House, 2016). 23 Littleton, Cynthia. “UTA Sells Minority Stake to Investor, Buys Top Music Agency,” Variety, 20 Aug. 2015, http://variety.com/2015/biz/news/uta-investoragency-group-jeffrey-ubben-1201574539/. 24 Creative Artists Agency, www.caa.com/; William Morris Endeavor Entertainment, http://wmeentertainment.com/. 25 United Talent Agency, https://unitedtalent.com/. 26 “William Morris Endeavor Entertainment and Silver Lake Announce Strategic Partnership,” PR Newswire, 2 May 2012, www.prnewswire.com/news-releases/ william-morris-endeavor-entertainment-and-silver-lake-announce-strategicpartnership-149861875.html. 27 Macias Jr., Martin. “Talent Agency, Writers Guild Settlement Ends Bitter Standoff Over Packaging Fees,” Courthouse News Service, 5 Feb. 2021.

9 GLOBALIZATION OF THE BUSINESS

Summary—The recent globalization of the movie business is discussed in detail. The growing role of China is analyzed and the Indian film industry is contrasted with the Chinese. Other countries’ film industries are discussed, including how countries support their local film industries. Particular attention is paid to France’s and Canada’s approaches to nurturing their indigenous industries. The value and importance of coproduction treaties is stressed as is the ongoing challenge of addressing worldwide piracy. Finally, the emergence of Netflix and Amazon as major players in the international marketplace is highlighted. Arguably, filmed entertainment, including both films and television, is the leading export industry in the United States—with apologies to Boeing. While US product is facing increased competition from home-grown fare, according to The Guardian, the United States had a whopping 70%+ share of the total global box office in 2013, but this estimate may even be somewhat conservative since we do not have meaningful numbers with regard to US films not released through the major studios.1 Locally produced films generally consist of low-budget dramas, comedies and romantic comedies because the money is simply not there to finance high-budget films. Local films typically do not travel, so producers have to rely on domestic box office and local television to recover their budgets and earn a profit. To put this lack of competitiveness in perspective, apart from China, no other country’s box office represented even 20% of US box office in 2014.2 China’s box office growth has been nothing short of stupendous in the last few years, driven by a herculean building program of new screens. In 2008, there were approximately 4,100 cinema screens in China. By 2020, the number had reached 75,000.3 In comparison, there are currently around 41,000 screens in the United States.4 China showed 5.4% year-over-year box office growth in DOI: 10.4324/9781003153702-10

Globalization of the Business  121

2019, which represented a slowdown from previous years, but in comparison the United States experienced a downturn of 4.8%. And as a result of China’s much speedier recovery from the effects of the pandemic, Chinese box office in 2020 surpassed the United States’ for the first time. It remains to be seen what will settle down as the new normal in both countries after theaters open up at full capacity once the effects of the pandemic are played out. Growth was definitely helped by the Chinese government’s decision in 2012 to relax the restriction on the number of foreign films allowed to screen each year from 20 to 34. This cap only applies to foreign films’ ability to participate in true revenue sharing. Distributors can still sell their films “flat” without having to go through the quota system. This quota also does not take into account Chinese co-productions with foreign countries, which was expected to grow rapidly given the proliferation of Chinese pools of capital, which are aggressively looking to partner with studios and leading independents on high-profile international films that can be partially or largely shot in China, although for various political reasons the growth in co-productions has been less vigorous than was anticipated. It is no longer the priority that it was 5 years ago.5 The Chinese government still insist that they intend to broaden the quota for foreign films, but, given the political tensions with the United States, that effectively applies to non-American films. However, from a geopolitical point of view, China currently has problems with Australia, Canada, the UK and India, although relations with Japan and South Korea are relatively positive. On balance, therefore, I don’t expect a dramatic improvement in the number of foreign films being imported annually. A preference for local movies in addition to ongoing US-China tensions has significantly eroded the market for Hollywood movies in China. Adding to the pressure on the studios, a bilateral pact that required China to import a minimum number of American films per year expired several years ago. This agreement has not been renegotiated, and while the Chinese government has continued to allow American films in, it could pull the plug at any time, particularly if it chooses to use it as a diplomatic lever with the new US administration. The share of foreign films, predominantly from Hollywood, which was steady at around 40% for the past 7 years, slipped to 16% in 2020.6 Chris Fenton, an American film producer and trustee of the US-Asia Institute recently commented, “Chinese consumer sentiment towards anything American is at an all-time, modern day low.” Chinese website Mirror Entertainment wrote, “Local films are catching up to Hollywood on many indicators like IP, story special effects and genre.” I would point out that the bureaucrats in China have never been that benevolent when it comes to opening the domestic market for foreign productions. State regulators are more intent than ever to promote local fare. They enforced a 2-month blackout way back in July and August 2015, permitting no new Hollywood films to enter the country, and Hollywood was essentially locked out of

122  Globalization of the Business

December in that year as another pre-Christmas blackout was enforced (my client Alcon’s production of Point Break overcame that ban thanks to the intervention of the Chinese investor in the film). Thus, despite the huge jump in Chinese box office in 2015, US films’ market share fell from 45.5% in 2014 to 38.4%.7 But the bureaucrats are also susceptible to external pressures. At negotiations the MPAA had in 2016 with China Film Group, the country’s powerful statebacked studio, China made two key concessions: it agreed to allow international firms to audit ticket sales at China’s box office as well as to significantly increase the number of foreign films allowed into China on what’s known as a flat-fee basis. In addition to the 34 foreign films that are allowed into the Chinese market each year on a revenue-sharing basis, China has typically permitted 30 to 40 other films to be released on a flat-fee basis. I understand that China Film Group has now agreed to allow a potentially unlimited number of films into the market via flat fees, which should enormously benefit independent productions. But I also understand that the China Film Bureau will get final say on which companies are given permission to import, which may require foreign distributors to take a certain number of Chinese films in order to get import permits.8 Virtually every producer I know had a China project in development or was looking for one before the pandemic hit. The problem is they are not so easy to find—at least not commercial properties. There is also the issue of government censorship. My client River Road co-financed Lust, Caution with Focus Films, the specialty arm of Universal. The film got an NC-17 rating in the United States (over what I considered an extremely erotic but tasteful love-making scene—a pathetic statement about American prudishness when you consider that some action films can depict the most gruesome murders, rapes and dismemberments and still get an “R” rating) and was banned in mainland China—although it did huge business in Hong Kong, where it was shown uncut (and thousands of mainland Chinese came over to see it). The deal we entered into on Lust, Caution is a useful testament as to how gringos/ gai-jin (I understand the equivalent word in Cantonese is gwai lo) can be fleeced doing high-profile English-language international films business in Asia. The film was produced and directed by the great film-maker Ang Lee. Neither Focus nor we knew the true budget—that was Ang Lee’s responsibility—but I suspect he made it for around the same number as our advance. We simply paid a certain sum for all rights outside of China. Ang retained Chinese and certain Asian rights. If I am correct that he made the film for no more than what we put up for non-Chinese rights (maybe he risked a portion of his director’s fee), he effectively got China and certain Asian rights for free. Focus and we lost a few bucks, but I suspect Ang made out like gangbusters. China’s appetite for huge US tentpole films, particularly those that can be viewed in 3-D and on large-scale formats like IMAX, has been virtually insatiable, at least until Chinese filmmakers developed the expertise to compete on

Globalization of the Business  123

this scale. In 2014, Transformers: Age of Extinction became the first tentpole film with a box office in China that actually exceeded what it made in the United States ($319 million versus $245 million).9 In 2015, Furious 7 became the highest grossing film ever in China, with $326 million in 15 days of release, which exceeded the film’s North American take of $320 million over 24 days.10 It is important to note, however, that the share of the box office that sticks to distributors is much lower in China than in the United States, where it is around 50%. In China, it has been fixed at 25% for foreign quota films (except in the case of official co-productions where it is more like 42–43%).11 Also, in China where practically no one buys DVDs—at least not legitimately—and digital and television distribution are minimal, the studios’ take home revenues are basically relegated to what they can retain out of the box office. So, don’t pack your bags yet, even if Chinese box office does continue to surpass the United States in the next few years. I have been around long enough to know that no economic trend lines go up indefinitely, certainly not in the case of stock market indices. I was in charge of Japan at Salomon Brothers in the mid-1970s. While I was a great admirer of Japan Inc., I also saw a number of structural problems with the Japanese economy that would eventually come back to bite it. I remember having a conversation with a Japanese banker some 10 years later where I argued that it made no sense that the aggregate real estate value of the Ginza district of Tokyo could exceed the aggregate real estate value of the entire state of California—but the banker couldn’t see anything problematic about that fact. When the bubble finally burst in Japan, the 20-year recession there was driven to a large extent by the collapse of real estate prices. I am not suggesting that the bubble is also about to burst in China, but in 2016 the Shanghai Stock Exchange fell 30% in the course of not much more than 1 month, and the Index retraced almost half this decline thanks to the Chinese Central Bank’s enormous priming of the monetary pump— exceeding the monetary stimulus provided by the Fed, the Bank of England and the European Central Bank combined. While the 9% annual growth rate in GDP China enjoyed from 1989 to 2015 fell to the 6–7% range until the pandemic in 2020 cut that rate to 2.3%, the government forecasts a return to a more normalized 6% in 2021. China is clearly undergoing a dramatic shift from an investment-led economy to one that will be more driven in the future by retail consumption. In that sense, perhaps, you should retain a sense of bullishness about the continued dynamism of the Chinese film industry—particularly when it is based on continued strong growth in Chinese box office. But to the extent that real estate investment in China starts to exhibit more and more the symptoms of a bubble economy, we might legitimately question whether the same frenzied rate of growth in screen construction can continue in the future. In fact, it appears obvious that China is now overscreened and more marginal theaters will be shut down in the future.

124  Globalization of the Business

To be candid, I have not done much business in China—not because I wouldn’t like to, but because I can’t figure out who’s real and who’s not, and even if they are real today, whether they won’t be caught up on corruption charges a year from now. Yet, on behalf of one of my US clients, I am seriously evaluating shooting a huge special-effects film in China. Why? It’s not because China is cheaper or has significantly better studios (this film will be shot virtually entirely on sound stages), but because the Chinese province in question, I have been assured, is about to announce a very generous program of incentives. In addition, if we shoot in China, we can hopefully qualify the film as an official co-production (but this is not assured) and if we succeed, we will likely get a more preferred placement in the release calendar, plus we will retain a higher percentage of box office. There have been several announcements over the past few years of significant Chinese investment in US studio start-ups. The private equity firm Hony Capital invested in STX, a new studio looking to target films in the $20–80 million budget range (i.e., films that the major studios have largely moved away from in their pursuit of big blockbusters). Hony was joined by Huayi Brothers, a Chinese production company that formed a joint venture with STX to jointly finance, produce and distribute up to 15 films annually, but this venture never approached anything close to that target volume, and it was terminated in 2018. STX itself filed for an IPO on the Hong Kong Stock Exchange in April 2018, but it called it off in October, citing the China-US trade war and deteriorating conditions in Hong Kong due to turbulence in the mainland Chinese equity market. Instead on April 16, 2020, STX announced that it would merge with the Indian film and television studio, Eros International. In 2014, Fosun, a large Chinese conglomerate, invested in Studio 8, a new production company established by Jeff Robinov, the former head of the film studio at Warner Bros., but pointedly Fosun did not disclose financial details of the deal.12 The venture was a total fiasco, and the company shut down in 2018. Equally important, there have been several investments I am aware of by Chinese distributors in individual Hollywood films that have been structured as part equity and part Chinese rights acquisitions. In my opinion, these have been done not because the Chinese partners wanted desperately to have a stake in the worldwide revenues of the films, but for competitive reasons—in order to trump their competitors seeking Chinese rights on the films by putting up co-financing that significantly contributed to the films being made. Simply overpaying for Chinese rights would not have been sufficient. There were a lot of Chinese groups trolling around Hollywood—not just media powerhouses like Dalian Wanda, who took control of the largest exhibition chain in the world, AMC, but was forced by the Chinese government to dramatically reduce its stake because it was significantly overleveraged. Many of them seemed to have little, if any, exposure to the media space. So, what were they looking for in Hollywood? My good friend Sky Moore of

Globalization of the Business  125

Greenberg, Glusker is one of a small set of powerhouse lawyers who seem to represent most of these Chinese groups; Stephen Saltzman of Paul Hastings and Lindsay Conner at Manatt, Phelps also come to mind. Sky published a short article in Forbes that discussed Chinese investors’ objectives.13 It seems clear they are not just looking for financial returns. The Chinese are not “star f-ckers,” in the traditional sense, but they are clearly impressed by high-profile talent. More importantly, they generally prefer projects that can be set up as Chinese coproductions. It is important to note that these need not be formal co-productions (i.e., conforming to official co-production treaties). These are no such official co-production treaties between the United States and other countries. What constitutes a China/United States co-production is really a US production with significant Chinese elements. Such “co-productions,” as I mentioned earlier, command a significantly larger share of Chinese box office receipts. Interestingly, Sky alluded to another motive that is more driven by nationalistic, cultural considerations than pure financial desiderata. The Chinese are keen to tell stories on screen gleaned from their history, mythology and literature. I am reminded of a remark by Disraeli, who when confronted by an antiSemite at a posh English dinner party replied something like the following: “Sir, when your ancestors were running around naked in the forest, mine were serving God at the Temple in Jerusalem.” The Chinese are equally proud of their cultural heritage, but I fear they will find it a tremendous challenge to source indigenous material that can be transformed into movies that audiences around the world will want to see. It will take time to nurture Chinese actors and directors who can become international household names to drive these projects; but the Chinese are a patient people, and I have no doubt they can succeed on some basis given enough time, especially if they are willing to throw around enough money without having to demonstrate short-term results. In any case, all of this outward investment by Chinese companies has virtually ground to a halt, as the Chinese government has blocked capital transfers offshore to pay for these acquisitions. As an aside, I caution investors and producers not to simply rely on the numbers coming out of official Chinese government sources as gospel. I am not suggesting they fudge their numbers, but remember it is an expressed goal of the Chinese government to laud the achievements of its indigenous film industry, which it hopes will surpass the size of the US market within the next 5 years (the sooner the better as far as the Chinese are concerned). I’m lucky because one of my oldest friends in Hollywood, Andre Morgan, is arguably one of the real (as opposed to faux) experts on the Chinese film industry. He commutes between Shanghai and Los Angeles and is himself an approved Chinese producer for co-production and qualified Chinese film purposes. He also speaks absolutely fluent Mandarin and Cantonese. Andre ran Golden Harvest, the leading Hong Kong–based film company, more than 30 years ago, and no one is better able to separate truth from fiction when it comes to China.

126  Globalization of the Business

India is a very different model from China. India’s film industry is highly fragmented and tailored to local markets. Hindi-language Bollywood films account for less than half of the total market. There is also a big market tailored for the large Tamil-speaking population. It should be kept in mind that local productions in India represent a greater percentage of total box office than in any other country in the world—a whopping 85%. Given that India is the third largest market in the world, at least pre-pandemic, it is clear that a lot of money changes hands in Bollywood. In India, it is typically the case that no foreign films rank in the top ten in any year. In the halcyon days of Hollywood’s success in China, American films could easily represent 50% of the top ten box office hits, but that has significantly changed recently. American titles accounted for just two of the country’s top ten grossers in 2019 with Avengers: Endgame placing third and Fast and Furious Presents: Hobbs and Shaw placing tenth.14 Meanwhile, nine out of China’s top ten highest grossing films of all time are now Chinese, four of which came out in 2019. In 2014, five out of the top ten box office hits in China were American films, including the number one hit Transformers: Age of Extinction. In India, no foreign films ranked in the top ten. While Bollywood, the Indian film industry, produced more than 3× the number of films than the United States in 2014 (1,602 versus 476), the Indian box office represented barely one seventh of the United States/Canadian box office. But Indian cinema admissions represented twice the volume of United States cinema admissions (2.7 billion admissions versus 1.36 billion). This is despite the fact that the number of screens in India is only one-third of the total number of screens in the United States.15 Average ticket prices in India during the week are around $1.50, but they go up to $2.70 during the weekend. This compares with $9.16 in the United States in 2019 before the pandemic struck. The cost of going to the cinema is much higher in several other developed countries than it is in the United States. In Britain, a ticket costs roughly $9.95, approximately 9 Euros in Germany ($10.80 based on current exchange rates), and in Japan it’s a whopping $12.77 (with a $3 surcharge for 3D films). Not surprisingly, Japanese cinemagoers make extensive use of presale tickets and discount days. By the way, the average ticket price in China is around $7.60, but significantly higher in first-tier cities like Beijing and Shanghai.16Bahrain ranks as the country with the most expensive ticket prices, but it is closely followed by Switzerland and the Nordic countries. These statistics belie the frequently heard complaint in the United States that moviegoing has become too expensive—at least for married couples with children. Ticket prices in the United States have increased at an annual compound rate of only around 2% over the past 10 years. Where the theaters hit you is at the concession stand, where exhibitors make an 85% profit margin on popcorn, sodas and candy.17 Given the relatively low price of movie tickets in the United States versus other developed countries, it is not surprising that a number of large exhibition chains, as well as some specialty groups, are aggressively

Globalization of the Business  127

upgrading their seating as well as the quality of food and snacks available at their concession stands. In exchange, they can jack up their prices. It’s a calculated risk, of course, because those big leather recliners that are replacing the fold-up stadium seats can reduce the overall seat count by as much as 50%, but the audiences are voting with their feet—with AMC, one of the leaders in cinema upgrading, claiming that it has seen an 84% increase at theaters with new seats.18 Some of that increase is undoubtedly due to the change-over to digital film, better sound systems and 3-D. I started out this chapter focusing on China and India, not because they are the tails that wag the dog, but because the international marketplace is clearly where the growth has been in the past few years and where it will undoubtedly be in the future. Europe, of course, like the United States is a relatively mature market, and to the extent it also includes weak economies like Spain and Italy, it should continue to show lower growth than the United States. I have already mentioned two of the BRIC countries—China and India. What about Russia and Brazil? Russia is currently the eighth largest film market outside the United States, with annual box office of around $1.2 billion. Between 2008 and 2013, the number of screens in the country doubled.19 However, with the huge decline in the ruble and the continued impact of Western sanctions on the Russian economy, the Russian industry is clearly short of cash. You have to remember that virtually all advances put up by foreign distributors are denominated in US dollars, which has presented a huge burden for Russian film distributors since sanctions have been imposed. The impact on the major studios that distribute directly or through sub-distributors from the effect of the de facto ruble devaluation has hurt, but the impact for independents has been much more severe. This is because independents typically presell their films internationally to mitigate risk and to help finance their films—because they can bank foreign minimum guarantees if they come from creditworthy distributors. The problem is that many Russian distributors have gone out of business or have gone hat in hand to the foreign sales agents to plead for a reduction in their dollar-dominated commitments. As a result, the banks which lend against distribution contracts have shown an unwillingness to lend against all but the very top Russian distributors. Accordingly, if Russia is no longer bankable to a large extent, independent producers have to make up the shortfall by coming up with more equity. Brazil is underscreened, and the weak performance of the Brazilian real versus the dollar over the past 4 years, when it has effectively devalued by more than 40%, has not helped Brazil’s contribution to Hollywood’s bottom line.20 But prior to the pandemic, Brazilian box office was still relatively flat over the previous 10 years in dollar terms, primarily due to the contribution of Portuguese-language films.21 Mexico, in contrast, exceeded Brazilian box office for the first time in 2014.22 I also want to mention South Korea, which in 2014, although it has only 40% of the population of Japan, generated box office equal

128  Globalization of the Business

to 80% of Japanese box office and 25% higher box office than Germany.23 Today, South Korea ranks number six in the box office tables outside the United States, just behind India and Great Britain. If, as I assume, most of my readers are primarily interested in US films, I would not get too excited about this dynamic growth in international box office—because a lot of that growth can be attributed to locally produced films. I mentioned earlier that China has imposed quotas on foreign films theatrically released in China and subject to revenue sharing arrangements, but it increased the number from 20 to 34 in 2012. There has been a long-standing rumor that the quota will be increased by ten more films to include “prestige” arthouse films and Oscar winners. China signed a 5-year agreement on its current quota system with the World Trade Organization in 2012, which meant that the next round of negotiations were scheduled to commence in early 2017, but negotiations have been postponed indefinitely. Other countries also seek to “protect” their local production industries by imposing quotas or subsidizing local production. Interestingly, Russia scrapped plans more than 5 years ago to cap the number of foreign films shown in Russian cinemas—presumably in retaliation for the imposition of sanctions by the West. The head of the Duma committee said “if a good Russian film is released, people will come and watch it anyway.”24 Russian film professionals lobbied against the bill and won Putin’s support, on the basis that restrictions on foreign films would backfire, undermining the government’s campaign to stop video piracy, plus protectionist measures would not make sense unless state subsidies were increased to promote cash-starved Russian studios. One of my good buddies, Clifford Werber, a former Warner Bros. executive, spotted the emerging rise of local-language production early on and set up a company to produce local-language films—primarily in Europe. But Europe was not the place to launch such an initiative, and Clifford eventually gave up the ghost, repositioning his activities to take a more global approach. While he was somewhat premature in this initiative, Clifford would have been better off concentrating on Chinese and Indian remakes of English language films in genres that appeal to the local audiences. That is where I am concentrating my attention today, and I have identified local producer partners in both India and China who can assist me in those endeavors. Brazil, Spain, France, South Korea and Italy, among others, support their local film industries by imposing a minimum number of days that theaters have to show local films. In Brazil, the requirement depends on the number of screens, varying from 28 days per year (for single-screen movie theaters) to 644 days (for 20-screen multiplexes). In Spain, the minimum number of screening days for domestic films is between 73 and 91. France requires cinemas to screen domestic films 5 weeks per quarter. Italy requires 100 days a year, and South Korea at least 106 days.25 But quotas are not the only protectionist measures to “protect” a local film industry from the Hollywood behemoths. France is probably the most beneficent in terms of providing support. It is estimated that

Globalization of the Business  129

the French subsidy program for cinema and video is worth €250 million annually.26 It is managed by the Centre National de la Cinématographie (CNC), a public institution under the authority of the Ministry of Culture and Communication. In addition, funding for cinema is also available from numerous other national and regional bodies. To complement this public funding, France has put into place numerous mechanisms to encourage investment in film production via tax benefit schemes for private investors or production societies (SOFICAs and the Credit d’Impôt respectively), and via organizations such as the Institut pour le Financement du Cinema et des Industries Culturelles (IFCIC). Probably, the most important support the French government gives to its indigenous film industry is the tax it levies on the income of French television companies, which is designed to bolster the budget of the national public funds for motion picture production. In fact, this tax means that more than half of the CNC’s funds come from the television industry, compared to only 15% coming from the state.27 Today, all French television channels broadcasting more than 52 feature-length films per year are required to give 3.2% of their annual net income to European film production. Of that, 2.55% must be spent on French language productions.28 The obligations for private pay television channels are different. Canal Plus, for example, is required to pay 18.5% of its pre-tax revenues to subsidize the French movie industry.29 France has always been the most protectionist of the EU countries in terms of combatting American hegemony in the film industry. In the 1990s, it established a quota system whereby non-EU films could not command more than 40% of the playing time in French cinemas. Arguably, this overly benevolent system has undermined the competitive position of the French film industry. Vincent Maraval, the head of distribution and international sales at Wild Bunch, a leading French distributor, dropped a bombshell when he published an article in Le Monde arguing that French films were too expensive, directly due to France’s subsidy system—above all, its obligation for broadcasters to invest in French cinema. Putting his money where his mouth is, Maraval followed up the article with an announcement 12 months later that his company was scaling back on its French film investment.30 I remain very interested in becoming more involved in the French film industry. If Vincent Maraval is correct that French films are too expensive, what could I be smoking? While I love to spend time in Paris, I actually have a legitimate financial motive for this decision. My reasons are threefold. My first reason is that France is a fertile source for intellectual property—novels and graphic novels, 90% of which have not been translated into English. In particular, French graphic novels are a potential goldmine for cinematic adaptations, for both feature films and television. The French graphic novel as source material for motion pictures goes all the way back to Barbarella, which was first published in the early 1960s and was the first “adult” comic to receive mainstream attention. More recently, the Korean director Bong Joon-Ho adapted the post-apocalyptic French graphic novel Le Transperceneige as the basis of his

130  Globalization of the Business

film Snowpiercer. The critically acclaimed Persepolis also saw light of day first as a French graphic novel. I understand that both David Fincher and Nicolas Winding Refn have had big budget adaptations of French graphic novels in development. Of course, let us not forget the traditional French novel. I was approached a few years ago by Eliot Berry, a civilian (i.e., non-film guy) who was a Francophile and had written a spec script in English based on Albert Camus’s iconic novel L’ Etranger. Neither Camus nor his estate (which is presided over by his daughter and son) had ever granted either English or French language film rights to the novel, although the celebrated Italian director, Luchino Visconti, had directed an Italian-language version, Lo Straniero, which received very mixed reviews from the critics. Incredibly, Berry had managed to get his script to Catherine Camus, and even more incredibly, she granted him an option on the novel—provided the film was shot in English and was based strictly on his script. In hindsight, I am not surprised that Catherine Camus granted an option to a cinema neophyte because Berry’s script totally conformed to the novel. I arranged for Berry to come to Los Angeles to meet with the leading talent agencies to discuss an appropriate director, but sadly on the weekend Eliot was due to fly out, he died of a heart attack. His brother Charles, a prominent New York attorney, agreed to let me try to set up the film and Catherine Camus extended our option. Again, I focused on the choice of director because he or she would need to attract a world-class actor to play Meursalt. I suspected that no French director would tackle such an iconic novel in English—the French intellectual community would savage him or her—but I hoped that I could interest an Italian or British director. I wanted someone from the EU because I wanted to structure the film as a European co-production. Much to my disappointment, however, I could not persuade any auteur director to tackle such challenging material. When the extension on Berry’s option expired, Catherine Camus said that she wanted to have a go at a cinematic adaptation herself, but I have heard nothing about the project since. Just as I wanted to do L’ Etranger as a French co-production—in this case, either a France/Italy or a France/UK co-production depending on the director—that is my second reason for wanting to be more involved in the French film industry. France has co-production treaties with virtually all EU countries, but in particular I was intrigued by the opportunities presented by the France/Canada co-production treaty. Canada continues to double for the United States in a big way, and it also has a large pool of very talented writers and directors. I like to kid my client Black Label Media that it is fixated on French Canadian directors, having made its first three films with French Canadians: The Good Lie with Philippe Falardeau, Sicario with Denis Villeneuve and Demolition with Jean Marc Vallee. For purposes of qualifying as an official France/Canada co-production, both the writer and the director have to come from one of the two countries—but there’s a big loophole. Any EU country counts for France. That applies to actors as well. As I said earlier, the producers

Globalization of the Business  131

also have to come from one of the co-producing countries, but that requirement doesn’t apply with respect to executive producer credits. However, I have seen some projects go up in smoke when I tell a big-shot American producer that he can’t take producer credit if we set the project up as an official co-production. To repeat, credits often trump money. To take advantage of the Canadian benefit that accrues on qualified Canadian productions or co-productions, a number of American producers have even sought “landed immigrant” status in Canada. My third reason for wanting to get more involved in the French film industry is that France has recently sweetened its incentive program for foreign films shooting in France. In 2020, France’s parliament increased its tax rebate from 30% to 40% for international productions boasting a large portion of visual effects, although parliament did not approve a proposal to include abovethe-line expenditures such as the salaries of actors to qualify for the rebate, as is the case in Ireland and the UK. Canada has two incentive structures on the federal level. One is for a Production Services Tax credit, which is available for any productions shooting in Canada. The federal credit is equal to 16% of the qualifying labor paid to Canadian residents and is uncapped. In addition, there is no minimum number of days required and a non-Canadian company can hold copyright.31 Combining the federal credit with provincial credits, foreign producers can access aggregate credits ranging from 32% to in excess of 50% of eligible labor costs, as well as tax incentives on local qualifying spend ranging from 20% to 30%.32 To qualify for the Production Services Tax credit, there are no Canadian “cultural” tests to be met, but if you can qualify as “Canadian content” the benefits are even more substantial. However, it’s not easy to qualify: the Canadian producer must develop the production, must produce the project and have financial and creative control, and must own 100% of copyright. Plus, 75% of all service costs (generally below the line) must be paid to Canadians, and the production has to achieve at least 6 out of 10 points for Canadian personnel (director counts for 2, screenwriter for 2, first and second lead actors 1 each, director of photography 1, editor 1, composer 1 and production designer 1). Also, either the director or the screenwriter and either one of the two lead performers must be Canadian citizens or permanent residents (hence the scramble for landed immigrant status).33 The restrictions on the producer function are even tougher. All positions related to the producer function—including producer, co-producer, line producer or production manager (but not executive producer!) must be held by Canadians. If foreigners receive executive producer credit, they cannot be on the set for more than 25% of principal photography. The provinces apply equally tough criteria. When Tony Scotti, the producer of Eddie and the Cruisers II, which shot in Quebec, was seen spending more time than allowed on the set, the Quebec Film and Television Council disqualified the film as “Quebec content.” The same provincial body disqualified another film I financed because the production company, which was a Quebec-based subsidiary of the

132  Globalization of the Business

largest producer/distributor in Canada, Alliance, was deemed to be a front for the Ontario-based parent. Talk about tensions between French-speaking Canada and English-speaking Canada! The enhanced benefits, if you can qualify a film as “Canadian content,” include significantly increased Canadian broadcast license fees and access to public discretionary funding, primarily through Telefilm Canada. Telefilm administers the Canadian government’s co-productions and will put up equity funding on selected “Canadian content” films and television programs. Even more important, Telefilm’s equity contribution is generally subordinated to other equity investors, plus its profit participation is fixed at a significantly lower percentage than its equity percentage would typically warrant—just the kind of equity partner you would like to have! Technically, Telefilm could also make an equity investment in an official co-production, but practically I doubt whether it would do so unless the director (not the writer) was Canadian. Canada, like France, has an extensive network of co-production treaties. I organized tax shelters (structures that were subsequently replaced by the direct rebate systems on both the federal and provincial levels) on the first Canada/ Australia co-production, Black Robe (directed by Bruce Beresford, an Australian, and written by Brian Moore, a Canadian), and the first Canada/Israel co-production, Iron Eagle II (directed by Sidney Furie, a Canadian, and written by Sidney and Kevin Elders, who was not a Canadian at the time but later became a Canadian citizen based on his father’s Canadian citizenship). We went the Canada/Israel co-production route despite the fact that there were no financial benefits from shooting in Israel, because the Israeli air force was the only air force in the world able to perform the stunts and crazy enough to attempt them. Co-production treaties vary in their terms. In particular, each treaty sets out the minimum financial participation of the co-producers (and copyright ownership must track the relative financial contributions). Most treaties today require the minority partner to be responsible for at least 20% of the budget, but this calculation is complicated and does not necessarily mean that the minority co-producer must deliver his contribution in the form of equity. In general, again a complicated calculation, the expenditures in each co-producing country should match the financial contribution of the applicable co-producer and they cannot be less than the minimums in the treaty. The calculation of the incentives that can be accessed in a co-production is a function of the percentage each country (there can, of course, be more than two countries involved in a given co-production) bears of the budget—so if we have a Canadian coproduction where Canada is the 70% majority partner, the Canadian federal and provincial credits are calculated on the Canadian/provincial portion of the budget. As I mentioned earlier, ancillary revenue in China is practically nonexistent. Historically, that has not been the case in Europe, where, in particular,

Globalization of the Business  133

the European free television networks have been significant licensors of US feature films. These networks include the BBC and ITV in the UK; RTL, SAT 1, ARD and ZDF in Germany; TF1, M6 and France 2, 3 and 5 in France; RAI and Mediaset in Italy; and Los Angeles 1 and 2 and Telecinco in Spain. Of course, there are also the major pay television services, which are omnivorous consumers of Hollywood films: Sky UK, Sky Deutschland, Sky Italia, Canal Plus in France and DTS in Spain. The importance of both free and pay license fees can be seen in the buying behavior of the key independent distributors in those territories, where it is difficult to obtain the level of historical minimum guarantees today unless the local distributor has a commitment in advance or can be reasonably assured that one of his country’s leading broadcasters will pick up the title. Many of these broadcasters, particularly in Spain and Italy, have seen their acquisition budgets squeezed by overall economic pressures, plus there is less demand by European consumers to watch Hollywood films during the traditional television window, given the opportunity to see such films earlier in the cycle on pay television, pay-per-view and various streaming platforms. In addition, there is increased governmental pressure for indigenous broadcasters to show local-language films. In 2015, The EU filed antitrust charges against Sky UK, alleging that it has conspired to block consumers from watching pay-television channels of their choice regardless of where they live or travel in the EU—but prohibiting consumers from viewing content outside of their home country has always been the norm. After a prolonged 4-year period of negotiations, The EU accepted promises from Sky and the Hollywood major studios not to engage in “geo-blocking” of their content without imposing fines or punitive action, which effectively allows consumers across the EU access to a wider range of content regardless of their location. I believe this settlement was a primary driver of Fox’s decision to sell Sky to Comcast in a $40 billion deal. Under the agreement, the studios will now permit EU customers outside Britain and Ireland to subscribe to Sky UK’s pay-television services. In future license deals with companies in the European Economic Area, the studios agreed not to carve out countries or regions, which would violate competition rules. Ironically, one result of this successful antitrust proceeding may actually benefit Sky UK, which expanded its European footprint by acquiring Sky Italia and a 90% interest in Sky Deutschland in 2014, by consolidating the market into a few mega-satellite television companies with trans-European footprints.34 In addition, it would undoubtedly lead to the amalgamation of many of the territorial independent distributors that are so reliant on the support of their local television channels, which help them underwrite the cost of obtaining content for their territories. Home video has never been as important in Europe and elsewhere as it has been in the United States. One reason, of course, is piracy. The Guardian reported in 2014 that 30% of Britons were watching films illegally online or

134  Globalization of the Business

buying counterfeit DVDs, costing the industry £500 million a year.35 The effect of piracy in Asia is much more severe, effectively decimating the legitimate home video market. The Chinese, for example, just think illegal software is the smart choice because it’s cheaper. Government censorship policies further complicate the situation in China, because the censors will sanction only a narrow range of content on legal channels. Hence, uncensored Hollywood (and Chinese) films are sold on the cheap on street corners across the country and in private shopping centers, despite the fact that the quality of film and sound is often vastly inferior. I was in Hong Kong 4 weeks after Brokeback Mountain came out theatrically in the United States (and before it came out theatrically anywhere in Asia), and I saw a street vendor hawking a counterfeit copy of the film. Since no DVDs had been available in the United States to copy from so soon after the theatrical release, I have to assume that someone recorded the film on a camcorder in a theater somewhere. Online piracy began with illegal file-sharing sites like Pirate Bay and Popcorn Time. Pirate Bay’s founders were subject to a joint criminal and civil prosecution in Sweden in 2008 (all four were convicted), but the site simply changed its official domain name to thepiratebay.se to shield it from the US authorities. It changed its domain name again in 2013 to thepiratebay.gl in anticipation of a possible seizure by Swedish authorities of its domain. Over the years, the Pirate Bay website has been blocked in some countries, but these blocks can be circumvented with relative ease through the use of mirror websites that can route traffic through different URLs. It should be added that a number of Silicon Valley moguls have pushed back on government efforts to block such file-sharing sources. Google chairman Eric Schmidt even asserted that “government plans to block access to illicit file-sharing websites could set a disastrous precedent for freedom of speech.” He added that “Google would fight attempts to restrict access to sites such as the Pirate Bay.”36 Popcorn Time, which has been dubbed the “Netflix for Pirates,” also had its primary domain name struck down—i.e., unreserved—but it appears that it simply switched to other domain names and remains in operation, although it has faced legal challenges in a number of countries, including Israel, Norway, Denmark, Canada and New Zealand. Arguably, the future of piracy is not file sharing, but live streaming. In April 2015, 8 million people watched the fifth season premiere of Game of Thrones on their televisions. But on Periscope, the new Twitter-owned live-streaming app, thousands of users also watched the show on their phones.37 HBO recognizes that tens of thousands of people pirate the show every day, but in this case, it took immediate action by sending a series of takedown notices to Periscope. HBO’s action did not have clear legal support, in my opinion, because with Periscope there are no files or DVDs. Knowledgeable copyright lawyers even admit that the legal situation is not so clear cut. Under the Digital Millennium Copyright Act of 1996, online platforms are not responsible for what users post

Globalization of the Business 135

to them—but if they receive a complaint from a rights holder, they have to remove the violating content. The problem is, of course, that there is no content to remove on live streaming. Each episode of Game of Thrones lasts only 1 hour: by the time HBO filed its takedown requests, they applied only to users who had archived their stream for later viewing. It should be appreciated, with respect to addressing online piracy, that the quality is poor, the streams are hard to find, and if you join late or your phone needs to buffer, there is no way to pause or rewind. Real fans are unlikely to be seduced by such second-rate viewing conditions—provided, of course, they can access the content they want to watch over a television, Apple iPad, a tablet or another platform at a reasonable price.

Notes 1 Hoad, P. (2013, April 02). “Hollywood Global Box Office.” Retrieved from ht t ps://w w w.theg ua rd ia n.com /f i l m /f i l mblog/2013/apr/02/hol ly woodhold-global-box-office. 2 Ibid. 3 Thomala, Lai Lin. “Number of Cinema Screens in China 2009–2020,” Statista, 15 Jan. 2021. 4 Stoll, Julia. “Number of Cinema Sites in the United States”, Statista, 22 Jan. 2021. 5 “Spotlight on China,” Ernst and Young, www.ey.com/Publication/vwLUAssets/Media_and_ Entertainment_-_ Spotlight_on_China/$FILE/Spotlight_ on_China.pdf; Ben Child, “China Will Be the World’s Biggest Film Market by 2020,” The Guardian, 29 Nov. 2012, www.theguardian.com/film/2012/nov/29/ china-biggest-film-market-2020. 6 Davis, Rebecca. “Foreign Films Account for Just 16% of Total China Box Office,” Variety, 4 Jan. 2021. 7 Ibid. 8 “Spotlight on China”; “China’s Film Industry: A Blockbuster in the Making,” Wharton, 17 Feb. 2016, http://knowledge.wharton.upenn.edu/article/lights-chinaaction-how-china-is-getting-into-the-global-entertainment-business. 9 “Transformers: Age of Extinction (2014),” Box Office Mojo, www.boxofficemojo. com/movies/?id=transformers4.htm. 10 “Furious 7 (2015),” Box Office Mojo, www.boxofficemojo.com/movies/?id=fast7. htm. 11 “Spotlight on China”; “China’s Film Industry”; Child, “China Will Be the World’s Biggest Film Market by 2020.” 12 Busch, Anita. “Studio 8’s Fosun Financing Intact Despite Chinese Founder’s Disappearance,” Deadline Hollywood, 11 Dec. 2015, http://deadline.com/2015/12/ fosun-chinese-founder-disappearance-studio-8-financing-intact-1201665381/. 13 Moore, Schuyler. “What Chinese Companies Are Looking for in Hollywood,” Forbes, 4 July 2016, www.forbes.com/sites/schuylermoore/2016/07/04/ what-are-chinese-companies-looking-for-in-hollywood/#6acef b49292e. 14 Brzeski, Patrick. “China’s 2019 Box Office Hits All-Time High,” The Hollywood Reporter, 18 Dec. 2019. 15 Matusitz, Jonathan and Payano, Pam. “The Bollywood in Indian and American Perceptions: A Comparative Analysis,” India Quarterly: A Journal of International Affairs 67, no. 1 (2011): 65–77.

136

Globalization of the Business

16 “Average Movie Ticket Price in India in 2013, by Theater Type (in Indian Rupees),” Statista, www.statista.com/statistics/319496/movie-ticket-price-theatertype-india/; “Average Movie Ticket Price in Germany from 2002 to 2015 (in Euros),” Statista, www.statista.com/statistics/382600/cinema-ticket-pricegermany/; Pamela McClintock, “Average Movie Ticket Price in 2015 Sees Biggest Jump in Five Years,” The Hollywood Reporter, 19 Jan. 2016, www.hollywoodreporter.com/newsaverage-movie-ticket-price-2015-857302. 17 Tuttle, B. (2009, December 7). “Concession Stand Profits.” Retrieved from http://business.time.com/2009/12/07/movie-theaters-make-85-profit-at-concession-stands/. 18 Giridharadas, Anand. “The Screen Is Silver, but the Seats Are Gold,” The New York Times, 17 Oct. 2013, www.nytimes.com/2013/10/18/movies/amc-theaterslure-moviegoers-with-cushy-recliners.html. 19 McKay, Hollie. “Russian Film Industry and Hollywood Uneasy with One Another,” Fox News, 14 Oct. 2014, www.foxnews.com/entertainment/2014/10/14/ russian-film-industry-and-hollywood-uneasy-with-one-another.html. 20 González, Roque. “Emerging Markets and the Digitalization of the Film Industry,” UNESCO Institute for Statistics, August 2013, www.uis.unesco.org/Library/Documents/ip14-emerging-markets-digitalization-film-industry-culture-2013-en.pdf. 21 Ibid. 22 Hetch, John. “Mexico Box Office: 20th Century Fox Tracking to Shatter Record,” The Hollywood Reporter, 15 Sept. 2014, www.hollywoodreporter.com/news/ mexico-box-office-20th-century-732866. 23 “South Korea Yearly Box Office,” Box Office Mojo, www.boxofficemojo.com/intl/ korea/yearly/. 24 Pyeongguk, Jeon. FTA, Screen Quotas and Cultural Politics (Seoul: Korean Movie Association, 2006). 25 “French Cinema,” Bonza, www.bonzadb.com.au/static/fr/funding/index.html. 26 Ibid. 27 “Plans to Limit Foreign Films in Russia Abandoned.” (2014, November 28). Retrieved from http://www.bbc.com/news/entertainment-arts-30243335. 28 Ibid. 29 Ibid. 30 Hopewell, John and Keslassy, Elsa. “Vincent Maraval: ‘We Are Not Making Movies for a Cinema Audience’,” Variety, 9 Jan. 2014, http://variety.com/2014/ f i l m/g loba l/v incent-marava l-we-are-not-mak ing-mov ies-for-a-cinemaaudience-1201030444/. 31 “Canadian Content Tax Credits,” Canada Film Capital, www.canadafilmcapital. com/Tax-Credit-Overview/Learn-About-Tax-Credits.aspx. 32 Ibid. 33 Ibid. 34 Garside, Juliette. “BSkyB to Buy Sky Italia and Sky Deutschland for £4.9bn Cash,” The Guardian, 25 July 2014, www.theguardian.com/business/2014/jul/25/ bskybbuy-sky-italia-deutschland-fox. 35 Lodderhose, Diana. “Movie Piracy: Threat to the Future of Films Intensifies,” The Guardian, 17 July 2014, www.theguardian.com/film/2014/jul/17/digitalpiracy-film-online-counterfeit-dvds. 36 Kalliday, Josh. “Google Boss: Anti-piracy Laws Would Be Disaster for Free Speech,” The Guardian, 18 May 2011, www.theguardian.com/technology/2011/ may/18/google-eric-schmidt-piracy. 37 Harding, Xavier. “‘Game of Thrones’ Season 5 Piracy: Periscope Streamers Could Face Account Suspension after GoT Premiere,” iDigitalTimes.com, 13 Apr. 2015, www. idigitaltimes.com/game-thrones-season-5-piracy-periscope-streamers-could-faceaccount-suspension-after-432379; Kissel, Rick. “‘Game of Thrones’ Premiere Draws 8 Million TV Viewers—Just Shy of Series High,” Variety, 26 Apr. 2015, http://variety.com/2016/tv/news/game-of-thrones-premiere-ratings-season-6-1201759863/.

10 HOW TO HAVE FUN AND NOT LOSE YOUR SHIRT

Summary—This and the next chapter represent the core of the book in terms of offering advice to prospective investors in the film industry. It discusses crowdfunding as a viable means of raising capital and sets forth what an investor should look for in any information memorandum or prospectus. It raises some key accounting issues to keep in mind and discusses various strategies to minimize tax obligations—focusing on non-US investors. Finally, it highlights the risks and rewards associated with investing in film companies as opposed to single pictures or slate of films—highlighting two historically prominent independent production companies, The Cannon Group and Carolco Pictures. Most of you have heard that old saying, “How do you make a small fortune in the movie business?” “Start with a large fortune.” But I have heard the same advice about investing in thoroughbred horses, Broadway plays and penny stocks. Of course, if you want some exposure in Hollywood, you can always buy the stocks of the big motion picture studios—or rather their parent companies, which offer a much broader panoply of assets than a pure motion picture play—television, theme parks, hardware, cable operations, video games, Internet companies and so on. If you did that selectively a year ago, you would be a lot better off: Disney is up 90%, Sony 78%, ViacomCBS 191% (although it reached seven times its low during the year before the share price collapsed as a result of the bankruptcy filing of the highly leveraged family office, Archegos), Comcast (the parent of Universal) 56% and Lionsgate 166%. Much of this appreciation can be attributed to the excitement engendered by the introduction of streaming services by the major studios, not including Sony, on this list. Markets are very volatile, however, and the stocks a year ago were all suffering from the impact of cord cutting and the shock effect of the pandemic both on production and theatrical releases.1 DOI: 10.4324/9781003153702-11

138  How to Have Fun and Not Lose Your Shirt

Trading stocks can be intellectually challenging and financially rewarding, even exciting, but rarely have I heard it described as being fun or creatively rewarding. But the movie business does offer those rewards. The last chapter of this book is entitled “Art Versus Commerce,” and in it I will discuss the tension between movies being a business and movies being a creative enterprise. While I indicated at the beginning of Chapter 1 that most of my clients are committed to developing the same rigorous business strategies in their approach to film investment that they apply in their primary businesses, I would also admit that virtually none of them are in the movie business simply to make money. Some are pure cinephiles, others get enormous pleasure out of being involved in the creative process (most actually enjoy reading scripts!), while others, like Jeff Skoll, who made his first billion as president of eBay, are motivated by the power of cinema to promote social values (without sacrificing commercial viability). Accordingly, Skoll orchestrated a major restructuring of his company, Participant Media, several years ago because he was unhappy with how it was functioning, and also because he had probably accumulated several hundred million dollars in losses in his fledging cable network. In 2015, Skoll joined with Reliance Entertainment in India, eOne in Canada and Alibaba Pictures in China to finance Steven Spielberg’s Amblin/DreamWorks empire—primarily, I assume, because they would rather bet on Spielberg’s film picking skills than on their own creative teams. In 2017, Universal joined the consortium. Of course, you do not have to own a production company to play in the movie business. At the low end of financial commitments, there are the crowd-funding platforms, primarily Kickstarter and Indiegogo. When you contribute to the funding of a film on these platforms, you are not an equity participant in the film—you are a benefactor, which may entitle you to everything from merchandising related to the film (T-shirts, posters, mugs, etc.) to a ticket to the premiere if you give enough—and the individual contributions people make on these platforms will never break the bank. Two of my producer clients, Michael Shamberg and Stacey Sher, raised $3.1 million for their film, Wish I Was Here, starring Scrubs star Zach Braff. The Kickstarter campaign had 46,520 contributors, which works out to less than $70 per contributor. After conversations with Michael and Stacy, I doubt they will repeat their crowdfunding experience any time in the near future. It took an enormous amount of their time, as well as Zach Braff’s, to support the marketing campaign required to generate retail commitments on that order of magnitude— plus, it wasn’t cheap, although the several hundreds of thousands of dollars required to make video appeals and run online advertising arguably represented money well spent if you take into account the fact that no money ever had to be returned to the contributors from the film’s exploitation. Crowdfunding campaigns are not without risk. On the one hand, under Kickstarter, if you don’t hit your funding goal, you can’t keep any of your contributions. Indiegogo, on the other hand, lets you keep any money you source even if

How to Have Fun and Not Lose Your Shirt  139

you don’t hit your funding goal, although it does collect a 9% fee in that case plus additional payment processing fees of 3–5% (if you do hit your funding goal, its bare fee is only 4%). In the case of Kickstarter, you get a maximum of 60 days to hit your funding goal, and if you hit it, it takes a 5% fee plus additional payment processing fees of 3–5%.2 Not every independent project is suitable for crowdfunding campaigns. Zach Braff’s directorial debut, Garden State, was made for only $2.5 million, but grossed over $35 million at the box office and was praised by critics, leading it to gain a cult following—plus he was already well-known for his role as Dr. John Dorian on the television series Scrubs.3 If you do not have that special hook for the millennial crowd that is likely to participate in crowdfunding campaigns, you could easily find such campaigns a very depressing experience. One of the most hilarious YouTube videos I have ever seen is German director Uwe Boll’s rant after his third failed crowdfunding effort in which he wished Hollywood “goodbye” and said he had enough money to play golf until he was dead. C’mon, Uwe: did you really believe anyone would step up to support the second sequel to the mass-murder thriller film Rampage, which got a theatrical release only in Germany and was released direct-to-video in the rest of the world? I don’t want to write off crowdfunding opportunities totally, especially if the project appeals to millennials and online junkies. After having raised $2.4 million on Indiegogo in 2015 for the sci-fi film Lazer Team, the producer Rooster Teeth collaborated with a crowdsourcing company called Tugg to effectively presell theater tickets for the film over the Internet. It works like this: Let’s say you are a fan in Memphis. You can contact Tugg and if the presales meet a certain threshold, Tugg will then work with the fans to book a theater in Memphis. Under this structure Rooster Teeth was able to generate theatrical presales in excess of $1 million, including such international territories as the UK and Australia/New Zealand.4 In my opinion, a better opportunity to raise money from the public will be the new Regulation A+ offering promulgated by the Securities and Exchange Commission (SEC). Under a Reg A+ filing you can now (a) approach nonaccredited as well as accredited investors, (b) advertise your offering and (c) not be subject to onerous and expensive state securities laws. It will, however, take approximately 3 months, at least initially, for the SEC’s approval process, during which time the sponsoring broker/dealer can “test the waters” via an “Indication of Interest (IOI).” This is a pre-offering information package to investors that permits the broker/dealer to gauge the level of investor interest in the project and assess whether or not it is worth going out with a full-fledged public offering. The upside to this is that you can circulate the information package and gather investor support. While the broker/dealer cannot accept any investment until it has received SEC approval, those persons who have expressed interest can be re-approached once the approval is received.

140  How to Have Fun and Not Lose Your Shirt

The concept needs to be proven, and accordingly, I anticipate that the first few raises would involve lower-budget films, probably no more than $10–15 million. Since these offerings will not be underwritten, but will be on a “best efforts” basis, and in order to accommodate the timetable, the co-operation of producers, directors and talent will be needed to confirm their attachment to the project and their willingness to proceed to production once the offering is consummated. They must also be willing to appear in advertising and marketing materials. Technically, any genre is feasible, but I am looking for a project with a recognizable cast and a theme that hopefully will appeal to a broad range of US investors. My first few projects will probably be passion projects of the talent—otherwise, they are unlikely to take themselves off the market for the 4–5 month period required to raise the funds. Hopefully, the initial 3-month SEC approval process will come down over time, so talent’s open-ended commitment will also be shorter. There is another structure described by new SEC rules under Title III of the Jobs Act, which became effective May 16, 2016. This permits film companies to raise funds from non-accredited investors without having to file a registration statement under the Securities Act of 1933. This structure does not require audited financial statements for offerings under $500,000 (the cost of preparing audited financials could virtually wipe out the full benefit of the raise), nor does it require a sponsoring broker/dealer, but you are limited to a $1 million raise, so it is feasible only for microbudgeted films. Under Reg A+ a single company can raise up to $50 million in a given year. As Sky Moore pointed out to me, an alternative structure for microbudgeted films under $1 million is simply to rely on SEC Rule 504, which exempts offerings of not more than $1 million to whomever, as long as the issuer discloses all material facts, does not commit fraud, does not advertise and files Form D with the SEC. While Rule 504 offerings must comply with state securities laws, for most states the issuer is simply required to limit the offering to under 35 investors that either have a pre-existing relationship with the promoter or that are financially sophisticated (or are represented by someone who is). I indicated earlier that these structures may result in both shenanigans on the part of the promoters and just plain bad deals that never should be done in the first place. I can easily come up with comps for any film project that suggest that the film is likely to generate an attractive ROI. If you have an urban-themed film, we can compare it with such urban-themed successes as Madea’s Family Reunion or Why Did I Get Married? But not everyone is Tyler Perry. A proper analysis of the potential of an urban-themed film would have to take account of the entire universe of theatrically released urban-themed films—we are back to Monte Carlo simulations again—and to do such simulations properly, you would need full P&Ls on all the films in the sample, which as I also indicated earlier, we do not have. In fulfilling your fiduciary responsibilities, you would also have to acknowledge that urban-themed films typically “do not travel” internationally, so if I were advising prospective investors on such a project, I

How to Have Fun and Not Lose Your Shirt  141

would recommend they hone in on what level of domestic box office in combination with correlated ancillary revenues, is necessary to fully recoup their investment. Foreign revenues should be assumed to be de minimis and a bonus, if indeed they are forthcoming. The other cute move I see all the time is to generate comps based on other films an actor has performed in. So much of that is comparing apples with oranges. You can appreciate that comparing a $15 million drama with a $70 million action film just because both films share the same actor is not a very justifiable comparison—but it is done all the time, and it’s even worse when the actor’s star power has waned significantly over time. The SEC is not in the business of vetting budgets or deal terms, so at the end of the day, investors will be reliant on the integrity and fair dealing of the producers on a film—that they will not pad the budget, inflate their own fees or depart from industry practice in structuring the film’s waterfall. Investors will also be reliant on the producer’s ability to select a capable distributor for both domestic and international distribution, and to negotiate the best distribution terms possible. Remember, producers are primarily in it to earn a fee—perhaps also to garner some awards—but they are likely to want to do business again with the studio distributing the film. How motivated are they going to be to push back on the studio’s negotiating stance? We are back to my earlier dictum: You had better be sure your producer is both competent and a trustworthy partner. If my client is going to fully finance a film or be a major equity investor, he can afford to do the necessary due diligence to check out the producer’s bona fides, but small-time investors participating in a broad public offering do not have the means or the wherewithal to do the necessary homework—and they certainly should not rely on the SEC to do it for them. Nor am I confident that many broker/dealers handling such an offering will do their homework either. Just because a given producer has some successes under her belt, maybe 20 years ago, or won an Oscar in the primordial past, does not mean she can be trusted with the public’s money. If these Reg A+ offers take off, I should probably devote some sweat equity and set up a research division within my company to analyze such deals—but I’m not sure how I can be paid for devoting the time. Also, do I really want to provoke producers with whom I may want to do business in the future by giving them a “thumbs down” on their offering? Remember my earlier comment on the egregiousness of the leveraged nonrecourse tax shelters based on the then-existing ITC? I will now confess that the IRS approached me to educate their agents on how the deals worked and whether the investor was truly at risk. Not surprisingly, I did not want to be compliant in bringing down the offerings of some powerful producers in Hollywood—but at the same time, I certainly did not want to provoke the IRS. So, I thought the best tactic for avoiding having to assist the IRS was to quote an hourly billing rate that was so high as to be unacceptable (when you advise a government agency you have to be paid by the hour). I do not remember what I quoted, but I think it was around $800/hour (this was in the mid-1980s). Much

142  How to Have Fun and Not Lose Your Shirt

to my chagrin, the IRS did not blink. Then I realized that whatever they paid me was chump change if I could help them recover hundreds of millions of dollars in disallowed deductions. The good news is that I was never deposed, so my tutorial role in these proceedings was never publicly revealed. With all these caveats in place and given that the Wall Street retail houses do not seem inclined to revive the Silver Screen limited partnership structure, Reg A+ public offerings seem to offer the only realistic alternatives for small investors to invest in feature films. One of the benefits of the Reg A+ structure is the liquidity it provides. I presume most of the lead underwriters will make a secondary market in the shares—hopefully, other market makers will be persuaded to come in as well. Thus, unlike a direct equity investment in a film, where you wait to collect your revenue entitlement as per the waterfall—with an average life on your investment of probably 2 1/2 to 3 years—if you invest in a Reg A+ offering, you will be able to sell at any time, even before the film is released. You can even buy shares in the secondary market, based on the prevailing quotations at the time. If you have good financial models, you may even be able to outguess the market makers as to fair market value. All of this presumes that substantial retail houses will want to play in this arena. Otherwise, we will have to rely on smaller crowdfunding specialists who do not have the same size client base as the larger retail houses. But maybe that’s not so important when you have the Internet to reach out to prospective investors. The Hollywood Stock Exchange (HSE) is the leading tracking index where fans can bet on prospective domestic box office during the first 4 weeks of wide release, or 12 weeks if the film remains in limited release. But the HSE is a faux stock exchange: You cannot actually risk real money, nor are you valuing real securities. Rather it is a web-based, multiplayer game for trading virtual securities using virtual currencies over a network. The secondary market I hope will develop for Reg A+ offerings will be the real thing. The brokerage firm Cantor Fitzgerald purchased the HSE in 2001 and invested significant monies trying to turn the popular website into a legitimate exchange. It commenced the regulation process in 2008 and announced its intention to permit studios, institutional and individual investors to place bets on box office performance for a wide array of films. But after Cantor received approval from the Commodities Future Trading Commission to begin trading, Congress inserted a ban into its financial reform legislation after the economic debacle in 2008. When I reviewed current quotes on the HSE some 8 years ago, I was impressed by how reasonable many of them looked. Apparently the HSE has been a pretty accurate predictor of domestic box office performance. In 2007, for example, players on the HSE correctly predicted seven out of the eight top Oscar winners! Mission Impossible–Rogue Nation, which was released the weekend after I wrote the first edition of this book in 2015, was quoted at $151.95. For the record, I was a buyer, not a seller. In retrospect, I was right on—the film did $162 million at the box office in its first 4 weeks of release.

How to Have Fun and Not Lose Your Shirt  143

If you wish to consider investing in a future Reg A+ offering, let me at least give you a few tips as to what you should be looking for in the prospectus. First, I would want to see the full background of the producers and the production companies on the film, including any record of litigation against them or involvement in bankruptcies, whether in the movie business or otherwise. Second, I would like to see a detailed synopsis of the project and the credits of the screenwriters. Third, I would like to see a detailed record of the development of the project—how it was conceived, who commissioned the original screenplay and how many iterations of the screenplay there have been. Fourth, I would expect that at least a director and the two leading actors have been attached. Fifth, I would like to see at least the top sheet of the budget (including a breakdown of each producer’s fee) and confirmation that it has been vetted by a reputable completion bond company that has confirmed the budget provides for all necessary delivery items. Sixth, I would expect to see a reputable foreign sales company attached, and while I would not expect them to disclose their estimates territory by territory (because that would undercut their negotiating leverage with the various territorial distributors), I would like to see a summary of their aggregate “take” prices (i.e., the minimum guarantees on which they are prepared to close). I would also like to see a report from a reputable financial analyst in the industry as to a range of likely aggregate foreign advances plus projections as to the quantum of “soft money” benefits that are expected to accrue. That will give investors a good sense of how much risk there is with respect to their investment. The budget, less projected foreign sales, net of sales commissions marketing expenses and residuals (guild payments) and less “soft money” benefits, equals the so-called domestic gap—i.e., how much of the budget remains to be recouped out of net domestic receipts. Seventh, I would like to see a full description of the “waterfall,” which describes how the revenues will be distributed, and in what order, among the parties. This is typically set forth in the Interparty Agreement, and I would like to see the precise definitions of all terms referred to with respect to the waterfall. Eighth, I would expect the film to be governed by a collection account management agreement (CAMA), which is absolutely essential before I would ever consider investing in an independent production. A collection account is an account in the name of a neutral third-party collection account manager (CAM), who receives from the local distributors the worldwide revenues generated from the exploitation of the film and disperses them according to strict instructions set forth in the CAMA to the multiple beneficiaries including the sales agent, the producers, the financiers, talent and investors or anyone else who is entitled to a share of the revenues. I work with both of the two leading CAMs—Fintage House and Freeway Entertainment. The benefits of a CAMA are fourfold: 1

With a CAMA, none of the parties with a financial interest in the film controls the specific allocation and distribution of receipts, which is carried out by a neutral third-party CAM.

144  How to Have Fun and Not Lose Your Shirt

2

3

4

The CAMA is typically signed by all parties with a major financial interest in the revenues of the film, which entails that the CAMA supersedes all other agreements with respect to the allocation and distribution of receipts, thus reducing the risk of disagreement and conflict between parties. The CAMA typically provides quarterly, or later in the cycle, annual statements that provide current and cumulative breakdowns of revenues as per the recoupment schedule as well as a gross receipts report, showing all sales made per territory and distributor, and minimum guarantees payable in connection therewith, against the revenues received in the collection account. The CAMA provides complete periodic reporting that can be used by all the parties for internal accounting and audit purposes.

Ninth, I would like to see a full breakdown of locations and studio facilities to be used together with a comprehensive timetable covering, pre-production, principal photography and post-production. Finally, I would like to see projections covering at least five likely performance scenarios, which would be provided not by the producers, but by an independent financial analyst—with obviously the normal “forward looking statement” caveat included. Different people find different ways of having fun in the movie business. I am talking about civilians here—i.e., non-professionals. Some love to read scripts, although I have not always found much of a positive correlation between money and taste. Even experienced producers, if they are smart, surround themselves with experienced development executives, whose job it is to vet projects, assess scripts and give extensive notes on how the script can be improved. Yes, opinions are subjective, but smart, experienced development executives have been through the wars and have seen what works and what doesn’t work over a multitude of submissions. Just because the development executive is half your age, that doesn’t mean his or her opinion (many more development executives are women) shouldn’t count for much. Also, many films are aimed at a millennial audience, and you can’t expect a middle-aged white male producer to appreciate much of the material aimed at that younger audience. Other investors like to visit the set—generally for not too long, because being on a set is like watching paint dry. Before you can shoot a scene, you first have to block it, determining where the actors will be on the set and the first camera position, then the director of photography has to light the set and position the camera for the first shot, then there is the camera rehearsal of the first setup with the actors and crew, then you have to make lighting and other adjustments—all this before you can even shoot the first scene when the director will orchestrate multiple takes of a particular shot. A one-take occurs when the entire scene is shot satisfactorily the first time. Needless to say, if that occurs it’s generally by happy accident. So, most of the time, if you hang out on a set, you will be checking emails on your phone. Maybe investors also hope to hang

How to Have Fun and Not Lose Your Shirt  145

out with the stars—but if that is their hope, rarely will they get much more than a brief introduction. Time is money on the set, and a good producer (as well as a good agent) will want to shield his talent from any distractions that interfere with their ability to perform. Finally, many investors really enjoy going to festivals, where there is glitz and more time to hang out with the stars. But festivals are not just an opportunity to showcase the film and hopefully garner positive critical reviews. Festivals are also a place to nail down distribution deals—taking advantage of the overall buzz the film generates. The most important festivals that also double as markets, where distribution deals are made, are Sundance ( January), Berlin (February), Cannes (May) and Toronto (September). Prominent stand-alone festivals (which do not have accompanying markets) include Venice, Tribeca, San Sebastian, South by Southwest, Telluride and London. For the right kind of film—i.e., one that is expected to receive strong critical reviews and enthusiastic audience reception—sales agents like to premiere it at a leading festival that also doubles as a market because all the key buyers attend, and the hope is that a competitive bidding war can be initiated. Since this chapter is also supposed to be about how to avoid losing your shirt, indulge me for a few pages while I give a brief background on film accounting. Why is this important? Because I assume most of my readers will be subject to taxes somewhere in the world, and the last thing you want to do is pay more taxes than you have to. When you finance a film, you are effectively acquiring a capital asset that must be amortized over time. To the extent your declared revenues, for tax purposes, exceed the amortized value of the asset, you have taxable profits against which taxes must be paid. So, cost mitigation strategies are as important as revenue enhancement strategies to achieve desired ROI. Before I go into detail about how film costs are treated from an accounting point of view, I want to point out with respect to development expenditure, such costs should be written off if the project has not been greenlit, or set for production, within 3 years of the date of initial capitalization. Now, I want to focus on Generally Accepted Accounting Principles (GAAP) as applied to the amortization of a film asset. The most common method of depreciating interests in motion pictures, and television films, is the income forecast method, which attempts to match the recognition of a film’s income ratably with its associated costs. By preventing any significant mismatching of income and depreciation, the income forecast method does not produce significant tax deferral benefits. It works like this: Once a film is theatrically released, the taxpayer must estimate the film’s lifetime revenue; then he or she is permitted to amortize in each year that percentage of the film’s capitalized cost equivalent to the percentage that year’s revenue represents to the total estimated lifetime revenue. For example, if in the year after theatrical release, the accountants project that the actual receipts generated in that year are projected to equal 20% of the film’s ultimate lifetime revenue, they would stipulate an amortization charge

146  How to Have Fun and Not Lose Your Shirt

equal to 20% of the initial capitalized value of the asset. While this looks like a purely objective test, it has a strong subjective element to it. Let me explain what happened to Orion Pictures. Orion was a US distribution company that was responsible for many of the great films released in the 1970s, 1980s and 1990s—including Amadeus (1984), Platoon (1986), Dances With Wolves (1990) and The Silence of the Lambs (1991)—each of which won the Academy Award for Best Picture. Despite years of showing consistent profits and having two of its most successful films in 1990–91—Dances with Wolves and The Silence of the Lambs—the company filed for Chapter 11 bankruptcy protection in December 1991. This bankruptcy filing was primarily the result of a quirk associated with income forecast accounting. It turns out Orion had been overestimating the value of television rights on its film library for years. Since these rights are back-ended, the denominators on its income forecast calculations had been consistently overstated, which means that Orion had been underamortizing for many years. When the library value was recalculated, it caused the company to take a sizeable charge against profits in 1990–91, which generated a massive loss for the year in question, which tripped some of their bank covenants, which effectively put it in breach of its bank loans, which prompted its banks to turn off the lending spigot, which forced it into bankruptcy. I am not suggesting any malfeasance on Orion’s part, but I would point out that it is tempting for public companies to pursue less aggressive income forecast amortization calculations in order to show more robust profits, while privately held companies, which are more interested in reducing their tax obligations than in showing higher earnings, might be tempted to pursue more aggressive income forecast amortization calculations by front-loading their revenue projections. As I mentioned earlier, Congress recently reinstated Section 181 of the Tax Code, through 2025 which permits US taxpayers to accelerate their deductions with regard to film amortization, but only on films produced in the United States, to a cap of $15 million ($20 million in certain instances) of film costs, including development and pre-production costs. Section 181 of the Tax Code permits a 100% write-off in the year in which such costs are incurred. However, the deduction of the costs must be recaptured as ordinary income in any subsequent taxable year—so the taxpayer gets a timing benefit only, but as long as the Section 181 deduction is available the taxpayer could theoretically continue to defer his or her tax bill indefinitely by rolling over into new US qualifying films each year. I would point out, though, that US individual taxpayers are able to apply the deductions permitted under Section 181 against passive income only, so not every individual investor in film and television can take advantage of such accelerated deductions. Sky Moore pointed out in the May 17, 2013 issue of the Hollywood Reporter that there are other hidden loopholes that can benefit film investors.5 The first is a clever way to use overseas income. There is a little-known subsidy in the Tax Code for export activities called a “Domestic International Sales Corporation,” which permits any pass-through

How to Have Fun and Not Lose Your Shirt  147

film company that has net income from outside the United States attributable to films produced in the United States to save almost 50% of its federal taxes, subject to a cap of approximately $2 million per annum. The second strategy is an extension of the well-publicized ploy utilized by large multinationals to avoid paying taxes on foreign-source income indefinitely until profits are repatriated as dividends. Sky points out that even when dividends are paid, the federal tax rate can be reduced by almost half if the dividends are structured properly, resulting in a permanent benefit. Third, more tax savings are available through Section 199 of the Tax Code, which provides for an exclusion of 9% of worldwide net income attributable to film and television if at least 50% of the total production expenditure is for US-based services, with a cap on the exclusion equal to 50% of the total wages paid by the film company during the tax year. Finally, Sky indicated that there is a good reason why most of the studios are based in California, despite California being a high-tax state: For C corporations and non-California residents, California-only taxes income that is “attributable” to California, and income from the licensing of films is allocated to the place where the movie is watched, as opposed to the location where the production or sales activity occurs. Since California probably represents less than 5% of the worldwide market for films, less than 5% of the studios’ income is subject to tax in California. Many of my investors over the years have been non-US investors, so we have had to pay careful attention where to establish the domicile of the investment vehicle and how to minimize US taxes. Non-US income generated by the production entity will not be subject to tax in the United States provided the licenses generating the income are not negotiated, solicited or executed from an office or subsidiary of the investment vehicle based in the United States. At the same time, we want to set up our structure in a domicile that will not impose significant taxes on worldwide income. Hence, we focus on tax-friendly jurisdictions like the Netherlands Antilles, the British Virgin Islands, and if you feel more comfortable with a European address, Luxembourg. Typically, such tax havens, while they permit you to pay low rates of taxation, do not have a significant network of tax treaties that reduce the withholding taxes that most countries impose on income generated there. Accordingly, film rights must be licensed back-to-back through an intermediary in a country with a favorable treaty network to minimize withholding. The most common back-to-back structures use licensing intermediaries based in Hungary. Both Fintage House and Freeway Entertainment, the two leading international collection agents, have Hungarian subsidiaries that perform this function (typically for a 1% service charge with an annual cap of under $100,000). But this structure does not work for the United States. Other methods must be employed to minimize US withholding taxes. Let’s start with the counterintuitive premise that a foreign partner in a US LLC established to produce and exploit a film is subject to federal and state income

148  How to Have Fun and Not Lose Your Shirt

taxes despite the fact that the foreign partner (a) is not physically located in the United States, (b) does not maintain an office in the United States and (c) does not have any employees or representative agents in the United States. The problem is that a domestic LLC engaged in film production is deemed to be engaged in a trade or business within the United States, and thus a foreign partner’s mere ownership interest in the LLC makes the partner the recipient of partnership income that is “effectively connected” to such trade or business. Even if the foreign partner does not file tax returns in the United States, the LLC is obligated to disclose the identity of the foreign partner and amounts actually or constructively received by the foreign partner from the LLC. The LLC must withhold taxes for each foreign partner’s distributive share of partnership income, even if no actual distributions are made to the foreign partner. A non-US investor can circumvent this tax obligation through the use of entities known as “corporate blockers.” By having the corporate blocker invest directly in the LLC, the trade or business conducted within the United States by a domestic corporate entity is not attributed to the foreign investor. This means that mere ownership of shares in a corporate blocker will not give rise to effectively connected income, and thus the LLC is not required to pay withholding tax, because the entity holding the LLC membership interests is a domestic corporation. But the corporate blocker structure has several downsides, the most obvious being the fact that corporations are doubly taxed in the United States—first at the corporate level and again at the shareholder level upon the corporation’s distribution of earnings and profits to shareholders in the form of dividends. If a shareholder receiving dividends is a foreign shareholder, the received dividends are net of US withholding tax. A domestic corporate blocker incorporated in Delaware pays federal taxes on its distributive share of LLC taxable income at a rate of 35% and dividend amounts to the foreign shareholders of the corporate blocker are subject to a 30% rate of withholding tax. This can be reduced or altogether avoided if there is an income tax treaty in place between the United States and the foreign shareholder’s country of residence for tax purposes, but, in cases where the foreign shareholder has set up shop in a tax haven to minimize his tax burden, such havens typically do not have double taxation treaties with the United States to allow a reduction or elimination of US withholding taxes. Accordingly, we have employed other strategies to minimize US withholding taxes. I do not want to go into great detail because a lot of this represents proprietary information that has been developed over time with an expensive tax council. The basic premise, however, is for the foreign entity that produced the film to sell the US rights for a fixed price to a US subsidiary that can then license the rights to third parties within the United States. Under this approach, the sale price is not subject to US withholding tax. Nor is any income to the offshore entity from the sale subject to US tax. The US subsidiary, of course, will be subject to tax in the United States, but in calculating its taxable income,

How to Have Fun and Not Lose Your Shirt  149

it will be entitled to deduct the cost of purchasing the US rights applying income forecast amortization. The net result is that the US subsidiary generally is not taxed on income it receives up to the amount of its purchase price for the rights, but any income in excess of that amount is subject to US tax. Up to now, I have focused only on investing in single pictures or slates of films. I have ignored stock plays in public companies. Of course, you can always buy shares of the big conglomerates—Disney, Comcast, Fox, Sony, Viacom, Time Warner—that have studio subsidiaries. But I want to say a few words about several of the independent production companies that have gone public over the past 35 years. Virtually all of them eventually declared bankruptcy, primarily because their films didn’t perform, but there were also failings in their underlying business plans that contributed to their demise. There really haven’t been any IPOs for independent production companies since the heydays of the 1980s, which saw companies like The Cannon Group, Carolco Pictures, De Laurentiis Entertainment Group and Kings Road Entertainment raise money from the public. There is a very good reason for that, even apart from the lackluster performance of these companies’ films. Investors value predictability of quarterly earnings, and small independent production companies are dependent on the unpredictable performance of just a few films per year, plus they don’t have substantial libraries with stable cash flows that can smooth out extremely variable quarterly earnings. Cannon probably provided the greatest roller coaster ride of all the indies. Two Israeli cousins, Menahem Golan and Yoram Globus, bought a soft-core film producer on its last legs for $500,000 in 1979 and transformed it into the leading producer of B-action films in the industry, taking advantage of the boom in home video sales and rentals in the 1980s. As long as they stuck to their original business plan of producing low-budget action films (most notably the Death Wish series starring Charlie Bronson) for a few million bucks each (or even less), they were virtually assured of making a profit on every film just out of foreign presales and US home video revenue. They had a foolproof plan for raising the necessary capital for financing their ever-increasing film slate (the company’s production volume peaked in 1986 when it produced an astounding 46 films in that year): They went to Cannes each year armed with posters and billboards for their announced but as yet unproduced films. The deposits they received with respect to sales on the new films effectively financed the earlier films in their production cycle. This recycling mechanism functioned like a perpetual motion machine. During this period its stock went up a hundred-fold—but then the music stopped, for two reasons. The first you can attribute to the peaking and the rapid decline of the home video market. But the second you can attribute to hubris. Menahem in particular had grander visions for the company. He wanted to be Louis B. Mayer, the legendary chairman of MGM, which meant that he wanted to produce higher-budget films to compete with the studios. I should admit here that I had a close personal

150  How to Have Fun and Not Lose Your Shirt

involvement with the cousins. In the early 1980s, my UK company, Albion Films, provided significant financing to Cannon through its sale-and-leaseback structure in the UK. Then, in the mid-80s, I introduced them to E.F. Hutton, which took them public, following which I structured a limited partnership offering with Hutton to finance Cannon’s slate going forward. I was going to serve as the general partner. But right before we were planning to go out, Disney approached Hutton to handle a similar offering that became Silver Screen Partners. A condition of Hutton becoming the lead underwriter was that it would be exclusive to Disney for this kind of offering. You can imagine how difficult it was for Hutton to choose between Disney and Cannon as a client— so my big payday was not to be. Ironically, the deal terms for investors that we proposed for the Cannon partnership offering were dramatically more favorable than the deal terms on Silver Screen—but who can say how successful the underlying Cannon films would have been? I did a UK sale-and-leaseback deal on Cannon’s first venture into higherbudget films, Lifeforce (aka Space Vampires), which helped defray some of the cost—but the film flopped at the box office. It was followed by the laughable Over the Top, starring Sylvester Stallone. A film about arm wrestling—give me a break! Rocky it wasn’t. On the one hand, Menahem was obsessed with winning an Oscar—Yoram, on the other hand, was totally fixated on the bottom line and the company’s stock price. To be fair, Cannon did produce one critically acclaimed film: Runaway Train. The two leads, Jon Voight and Eric Roberts, were both nominated for an Oscar. Knowing Menahem’s desire to be involved with “A”-list talent (and knowing that Jack Nicholson’s pet project Henderson the Rain King, based on Saul Bellow’s acclaimed picaresque novel about a troubled middle-aged man who goes to Africa to regain his spiritual compass, was not financeable within the studio system), I went against my instincts and set a meeting between Menahem, Jack and Hal Ashby (who was attached to direct). Jack showed up in his traditional outfit of torn jeans and sunglasses as reflective as what the guards wore in Cool Hand Luke. The meeting started off reasonably well, with Menahem being incredibly deferential, until Menahem asked how much the film would cost. Hal and Jack deferred to me as the money guy. I can’t remember the exact number I quoted, but it was around $18 million for a cast consisting basically of Jack and several hundred pygmy tribesmen. Menahem cut me off, saying that’s what it would cost if a studio made it, but Cannon knew how to achieve comparable production values for a fraction of the studio cost. He bragged about Cannon’s film Sahara in which there was a scene in an oasis where 50 horses or so were running around in a circle. Menahem said they accomplished that effect with four horses, but they were running very fast! This was absolutely true. I couldn’t see Jack’s eyes behind his sunglasses, but I could tell they were rolling, and I knew the meeting was effectively over. Cannon is also an excellent counterexample to the old dictum that you can never have too much capital in the movie business. After Hutton abandoned the company in favor of Disney, Cannon discovered Drexel Burnham,

How to Have Fun and Not Lose Your Shirt  151

which was then at the height of its powers in the junk bond business. In 1986, Cannon filed through Drexel a package of senior subordinated and convertible debentures. The senior subordinated debentures carried a coupon of 12 7/8% and were priced at a discount (it is worth noting they were noncallable for 3 years).6 I was having dinner with Menahem in Los Angeles during the offering when he took a call from Mike Milken, head of Drexel’s junk bond department. Menahem returned to the table with a broad grin and informed me that Drexel had so much demand for the senior subordinated debentures, it was increasing the size of the offering by $50 million. I said to Menahem, “You have just taken on an additional $6.5 million in annual interest charges. How are you going to cover that?” Menahem waved me off—I realized he was simply going to make more expensive films. Plus, he needed the money to finance his acquisition of Thorn EMI’s Filmed Entertainment Division, which—together with a series of box office flops and the revelation that the company was being investigated by the SEC for alleged misrepresentation of its financial statements—pushed Cannon to the brink of bankruptcy in 1989. It had to be bailed out by Pathe Communications, a holding company controlled by Italian financier Giancarlo Parretti, a legitimate bad guy, who was financed by Credit Lyonnais, Cannon’s own bank. Who was bailing out whom? After Pathe acquired MGM in 1990, Credit Lyonnais forced Parretti out after he defaulted on some loan payments and MGM went into a downward spiral that resulted in its own bankruptcy filing in 2010 (but it was a “pre-packaged” bankruptcy and the studio emerged debt free after a few months). The market is still waiting for MGM’s IPO, the process for which was commenced way back in 2012. The company is controlled by a number of hedge funds that specialize in distressed debt, and undoubtedly, they would like to take some money off the table, if not totally cash out. But it is still radio silence from MGM, despite the tremendous success of the Bond film Skyfall and the last of the Hobbit films, The Battle of the Five Armies during this period. Rumor has it that Gary Barber, MGM’s CEO, was fired because he pushed too hard for a sale of the company. Carolco, in contrast, was lionized for its ability to put together films that could compete with the studios’ own high-end product on even terms. Even today many knowledgeable industry insiders can’t fathom how Carolco got itself in such dire straits that it had to file for bankruptcy in 1995. After all, wasn’t this the studio that produced such box offices successes as Terminator 2: Judgment Day, Total Recall and the Rambo franchise? Agreed, it also produced such flops as Showgirls and Cutthroat Island—but you might have thought that it had enough hits to offset the losers. Plus, Carolco was famous for getting the most money out of the international marketplace in the form of presales. The latter fact was not surprising because Carolco was virtually the only independent production company that was delivering high-profile studio-level films that were available to independent distributors around the world. The studios invariably kept their own product for their in-house distribution network.

152  How to Have Fun and Not Lose Your Shirt

As I mentioned earlier, preselling is not only a financing technique, but it also represents a risk mitigation/transference strategy. However, risk mitigation is a two-edged sword. The trade-off is that it also entails leaving money on the table in the case of successful films. I have had an ongoing philosophical debate with former Carolco CEO Peter Hoffman about the net plusses and minuses of the presale strategy. As indicated earlier, Carolco was relatively unique in its heyday in the 1990s in terms of its ability to deliver high-profile star-driven action films and thrillers to independent distributors abroad. From its initial success with Rambo and its sequels, through Terminator, Total Recall and Basic Instinct, the company delivered a series of highly successful films to its international partners. Peter argued the territorial distributors paid very high advances relative to what they were paying for more mid-level projects. So, Carolco in effect was successful in transferring some degree of risk to its international distributors irrespective of actual performance. This argument, while true, ignores the fact that if these films didn’t perform, Carolco’s distributors would demand a break on the prices they paid for future product, so the risktransference mechanism works only if you continue to produce successful films. In addition, I countered that as a percentage of budget Carolco left too much money on the table on its successful films to make up for the duds. In fact, Carolco had no choice because its capital structure was not sufficiently deep to permit it to swing for the fences and do straight distribution deals—at least in certain territories with high potential upsides like the UK, Germany and Japan. I should also mention that there was another problem, in my opinion, with Carolco’s business plan: It had to overpay stars to get them to appear in Carolco films. Because it employed an aggressive presale strategy, it could not offer the so-called gross players—that is, major stars who were entitled to worldwide gross participations from dollar one—similar deals as the studios. Carolco had to account internationally in terms of minimum guarantees and overages. It did not have access to true gross, so it could not offer true gross to its talent. Accordingly, Carolco had to anticipate what such stars might make from their gross participation on reasonably successful films by paying them more as a fee in the budget, which drove up budgets and ate into Carolco’s profit margins. I remember a story my old boss Larry Gordon told me about a project he was attached to as producer with Carolco. It was called Stone City, and Larry called Mario Kassar, one of the two principals of Carolco, with exciting good news: Dustin Hoffman, who was then one of the biggest stars in the world, wanted to play the lead. Mario asked Larry what Dustin’s “quote” was. Dustin’s quote in the late 1980s, when the conversation took place, was $8 million—not bad. Mario said he would get back to Larry shortly, and presumably he called his head of foreign sales, Rocco Viglietta, to ascertain what Rocco could generate in foreign presales with Dustin in the lead. Mario called Larry back after a few minutes and said “offer him $13 [million].” Larry’s response was typical Larry: “What happened to 9, 10, 11, and 12?” Mario calculated that he could

How to Have Fun and Not Lose Your Shirt 153

be relatively assured he could persuade Dustin to take on a Carolco project for that fee, as opposed to signing on to a studio project with a lower up-front payday (but the potential of making more if the film were successful). But the extra money Carolco would have had to pay him would also have had a dollarfor-dollar negative effect on Carolco’s bottom line. By the way, the film never got made—I’m not sure why.

Notes 1 Levy, Adam. “How Bad Will Coronavirus-Fueled Cord-Cutting Get?” The Motley Fool, 30, Apr. 2020. 2 “Kickstarter vs Indiegogo: The Ultimate Guide (2015 Edition with Free Fee Calculation Tool),” Crowdfunding Dojo, 2015, http://crowdfundingdojo.com/articles/kickstarter-vs-indiegogo-the-ultimate-guide-2015-edition-with-free-feecalculation-tool. 3 “Garden State (2004),” Box Office Mojo, www.boxofficemojo.com/movies/?id=gardenstate.htm. 4 McNary, Dave. “‘Lazer Team’ Scores $1 Million in Presales for Tugg Screenings,” Variety, 27 Jan. 2016, http://variety.com/2016/film/news/ lazer-team-box-office-screenings-1201690485/. 5 Moore, Schuyler. “5 Ways Hollywood Can Cut Its Taxes (Guest Column),” The Hollywood Reporter, 10 May 2013, www.hollywoodreporter.com/news/ tax-loopholes-5-ways-hollywood-500180. 6 Cannon Group and MCI Make High Yield Offers (1986, April 9). Retrieved from http://www.nytimes.com/1986/04/09/business/f inance-new-issues-cannongroup-and-mci-make-high-yield-offers.html.

11 MANAGING RISK

Summary—The chapter focuses on how we measure risk in the movie business. It starts with a discussion of individual film volatility and presents what a single-picture financial model looks like. Special attention is paid to the challenges independent producers face in securing meaning ful theatrical releases, with a case study on the film My Dog Skip introduced. The chapter ends with a discussion of strategies to minimize risk on individual film investments, addressing the entire budgetary and genre spectra, and assessing the alternative strategies of bifurcating rights by preselling foreign or doing a worldwide studio deal. How do we measure risk in the movie business? The answer is with difficulty. Clearly there are a number of parameters at work, including budget, genre, level of cast and director, distribution arrangements, presales and incentives, to name a few. Earlier, I claimed that budgets and risk do not have a positive correlation. By that I meant that just because a film does not cost a lot to produce does not mean that the investor’s risk position is limited (at least in percentage terms, if not in absolute dollar amounts). Earlier I mentioned an industry study that showed that very positive returns for studio films were achieved in the under–$25 million budget category, then declined monotonically until–$100 million budgets, at which point they spiked to the highest ROI in the entire budgetary spectrum.1 This study was confined to studio films and did not examine independent productions, which can range from microbudgeted films costing less than $1 million up to studio-lite films—i.e., films with more substantial budgets, typically in the $20–60 million range, with recognizable stars and that are expected to have substantial theatrical releases supported by significant P&A expenditure. The beta (i.e., the measure of volatility, or systematic risk, associated with a single film versus the film market as a whole) associated with individual film performance has also increased over the past few years. “It’s a binary world,” DOI: 10.4324/9781003153702-12

Managing Risk  155

FIGURE 11.1

Measure of Domestic Box Office Variability.

Source: All data found on specific film pages at Box Office Mojo, www.boxofficemojo.com.

Sony Pictures chairman Tom Rothman recently lamented. As he pointed out, gone are the days when minimum opening weekends on the order of $10 million plus were virtually guaranteed by a given star and assuming a robust marketing spend. Now opening weekend grosses of $3–5 million are not uncommon even on broad national releases. To put this trend into perspective, the top ten films in 2014 represented 24% of total domestic box office; in 2019 they represented 38%.2 To test the hypothesis that box office performance has become more volatile recently confirming Yeats prediction that “the centre cannot hold,” I asked one of my colleagues to prepare the following chart showing the range of percentile deviations in domestic box office performance for broad-released films (more than 1,000 screens) over the period 2014–15. As I anticipated, the bottom has dropped off the map, and the variability continues to increase since then (Figure 11.1). Mid-budget films, whether produced by a studio or an independent, tend to fall more and more within the action/thriller genre, because those films tend to travel better internationally. Star-driven thoughtful dramas and dark comedies, if not actually extinct, are less and less produced—unless they can be made at a price, and by a price, I mean a very low price. The movie business is becoming increasingly bifurcated, at least from the studios’ perspective. Either they want to be making tentpole films with big special effects and concomitantly huge budgets of $100–$150 million or more, or they want to concentrate on raunchy teenaged comedies, horror films or the occasional urban-themed films appealing to the African-American or Latino audiences. (Hollywood has not yet figured out how to appeal consistently to the Latino audience with Latino-themed films—although this audience represents the most frequent

156  Managing Risk

theater-going segment of the overall population, with significant overrepresentation on family-oriented films. Lionsgate, though, is aggressively courting this market and has set up a joint venture with Televisa, the leading Spanishlanguage network in the United States, to release English and Spanish language films directed at the Latino audience.) While the independents in general cannot compete in the over–$100 million budget arena, they can compete in the lower-budgeted space I mapped out earlier, and because they can achieve a high level of international presales on mid-budget action/thrillers, they continue to churn those out as well. Everyone is looking for a new Taken franchise that can be made in the $20–30 million budget range (at least the first one) and trying to figure out who will be the next Liam Neeson to drive that franchise. I must admit that one of my investors, on my recommendation, made a preferred equity investment (an equity investment that is senior to the other equity investors) in a Liam Neeson–starring thriller, A Walk among the Tombstones. I thought it was a relative no-brainer because our breakeven was around $30 million US box office and all of Liam’s thrillers to date had achieved box office well in excess of that number. But the film was too dark (and I am not referring to the lighting of the set) and certain scenes were too off-putting for the female audience, which is becoming increasingly important (after all, they are half the population), so it was just my luck to invest in the one Liam Neeson thriller that did not work. His subsequent thriller Run All Night did even worse. Now is probably a good time to show you what a single-picture financial model looks like. Figure 11.2 shows our model for an unnamed film with a $35 million budget that my production company client produced and cofinanced 50/50 with another investor. You will see that the net budget is $30 million after a state rebate of $5 million. The film, which was the kind of action genre that international audiences eat up, was projected to be pre-sold foreign for a very healthy aggregate minimum guarantee of $25 million. The model considers a range of domestic box office between $20 and $100 million, with 42.5% of profits allocated to our individual producer partner, who covered all of talent out of his share. The co-financiers retained 57.5%. My client, who shouldered half the equity risk, retained 25% of profits plus an additional 7.5% for also performing producer services (my client is a real producer who does a lot more than simply writing checks). You will see that breakeven on the film is attained when domestic box office hits just north of $42 million, and my client’s ROI ranges from a negative 76% when the film underperforms at $20 million domestic box office, to a high of 200% if it achieves miniblockbuster status at domestic box office of $100 million. In fact, the film did quite well, achieving domestic box office close to $50 million. Please note that this model covers revenues for the 10 years following theatrical release only (which a studio’s ultimates forecast typically covers), so there is additional library value post the 10-year period.

Managing Risk  157

FIGURE 11.2

Performance Model for a Specimen Single Picture.

One of the attractions of the movie business, of course, is its reasonably short time horizon for return on investment relative to some other asset classes. A film should typically take roughly 1 year from the start of pre-production to delivery (big budget films, particularly those which require a significant number of special effects shots may entail production schedules of 15–18 months), at which time minimum guarantees from both domestic and international distributors should be forthcoming (sometimes subject to certain holdbacks for a couple of months). Theatrical release would typically occur within 2–6 months following delivery, and the bulk of revenues would come in within

158  Managing Risk

FIGURE 11.3

Sources and Timing of Revenue for a Typical Film.

2–3 years following theatrical release. However, I would point out that distributors typically account on a quarterly basis only for the first couple of years, then moving to semiannual accounting, with a 30–60-day lag. Payment might be delayed a further 30–60 days following issuance of the distribution statement. So, there could be as much as a 4-month lag before payments are received. If it goes through a collection account, there could be an additional delay of several weeks before the relevant allocations among the entitled parties are made. Thus, the relatively short time horizon for film investing is not quite as short as some would believe. In Figure 11.3, I set out the specimen timing of revenues chart (for a bifurcated rights model), which we typically include in an investor memorandum. The only difference between studio and “studio-lite” films is that studio films are, by definition, guaranteed a studio release. Well, not really: I can cite numerous examples of studio films that have been “buried,” without theatrical releases or throwaways on a limited number of screens. In such instances the studios have determined that they are unlikely to recoup the P&A required to release the film, so better to save their money and go straight to video, which today means VOD as the first window. Alternatively, during the pandemic it has become relatively common for the studios to offload in-house productions on streamers and thus enable the studio to lock-in an upfront profit and avoid having to take P&A risk in a chaotic theatrical environment. If a film is made independently, there is no guaranteed theatrical release unless one has been negotiated in advance or if the producer in question has the so-called puts with a studio/distributor. Very few production companies have definite theatrical slots that guarantee them a theatrical release with a major studio. My client, Alcon, was one of the lucky ones. Under its output arrangement with Warner

Managing Risk  159

Bros., Alcon was guaranteed a certain number of release slots per year, but that is no longer the case. Alcon had enormous flexibility in determining what films it chose to “put” to Warner Bros., but practically speaking, Alcon would probably not greenlight a project that Warner Bros. was totally keen against, even though the ultimate P&A risk on the release was contractually Alcon’s— Warner Bros. cash flows the P&A but Alcon guarantees it. I want to disabuse producers and investors who think that just because they are prepared to bring P&A expenditure to the table or guarantee it, they will have no problem finding a theatrical home with a major studio distributor for their film. Studios and leading independent distributors have only so many theatrical slots each year. It behooves them to first reserve those slots for their own films, where they keep all of the proceeds less what they pay out to talent, as opposed to pickups from third-party producers, where they are simply earning a distribution fee and perhaps some back-end profit participation. So, each studio will have a limited number of slots each year for third-party product. How does an independent production company earn such slots? The answer is that it takes time. Money helps, but money is only one factor in determining whether a studio wants a special relationship with a given producer. Even more important is the studio’s assessment of the producer’s ability to deliver a volume of high-quality product over time. Another key factor is whether the producer is considered to have the professional chops to oversee studio-quality motion pictures. That’s why I said it takes time. It took Alcon several years to prove its bona fides to Warner Bros. It started with producing and financing a low-budget film, My Dog Skip, which actually was developed at Warner Bros. and Alcon took it over. Ironically, Alcon made the decision to greenlight the film because Warner Bros. convinced it, based on a comparable film featuring a dog, Shiloh, that it had very little at risk given that most of the budget of $5 million could be covered out of home video revenues. The problem was that between the time My Dog Skip was greenlit and the time production was due to start, the home video market transitioned dramatically from a videocassette rental/sell-through market to a DVD market, so the old metrics no longer applied. Thus, Alcon was faced with a dilemma, which in a similar guise faces many independent producers today: should it stick with a $5 million budget with a no-name cast and not count on a theatrical release (which given the uncertainties surrounding the new DVD technology made it extremely difficult to project likely performance) or should it bite the bullet, increase the budget with some meaningful names and assume greater dollar risk but also have a much greater chance of upside? Alcon opted for the latter strategy. It cast Kevin Bacon and Diane Lane as Frankie Muniz’s parents (Frankie wasn’t yet the television celebrity he became in the family sitcom Malcolm in the Middle, for which he was cast after the success of My Dog Skip). The budget promptly went up to around $7 million as a result, but Alcon felt that in so doing it had a real shot at a theatrical release that could work. The film came out great. Enzo,

160  Managing Risk

the dog, stole the show, but Kevin and Diane added real presence to the cast. Notwithstanding the fact the film tested great (I strongly recommend that all independent films, indeed all films short of the big studio blockbusters be tested before they are officially “locked” to judge a sample audience’s reaction and to assess what improvements can and need be made), Warner Bros. was still nervous about the commercial prospects of the film. It was clear that the film had to “breathe”—it needed to build an audience, unlike the broad national releases that the studios blow out on 3,000 or more screens on opening weekend. Let me surprise you here: arguably, the studios aren’t great at limited platform releases. Nor are they that interested in such strategies, because the big bucks just aren’t there. Yes, they aren’t committing anything like the $30 million plus in P&A on platform releases—more like $3–7 million, which they might add to if the film’s performance warrants—but, as I indicated earlier, each studio has only so many theatrical slots per annum that it can devote time to, so it has to bet on films that have the potential to deliver major box office dollars. So, Alcon decided, with Warner Bros.’ connivance, to “test” the film in two sample markets in Middle America—Columbus, Ohio, and Austin, Texas—as a proxy for how well the film might perform across the entire nation. Instead of buying national television spots, which a studio would do to create awareness and want-to-see for a broad national release, Warner Bros. bought time on local television stations, but it bought the amount of rating points that would have been equivalent to what viewers in those two markets would have been exposed to as part of a national campaign. However, the ad buys were restricted to those two markets. The rationale behind this was that if the film opened in those two markets at a satisfactory per-screen average, that would demonstrate the film’s playability across all markets and would encourage Warner Bros. to get behind a national campaign, albeit several weeks down the road. All this would be achieved with a much lower P&A spend than a national release would demand. Texas and Ohio certainly fall within Middle America, but you will note that the two markets selected were also homes to major universities: the University of Texas and Ohio State. There was a good reason for selecting more upscale communities with a strong educated professional population. My Dog Skip was adapted from an autobiography of the celebrated Southern journalist Willie Morris. While it is not highbrow fare and audiences across the board found it exceptionally moving, it was still a serious drama with stark depictions of the traumas of war, physical abuse of the protagonist, and culminating in the death of a beloved pet. Rightfully, Alcon and Warner Bros. both felt it would have greater resonance with more white-collar and educated audiences. Despite the fact that the film opened in the middle of a snowstorm in Columbus, the first few weekends actually saw the film hold steady in terms of average perscreen box office (films typically decline 25–60% week on week in the first few weeks of release).3 Warner Bros. let the film breathe and only went wide (2,331 screens) on the eighth weekend. The film played for 24 weeks (compared with

Managing Risk  161

an average of 6–8 weeks) and eventually generated $34 million in domestic box office. That’s a very estimable performance for a film costing $7 million!4 Alcon had one significant advantage on My Dog Skip: it knew it had a theatrical release commitment from Warner Bros.—the only question was what kind of a release. Most independent films do not have the benefit of a domestic theatrical release commitment when they are being set up. Not only does that mean the equity investors on the film have to absorb that risk because bank lenders will not lend one dime against the imputed value of domestic revenues, but it also impacts the value of foreign rights. Foreign distributors will pay significantly higher advances if they know there is a meaningful US theatrical release in place (typically at least 1,000 screens), because that gives real credibility to the commercial chops of the film. That level of release commitment up front translates into higher foreign presales, and it also gives greater underpinning to the foreign sales agent’s estimates on the value of unsold territories, which supports a higher loan to value number from gap lenders, including both banks and non-bank lenders, who will supplement the secured loan from the banks. Managing risk on the equity front involves different analytics. On singlepicture equity investments in independent productions, I look to cover on the order of 70% or more of the budget out of foreign sales and tax incentives. Both of these revenue streams have to be netted out. In the case of foreign sales, sales agency fees, marketing expenses and residuals have to be deducted. Marketing expenses include actual out-of-pocket expenses as well as non-accountable marketing allowance to cover the sales agents’ expenses for going to the key international markets—Cannes, the American Film Market (AFM), Toronto and Berlin. Tax incentives may take the form of cash rebates or transferable tax credits that have to be sold, typically at some discount, to tax-paying entities in that jurisdiction. So, you have to deduct the cost of monetizing the tax credits in such cases. I typically want to have ultimate risk equal to no more than 30% of the budget against domestic (sometimes Canada is presold like other foreign territories, so in a stretch I might be looking to recoup that 30% out of the United States alone—plus, of course, foreign overages). By ultimate risk, as I explained earlier, I mean after all foreign territories are sold and the minimum guarantees monetized through a bank loan. One of the principal advantages of preselling titles territory by territory is that the territories are not cross-collateralized, so if one or more territories overperforms while the rest of the world, including the United States, tanks, you could still see overages from the successful territories. But I never count on overages. I model each project carefully to assess not only the domestic box office breakeven number but also the shape of the profitability curve. In the modified bell curve I construct, I first determine what I deem a most likely box office number corresponding to the mid-case scenario of the film (which hopefully will be better than breakeven) and I then calculate various percentage deviations. All of this, of course, is highly subjective (at least

162  Managing Risk

my projected mid-case box office) but I find it incredibly useful to compare breakeven with my estimated most likely box office result. I actually quantify five different box office scenarios on every film project I assess—including a flop scenario, low-case, mid-case, high-case and superlative scenarios. To the extent the high-case scenario, for example, significantly underperforms the lower-case scenario in terms of absolute value ROI (i.e., the projected losses on a flop or low-end scenario exceed the projected profit on a high-case or superlative scenario), that is an obvious red flag and means something is wrong with the project. It generally means that the film is too expensive relative to its commercial prospects and the obvious conclusion is that the budget has to come down, or maybe you have to change locations to generate greater incentives, or maybe you have to recast the film with talent that means more throughout the world. But not all budgets can be reduced! Maybe you should just shelve the project. I learned as a young portfolio manager on Wall Street not to fall in love with any of my positions, and producers in Hollywood should also keep that little pearl of wisdom in mind. The 30% number is just a guide, of course. Some films, for example, skew dramatically in favor of domestic. Urban dramas are an obvious example. In such cases, you should be willing in principle to bear greater than 30% of the budget against the United States. Let me address a well-known shibboleth in the film industry: the myth that black actors don’t “travel.” If there is any truth to the myth, it is not that black actors can’t be popular abroad—witness Will Smith, Denzel Washington or Morgan Freeman. It is that strong urban-themed films with large black ensemble casts don’t ordinarily work internationally. Even that myth was challenged to some extent when Universal released Straight Outta Compton. The film generated foreign box office of around $40 million, and while this represented only 25% of domestic gross, it was still a very respectable number for a film with virtually an entire African-American cast.5 And, of course, there is Black Panther, which did $1.35 billion in worldwide gross! But that was a Marvel super-hero movie. When I assess domestic risk, I do not simply look at the percentage of budget I have to recoup. I also look at absolute dollars at risk relative to the likely range of minimum guarantees the film can be projected to command. At the low end of the budgetary range, genre films in the $3–5 million category, advances of $250,000–500,000 are not uncommon. Those advances are geared to the VOD/home video/television value of the film and they assume minimal, if any, theatrical value. Guess what—that’s below the 30% of budget threshold, which tells you why low-budget genre films are highly risky. If you want to make money in this arena, you practically always have to assume you can deliver one of the few films—maybe one in 20—that can warrant some kind of meaningful theatrical release. But if you can deliver a theatrical release, you have a shot at a real jackpot in terms of ROI. Sound like the probability metrics that apply to start-up venture capital investment? They have a lot in common. I would point

Managing Risk  163

out that a streamer, if it wants the film, will undoubtedly pay significantly more than the low-ball range I indicated above. Low-budget art films face similar obstacles. Advances in the $250,000– 500,000 range are also not uncommon in this sector—if you can get any advance at all. Against my better judgment, I agreed to try to set up domestic distribution for a little romantic comedy with a no-name cast as a favor to a producer friend. The film was OK, just OK. The romance was not scintillating, nor was the comedy all that funny. The best thing about the film was the title—I won’t reveal it here because the producers are still trying to get it in some second-tier film festivals in the hope that it will spark some distributors’ interest. The film cost only $1.2 million. At that price you might think, how much risk could there be? But with no recognizable names for the foreign market, the foreign sales agent, who was also doing me a favor by representing the film, has barely managed to generate a couple hundred thousand dollars in sales and there is still no domestic sale. So, the investors at present are out approximately $1 million on a $1.2 million investment. This experience is repeated all the time with independent productions. In fact, it is probably more typical than atypical. At least with low-budget genre films, you have a shot at a big score. With low-budget dramas and romantic comedies, you don’t even have that. I know—there is always a My Big Fat Greek Wedding. Enterprising producers can come up with comparable films—i.e., films in the same genre and budget range—to convince prospective investors that their project will perform out of the box. But simply enumerating comparable films gives no sense of the probabilities at work. When you start moving up into higher budgets, you soon realize that you are becoming more dependent on the success of the theatrical release. Probably the most dangerous budgetary and genre range to play in is the $7.5–15 million drama. In all likelihood you will not be able to get an up-front domestic theatrical release commitment based solely on script and elements. Distributors will generally want to see the finished film before they commit, and concomitantly you will not be able to accomplish the level of foreign sales necessary to justify the budget without being able to demonstrate some kind of theatrical release commitment—forget about the 1,000 screen release pattern that you typically need to generate a satisfactory level of foreign sales relative to the budget. These films are totally dependent on execution to justify their budget—and by execution I don’t mean just OK execution. The film will probably have to attract strong critical response; otherwise, you will be in limbo land, warranting only a day-and-date type release domestically, with a “limited” number of theatrical screens to drive awareness for VOD sales and an unsatisfactory foreign sales performance that may ultimately generate only 20–40% of the budget in terms of aggregate minimum guarantees. I was approached last year by some producers who had a script in what I would call the “magical realism” vein. The good news was they had an equity investor

164  Managing Risk

who was prepared to fund half the budget up to $6 million. They presented me with a gross budget of $12 million, which netted out to around $9 million after Italian incentives (the entire film was to be shot in the Dolomites in Northern Italy). The script was written by an accomplished Hollywood screenwriter, who was also attached to direct. He was a first-time director, however, and I cannot emphasize enough that foreign distributors in general are not terribly interested in a project unless the director has demonstrated some proven chops. I was not that enamored of the project; I thought the script’s main conceit was stilted and neither the romance nor the comedy was overly compelling. Accordingly, even with half the budget financed with equity, I thought the budget was too high, and I strongly recommended that the film’s only chance for commercial success required them to cast a high-profile male lead. I prioritized the list of actors they gave me, and they dutifully went off to make serial offers (I don’t recommend making multiple offers simultaneously—you can get into a lot of trouble if several candidates show interest at the same time). Unfortunately, every lead actor they went out to passed. They finally cast someone with a television name, and at least they followed my advice by bringing the budget down to $8 million ($6 million net after Italian incentives)—but they were aghast when I told them that was still too high. A foreign sales agent I respect estimated that she could generate maybe $2.5 million tops in gross foreign sales—$2 million and change net after sales commissions, marketing expenses and residuals. I believe they may have persuaded their equity investor to still put up $6 million, which now represented 100% of the budget, but I refused to recommend such a strategy to the investor: $4 million against domestic was way too much of a stretch. Unless the director hit the ball out of the park, I couldn’t in good faith project any sort of meaningful theatrical release—so the value of domestic in all likelihood would fall in the $250,000–500,000 range in terms of a minimum guarantee, unless the investor could be persuaded to double down and put up the necessary P&A expenditure to support at least a platform theatrical release. I told them they could test the film after it was completed and see if it warranted a theatrical release. But to generate $4 million in net domestic receipts would require a very aggressive platform release entailing a P&A spend on the order of $5–7 million—i.e., the investor would be required to double down. By now, I think they were tired of my Cassandra-like negativity and we agreed to part company. This project is exactly the kind of project that makes no sense and should be made only if the producers can secure a substantial male lead, plus they would have to solve the creative problems with the script through a major rewrite. Apparently, however, the film did get made (with the television name in the lead). I have not seen any reviews or any suggestion that it acquired distribution, either domestic or international. What should the producer’s reaction be if it becomes clear the aggregate foreign presales will probably not come close to the percentage of budget that translates into an acceptable domestic risk position? He has three choices: he

Managing Risk  165

can bring the budget down, he can find a more favorable venue to shoot in that generates higher incentives or he can raise his risk level by not preselling certain foreign territories and instead entering into straight distribution deals. By entering into a straight distribution deal, he will benefit from significantly higher upside if the film is successful, but if the film tanks he may see little if any net receipts from that territory, as opposed to retaining a non-refundable minimum guarantee that he would have received from a presale. In the 1990s, territorial distributors were not as hard-nosed in their negotiations. Minimum guarantees were consistently negotiated as a percentage of budget. Today, that is no longer typical. Distributors are much more discriminating, and the advances they offer are all over the place as a percentage of budget. Distributors are much more focused on likely returns and tend to set the level of advances as close as they can to what permits them to recoup their advances and P&A plus earn a distribution fee. To a large extent, they try to peg their advances based on the quantum of television license fees they can generate in their territory. Theatrical revenues and net of P&A represent blue sky—if they come in, great, but if not, the distributor hopefully will not leave too much money on the table, taking into account what the television network pays. Of course, for high-profile films, where there is significant competition among international distributors in a given territory, distributors have to stretch to acquire the product, but they should try not to stretch to the extent the film has to rank in the ninetieth percentile or higher of theatrical releases that year in order for the distributor to break even. In its heyday, Carolco could typically sell out the world before the film went into production. This is no longer the case today. Often distributors will not commit until they see the finished film or at least some footage—which means the producers need greater capital resources to bridge the required financing before they can pencil in certain sales. Accordingly, if they have sufficient capital at hand, there is a temptation to do what I call “hybrid” deals—i.e., preselling some territories and holding out certain other territories to do straight distribution deals. Frequently, they enter into such straight distribution deals with the international subsidiaries of the US major studios. Given that the studios are producing fewer films in house, while at the same time they still need a certain volume of throughput for their international distribution operations (often to meet supply obligations they have for their television output arrangements), the studios are more active in acquiring independent films for certain key international territories. Because the studios’ television output arrangements are very lucrative, often with contractual floors, partnering with studios can be a very favorable strategy. If you are a well-capitalized independent, I would even argue that for films with budgets of $20 million or less, there is a strong argument to do a worldwide deal with a studio and forego preselling individual territories entirely. The studios’ aggregate television deals can come close to matching overall presales for all rights at that budgetary level, so it makes absolute sense

166 Managing Risk

if you are not risking much downside, you may as well go for the much greater upside a studio straight distribution deal can offer. Unfortunately, as existing television output arrangements wind down, foreign television rights are proving less valuable, but this also implies that local distributors are also reducing the level of minimum guarantees they are willing to pay.

Notes 1 According to author experience. 2 McClintock, Pamela. “Box Office: 5 Lessons for 2016 From Hollywood’s Record Highs and Lows,” The Hollywood Reporter, 6 Jan. 2016, www.hollywoodreporter. com/news/box-office-5-lessons-2016-852391. 3 “My Dog Skip (2000),” Box Office Mojo, www.boxofficemojo.com/movies/?id=mydogskip.htm. 4 Ibid. 5 “Straight Outta Compton (2015),” Box Office Mojo, www.boxofficemojo.com/ movies/?id=straightouttacompton.htm.

12 WORKING THE BANKS AND NON-BANK LENDERS

Summary—The chapter discusses the role of banks in financing the film industry starting with a historical discussion of how the banks began to finance independently produced films. An important distinction is made between cash-flow risk and ultimate risk and what level of financing producers and investors can expect to receive from banks. Collateralized and non-collateralized lending are distinguished from one another. Finally, in particular, mezzanine and “gap” loans are introduced. Other mezzanine facilities, including finishing funds, and prints and advertising loans are discussed. In addition, preferred equity investments and mezzanine loans are contrasted. The author describes how he structures the gap loans he makes out of a dedicated fund he manages. The benefits of borrowing on a single-picture basis versus a dedicated credit facility are reviewed in detail. Equity is a finite resource. That maxim is probably truer for the film industry than virtually any other asset class—even asset classes that are perceived to be equally high risk. But the quantum of equity capital available for the independent film industry ebbs and flows depending probably more on general macroeconomic trends, such as stock market levels, than on industry-specific trends. The amount of debt financing available, and the risk profile of such debt financing, also varies over time. At the turn of the millennium, the market was flooded with banks—both European and American—offering pretty aggressive terms on both singlepicture loans and revolving credit facilities. These included such less-thanhousehold names as Allied Irish, Berliner Bank, Westdeutsche Landesbank, Dexia and Banque Internationale à Luxembourg. When the deep recession of 2008–09 hit, many international distributors found their credit lines shut off, which caused them to default on their contractual payments, which banks were lending against, or at least caused them to renegotiate the payments downward. Many of the European banks took huge hits on their single-picture loans in DOI: 10.4324/9781003153702-13

168  Working the Banks and Non-Bank Lenders

particular, and by 2012, when the global economy started to pick up, there were virtually no European banks left standing. When banks began to engage in single picture loans, they followed their traditional lending practices, which meant they were making secured loans against creditworthy collateral—in this case, distribution contracts. But as more banks piled into the market, competition heated up, and one way a bank could favorably position itself against its competitors was to provide a certain unsecured component against the estimated value of unsold rights. One of the main banks that pioneered the so-called gap lending was Comerica (formerly Imperial Bancorp, which was co-founded by a shopping center developer George Graziadio, who was frustrated by the lack of attention the mainstream banks paid to entrepreneurs like himself ). George was a consummate risk-taker and it was not surprising that he was prepared to weigh the additional risks that “gap” lending entailed with the significantly higher fees and interest rates he could charge for making such loans. Many of those banks (but not Comerica) that were actually pursuing “gap” loans got murdered as the 2008–09 recession hit. Probably the first banker to largely control the flow of capital to the studios was Serge Semenenko, the Russian-born vice chairman of First National Bank of Boston, who in the 1950s and 60s was active in the affairs of Columbia, Universal, Cinerama, Warner Bros. and Seven Arts. Semenenko was famous or notorious, depending on your point of view, for the primary role he played in assisting Jack Warner to gain control of the eponymous studio and stab his brothers in the back. In 1956, a group of investors led by Semenenko made an offer to buy out Harry, Jack and Albert Warner for $22 million, in return for 80% of the company. All three brothers would remain on the board. Unbeknownst to Harry and Albert, however, Jack had made a prior arrangement with Semenenko to buy his shares back, retain his title and keep running the studio. Using the leverage his block of stock provided, Jack appointed himself the new president. Neither Harry nor Albert ever spoke to Jack again.1 Banking the independent film industry is a relatively recent phenomenon, and much of the credit can be given to a charming Dutchman, Frans Afman, who was responsible for drumming up international business for a medium-sized Dutch commercial bank, Slavenburg’s. In 1972, Afman was introduced to one of the icons of the independent film industry, Dino De Laurentiis, who talked Afman into discounting distribution deals he had made in the biggest territories ( Japan, Germany, Italy, France, Spain, Scandinavia, Latin America, South Africa, Australia/New Zealand, Hong Kong and South Korea) on a film he was producing, Three Days of the Condor. At that time, US banks were not prepared to lend against foreign contracts based solely on the credit of local distributors. But Slavenburg’s was a European bank and wasn’t afraid of French, German, Italian or Spanish credits. By 1976, Afman was king of the independent banking space, with such well-known clients as Alexander

Working the Banks and Non-Bank Lenders  169

Salkind, Golan and Globus (who ran Cannon Films) and Hemdale. He was lured away in 1977 by Banque Nationale de Paris, then one of the largest banks in the world, who made him general manager in the Netherlands. Mimicking a Gallic accent, Afman said, “They wanted no more of these ‘uh … movies,’” which according to Afman, was OK with him because he was tired of the film industry loonies who always called after midnight.2 But Afman couldn’t shake the bug. He realized that he was hooked on the movie business for life. To make matters worse, Dino De Laurentiis refused to negotiate deals at Slavenburg’s without Afman—so Frans returned to his former job. Afman was a hands-on banker. While he didn’t meddle creatively in projects, he certainly vetted budgets and approved casts, sensitive to the bankability of the lead actors in the international marketplace. Afman was not your typical banker, who insisted on having every necessary document in place before he turned on the tap: he put his trust in the producers because he knew that the producers needed him more than he needed them, and that if they screwed him, he would not hesitate to cut them off—which means in an environment where there were not too many other places to go, the producers could not finance their films. Times are different today. There are a lot more banks operating in the space, but they won’t let any money flow until all of the necessary security interests are perfected, the completion bond fully negotiated and operative, the notices of assignment assuring that advances flow directly to the bank under all circumstances completed, etc., etc.—which explains why the process of completing a single-picture bank loan today is so arduous and why it has become almost commonplace that such loans aren’t funded until principal photography has or is about to commence. Frans was so close to his key clients—particularly Dino, Golan and Globus and Alexander Salkind—and did so much for them, frequently avoiding having to dot every “i” and cross every “t” that traditional bankers were taught to do, that not surprisingly there were always rumors that Frans was being “schmeared.” I can only say that I have no evidence of any shenanigans, and to prove my point, on the one “funny money” deal where I have no doubt that gravy was bestowed on some bankers—Giancarlo Parretti’s acquisition of MGM in 1990 for $1.2 billion using money borrowed from Slavenburg’s, then the Dutch subsidiary of French Credit Lyonnais. Frans was an outspoken critic of the deal, but was overruled by his French superiors. Following the acquisition, MGM released almost no films, while Parretti enjoyed a Hollywood mogul lifestyle. But Frans always avoided Parretti like the plague. When Parretti defaulted on his loan to Credit Lyonnais and was indicted on charges of securities fraud both in the United States and Europe, no hint of scandal ever surrounded Frans. I worked closely with Frans on a number of transactions on behalf of his clients Cannon, Salkind and Tarak Ben Ammar on Pirates, which Tarak produced and Roman Polanski directed. The film went way over budget. If it weren’t for the fact that Tarak obtained an $11 million

170  Working the Banks and Non-Bank Lenders

jury verdict in a breach of contract action against Universal for refusing to distribute the film, Tarak’s budding producer career may well have been stopped dead in its tracks. You will recall that my company Albion Films was the dominant player in the UK sale and leaseback market in the early 1980s. We consummated a number of such deals that were key to the financing packages of British qualified films, since we would effectively be providing between 10% and 20% of each budget—and equally important, we weren’t taking a profit participation for so doing. So, between foreign presales and our sale and leaseback deals, producers could frequently come close to fully financing their films, leaving the United States as pure profit. When the international presale market was in its infancy, the master of bifurcating domestic and foreign rights, Dino De Laurentiis, could frequently lay off domestic rights on a studio and presell foreign rights territory by territory for an aggregate sum well in excess of the budget of the film—until the studios wised up and lowered the amount of domestic advances they were willing to give. In those halcyon years, I know of several films where Dino got 50% of the real budget from a studio for domestic rights, presold foreign for 60–70% of the budget, and tacked on a sale and leaseback deal for another 15%. He may have forsworn much chance of overages, but who cares when you are walking away with a profit of 25–35% before you have shot one frame. I want to distinguish between cash-flow risk and ultimate risk—a distinction that is crucial for prospective investors in films to understand. When a film is greenlit, there must be a well-documented financing plan that lays out how the film will be cash-flowed in real time. Too often producers overestimate how much they can borrow from banks to meet the cash flow requirements of the production schedule. When that happens, either the producer has to persuade his equity investors to pony up more money (it helps if the producer is funding the production himself and has the capital resources to make up the shortfall on the bank loan—which is the case with most of my clients). Unfortunately, the foreign sales market has changed over time in terms of when foreign distributors are prepared to commit to a project. In the glory days of the business—the 1980s, 1990s and pre-2008—it was customary for foreign distributors to commit to packages (i.e., scripts with a director and one or two leads) up front (i.e., prior to principal photography). The minimum guarantees paid were frequently pegged to a percentage of budget—subject, of course, to some variation depending on the international appeal of the material and the package. Territories might pay a higher percentage for appealing genres— action typically stood at the top of the list—or if a super-star actor were attached. Over the years, however, the cost of releasing a film internationally, while nowhere near what it has been in the United States, has still grown rapidly. So, the foreign distributors are more wary of making upfront commitments and in particular want to know if a domestic release commitment

Working the Banks and Non-Bank Lenders  171

is in place and what the level of such a commitment is—in terms of number of screens or P&A spend before they commit. Often, they want to see some footage, or not infrequently even the finished film, particularly for projects that are execution dependent—which is more common in the case of dramas than action/thrillers. Of course, savvy sales agents, if they have an attractive package to sell, particularly one that has the star power or sufficiently sized budget to virtually guarantee that it will secure a meaningful domestic release, can orchestrate a competitive bidding environment, especially in those territories with a large number of buyers, and persuade distributors that they have to step up early in the process or risk losing an attractive project. That’s another reason, by the way, to concentrate your film investment in higher-profile projects— they enable you to leverage your equity capital to a greater extent by optimizing their presale value in the foreign marketplace. Producers who are not used to navigating the murky waters of independent film finance—and in this category I include both experienced producers who are used to working within the studio system as well as neophyte producers—can easily be snookered by foreign sales agents who represent they can ultimately deliver a big chunk of the budget out of foreign presales. The key word here is “ultimately.” As I indicated earlier, sales have become more and more delayed until the foreign buyers can see actual footage or frequently the finished film. So, to the extent that there are not executed contracts to be banked, producers suddenly are confronted by the realization that they have to find a way to monetize the value of these unsold rights. The good news is that a mezzanine or “gap” market has arisen, where both banks and specialty finance sources are willing to provide a certain percentage of the estimated value of unsold rights (see my more detailed discussion of this market later in this chapter), but as you will learn, even the most aggressive gap lenders will significantly discount foreign sales agents’ estimates, thus almost always requiring more equity investment up front than producers anticipated. Certain prominent producers and distributors tried to address this problem by negotiating output deals in a number of foreign territories. The output deals required a foreign distributor to take all of the producer’s/distributor’s films, provided they met certain criteria. Typically, this meant a film had to have a minimum domestic theatrical release, defined in terms of number of screens (usually simultaneously) or P&A spend, as well as requiring the producer/distributor to have a minimum investment in the film (to prevent the producer/ distributor from simply selling a slot to a third-party filmmaker). The license fees under such output deals are tied to a percentage of budget, so a producer can take this paper to a bank and borrow against it up front. I would point out that it has been extremely difficult to negotiate output deals in several major foreign territories—France and the UK are prime examples—so the producer is still challenged to monetize the value of non-output territories that remain unsold prior to the start of principal photography.

172  Working the Banks and Non-Bank Lenders

The fact remains that a distributor who has an extensive network of output arrangements has a leg up in helping to arrange overall financing for independent films; prominent players with such extensive output networks include Lionsgate and STX. To the extent these distributors are also willing to put up minimum guarantees not only covering their output territories but also unsold foreign territories, that represents a huge benefit in structuring a financing package that minimizes the quantum of equity investment required. Let me give you a practical example. One of my clients is currently trying to put together a big action/adventure film with a budget of $40 million, net of incentives. We are discussing either a two-party equity co-financing, or possibly a three-party co-financing. Because of the talent’s very narrow window of availability, we have to greenlight the project immediately or put it on the shelf, so there is no time to do actual presales. The sales agent’s output deals are worth approximately $9 million gross, which reduce to a bankable value of around $7 million (taking into account the bank’s haircuts, which are a function of the specific foreign distributors’ perceived creditworthiness, sales fees and marketing expenses). The sales agent’s aggregate “take” prices, assuming all the foreign territories are sold, are around $23 million. Together with the output deals and “gap” financing I believe I can procure debt financing on the order of $14 million, which means we have to come up with approximately $26 million of equity to greenlight the film. That is a lot of equity, even split among three investors. But this film is a “hot” property, and I just received a call from another distributor who is prepared to put up a minimum guarantee of $24 million against all foreign rights (including Canada). The banks will lend 100% against this distributor’s paper, so if I take his offer, I can reduce our equity requirement by $9 million. There are certain costs associated with his proposal, including a need to increase the budget by an executive producer fee, but needless to say, it is a very enticing offer. My producer client is taking it very seriously. What are foreign distributors looking for? They are generally agnostic when it comes to genre and, of course, they would love to have a film starring Leonardo DiCaprio, but their primary “hot button” is the kind of domestic theatrical release commitment the film has secured up front. In general, they are looking for a minimum 1,000–1,500 screen domestic release. Better yet would be 2,000–2,500 screens, which practically can’t be done for a P&A spend much below $25 million in the case of independent distributors and mini-majors, and $30 million plus in the case of studios. We live in the age of instantaneous worldwide awareness of the “buzz” surrounding individual films. A distributor in France knows in real time how a film is “tracking” pre-release in the United States and that will obviously affect her release plan in her own territory, but not necessarily definitively since audience tastes vary across borders.3 Of course, anyone with access to the Internet can log on to Rotten Tomatoes to ascertain the general critical opinion of the film. Monthly unique visitors to

Working the Banks and Non-Bank Lenders  173

the rottentomatoes.com website total 26 million globally (14.4 million in the United States).4 In addition, he or she can check the film’s CinemaScore rating, which provides letter grades based on surveys of audiences’ viewing experience of the film. CinemaScore will also forecast box office performance based on its surveys, but I find industry distribution executives to be very divided on the accuracy of CinemaScore’s predictions. Rotten Tomatoes works with some 900 critics, but it calculates a score that reflects what percentage of reviews are positive, without differentiating between a rave and only a modestly positive review. Its smaller competitor, Metacritic, which works with 55 publications, attempts to measure each critic’s sentiment and then averages those scores based on a proprietary algorithm that gives more weight to established, better-known reviewers. Because of their different approaches, the scores on the two sites can be very disparate. Kevin Goetz, president of a research firm Screen Engine, which runs test screenings for the studios, claims that the direct correlation between aggregated reviews and actual attendance is only 30%.5 There is a great temptation for producers to negotiate revolving credit facilities to handle their entire volume of production over time, but neophyte producers will learn to their chagrin that they are no better off with a revolver than a single-picture loan in that they cannot actually draw down under either facility unless they have bankable contracts in place. Enter the notion of “notice of assignment.” Distributors enter into distribution agreements with the rights holder of a film—typically a special purpose vehicle (SPV) that is created to hold the rights, which are conveyed to it by the producer (who also controls the SPV) and produce and exploit the film. A newly formed SPV is used because it has no liabilities apart from bank borrowings and associated contingencies related to that specific film. In order for a bank to lend against a promise to pay a negotiated advance from a given distributor, the distributor must execute a notice of assignment in a form acceptable to the bank whereby the distributor irrevocably commits to pay such advance directly to the bank and waives all potential counter-claims that might cause it to withhold payment. The distribution agreement must involve an absolute promise to pay, provided the film is delivered no later than the outside date stipulated in the agreement, and provided the actual film reflects the script on which the distributor based his commitment. The latter clause can be a touchy subject because invariably the finished film deviates to some extent from the original script. The key is that it cannot deviate too much. There was a case in the UK in 1994 whereby the distributor, Mayfair Entertainment, refused to accept delivery of a film, Mesmer, starring Alan Rickman, on the basis that the finished film did not resemble the original script in significant ways. You can bet the distributor would have taken the film if it had liked what it finally saw on screen. The UK courts upheld Mayfair’s position,6 and for about 10 minutes the international sales fraternity was in a panic because independent films are reliant on the bankability of territorial distribution contracts (i.e., they must represent acceptable collateral

174  Working the Banks and Non-Bank Lenders

against a production loan) and the bank in question had lent against the Mayfair contract.7 I say there was panic for 10 minutes because the bond companies as a result tightened up their oversight of productions to ensure script compliance. Producers have to work closely with foreign sales agents to ensure that the distribution contracts they generate are bankable—if not immediately, then at least at some point in time with reasonable certainty. For example, it is not uncommon for international distributors to tie their minimum guarantees (MGs) to a prescribed level of US theatrical release—e.g., a minimum number of screens. If there is no up-front domestic distribution deal that guarantees that minimum number of screens, that contract is not bankable. Another potential sticky point is the so-called essential elements clause, whereby if a distribution contract stipulates that a given actor or director is an “essential element” and he or she falls out of the project, the distributor can get out of the contract unless a marquee equivalent can be procured. Again, the producer is relying on the bond company to ensure that the film complies with any such “essential elements” clause so the bond company must do its homework and be satisfied that such conditions will be met. Needless to say, sales agents will try as much as possible to avoid having to include conditions like that in the agreements they negotiate. Sometimes, the foreign distributors will negotiate a two-tier minimum guarantee: a higher advance if a meaningful US theatrical release is obtained, and a lower number if the domestic distributor has no such obligation. Some banks specialize in single-picture lending, others in providing revolving credit facilities to production companies (some banks do both). Either way, the banks have to do their homework in assessing the creditworthiness of individual distributors, both domestic and foreign. The bank lending model starts with the premise that the bank is primarily lending against stipulated minimum guarantees provided by distributors. The bank, in the case of a single-picture loan, will have a first-priority security interest against the underlying rights to the film and all revenue generated from it. Think of that like a mortgage on your house: if you don’t keep up with the interest and principal payments on your house, the bank can foreclose and seize the property. It works the same way on a film. If you don’t repay the bank loan on a film, the bank can seize that asset and exploit it in an effort to obtain repayment. In the case of a revolving credit facility, the bank (or banks if a syndicate is formed) has a first lien on all the assets of the company. All distribution contracts carry with them notices of assignment directing the distributor to pay the bank provided timely delivery is met. As the bank market became more competitive 10–15 years ago, banks became more aggressive lenders and started to supplement the secured portion of their loans with a “gap” component pegged to a certain percentage of the estimated value of the unsold rights. That is, they were no longer simply secured lenders; they were now prepared to also take a punt on the quantum of additional sales—for higher fees, of course. Most banks will cap the “gap” portion at the lesser of 20% of the budget or 50% of the estimated value of the unsold

Working the Banks and Non-Bank Lenders  175

rights, net of sales fees, marketing expenses and residuals. Banks will typically not ascribe a value to domestic rights, because unless a minimum guarantee is negotiated for the United States/Canada, the producer is sitting behind the domestic distributor’s fee plus recoupment of P&A, so the net receipts attributable to the producer cannot be quantified. There are plenty of instances where the domestic distributor has not earned its full fee and recouped 100% of its P&A expenditure. In such cases, there was no allocation of receipts to the producer. As is the case in real estate lending, there is an acceptable loan-to-value formula at work, which is referred to as the “borrowing base calculation.” In this case, it refers to the haircut the bank applies to specific distributors’ advances. Some distributors’ minimum guarantees, including those from the US major studios and the most creditworthy streamers, will not be discounted at all. Leading international distributors deemed very creditworthy may be subject to 10% discounts, others, particularly in countries experiencing some level of economic distress, may be subject to discounts of 25–50%. In addition to the discounts the banks apply in terms of calculating their borrowing base, banks will increase their loans to provide for their up-front fee, legal expenses plus an interest reserve that is conservatively calculated (i.e., the bank will assume a higher cost of borrowing than currently applies and it will presume the term of the loan extends, on average, at least 3 months beyond the outside delivery date stipulated in the completion bond agreement). One of the benefits of controlling your own production vehicle is you have the flexibility to decide whether you want to borrow on a single-picture basis or whether you want to set up a dedicated credit facility. The advantage of the latter is you know you have a committed line of credit and do not have to worry about uncertainties in the credit markets. Today, when credit is relatively free flowing, that is less of a concern, but I remember 2008–09 when the banks’ spigots virtually dried up. Knowing you had a committed line in place then would have saved you many sleepless nights. Having a credit line in place also saves a considerable amount in legal fees since you don’t have to replicate bank documentation on a project-by-project basis. But there are costs associated with a credit facility: you typically have to pay an up-front fee calculated as a percentage of the overall facility as well as a fee on unutilized balances, so you had better be reasonably assured that you will consistently be in a position to have outstanding borrowings equal to a meaningful percentage of the facility. I should also point out that the banks are usually quite happy to establish a credit facility for you if you pay their up-front fees, but your ability to borrow under that facility will still be a function of your available borrowing base, just like it works in the case of a single-picture loan. Interest rates can also be a tad lower if a credit facility is involved, but in today’s competitive banking environment, a quality project can probably command similar terms on a single picture loan. It used to be tough to crack LIBOR+ 3% and 1% upfront fees on either a credit facility or on a single-picture loan, but the right borrower or project can

176  Working the Banks and Non-Bank Lenders

reasonably hope to do better than that today. Small single-picture deals will typically command both higher interest rates and higher upfront fees. I should point out that there are two additional benefits associated with a credit facility. Because the banks have a first security interest in a portfolio of films in the case of a credit facility, a well-regarded production company can frequently negotiate a production credit as part of its borrowing base, which is calculated as a percentage of budget when a new film is greenlit. Since this production credit is independent of any bankable contracts in place, it functions effectively like preferred equity. This enhances your leverage and enables you to stretch your equity resources. In addition, credit facilities typically enable you to borrow for new production against an “ultimates” credit on already released films, provided such ultimates are provided to the bank by a studio or mini-major (they are typically produced within 10 weeks following theatrical release). Banks will typically lend 85% of the projected net revenues over a 4-year period following theatrical release. However, as the banks have become more aggressive, some will now provide “ultimates” loans as part of a single-picture loan if they feel comfortable they will have an ongoing lending relationship with the producer. As I indicated, banks by tradition are secured lenders. Even when they are making “gap” loans, they are effectively in first position against the world. Mezzanine or “gap” lenders who are prepared to lend a greater amount against the value of unsold rights are subordinated to senior lenders. They are subrogated to the banks, so once the bank is repaid mezzanine lenders step into the bank’s shoes with all of its rights. To the extent mezzanine lenders will lend additional “gap” above and beyond what the bank is prepared to do, they are sometimes referred to as “super-gap” lenders. I can’t prove it, but I believe I invented the term, having pinched it from an article I wrote when I was a graduate student in philosophy entitled “Tasks, Super-Tasks and Super-Dooper Tasks.” Most mezzanine loans are made on a single-picture basis, but some private equity firms have been prepared to slot in overall mezzanine facilities as an additional capital tier over and above a senior secured facility—much like the hedge funds were prepared to do with respect to studio slate deals. There is no standard formula for determining what “super-gap” lenders are prepared to advance. The first hurdle I have to overcome when I consider whether I am prepared to make a mezzanine loan is whose estimates am I relying on. I don’t blackball any foreign sales company, but with regard to some of them I discount their estimates by 100%. There is one sales agent who should go nameless, and whom I actually like, but he is someone I would not do business with. He is absolutely consistent: he always misses his estimates by roughly 50%. Other considerations come into play. When banks make “gap” loans, they often require the foreign sales agent to sell two primary territories before they will extend the loan. The primary territories are the main foreign territories,

Working the Banks and Non-Bank Lenders  177

including the UK, Germany, France, Spain, Italy, Japan and Australia/New Zealand. Russia, based on the level of advances distributors there were offering, 2 or 3 years ago almost joined the select circle, but post sanctions, a number of Russian distributors have gone belly up or, facing financial hardships, they have gone back to renegotiate their deals—and they are certainly paying much less than they used to. China remains a wild card. For the right film, distributors can pay a lot, but their behavior is quite unpredictable. Clearly, China is now a bona fide primary territory, but only for the right films—censorship remains a problem. I don’t have any hard-and-fast requirements in my mezzanine fund. For the right sales agent, I won’t necessarily require any up-front sales of primary territories, but the lack of any sales would probably affect how much I am prepared to discount the foreign sales company’s estimates. Assuming I like the project—in the sense of being comfortable with its commercial potential—I typically discount foreign sales agents’ estimates by 20–35%, depending on my assessment of the sales agent, whether there is a domestic distribution deal already in place and whether any primary territory sales have been made. I am not overly impressed by a few secondary territory sales, because they typically represent low-hanging fruit. In Figure 12.1 I set out the coverage analysis we prepared for a prospective “super-gap” loan, which we did in fact fund. You will see that our loan to the production was $2,636,404, but this was grossed up by $680,196 to cover our 10% fee, interest reserve and legals. Even though there were no presales, apart from India, when we committed to the loan, we haircut the sales agent’s estimates only by 25% because of the high regard with which we held this particular sales agent. Even so, the coverage ratio of 1.11× was pretty thin based on our usual requirements. The deal worked out very well, however. The foreign sales agent hit his estimates spot-on and the US minimum guarantee actually exceeded the estimate significantly. Mezzanine lending and “gap” lending are not synonymous. Mezzanine lending subsumes “gap” lending, but it also includes several other categories— preferred equity, bridge financing, finishing funds and P&A, to name a few. The risk/reward profiles of each category differ significantly, but the amount of money that can be reasonably deployed in each category also differs significantly. From an investment point of view, scalability is almost as important as risk/reward, certainly from an institutional investor’s point of view. In the “gap” space, for example, I target on the order of ten investments per year, each in the $2–5 million range. Thus, I would hope to put to work $25–30 million a year, which is an investment size of interest to my primary investors (high-networth individuals and smaller family offices). But that size of annual outlay is not really of interest to hedge funds and private equity firms. It’s just not worth their trouble. Bridge financing and finishing funds offer even less opportunity to deploy funds. Bridge financing opportunities typically arise when bank

178  Working the Banks and Non-Bank Lenders

FIGURE 12.1

Mezzanine Loan Analysis.

loans do not close on time, so bridge financiers have to step in, typically for a couple of weeks up to a couple of months. From a cost-of-capital point of view, bridge financing is very expensive—often with a minimum absolute return of 15%, even if the money is outstanding for no more than a month, or less. But what can you do if you are not a well-capitalized producer who can afford to bridge the bank loan himself? My clients are all in a position to do that—so this is not a market I typically traffic in except as a supplier of capital through my mezzanine fund. I want to be clear about bank loans. The banks will not open their spigots—not one drop will flow—unless all the necessary documentation has been completed and executed, and every penny of the required equity has been funded. Finishing funds is another arena I do not traffic in on behalf of clients and I am not particularly interested in it even as a supplier of capital. The deals tend to be very small, and even though a provider of finishing funds will typically

Working the Banks and Non-Bank Lenders  179

think he or she is in a low risk position because he or she is last-in, first-out, the fact that a producer would commence production on a film without having all the money in place to deliver the film tells you something about the kind of producer who falls into this trap and the kind of films this happens to: definitely the minor leagues. Even if you are in first position against the world on such films, they often have minimal commercial potential. You may find yourself unable to procure any domestic distribution even on a straight-to-VOD basis, and the international potential may be equally slim. If you do not have a lot of capital to invest, but you have a knowledgeable line producer on board to ensure that the money the producer is requesting to finish the film will actually deliver the goods (remember, no completion bond will be operative in such cases because the completion guarantor requires that the producer demonstrates the film is funded to the strike price), and you have a good lawyer to ensure that you are protected if something goes wrong, this is an arena you may want to play in. Because the producer is in no position to negotiate, you can charge whatever you want. For larger institutional investors, the obvious place to play is the P&A market. But here there is a beguiling trap. It would appear from a risk point of view that it is much safer to provide P&A funding on platform releases, which involve a reasonably small investment in a few markets, which can then be expanded if the film performs. We are talking about an initial investment of, say, $3–5 million to open in New York and Los Angeles, and maybe a few other major markets—anywhere from 6–10 screens up to 30–50 initially—and then gradual increases in the number of screens until you might get up to as many as 800 screens or more nationally if the film really works. In such cases, you might find yourself spending in excess of $10 million eventually, but that is still far less than what it takes to open a film on 2,500–3,000 screens. The problem with this strategy is that it is expensive to open in New York and Los Angeles if you want to make television buys (you can always, of course, restrict yourself to buying ads in newspapers and maybe some relatively cheap radio spots and hope favorable critics’ reviews will drive audience awareness and want-to-see). If the film warrants an aggressive rollout in other major and secondary markets, you are effectively duplicating your initial P&A spend to the extent you are buying additional national television spots in the roll-out phase. The movie business is about the occasional hits, and platform releases are primarily about hitting singles. The occasional single just does not make up for the platform releases that do not work unless the distributor has access to a consistent flow of high-quality specialty films and is adept enough to pull the plug as soon as it is clear that the film is not working. I have seen too many examples of platform releases that give false signals—especially when a film opens well in New York, Los Angeles, and maybe a few other major markets like Chicago, Philadelphia, San Francisco, Miami, Atlanta and Dallas. Will it play in Des Moines? Too many critically well-received art films just don’t play in Des Moines.

180  Working the Banks and Non-Bank Lenders

Sony Classics has built a real business of specializing in platform releases. It acquires a ton of films each year and basically throws them all up against the wall. If they stick—i.e., if they open with meaningful per-screen box office averages—it supports the film and gradually rolls it out, but if they do not perform it dumps them immediately. But Sony Classics is also earning distribution fees, so it gets to keep a greater percentage of film receipts than a pure financial investor would simply putting up P&A. Since distributors charge distribution fees as an off-the-top percentage of gross receipts, and they get to recover their P&A expenditure off the top (after their distribution fees) there is a natural tendency to buy gross—that is, spend incremental P&A dollars that will generate a multiple of gross receipts that will just cover the incremental P&A spend after deducting the incremental distribution fee. Keep in mind that there is a multiplier effect at work here. The distributor is not just recouping the P&A expenditure out of distributor’s share of box office receipts (approximately 50%) but to the extent he or she is not recouped out of theatrical receipts, he or she can invade all ancillary revenues—home video, pay-per-view/VOD, pay television, free television and so on. And to the extent box office increases, ancillary revenues also increase, although not necessarily at the same rate. So, it takes a lesser ratio of theatrical film rentals to P&A expenditure on broad national releases to recoup P&A than it does in general on platform releases. Let me be clear here: the percentage of films that recoup their P&A expenditure simply out of distributor’s share of box office is quite small. Go on Box Office Mojo and check out how many films per year generate box office receipts in excess of $100 million. That’s what it takes to recoup domestic P&A expenditure of $40 million out of theatrical film retails only, assuming a 50% rental rate, a 15% distribution fee and certain off-the-top expenses such as trade dues checking and collection fees, taxes, etc. To get to $100 million box office, it will probably take well in excess of $40 million in P&A expenditure, especially if a studio is controlling the spend. I strongly believe that if you want to invest in P&A, you should consider doubling down by investing not only in P&A but also putting up the minimum guarantee that is required to acquire the domestic rights to the film. Assuming you are considering only broad national releases with an up-front P&A commitment of $25–30 million (which is less than what the studios would normally spend on their own dime, but you should be able to confine your spend to that range if you have approval rights on a line item basis or if you work with one of the independent distributors who have the clout to stand behind a broad national release), you would typically be looking at an additional investment of $4–8 million to acquire the domestic rights. But in exchange for increasing your risk by around 20%, you get to keep a much bigger percentage of the pie. Let me give you some examples. Assume you are putting up all the P&A but not the distributor’s minimum guarantee. The distributor may charge a 15% distribution fee and you may charge the producer a 10% override for putting

Working the Banks and Non-Bank Lenders  181

up the P&A. Let’s be generous and assume you also get 15% of overages after the P&A and distributor’s advance are recouped. If the film generates net domestic receipts of $48 million, say, against a P&A spend of $30 million and an advance of $6 million (I will ignore interest on the P&A and the advance just to make our calculations simpler), the distributor will recoup his advance and earn a distribution fee of $7.2 million—and you, the P&A investor, will net $4.8 million (against an exposure of $30 million because there are no domestic overages in this case). Arguably, this is not that exciting an ROI, given your risk position—especially when you factor in management fees. Alternatively, let’s assume you also put up the $6 million advance. Then, you might get to keep 15% of the distribution fee (in this case you keep $7.2 million). You will, of course, recoup your advance with interest, but even more important, you will be able to negotiate much more than 10% of domestic overages. That is the key to a successful film investment strategy: you have got to benefit to the maximum extent possible from the occasional hits. The probability of loss on straight P&A investment is too great to settle for mid-teen ROIs on base-case investments. Even better, you can consider investing in P&A on a preferred basis. That is, you can put up the first 50–75% of P&A risk, with the producer or the distributor putting up the last 25–50% of risk. I would prefer that the distributor shoulder this risk because I want him to have skin in the game. On this structure, if we don’t fully recoup, the distributor is fully wiped out—less his distribution fee, of course. Apart from the very occasional real stinkers, it is arguably the case that the first 50% of P&A risk involves minimal exposure. Rarely will a broadly released film not recoup at least 50% of its P&A spend. If we price the first 50% of P&A risk at 9% ( junk bond–type returns) and the second 25% at 18% (“gap” level pricing) we come up with a blended 12% return for such an investment., even assuming no ongoing revenue participation once the P&A is recouped. I am discussing just such a pricing on a P&A deal presented to me. You also have to assess the quality of the deal flow you can expect to see on P&A investments. In general, the studios are not interested in soliciting outside P&A investment—apart from one studio I know of that will consider such deals in the fourth quarter of its fiscal year to avoid having to take a big deduction in that quarter (GAAP now require a film company to deduct distribution and marketing expenditure in the quarter in which it is incurred, as opposed to the previous methodology whereby P&A, like production costs, was capitalized and then amortized on the income forecast method). Thus, you are limited to independent productions that need P&A in order to obtain a domestic distribution deal, and these are precisely the films that you should be chary about backing. There is a good reason producers have to bring P&A funding to the table on such films. The prospective distributors, if they were that keen on the film, should be willing to put up the P&A themselves—because, if they do, they can charge higher distribution fees. No, distributors who are willing to

182  Working the Banks and Non-Bank Lenders

rent their systems typically do so because they are worried about the commercial prospects of the project and do not want to shoulder the P&A risk. That is not the only reason why independent distributors, however, eschew putting up the P&A themselves. Independents, unlike studios, have finite resources—so they may be prepared to rent their system in certain cases because of capital constraints. I would point out that both studios and independent distributors have only so many distribution slots, in terms of what their marketing and distribution staffs can feasibly work on in a given year, so even if someone comes to them with all the P&A and do not even require a minimum guarantee, the distributor is unlikely to play ball unless the projected level of distribution fees it can earn makes it worth their while. It is difficult to prognosticate about the theatrical marketplace in a postpandemic world, so I don’t want to make any hard and fast assumptions about P&A financial models. In any case, I don’t think P&A financiers will be terribly keen to commit to deals until they are in a position to see finished films, especially since it is becoming increasingly common for studios and independents to lay off films to the streamers, which may eschew theatrical releases. A bit of caution here: a few years ago, I was advising a producer who wanted to strike a distribution deal with a relatively new distributor who was prepared to release his film but did not want to put up an advance or the P&A. My client was prepared to bring the P&A to the table. When I was negotiating the deal, however, the distributor’s head of business affairs insisted that the producer convey the distribution rights to his company. When I pointed out that it was not putting up a dime, the business affairs executive said the company needed the rights to satisfy its bank covenants. What he really meant to imply was that it wanted to borrow against those rights. Of course, I resisted, to which he mentioned three other name producers who, he claimed, had agreed to convey their rights under similar circumstances. My response was, “Clearly they weren’t the three Wise Men from the East.” It did not produce a laugh, I did not close the deal; and 6 months later the distributor filed Chapter 11. You can imagine what a mess we would have been in had those rights found themselves in the distributor’s bankruptcy estate. Under no circumstances should rights ever be conveyed unless the distributor is paying for them by putting up an advance and/or P&A. That includes deals with foreign sales agents—there is a good reason they are called “sales agents.” If I am advising a passive investor (i.e., someone who does not fund a production company he controls) and that investor wishes to minimize his risk—either due to the size of the aggregate dollars he is willing to commit to the space, or because he prefers to commit selectively to projects as opposed to taking a slate approach—I often suggest he consider making mezzanine investments rather than equity investments. I find the risk/reward ratio more favorable. There is a good explanation for this: mezzanine investors are required either because the combination of equity available on the deal plus available bank loans are

Working the Banks and Non-Bank Lenders  183

not sufficient to meet the strike price, or because the equity investor wants to jack up his projected IRR by the use of leverage. Of course, that works only if the mezzanine cost of capital is less than what the equity thinks he can earn on his unleveraged commitment. As I have consistently reiterated, the movie business is a hit-driven business, so it is clear that a successful film can deliver very attractive IRRs. Even if mezzanine funding carries a cost of capital in the mid-teens or higher, the leverage it provides can goose the equity returns on successful films. I would argue that mezzanine returns in the mid-teens are more akin to equity returns in other asset classes. Let me tell you how I approach possible mezzanine deals. First, let me distinguish between what I earlier termed “super-gap” deals and what I would term “preferred equity.” “Super-gap” represents more aggressive “gap” deals, in terms of loan to estimated value, than what the banks are prepared to do. As I mentioned previously, the banks might lend 50% of the estimated value of unsold rights, net, of course, of sales fees, marketing expenses and residuals. As a “super-gap” lender, I might lend 60–80% of the estimated value of unsold rights, depending on a number of factors that I enumerated earlier. “Super-gap,” like “gap,” therefore entails taking sales risk, not performance risk. That is, I am betting on the sales agent’s ability to deliver sales reasonably close to his estimates. Let me be precise here. Foreign sales agents will typically present two sets of estimates: “asks” and “takes.” “Asks” represent the minimum guarantees the sales agent will attempt to obtain. “Takes” represent the minimum guarantees the agent is prepared to close on. When I apply my “haircuts,” I always apply them to the “take” prices, because they represent the conservative numbers the sales agent is confident he or she can deliver. But is that always the case? No! Foreign sales is a very competitive business. You get the business either because you are willing to cut your fees, or, more likely, because the producer thinks you will deliver higher sales than your competitors. So, there is no reward for the foreign sales agent to err on the side of caution. There is every incentive to inflate the numbers. But those of us who are actively involved in providing capital on the basis of sales agents’ projections discover very quickly whose estimates we can rely on and whose we can’t. Some agents don’t even make it to the list of agents I am willing to do business with. Others, who are relegated to the bottom of my acceptable list, find themselves having their estimates discounted by higher percentages than I am prepared to apply to my preferred agents. I have a smell test I apply in choosing a foreign sales agent for a specific project. While foreign sales agents are hard-headed businesspeople across the board, they also tend to be passionate cinephiles. Nothing excites them more than representing a gem of a film that they can take the credit for discovering. So, my smell test attempts to gauge how excited they really are about representing the project, which means I have to cut through the customary sales pitch that they will make at the drop of a hat. Since I am effectively asking a foreign

184  Working the Banks and Non-Bank Lenders

sales agent to commit to a project simply on the basis of a script, director and key talent, it is important for me to get a sense of their creative take on the project and what kind of sales presentation they envision in order to excite distributors around the world. In other words, can they communicate their enthusiasm to third parties. That is what I mean by my smell test—I can’t objectively state my criteria for choosing the right foreign sales for a given project, but I can tell fairly quickly if the foreign sales agent is on the same creative page with the director and the producers. In the case of preferred equity, you are taking performance risk, not sales risk. In other words, you are typically recouping out of net receipts, either from the domestic market or those foreign territories where distributors are releasing on a straight distribution basis—without putting up an advance. In analyzing a preferred equity deal, I focus on what level of box office will generate aggregate net receipts from all revenue sources that will trigger breakeven— preferably breakeven plus a negotiated premium, typically on the order of 20% of investment. In addition to the premium, I also factor in an upfront fee that I will finance, plus a negotiated profit participation, typically kicking in once the equity investor sitting behind me has recouped 120% of his investment. While I don’t want the breakeven box office number to be a stretch, even if my preferred equity investment is predicated upon a conservative box office performance, there is no assurance that the film will not be a flop and will not hit even that conservative box office target. As I mentioned earlier, in 2014 we made a preferred equity investment on a Liam Neeson thriller, A Walk among the Tombstones. I calculated our breakeven at US box office of around $30 million. That calculation assumed, however, that the distributor, Universal Pictures, would spend $30 million in P&A to hit that number. To put my analysis into perspective, Neeson’s most recent thrillers (Taken 2, The Grey, Unknown and Taken) had generated domestic box office of $140 million, $51.5 million, $63.6 million and $145 million, respectively,8 so I thought I was pretty safe with a $30 million breakeven (to be precise, the box office numbers I quoted included Canada as well as the United States, but Canada typically represents only 7–9% of domestic box office). A Walk among the Tombstones did only $26 million at the domestic box office, plus Universal “over-spent” on P&A relative to the box office that it delivered. While we are sitting ahead of the other equity investors, we are also sitting behind Universal’s distribution fee plus its P&A, so we will clearly not recoup unless the film overperforms in ancillary markets or internationally, where we are entitled to recoup out of foreign overages— excess receipts over and above the minimum guarantees put up by the territorial distributors. The jury is still out. We did much better with regard to a preferred equity investment on Woman in Black 2: Angel of Death. The film—which was a sequel to a very successful, classy horror film—underperformed its predecessor domestically at $26.5 million box office versus $54 million.9 We were bailed out, however, by the UK, which generated significant overages, although we

Working the Banks and Non-Bank Lenders  185

had to wait for later-stage television revenues to come in to actually pay us back. On preferred equity deals, I typically receive significantly higher profit participations than on “super-gap” deals, which is appropriate given that by my analysis preferred equity deals carry with them a higher probability of loss. I structure my “super-gap” deals differently from other mezzanine lenders. I typically do not make separate mezzanine loans; rather I piggyback on the bank loans, which are secured by contracts and may also contain a “gap” component. My mezzanine fund puts up cash collateral, which enables the bank in question to increase its loan by the amount of my cash collateral. Once bankable contracts come in, the bank releases that portion of my cash collateral equivalent to the loan value the bank ascribes to the specific contracts. This structure has two advantages from my point of view: first, the bank, not my fund, is taking collection risk since the bank releases my cash collateral when bankable contracts are generated. The bank does not wait until the distributor actually pays the minimum guarantee, so the duration of my loan is reduced. This makes sense because the bank invariably will have much greater leverage than I have to compel payment by the distributors. Second, this means I do not have issues with the guilds—the Screen Actors Guild (SAG-AFTRA), the Directors Guild (DGA), the Writers Guild (WGA) and the International Alliance of Theatrical Stage Employees (IATSE). The guilds uniformly will not subordinate to non-bank lenders with respect to prescribed residual payments, but they will subordinate to the banks—and I am part of the bank loan. So, for purposes of calculating what I am willing to lend, I do not have to deduct residuals from my estimated revenue streams. As is the case with preferred equity loans, we charge an up-front fee, typically on the order of 5–10% (which we finance), and on that portion of the bank loan collateralized by our cash deposit, we receive an annual interest rate of 12–13% in excess of what the bank charges (which I indicated earlier is around LIBOR + 3%). That seems to represent very expensive money—around 15–17% today—but remember that once our cash collateral is replaced by bankable contracts, the interest rate goes back down to 3.40%. If the foreign sales agent does his job well and makes sales on an expeditious timeline, our money is actually quite cheap. My mezzanine fund, therefore, targets a return to investors of 18–20% (assuming our cash collateral is out for an average period of 1 year), less management fees and actual underwriting losses incurred (I assume around 5–7% probability of loss) but not taking into account profit participations. So, the net IRR we hope to achieve for investors on a portfolio basis (assuming an average duration on loans of 1 year) is around 12–14%. We also defer one-third of our management fees, which is recouped after the fund is wound up, assuming the investors are fully recouped. Arguably, our targeted IRR for our mezzanine fund is not dissimilar from realistic objectives for equity investment in films on a portfolio basis. In addition, it should be kept in mind that mezzanine investment carries with it a much lower probability of loss and a significantly shorter average duration than equity investment.

186

Working the Banks and Non-Bank Lenders

It is worth mentioning that my mezzanine fund has never worked with any of my producer clients—for a very good reason. My cost of capital is just too expensive for a well-capitalized producer. Arguably I am looking for equity-type returns for taking mezzanine risk. Producers who need my capital to fill the hole in their financing may have no choice but to accept my tough terms, but thankfully none of my clients are in such a difficult position. (I believe my terms are fair given the risk implicit in such loans—but remember, if I don’t recoup, the equity sitting behind me is totally wiped out.) It is difficult for me to recommend that they take mezzanine capital simply to leverage their equity. It makes sense only if their liquidity position is very tight at the time a new film is being greenlit. There are, however, mezzanine structures that do not involve onerous cost of capital and represent fair risk sharing arrangements that can appeal even to my well-capitalized clients. Remember all independents, by definition, have finite resources, so if they can leverage their equity to get up to the plate more times without paying through the nose for such leverage, it makes sense. Let me give you an example of a preferred equity deal that I think makes sense for both parties. We proposed taking on preferred equity on a given deal that matched our subordinated equity. The preferred equity investor would recoup ahead of us with a 5% preferred return, following which we would recoup with an equivalent 5% preferred return. Thereafter, profits would be split 75/25 in our favor with third parties off-the-top. My producer client would also receive his standard producer/overhead fee in the budget. So, for putting up 50% of the equity required in a preferred position (including the 5% premium), our co-financier on this film would be entitled to 25% of financiers’ profit. So, our co-financier gets to lower his breakeven dramatically and in exchange for slightly increasing our breakeven to reflect the co-financiers’ premium, we would be significantly increasing our ROI on a successful film.

Notes 1 Lumenick, Lou. “War of the Warners,” New York Post, 21 Mar. 2010, http://nypost. com/2010/03/21/war-of-the-warners/. 2 Borsten, Joan. “Films: Money in the Bank: To Frans Afman, Films Are Money in the Bank,” Los Angeles Times, 7 July 1985, http://articles.latimes.com/1985-07-07/ entertainment/ca-9344_1_film-industry. 3 According to author experience. 4 “Rottentomatoes.com Traffic Statistics,” Alexa.com, www.alexa.com/siteinfo/rottentomatoes.com. 5 Horgan, R. (2016, August 3). “Suicide Squad Box Office Numbers.” Retrieved from http://www.adweek.com/digital/suicide-squad-rotten-tomatoes-metacritic/. 6 Dawtrey, A. (1994, December 12). “Mayfair Entertainment Refused Delivery of ‘Mesmer’ Film.” Retrieved from http://connection.ebscohost.com/c/ articles/9501114676/mayfair-not-mesmerized. 7 Paton, Maureen. Alan Rickman: The Unauthorized Biography (London: Random House, 2012).

Working the Banks and Non-Bank Lenders

187

8 “Taken (2008),” Box Office Mojo, www.boxofficemojo.com/movies/?id=taken.htm; “Taken 2 (2012),” Box Office Mojo, www.boxofficemojo.com/movies/?id=taken2. htm; “The Grey (2011),” Box Office Mojo, www.boxofficemojo.com/movies/?id=grey.htm; “Unknown (2011),” Box Office Mojo, www.boxofficemojo.com/ movies/?id=unknownwhitemale11.htm. 9 “Woman in Black (2012),” Box Office Mojo, www.boxofficemojo.com/movies/?id=womaninblack.htm; “Woman in Black 2: Angel of Death (2014),” Box Office Mojo, www.boxofficemojo.com/movies/?id=womaninblack2.htm.

13 HOW TO BEAT THE ODDS Niche Strategies

Summary—The chapter begins by discussing the possibility of creating algorithms to predict film performance. Niche strategies are then explored—in particular, low-budget horror films, low-budget action films, faith-based programming, “urban” dramas catering to African-American and Hispanic audiences and “chick flicks.” Ryan Kavanaugh, the founder and CEO of Relativity, has been denigrated for his Moneyball approach to film selection—especially after his company filed for bankruptcy after a string of lackluster films. In hindsight, his vastly inflated overhead may have contributed as much to his crash and burn as his mediocre film slate. In two much-publicized articles in Esquire and Vanity Fair, Kavanaugh bragged about his company’s proprietary algorithm being based on an elaborate Monte Carlo simulation (I doubt whether Ryan really knows what a Monte Carlo simulation is), which supposedly could predict probabilities of film performance based on the past performance of similar films.1 Relativity’s computer program plugged in a multitude of variables, including principal actor, director, genre, budget, release date, rating and so on, and then churned out two critical numbers: the percentage of time the film would be profitable, and the average projected profit. What went wrong? Monte Carlo simulations are most suited to large samples of comparable iterations. One neutron bombardment of fissile uranium does resemble every other neutron bombardment. But it doesn’t work that way in the movie business. If it were that easy, the studios would be hiring MIT computer nerds to greenlight films. From time to time I receive unsolicited presentations from academics or other non-industry types who claim they have developed a proprietary model that can predict (with various degrees of certainty) the likelihood of success of a given project based on as little information as a log line; better yet a log line and a budget; or even better a log line, a budget, and a director and cast. DOI: 10.4324/9781003153702-14

Niche Strategies  189

Frequently the presentations even include a fair amount of arcane mathematical notation and/or reference to a supposedly huge database of historical comps. I never waste my time following up on them (to be fair, I might be more inclined to vet the presentations if the authors were a bit more humble and claimed only that their methodologies would give them an edge, rather like counting cards at blackjack, as opposed to being an outright predictor of results)—not because I am a Luddite, but because I don’t believe that such predictive algorithms are possible. There are too many unknowns at work. Plus, the success of a film is typically just as reliant on execution as it is on concept and cast—and I am not saying that just to protect the jobs of creative executives who are my friends. Every predictive algorithm I have ever seen works until a counterexample emerges, and they always do. In high school, I played around with polynomial functions that would generate only prime numbers, until I discovered that no such functions could exist. In my class at Peter Stark, I used to joke that I knew of one theme that was a guaranty of theatrical success: films featuring friendly dogs. But then Marmaduke was released. To be fair, my ears always perk up when I am presented with a project that is based on a successful underlying literary property. Such projects have a leg-up in terms of creating audience awareness and can benefit from a large pre-existing fan base. Witness the success of Marvel—but remember that as a pure comic book play, the company went into bankruptcy in 1996 as a result of being overleveraged when the comic book market tanked. The fan base remained loyal, however, but even that would not have been sufficient in my opinion if the movies highlighting the Marvel superheroes didn’t deliver in terms of production values and storylines. And it helps to have four quadrant appeal—which is necessary given the budgets Marvel is playing with. I use Monte Carlo modeling myself, but not on a single-picture basis for greenlighting individual projects. I do not include granular variables like individual actors, which I consider “noise” in a model rather than useful information. I also prefer not to use strict historical data sets unless they are updated to reflect current trends. The model I use most often is one I developed with a colleague, John Smith, who spent considerable time working with historical data models in the early to mid-2000s and not coincidentally did the in-house modeling for Alcon when it was doing its 2008 slate funding. We use a statistical probability curve for domestic box office performance for slates of films and use forward-looking correlations for expenses and ancillary revenues. With this, we present potential investors with a full range of possible and probable outcomes for a slate of films if they are financed and released according to assumptions that we present in a business plan. Results include the cash need for the slate and possible investor returns, from best- and worst-case outcomes but focusing on the median or most probable outcome. I do not like to overstress the importance of these models, however. As the statistician George Box liked to point out, “all models are wrong, but some are useful.”2 Instead I prefer to

190  Niche Strategies

focus on the team that will implement the business plan, and its track record and trustworthiness, since that is what an investor really has to rely on. To be fair, Kavanaugh admitted that his quantitative method was used more as a veto on projects he and his staff loved creatively but didn’t pass muster by the numbers, rather than vice versa—but if a film flashed green on their regression analysis, they still wouldn’t greenlight it if they didn’t like it creatively. It’s not that Relativity discovered some newfound epiphany about what works and what doesn’t. For example, Kavanaugh constantly referred to his company’s aversion to paying gross participations—as opposed to offering talent higher percentages after breakeven. But the studios have been aggressively moving in that direction for years. Kavanaugh’s most extravagant claim, in my opinion, was that most of Relativity’s films covered their budgets out of tax credits and foreign presales. Arguably, Relativity had negotiated favorable international output deals in a number of territories and was smart enough to jump on the Netflix bandwagon early on, which allowed it to negotiate a very favorable Netflix output deal (which was comparable to the pay-television deals offered by the premium pay services to the studios). Netflix tried to get out of the deal in bankruptcy court by arguing that the new Relativity could not demonstrate it had the capital resources to generate the flow of films required under the Netflix contract, but the judge affirmed the contract (which expired anyway in 2018).3 I don’t believe that Relativity covered the entire budgets out of these two revenue sources (tax credits and foreign presales) more often than not. Even that claim requires the addendum that it was able to recoup its P&A expenditure plus a premium on average out of all domestic receipts if its film operations were to show consistent profitability. It was revealed through the bankruptcy proceedings how unprofitable Relativity really was. In 2014, the company had negative EBITDA of $23 million on $506 million in revenue but lost an astonishing $135 million in 2013 on $379 million in revenue and $85 million in 2012 on $331 million in revenue.4 All of that can’t be attributed to excess overhead that couldn’t be amortized. No, I would attribute it primarily to a flawed business plan. Relativity wanted to compete with the major studios but lacked the capital resources and meaningful consistent cash flow provided by the studios’ substantial libraries (this became even worse in 2012 when Kavanaugh had to turn over most of his library to extricate Relativity from Elliott Management, its former chief backer). So, by default Relativity had to concentrate in the “studio-lite” space: mid-level budgets of $20–50 million. By itself, that was not a mistake, although Relativity’s regression analysis should have raised some red flags. In my view, if you can’t troll intellectual property you control, which all the studios are able to do, you have to engender a prolific development effort to identify and shepherd attractive projects. But Relativity did little, if any, internal development. It relied on agencies and outside producers to bring in attractive projects. While I have harped on the difficulties

Niche Strategies  191

of making a development fund work, I also recognize the need to tap into meaningful source material. How can you expect a major league baseball team to compete if it doesn’t have a strong farm organization? The same truth applies to the movie business. Relativity didn’t have the capital, or it did not choose to spend what it takes on internal development, nor was it prepared to pay for a network of housekeeping deals with first-rate producers. Even if the studios have cut the number of those housekeeping deals recently, they still maintain a meaningful set of such relationships. Relativity recognized the importance of a niche strategy when it purchased Rogue Pictures, the genre arm of Universal’s specialty division Focus Features, for roughly $150 million in 2009. While that looked like a stiff price since it involved only some 30 library titles, it did include more than 30 scripts in various stages of development as well as several producing deals, including one with the late Wes Craven, the originator of The Nightmare on Elm Street franchise.5 Rogue’s focus was very much on the horror space, which can be a hit or miss business, but in any case does not require significant capital expenditure. Based on my analysis, this section of the business has considerably outperformed studio averages across the entire budgetary spectrum, at least over the last few years. For whatever reason, Relativity did not take great advantage of this division. A cynic might say that Relativity did Universal a favor by acquiring it and did so only to cement its relationship with Universal, which entered into two slate deals Relativity arranged with institutional investors (Gun Hill Road I and II) that funded both Universal and Sony films. Neither Gun Hill I nor II fully recouped, at least based on numbers I examined a few years ago. Even niches are not uniformly homogenous. Certainly, the most successful producer of horror films over the past few years has been Jason Blum, whose production company Blumhouse Productions was responsible for such horror hits as Paranormal Activity (Blum re-edited the film with its director, Oren Peli, which is how he got attached). The original was produced for $15,000 and earned nearly $200 million, and not surprisingly spawned five sequels, the last of which was released in October 2015. The original film grossed $108 million domestically and $85 million in foreign markets, but almost never saw the light of day.6 The film was shot with a home video camera and focused on believability rather than gore, which had been a mainstay of the horror genre, as exemplified by Texas Chainsaw Massacre in 1974 and that arguably spawned the whole slasher film industry, encompassing such well-known franchises as Nightmare on Elm Street, Halloween, Friday the 13th, Scream, Saw and Hostel. The films, however, got more and more gruesome and unbelievable—hence the success first of The Blair Witch Project and then Paranormal Activity, which played on the audience’s primal fears as opposed to overwhelming them with gruesome scenes of torture and dismemberment. Blum has repeated his success with Paranormal Activity with other microbudgeted horror films including Insidious and Sinister. Both films spawned sequels

192  Niche Strategies

and delivered scares without much blood that can still make your flesh crawl. Blum is incredibly prolific: he has found a subspace within the overall horror space and continues to milk it for all it’s worth. Not all the films work but given Blum’s adherence to microbudget and low-budget productions, I am confident that his returns are well above the studios’ average performance—even well above high-end studio performance. Interestingly, Blum created BH Tilt in 2014, which is dedicated to generating movies from both Blumhouse and other film makers for multiplatform release. Blum is clearly trying to leverage his success in the horror genre over a broader distribution platform. Perhaps the ultimate hybrid (screenwriter, producer, director and actor), someone who has achieved exemplary success in a niche business, is Judd Apatow, who is considered to have invented the niche “bromantic comedy” (which blends the words “brother” and “romance,” focusing on close nonsexual friendships between men). Apatow has created such movie successes as The 40-Year-Old Virgin, Anchorman, Knocked Up and Talladega Nights, and then switched horses by coming up with the most successful R-rated female comedy at that time: Bridesmaids. Apatow is also responsible for such television hits as Freaks and Geeks, Undeclared and Girls. Apatow may not be as diversified in the themes he tackles as that other famous hybrid, Woody Allen, but his comedic flair is unquestioned, and the box office results he has achieved are outstanding. Why change gears if you are practically hitting it out of the box every time? This leads me to a rather obvious truism: if you can find an undiscovered creative genius, and you are the money source, you could do worse than hitch your horse to that wagon. It helps to find that creative genius before the rest of the industry has discovered him because then you have the leverage to largely dictate the terms of your partnership. Even if you are a little late to the game, such partnerships can still make sense, and I strongly recommend that a prospective film investor consider such opportunities when they arise. In this case, you are making a creative bet on an individual as opposed to a movie. You still have to choose the right horse, however, and you have to know when to get off the bandwagon—both when it comes to auteurs and niches. Avi Lerner of Nu Image, now Millennium Media, is a legend for consistently making both low-budget action films and resurrecting aging action stars in higher-budget action films. The latter model is perhaps best exemplified in Lerner’s The Expendables. The first film in the franchise united Sylvester Stallone with Jason Statham, Jet Li, Dolph Lundgren, Mickey Rourke and some other old action stalwarts, whose faces you would probably recognize but probably not their names. The film is supposed to have cost $80 million, which I don’t believe (Avi couldn’t stomach that high a number no matter what he could presell foreign for), but it grossed $103 million in the United States alone, and I am sure Avi presold it for a huge number foreign.7The Expendables 2 added Arnold Schwarzenegger, Bruce Willis and Jean-Claude Van Damme to the

Niche Strategies  193

equation (was anyone left out?).8 The budget supposedly went up to $92 million, but the US box office declined to $85 million. Nevertheless, Avi launched The Expendables 3—clear proof that 2 was still very profitable. Expendables 3 added Wesley Snipes, Harrison Ford, Mel Gibson and Antonio Banderas, but generated only $39 million in US box office.9 It is hard for me to imagine that 3 could have been profitable, but rumor has it Avi intends to reboot the franchise with The Expendables 4—the Rock’s name has been mentioned, but he is such a huge super-star now, I can’t believe he would opt into what is after all an ensemble cast. As I am editing this text, I was proved right as Millennium just announced The Expendibles 4 would feature Stallone, Jason Statham, Dolph Lundgren, 50 Cent, Megan Fox and Tony Jaa. It is worth noting that Avi has largely deserted the low-budget arm of the action genre he pioneered. As international box office results for such films plummeted and, even more important, home video sales collapsed, Avi was able to respond for a while by bringing his budgets down, but there is only so far down you can go before such films can barely pay for a week at the Hotel Du Cap during the Cannes Film Festival. In addition to cutting talent’s salaries, Avi was constantly seeking cheaper venues in which to shoot. First, there was the Czech Republic, then Hungary, then Romania and finally Avi discovered Bulgaria, where he was able to buy his own studio and thus save even more on the below-the-line. Avi even made some films in Lithuania, but I think even he couldn’t tolerate the paucity of professional crews there. This leads me to comment on the disappearance of the low-budget action genre. There is still demand internationally for such films. The problem is that the level of presales that can now be generated, combined with the collapse in domestic prices paid for such films, means that the justifiable budgets are now so low—probably in the $2–2.5 million range—that you cannot deliver satisfactory production values at that price. In addition, a new generation of action stars—to replace the Van Dammes, the Lundgrens and the Snipes—hasn’t emerged to energize the genre. Which is the chicken and which is the egg? Has the failing economics of the genre prevented new action stars from emerging or has the lack of new action stars driven down the budgets that can support such films? Whatever the answer, I am a sucker to prove that I can go against the prevailing wisdom. I hope to start production on the kind of low-budget action film that I have been railing against. I am making the film in Australia, where I can benefit from significant subsidies as well as from a depreciated Australian dollar. The budget is around US$5 million gross—before incentives. My foreign sales agent has projected gross foreign sales in excess of my budget net of incentives, if I can cast a certain recognizable martial arts cult figure in the lead role. If he is right, the United States becomes total profit for me, and in any case, I should not have a lot of risk in the project. At worst, I will probably make a few bucks. At best, I could make $500,000 plus, and I have a chance to launch a new action franchise.

194  Niche Strategies

Perhaps my favorite niche (not because I am active in it, but because I’m fascinated by it) is the Christian market. I’m fascinated by it because the right films—in terms of themes as opposed to production values—can generate significant domestic box office as a percentage of budget without a recognizable cast and frankly without quality screenplays behind them. The Kendrick brothers have emerged as the most commercially successful independent producers of faith-based films. With their latest hit War Room, they are now four for four. Their three previous films—Facing the Giants (2006), Fireproof (2008), which was the highest grossing indie that year, and Courageous (2011)—have taken in $87 million at the domestic box office on an aggregate budget of $2.6 million. Their just released War Room, which had a more ambitious $3 million budget, opened at $11.4 million on a relatively modest 1,100 screen release (Affirm Films, Sony’s Christian label, released it).10 It generated around $74 million worldwide gross by the end of its run. The Kendricks have developed a triedand-true formula for success: keep the budgets extremely tight and rely on aggressive grassroots marketing, mobilizing churchgoers via special screenings with pastors. While the marketing campaigns focus on targeted social media, mainstream awareness of their films is certainly growing. War Room in fact has a primarily African-American cast and has definitely tapped into the strong evangelical roots of the African-American family audience. While such films geared to the evangelical audience typically do not do much business overseas (apart from certain limited territories such as South Korea, where there is a large evangelical population), who cares when you can generate a significant ROI from domestic box office alone? And this is with mostly negative reviews. I loved Steve Pulaski’s review in Influx Magazine. He gave the film a D− rating, saying, I understand War Room has ideology to uphold, but just when I thought I hit the bottom of the barrel of Christian cinema for the year with Faith of Our Fathers, I land at the bottom of the barrel with an even louder thud upon seeing this picture. This film is so bad and contemptible that it would make Jesus himself take his father’s name in vain.11 That is not to say that more mainstream films with religious themes can’t also appeal to the evangelical market. Alcon’s The Blind Side clearly attracted a large evangelical following without carrying too obvious a Christian ideological message. The film highlighted a family of faith without beating the audience over the head with a religious message. Alcon also targeted the evangelical audience with an extensive outreach to churches and pastors across the nation— it’s a lot cheaper than buying television time and if done properly can be a hell of a lot more effective. “Urban” is a code word for films that are targeted at the African-American audience. Urban films can range from comedies to dramadies to gritty action/

Niche Strategies  195

ghetto themes. In 2015, a breakout film with a virtually total African-American cast, Straight Outta Compton, was the surprise hit of the summer, generating a phenomenal $56.1 million opening weekend.12 Clearly that number could have been achieved only if the film played throughout mainstream (i.e., “white”) audiences across the entire country (not only in the major cities with large African-American populations), which was possible because the hip-hop culture and music that permeated the film has been embraced by the entire millennial generation. The film also did meaningful business foreign (Universal pushed it very hard, bringing cast to the UK and Germany for big local events) but its $40 million in foreign box office represented only 25% of domestic gross.13 Straight Outta Compton may turn out to be a total outlier, but Tyler Perry with his Madea franchise has demonstrated that he can consistently come up with box office hits. Perry is the only filmmaker in history to have five films open number one at the box office over a 5-year period. His 13 most popular films have grossed more than $600 million at the box office, despite the fact that none of them cost more than $10 million.14 Because Perry writes, directs and produces all of his movies almost entirely independently, he is able to take home the lion’s share of the film’s profits. It is worth noting that Perry’s films typically appeal to two key demographic groups: African-Americans and faithbased moviegoers, since many of his films also contain positive messages rooted in Christianity. Interestingly, Hollywood has also transformed the romantic thriller genre, which has produced such box office hits cast with white actors such as The Hand That Rocks the Cradle, Fatal Attraction and Unfaithful, by developing similarly themed films directed at the black audience. Sony Screen Gems, which typically sails under the radar in comparison with its studio parent but has been consistently more profitable, has been coining money from these films, including The Perfect Guy, starring Sanaa Lathan and Michael Ealy, released in 2015, and 2014’s No Good Deed, starring Taraji P. Henson and Idris Elba. The first film did $57 million at the domestic box office, while the second one did $52.5 million. Not surprisingly, these films don’t travel (The Perfect Guy generated $3.25 million foreign while No Good Deed did $1.78 million)—but who cares when domestic box office amounts to around 5× budget?15 Screen Gems went three for three with its September 2016 release of When the Bough Breaks, which opened at $14 million on a reported budget of $10 million.16 While the Hispanic film audience overindexes in terms of theatrical attendance, the Hispanic film market has been notoriously underserved in terms of Hollywood’s delivering films with Hispanic thematic appeal. Hispanics bought 25% of the tickets sold in 2013 although they then comprised just 17% of the US population.17 Horror, action and comedy are considered the favorite genres of this audience, yet recent data confirms that the Hispanic audience is increasingly vital to the success of movies in every genre.18 Hispanics go to the

196  Niche Strategies

movies an average of six times a year, twice as often as the average movie goer. According to a PricewaterhouseCoopers’ report, word of mouth is even more important within that audience, because Hispanic consumers are more heavily engaged with their mobile devices than non-Hispanics.19 Yet the number of films set in Hispanic environments with predominately Latino talent is a fraction of the number of “urban” films produced that are directed at the African-American population. One explanation for that fact is the heterogeneity of the Hispanic audience, which consists of very diverse subgroups, including people of Cuban, Mexican, Puerto Rican and South or Central American culture. The tastes of each subgroup are very different, and the popularity of various Latino talent varies significantly depending on which group you are targeting. A few years ago, I was approached to put up the P&A on a film titled El Cantante starring J. Lo and her then-husband Marc Anthony, which was based on the life of the acclaimed salsa singer Hector Lavoe. When I interviewed a number of active Hispanic moviegoers to assess their interest in seeing a film based on Lavoe’s life and in particular how excited they were to see J. Lo and Marc Anthony together on-screen, I got very mixed responses depending on whether I was speaking to someone of Mexican background or Puerto Rican descent. In California, there are clearly many more people of Mexican descent, and they weren’t particularly interested in the subject matter, nor were they that keen on J. Lo—much to my surprise. After all, J. Lo had starred in the most successful Mexican-themed film to date—Selena, which grossed $35 million domestically in 1997.20 That interview process certainly represented time well spent. The film debuted at the Toronto International Film Festival in 2006 to mixed reviews and did less than $8 million at the domestic box office. I refuse to give up, however, on the possibility of Hispanic-themed films, and despite the heterogeneity of the Hispanic audience, I am still looking for the right project that I think can work across the various groups. By the way, in my assessment of the El Cantante deal, I was reminded of a lesson I learned more than a decade earlier on a film we produced at Largo— the remake of the Steve McQueen action film The Getaway, this one starring Alec Baldwin and Kim Basinger. The film tanked, and some of my colleagues blamed it on the fact that Alec Baldwin was not a credible action star. I was convinced, however, that the American public does not want to see a married couple romantically linked on-screen. We had the opportunity to cast Sharon Stone in the female lead, but Baldwin and Basinger were so keen to have the opportunity to co-star on what was thought to be a film with broad commercial appeal that I was able to get two for the price of one in terms of upfront fees. In hindsight, we would have been better off paying up for Sharon Stone, who was a bigger female name at the time. No discussion of niche markets can ignore the “chick flick” category. “Chick flick” is a slang term for the film genre that deals with love and romance and is

Niche Strategies  197

designed to appeal to a largely female target audience, primarily young women. Although the total female audience is arguably not a niche audience at all, the term “chick flick” is typically used to refer to films that are relationship based, although not necessarily romantic as many other themes may also be present. One filmmaker who has demonstrated a very consistent track record in this genre is Nancy Meyers, who started out as a writer, having created (along with her then-husband Charles Shyer and Harvey Miller) the script for the comedy Private Benjamin starring Goldie Hawn. Despite the conventional wisdom of the time that a female lead with no male stars was box office poison, Private Benjamin was one of the biggest box office hits of 1980, grossing nearly $70 million.21 In hindsight you could argue that it also served to incubate the notion of the chick flick that relies on strong female leads to attract a female audience. Following Private Benjamin, Meyers and Shyer co-wrote several successful films, including a remake of the 1950 Vincente Minelli film Father of the Bride. Meyers then turned to directing and, after a successful directorial debut rebooting the same-titled Disney’s The Parent Trap in 1998, Meyers directed the hit film What Women Want starring then–box office idol Mel Gibson and Helen Hunt, which became the most successful film ever directed by a woman, taking in $183 million in the United States and upward of $370 million worldwide.22 In 2015, Warner Bros. released the Meyers-directed film The Intern, starring Robert DeNiro and Anne Hathaway. Meyers delivered once again with the strong support of her core female audience. The film attracted 62% females, with 88% over the age of 25 and 55% over 50. While the film was set as one reviewer commented in the “chic upper-middle class NYC world of Meyers,” the female audience came out in droves in such less-chic markets as Oklahoma City, Charlotte, and Wichita.23 Meyers, like Tyler Perry and like Jason Blum, is a brand and her name on a film can command a broad want-to-see among her coterie of fans. While arguably it makes a lot of sense to bet on such brandname auteurs, it must be kept in mind that even tried-and-true filmmakers can stub their toes if they stray too far from the kinds of films their core audience expects from them. That dictum can apply equally well to actors as to director: witness the downturn in Eddie Murphy’s career when he moved away from family-friendly movies like Mulan, Dr. Doolittle, Daddy Day Care and The Nutty Professor to more adult-oriented films like Metro, I Spy and Showtime, which all grossed less than $40 million domestically, and Holy Man, which grossed less than $13 million and The Adventures of Pluto Nash, which is on record as one of the biggest money-losers of all time, grossing just $7 million worldwide on a reported $110 million budget. To be fair, a notable exception to this run was Bowfinger, which grossed $98 million, but benefited from positive critical reviews.24 I haven’t watched Eddie yet in the sequel to Coming to America, which was produced by Paramount but which they laid off on Amazon. The reviews have been OK, but it looks like Wesley Snipes stole the show.

198 Niche Strategies

Notes 1 DiGiacomo, Frank. “The Theory of Relativity,” Vanity Fair, March 2010, www. vanityfair.com/news/2010/03/kavanaugh-201003; Chris Jones, “Ryan Kavanaugh Uses Math to Make Movies,” Esquire, 19 Nov. 2009, www.esquire.com/ news-politics/a6641/ryan-kavanaugh-1209/. 2 Box, George E. P. “Science and Statistics,” Journal of the American Statistical Association 71 (1976): 791–799, www.sop.inria.fr/members/Ian.Jermyn/philosophy/writings/Boxonmaths.pdf. 3 Gardner, Eriq. “Netflix Battles Judge’s Suspicions of ‘Bad Faith’ Streaming Plan,” The Hollywood Reporter, 20 May 2016, www.hollywoodreporter.com/thr-esq/ netflix-battles-judges-suspicions-bad-895771. 4 SEC filings. Waxman, S. (2015, August 1). “Relativity Lost $135 Million.” Retrieved from http://www.thewrap.com/new-relativity-details-studio-lost-135million-in-2013-exclusive/. 5 Kit, Borys. “Relativity Completes Rogue Acquisition,” The Hollywood Reporter, 4 Jan. 2009, www.hollywoodreporter.com/news/relativity-completes-rogueacquisition-77074. 6 “Paranormal Activity (2007),” Box Office Mojo, www.boxofficemojo.com/movies/? id=paranormalactivity.htm. 7 “The Expendables (2012),” Box Office Mojo, www.boxofficemojo.com/movies/? id=expendables.htm. 8 “The Expendables 2 (2010),” Box Office Mojo, www.boxofficemojo.com/movies/? id=expendables2.htm. 9 “The Expendables 3 (2014),” Box Office Mojo, www.boxofficemojo.com/movies/? id=expendables3.htm. 10 “Facing Giants (2006),” Box Office Mojo, www.boxofficemojo.com/movies/?id=facingthegiants.htm; “Fireproof (2006),” Box Office Mojo, www.boxofficemojo. com/movies/?id=fireproof.htm; “Courageous (2011),” Box Office Mojo, www. boxofficemojo.com/movies/?id=courageous.htm; “War Room (2015),” Box Office Mojo, www.boxofficemojo.com/movies/?id=warroom2015.htm. 11 Pulaski, Steve. “War Room (Review),” Influx Magazine, http://influxmagazine. com/war-room-review/. 12 “Straight Outta Compton (2015),” Box Office Mojo, www.boxofficemojo.com/ movies/?id=straightouttacompton.htm. 13 Ibid. 14 “Tyler Perry Movie Box Office Results,” Box Office Mojo, www.boxofficemojo. com/people/chart/?view=Director&id=tylerperry.htm. 15 “The Perfect Guy (2015),” Box Office Mojo, www.boxofficemojo.com/ movies/?id=perfectguy.htm; “No Good Deed (2014),” Box Office Mojo, www.boxofficemojo.com/movies/?id=nogooddeed13.htm. 16 “When the Bough Breaks (2016),” Box Office Mojo, www.boxofficemojo.com/ movies/?id=whentheboughbreaks.htm. 17 Shaw, Lucas. “How Hispanics Became Hollywood’s Most Important Audience,” The Wrap, 14 July 2014, www.thewrap.com/how-hispanicsbecame-hollywoods-most-important-audience/. 18 Terrero, Nina. “5 Things Hollywood Learned about Latino Moviegoers This Summer,” Entertainment Weekly, 22 July 2014, http://ew.com/article/2014/07/22/ hollywood-latinos-summer/. 19 Shaw, “How Hispanics Became Hollywood’s Most Important Audience.” 20 “Selena (1997),” Box Office Mojo, www.boxofficemojo.com/movies/?id=selena. htm.

Niche Strategies 199

21 “Private Benjamin (1980),” Box Office Mojo, www.boxofficemojo.com/ movies/?id=privatebenjamin.htm. 22 “What Women Want (2000),” Box Office Mojo, www.boxofficemojo.com/ movies/?id=whatwomenwant.htm. 23 D’Alessandro, Anthony. “‘Hotel Transylvania 2’ at $48.5M Marks Record Opening for Adam Sandler; ‘Intern’ Slacks on Sunday—Monday Postmortem,” Deadline Hollywood, 28 Sept. 2015, http://deadline.com/2015/09/the-intern-hotel-transylvania2-the-green-inferno-weekend-box-office-1201550112/. 24 “Eddie Murphy Movie Box Office Results,” Box Office Mojo, www.boxofficemojo. com/people/chart/?id=eddiemurphy.htm.

14 EVALUATING PROJECTS AND HOW TO PITCH THEM

Summary—This chapter addresses how to evaluate projects (primarily independent features). Distinctions are drawn based on what stage the project is in when presented for evaluation, beginning with an underlying literary work before a script is commissioned to full-fledged scripts and complete creative packages. The bifurcated rights model is further discussed, and advice is proffered as to what levels of foreign sales are required in order to reasonably greenlight a project and what level of domestic risk should properly be assumed. Investors are advised to always confront the producer to justify what is special about the film he or she is promoting. In particular, the challenges of realizing attractive returns on low-budget art films are underscored. Last week a producer buddy of mine submitted a sci-fi script to me. I wanted to like it because I liked him, and he was struggling to get films made. The script was OK, just OK. From my point of view, my comment was damning with faint praise. I told him that I found it by the numbers, the set pieces were predictable, the characters unexceptional and the third act didn’t deliver. I told him that I didn’t think the script was redeemable. I doubted that it could attract a hot director; and without a hot director, high-profile actors wouldn’t commit; and without those elements, the project was not financeable—even if it was set up as a Chinese co-production, which he intended it to be, and which could theoretically attract significant Chinese equity. But that Chinese equity would be predicated on his signing up a US distributor to commit to a broad theatrical release, and I certainly didn’t think that was in the cards. Keep in mind that this is all my opinion. Maybe I underestimated the quality of the screenplay, and maybe it could attract a name director—maybe, maybe, maybe. But probably not. My boutique media consulting/investment bank, American Entertainment Investors (AEI) has five complementary core businesses: DOI: 10.4324/9781003153702-15

Evaluating Projects and How to Pitch Them  201

•

•

•

•

•

Financial strategic consulting to studios and independent production and distribution companies. AEI acts as an advisor on all aspects of finance, distribution, strategic planning, valuations and acquisitions/divestitures. Working with smaller production companies with meaningful capital resources to bring them into high-profile film and television projects as co-financers/co-producers to bolster their industry bona fides. Our objective is for such entities to become formal retainer clients over time. Investment banking services to traditional and new media companies. AEI provides advice on mergers and acquisitions, joint venture structures, and corporate and debt restructuring; performs enterprise and library valuations; and provides expert advice on complex litigations. Executive producing (financing/packaging/distribution) of film and television projects. AEI facilitates independent producers’ access to financing and distribution of film, television and new media projects. Mezzanine financing to the film and television industries. AEI, through a network of high-net-worth individuals, provides production financing, primarily on a gap or preferred equity basis, for individual feature film or television projects.

I mention the range of our services because the packaging function on one-off projects is only one leg of a five-legged stool, so we are in a position to be very discriminating in terms of what projects we take on. We are a small group— five professionals—so we have to be very scrupulous as to how we spend our time. Since the vast bulk of our remuneration on a project is a function of the fees we charge in the budget of a film that is actually produced (we typically also charge an up-front retainer payable upon execution of a consulting agreement, but not always—in any case, it is a nominal amount), we are effectively betting on our own ability to help the producer secure financing and distribution for the project. The role we play with respect to our retainer clients is quite different: in their cases, they typically select the projects that creatively they want to make. Frequently, they will have developed them in-house or, equally common, they will have been brought the projects by an agency or another producer. My role in those instances is severalfold. We do extensive financial modelling to come up with a risk/reward analysis. In particular, we focus on the proposed budget to reconcile it, or not, with our breakeven analysis. What we hope to avoid is the analogy of building a hotel where you need a 98% occupancy rate to break even. Yes, it is possible, but it’s not a very intelligent gamble. It should be made clear, however, that films are not greenlit based only on their commercial prospects. One of my clients that shall go unnamed was very keen on a project that I would describe as an expensive art film. The budget was in the high 20s, which was clearly excessive both in terms of projected foreign presales and likely domestic box office. But the director was a major auteur director, and my

202  Evaluating Projects and How to Pitch Them

client thought that the film would be acclaimed by the critics and embraced by sophisticated cinema-going audiences worldwide. Our models showed that we would lose money over the entire range of probable domestic box office performance, at least over 7–10 years following the theatrical release. Despite my caveats, my client greenlit the film—several critics did consider it a masterpiece, and it won several major awards, although not an Oscar—and, in fact, we lost a bit less than I predicted because the film overindexed foreign, probably due to the combined reputations of the director and the lead actor, who is one of the leading “A”-list stars in the world. The film will eventually recoup, but long after I have retired, since it will have significant evergreen value on worldwide television. In hindsight, my client is delighted to have made the film. It strongly enhanced my client’s reputation for artistic taste and being very talent-friendly, and while I can’t quantify the benefit of that in dollars and cents, I know it has accrued to my client’s benefit when it comes to writers, directors, actors and their agents deciding whom to bring a pet project to. One of my other clients has been developing a period action piece with an ensemble cast. I got a call from the principals 2 months ago with what they thought was some great news. The project was one of three independent films that had been granted incentives from the state of California. The bad news was that the incentives were not particularly generous—approximately equal to 8% of the budget. Notwithstanding the fact that we would probably be able to attract a better cast by shooting in California (every actor prefers to go home to his family in the evening), the California incentives had the additional disadvantage of requiring that we shoot 75% of the film in California. By doing so, we would forego a much greater incentive in Italy or some countries in the Middle East, which like all incentives, is tied to actual expenditure in the venue in question. So, our challenge is as follows: we have to lower the gross budget, increase the incentives or improve the international presale value by raising the level of cast (probably all three). Accordingly, we put the project temporarily on hold and we are trying to accomplish just that. Most industries are governed by a supply and demand dynamic. Arguably, that is not the case with regard to the movie business. You might suspect that the amount of capital available for film production determines how many films get made in a given year, as opposed to favorable versus unfavorable profitability metrics. That might be truer with respect to the volume of studio production, which is clearly linked to economic trends and overall industry profitability, but that is not the case with the independent sector. While annual studio production has declined sharply over the past 10 years, the slack has been more than made up by independent productions driven by increased availability of capital both in the form of equity investment based on economic considerations, real or illusory, and the proliferation of incentives around the world, most of the providers of which have no stake in the revenues of the films they subsidize. In trying to sift through the statistical data, it is important to note that there is

Evaluating Projects and How to Pitch Them  203

no standardized definition of what constitutes an independent film. Is Transcendence, which cost more than $100 million and was produced and financed by my client Alcon, a so-called independent production company, and was distributed domestically by Warner Bros. and sold internationally territory by territory by Lionsgate, an independent film? It is competing for the same broad audience around the world as the big films produced in-house by the six major studios. When you go to the theater to see it, the first logo that appears on-screen is the Warner Bros. logo, so in the minds of the American theater-going audience it is virtually indistinguishable from an internally produced Warner Bros. film. Or should we restrict the term “independent” to the smaller, quirkier films, the kind that you expect to see at the Sundance Film Festival? You can’t believe how many films are submitted each year to Sundance—try around 4,000, the vast majority of which never see any kind of theatrical release. In an article by Adam Leipzig, a respected former studio executive and professor of cinema studies, he estimates that independent films had an aggregate production budget exceeding $4.6 billion in 2014.1 I don’t know where he got that number, since I don’t know what films he has included in his sample, but if he’s right, that means the amount invested in independent films in a given year is close to triple what the most prolific major studio spends. The Independent Spirit Awards, which represent the Oscars of the independent industry, formulated a set of criteria that are primarily linked to creative categories: • • • •

Uniqueness of vision Original, provocative subject matter Economy of means (which in their guidelines, caps budgets at $20 million) Percentage of financing from independent sources (note that some contribution from major studio distributors does not automatically preclude a film from qualifying) Films made with an “economy of means” but that are fully financed by a studio or the “indie” arm of a studio, like Fox Searchlight or Universal’s Focus Films, can still qualify if the subject matter is original and provocative.

Are you totally confused now? Let me throw another spanner in the works: “independent” is also a marketing term, and in that sense a film is classified as independent if it is distributed outside of the traditional studio system, meaning the parent companies. Fox Searchlight, Focus and Sony Classics, which are subsidiaries of major studios, are each part of the independent nexus. On this definition, of course, Transcendence would not be considered a true indie because it was distributed by Warner Bros. As you may have gathered by now, I am trying to navigate prospective investors between Scylla and Charybdis in the current of independent films.

204  Evaluating Projects and How to Pitch Them

I actually believe this can be done and you don’t have to crash on the rocks. From my perspective, an independent film is basically one with no ties to any studio during production, which implies that the financial controls are somewhere else apart from a studio. I don’t care who releases the film theatrically in the United States. In fact, as you also probably have gathered, I want my clients to play in the major leagues, which generally entails I want a major studio to release the film or in the case of the “original, provocative” films referred to by the Independent Spirit Awards, I want one of the specialty arms of the studios, or a mini-major like Lionsgate, or a so-called leading independent distributor, like Bleecker Street, to release the film. There are only so many theatrical slots the major studios have available in any 1 year. The good news is that as the studios have cut back on in-house production, more slots are theoretically available to independent productions, however defined. But the studios are really only interested in independent productions that they deem to have broad commercial appeal. The qualification of broad commercial appeal is not directly related to size of budget, but there is definitely a positive correlation between the two. After all, major stars command major fees unless it is a passion project for them, which means more often than not an “art” film, which by definition has limited commercial appeal. Yes, some art films cross over—like Brokeback Mountain—but more often than not the appellation is applied after the fact as a consequence of the film’s having achieved limited box office success. Simply stating that a film is intended to be a serious artistic work is too broad a characterization to define what constitutes an art film. By that definition, Twelve Years a Slave would qualify—it is certainly serious enough. But, even when my client River Road told me it wanted to make the movie, I never considered it an art film, primarily because I consider art films to evidence a degree of experimentalism and unconventionality. This means, by definition, they are designed for niche audiences and are not intended to have mass appeal. Just because a drama, or even an oddball comedy, has serious intent does not make it an art film. One of the major challenges in assessing a project going in is to try to determine the audience for the film in terms of age, gender, ethnicity and location. All film projects can be rationalized in economic terms depending on their budget. I probably never would have recommended Eternal Sunshine of the Spotless Mind, even though Charlie Kaufman’s script was incredibly innovative, because the budget at $20 million was just too high in my opinion to warrant committing to such a nonlinear narrative—but boy, was I wrong. The film, not surprisingly, opened to high acclaim from film critics, and it also grossed over $70 million worldwide.2 Is it an art film? Yes, by some standards, but it crossed over, so maybe that disqualifies it. Why bother to argue, however? What does affirming or denying the title tell us about the movie. Nothing. The term has no explanatory value in my opinion. Let’s stick to dissecting the artistic credentials of the film judged as an individual work of art.

Evaluating Projects and How to Pitch Them  205

The proper evaluation of a project is a function of what stage the project is in when it is presented for evaluation. If it is based on an existing literary work— which can be a novel, short story or work of nonfiction—you can make certain assessments even before you have a screenplay adaptation. When I heard that Imagine Entertainment had optioned A Beautiful Mind, I thought they were even nuttier than the protagonist, John Nash. A movie about a schizophrenic mathematician? Give me a break! I was especially opinionated because I did my graduate work in mathematical logic and was acquainted with Nash’s work in game theory. What I did not appreciate then was the great conceit that the screenwriter, Akiva Goldsman, came up with, which obviously did not appear in Sylvia Nasser’s biography: the presence of the imaginary roommate. How close was the film to the real life John Nash portrayed in the book? Not very, but the fictionalization in the film worked dramatically, thanks in large part to the compelling performance by Russell Crowe. I do not know how involved Brian Grazer and Ron Howard, who run Imagine, were in the screenplay adaptation or whether they lucked out in the sense that Akiva Goldsman delivered a tour-de-force screenplay, working on his own. Nor do I know at what stage Russell Crowe committed to the project. We will probably never know. According to IMDb, the budget of the film was an estimated $60 million (in 2001).3 That seems very high to me, especially for a film produced some 20 years ago, but admittedly Grazer and Howard command high producer fees, Howard commands high director fees and Crowe then was one of the highest paid actors. Nevertheless, the film grossed $171 million in the United States and $313 million worldwide—so it was incredibly profitable for all parties (Universal distributed domestically and DreamWorks foreign).4 I would love to have seen Universal’s projections when it greenlit the film. I suspect its high domestic box office estimate was no more than two thirds of what the film actually grossed, but that’s simply indicative of the fact that film prognostication is more of an art than a science. When I taught Film Finance at Peter Stark, I always circulated a studio spreadsheet for an unnamed comedy (in fact, it was for Home Alone). Fox produced the film for an estimated budget of $15 million (that was 30 years ago). Ironically the project originally was developed at Warner Bros., but Warner Bros. passed because the budget was $2 million higher than it was prepared to spend! If I recall, Fox’s high estimate was around 30% of what the film eventually grossed in the United States. (Studios typically project low, medium and high scenarios. My company likes to do five projections: flop, low, medium, high and superlative.) Plus, the film spawned four sequels plus a television film—probably one of the most profitable franchises in movie history. An investor’s risk position in a single-film investment is partially a function of how much leverage he or she employs. As I indicated earlier, bifurcating rights (selling a film territory by territory internationally) is both a risk mitigation technique as well as a financing tool. You can borrow not only against

206  Evaluating Projects and How to Pitch Them

contracts and subsidies (senior, secured piece of a bank loan) but also against the estimated value of unsold rights (up to 50% of net estimates subject to a cap equal to 20% of the budget—the gap that banks will lend) and a higher amount (typically up to 75–80% of net estimates—the so-called super-gap, which non-bank specialty lenders will provide). If you opt for full leverage, you will dramatically reduce the quantum of equity investment you have to put up. But it should also be understood that while you are in a position to dramatically increase your ROI (to the extent the film generates a return that is higher than your cost of borrowing), you are also in a position where you can now have your entire equity investment wiped out. If the domestic distributor does not recoup his P&A investment out of all adjusted domestic gross receipts, net of his distribution fee, there is nothing left for the equity to recoup out of unless there are foreign overages. It’s much like oil and gas wildcatting: if you strike a dry hole, you are totally out of luck. Up until recently, one of my main clients had bragging rights that it had always recouped the domestic P&A in each of its films—but unfortunately that streak came to an end several years ago. It should be remembered that you cannot do a broad national release with a P&A spend much below $30 million (maybe $25 million on a more demographically targeted film, or if your distributor is a so-called independent), which means that if your film grosses much less than $30 million domestically, the P&A spend will not be fully recouped (at least through first cycle). The math is easy to understand: A $28 million box office will translate to around $13 million of theatrical rentals, closer to $12 million after certain off-the-tops—like taxes, shipping and MPAA dues. If the distributor takes a 20% fee, you are below $10.5 million net. Based on average ancillary revenues correlated to $10.5 million in net theatrical rentals, you will probably get to between $26 and $28 million of total net first-cycle revenues—so the P&A spend will not be fully recouped. To put this calculation into perspective, approximately 35% of broad national releases failed to do $30 million in box office in 2019. One of my clients has a studio deal that gives it the flexibility to limit the studio’s distribution rights to the domestic territory or, alternatively, it can do a worldwide deal with the studio. In general, my client (who is reasonably well-capitalized) will opt to do a worldwide deal on budgets below $20 million. The reason for this is that all the studios have substantial television output deals in the key foreign territories. These are typically worth at a minimum $8–10 million in aggregate, which represents 40–50% of a $20 million budget. Why presell foreign for 50–70% of the budget when you can preserve theatrical, home video, VOD and television in non-output territories and still know that you have locked in certain television output deals that will deliver 40–50% of the budget? To reiterate, the movie business is a hit-driven business, so on a film that delivers theatrically across the world, if you can afford it, you are almost certain to be much better off utilizing a studio’s worldwide distribution

Evaluating Projects and How to Pitch Them  207

network. Admittedly, when you do a worldwide deal with a studio, you have to accept cross-collateralization with respect to the studio’s recoupment of P&A across all territories, domestic and foreign—but given that foreign on average today represents more than twice what the United States/Canada delivers and foreign P&A expenditure measured as a percentage of correlated box office is considerably below the average domestic ratio, the potential upside foreign represents significantly outweighs the additional risk that worldwide crosscollateralization entails. Most independent production companies, particularly on bigger budget films, do not have sufficient capital resources to consider worldwide studio deals as opposed to a bifurcated rights model that permits them to monetize foreign sales contracts through bank loans. But if you have such flexibility, careful consideration should be given to what makes more sense from a risk/ reward point of view. I am currently advising one of my clients on a $60 million action/drama with major special effects. The net budget, after incentives, is roughly $50 million. The two leads are strong but not what I would call “A”-list stars; the film is really the star, and I feel confident that, depending upon execution, the film should perform strongly at the international box office. Remember the current ratio between foreign and domestic box office is around 2:1, depending on genre. Not surprisingly given the cast level, various sales agents’ foreign estimates on this project are around 42–48% of the net budget. If foreign box office on a given film equals twice domestic box office, at mid-level performance scenarios net foreign receipts will typically be somewhat less than twice net domestic receipts. Even though foreign P&A expenditure to generate the same level of box office as domestic P&A expenditure is typically 10–15% lower, foreign theatrical receipts are typically less than the percentage collected on domestic and domestic ancillary revenues (particularly home video and VOD) are typically higher than foreign. So, on the project I just mentioned, the level of presales attainable implies too high a performance bar on domestic. If my client wants to make this film, I will say it makes more sense to do a 50/50 co-financing deal with a studio that would distribute worldwide. Yes, this model entails more risk, particularly because the studio will cross-collateralize foreign with domestic, but at most levels of foreign performance (certainly at or around breakeven), our net return from foreign will be considerably higher than if we presold the film on a territory-by-territory basis. Also, we are more likely to attract a studio to do a 50/50 co-financing deal if we can offer worldwide, as opposed to just domestic, rights. The good news is that in today’s market there are many more production companies and financiers looking to co-finance high-profile studio released films, so there is a significant opportunity on this project to reduce my client’s

208  Evaluating Projects and How to Pitch Them

exposure from the 50% that a 50/50 co-financing implies to 25% of the net budget, or even less—which is better way in this case to reduce exposure than monetizing foreign sales contracts. I gave different advice on another action film the same client financed several years ago. We did a 50/50 co-financing deal with a mini-major that has very strong output deals with various distributors around the world, which entails relatively high minimum guarantees. In that case, aggregate foreign sales represented 65% of the net budget excluding the UK, where we did a straight distribution deal that worked out very well because the film performed strongly at the UK box office. Keep in mind that presale payments are made on delivery, while straight distribution deals generate revenues over a number of years (the typical average duration is on the order of 3 years following delivery—at least for well-established independents that typically receive preferred payment terms from the studios as compared to producers with one-off deals). That time value of money factor, of course, is less relevant in a very low interest rate environment, which we are in today and which is likely to persist for the foreseeable future. Even if one of my clients opts for a bifurcated rights approach on a given film, I am always on the lookout to pull out a few foreign territories from the foreign sales agent’s portfolio and negotiate separate straight distribution deals with the international distribution arm of a major studio, or sometimes with a leading territorial distributor, for territories where I believe the film may overindex in terms of box office performance. Sometimes I don’t have much of a choice if no local distributor is willing to step up to the plate in terms of offering an up-front advance, or if I consider the advance being offered to be unacceptably low. The international market has gotten tougher the past few years, and many territorial distributors these days don’t want to take much more risk than what they know they can lay off television rights in their territory to a local broadcaster for. If that is the case, why accept the much less attractive revenue split implicit in a presale contract versus a straight distribution deal— unless, of course, you need to bank a minimum guarantee to finance the film? If the producer opts to presell all of foreign, then the valuation of a project is basically predicated on the projected value of domestic rights (which could mean just the United States if Canada is presold). The value of domestic rights could take one of two forms. Conservatively, we might simply wish to take into account what we are likely to obtain from a domestic distributor in the form of a minimum guarantee. In such cases, I would ignore possible overages and simply assume the MG is all we get. So, from a risk point of view, the domestic MG plus aggregate foreign MGs plus incentives/subsidies have to equal at least the fully loaded budget. It’s not a great business to simply break even, but there may be domestic and/or foreign overages to push you into profit. When I work with the leading talent agencies’ sales divisions (these divisions typically concentrate on setting up domestic distribution deals), I find their estimates as

Evaluating Projects and How to Pitch Them  209

to what level of minimum guarantees they will achieve to be reasonably on the mark—but not always. I was recently brought into a project by a producer who was working with the two largest agencies on the domestic sale. They assured him the film would definitely sell at the next Toronto Film Festival for a minimum guarantee of between $2 and $4 million. In fact, the film attracted zero offers! The producer was shocked—but when I screened the film, I was not surprised. It was a grim but compelling story of post-traumatic stress disorder as exemplified in an ex-GI who goes off the deep end. The cast was very respectable, certainly relative to the budget, but it clearly was not the kind of film that merited a broad national release and the kind of P&A spend that was consistent with a broad national release. The big question I had in mind was whether it would resonate with veterans or would it be so off-putting that veterans wouldn’t want to go to see it. I encouraged the producer to test the film with a sample audience with a large contingent of vets. He accepted my advice and we are awaiting the results of the test. The producer indicated to me that he had access to P&A if that would be helpful to bring in a distributor, but I have seen enough examples of specialized films where an overoptimistic producer double-downed on the P&A spend only to see his loss on the film magnified by his inability to recoup the P&A. A specialized release in say, 35 of the top 50 markets would probably cost $3–5 million, and that’s not easy to recoup unless the film can open with at least $8–10,000 per-screen average opening weekend. That’s not an easy hurdle to achieve for most art films. I was being a bit glib earlier when I said that if the producer opts to presell all of foreign, then we are simply looking at domestic to cover our effective risk position. Let’s talk about selecting and working with the foreign sales agent. I don’t wish to impugn the integrity of my friends in the foreign sales community, but let’s face it: no one ever won a mandate to represent a film by being too conservative on his estimates. Conversely, no one ever went to jail, or was successfully sued, for being too aggressive on his estimates. There is obviously a great temptation to stretch on your estimates to win the business—especially if you don’t expect or don’t care whether you do business with the producer ever again. Given all the projects I am involved with, both on behalf of retainer clients and one-offs, I like to think foreign sales agents will tread lightly when they provide me with estimates on to-be-produced films. They will be very cognizant of the need to get my investors out. By the way, the same temptations play out on Wall Street. As an old bond guy and a member of the fixed income underwriting committee at Lehman Brothers, I can recall a number of underwriting meetings when the bankers put enormous pressure on us bond guys to shave our proposed terms on a new issue in order to win the mandate. We could always blame changing market conditions for our failure to perform. The first thing I tell a producer client is we should not necessarily select the foreign sales agent who generates the highest estimates. I have my priority list of sales agents, and, if I can help it (i.e., I am talking about sufficiently

210  Evaluating Projects and How to Pitch Them

high-profile projects to warrant interest from the top-tier foreign sales agents), I will always try to pick a sales agent from that list. If I am talking about a less high-profile project, I have a secondary list of credible agents (albeit with less clout) whom I believe can successfully represent the film in the international marketplace. Why do the approved agents on my secondary list have less clout? Because they don’t have sufficient volume of highly sought after films they are selling alongside mine. It really helps if the sales agent pushing my film has several other films the foreign market desperately wants to buy. By the way, it is not uncommon for sales agents to insist that if buyers want to have a particularly hot property, they will have to take one or more other films that the sales agent is peddling where distributors’ interest is less keen. I made the mistake several years ago of agreeing to a foreign sales agent with even less chops on a film where I was the senior lender. It was not a high-budget film; I would characterize it as a low-budget John le Carré–inspired spy thriller. I thought I would be OK on my loan, but I felt for the equity investors who might suffer because foreign buyers would automatically undervalue the film because of the less than stellar reputation of the sales agent. I hoped that if they took the trouble to watch the film, they could draw their own conclusions, but I was concerned they would pass on attending one of the multiple screenings in various film markets because of low expectations solely related to who was selling the film. Unfortunately, my fears were realized. I was brought in a while back to advise on a project that needed $5 million of net revenues out of the US market alone (Canada was already presold). I immediately told the producers that I didn’t think they could hope for that number as an up-front minimum guarantee, for one very good reason: I thought at best that the film would merit a platform release, which, of course, could be augmented if the film performed. Most distributors would not offer a $5 million MG unless they were also prepared to commit $20–30 million in P&A, because nine times out of ten, a $5 million MG can’t be recouped out of a platform release, even taking into account ancillary revenues. The producers were not in a position to bring P&A to the table, so I presented an alternative strategy whereby they would forego a minimum guarantee and do a straight distribution deal. That strategy, by itself, would not persuade the domestic distributor to step up to the level of the P&A required for a broad national release, but the distributor might be more aggressive on the kind of platform release it initiated, plus we could probably reduce the distribution fees by 5%. If, for example, domestic gross receipts totaled $10 million, we would save $500,000 in distribution fees. What is special about your movie? That is the first question I always ask when I am approached by a producer to help put a project together. Why do I ask this question? Because I truly believe too many films are produced each year. Forget about the microbudgeted films made for less than $1 million. Probably 99.9% of those films never get any sort of theatrical release—unless

Evaluating Projects and How to Pitch Them  211

the producer’s parents “four wall” a theater (by “four walling” I refer to renting a theater for a flat fee whereby the person renting the theater keeps the entire box office and the exhibitor keeps the revenue from concessions). But I’m also referring to most of the films that are made for less than $10 million. Why are there too many of those films as well? Because there are enough well-off investors who are prepared to risk a couple of million dollars for what they believe or are convinced by a glib producer is a pot of gold at the end of the rainbow. Leaving aside full-fledged private placement memoranda that are required for a broadly marketed offering interstate, most of these lower-budgeted films raise their required capital from a small group of investors and do so off the back of a rather abbreviated investor memorandum, often in the form of a PowerPoint presentation. These virtually always contain projections in the form of financial models and, not surprisingly, even their base cases typically show very high ROI. How do they accomplish this sleight of hand? In several ways. First, these presentations typically show the results of comparable films—but these comps represent subjective choices by the author of the document. There is no objective test to assess what constitutes a reasonable comp. You can’t simply assume that other films your lead actor has acted in or your director has directed represent appropriate comps. Picking films in the same budgetary range or films in the same genre category also does not automatically qualify as an acceptable criterion. You can see from my remarks that I distrust the comps approach. I prefer to show a range of performance scenarios—but this approach is also fraught with danger because the choice of domestic box office for each performance scenario is purely subjective. These choices are predicated on assumptions regarding the kind of theatrical release the distributor opts for. Too often I have seen a range of box office assumptions that might be appropriate if the film commands a broad national release, but they are clearly way too high if the film is platformed instead. It is worth pointing out that even broad national releases, when they don’t work, can perform off the chart—I mean at the low end. Talk about black swans! A 2015 release, Jem and the Holograms, which was released on 2,417 screens, had the dubious distinction of achieving the lowest opening in history for a film that bowed on more than 2,000 screens when it debuted at $1.3 million.5 Most investors do not appreciate how little specialty films can actually make at the box office. Sony Classics is perhaps the most active distributor of specialty films, and it has a reputation for throwing new releases up against the wall, and if they stick it continues to support the film with additional P&A. If they don’t work, it will quickly cut its losses. Table 14.1 shows domestic box office results on Sony Classic–released films in 2014 supporting that assessment. Even more than is the case with the parent studio, Sony Classics’ bottom line is driven by a small percentage of the films it releases in a given year. Three films out of 15 delivered 64% of the distributor’s aggregate box office for 2014. By the way, you will see that only one of the films in the lower half of Sony Classics’

212 Evaluating Projects and How to Pitch Them TABLE 14.1 Sony Pictures Classics 2018 Box Office

Gross (Non-documentaries) Title

Gross

Call Me by Your Name The Wife The Leisure Seeker The Rider Puzzle Una Mujer Fantastica Capernaum The Seagull Film Stars Don’t Die… Boundaries Foxtrot Nelyubov The Happy Prince Final Portrait

$13,158,311 $9,601,092 $3,224,126 $2,418,679 $2,031,242 $2,019,554 $1,661,096 $1,252,964 $979,074 $701,828 $617,972 $564,073 $464,495 $460,859

Source: All data found on specific film pages at Box Office Mojo, www.boxofficemojo.com.

performance grid was released on more than 130 screens. Michael Barker and Tom Bernard, who run Sony Classics, are pretty ruthless with regard to their distribution strategy. They rarely throw good money after bad, which has enabled them to remain in business for more than 20 years.

Notes 1 Leipzig, Adam. “$4.6 Billion Invested in Indies; Nearly All Festival Films Get Distribution,” Culture Weekly, 28 Jan. 2015, www.culturalweekly.com/ sundance-infographic-2015-dollars-and-distribution/. 2 “Eternal Sunshine of the Spotless Mind (2004),” Box Office Mojo, www.boxofficemojo.com/movies/?id=eternalsunshine.htm. 3 “Box Office/Business for ‘A Beautiful Mind’,” IMDb, www.imdb.com/title/ tt0268978/business?ref_=tt_ql_dt_4. 4 “A Beautiful Mind (2001),” Box Office Mojo, www.boxofficemojo.com/movies/?id=beautifulmind.htm. 5 “Jem and the Holograms (2015),” Box Office Mojo, www.boxofficemojo.com/movies/?id=jemandtheholograms.htm.

15 WHERE YOU SHOULD BE IN THE FOOD CHAIN Distribution versus Production

Summary—The risks and rewards of investing in distribution as opposed to production are analyzed in this chapter. A case study on a specialty distribution company, Apparition, which the author advised on, is presented in detail. Other distribution strategies are also discussed, including VOD. The attractiveness of the foreign sales business is analyzed. From the investor’s point of view, the need to audit distributors on your films is emphasized. Finally, the chapter points out the advantages of having an ongoing relationship with one studio distributor. In 2009, I advised my client River Road in structuring and implementing a new specialty distribution company, Apparition, which in hindsight was an unfortunate choice of name because the company lasted only 1 year. River Road contributed all of Apparition’s initial capital, which was supposed to be topped up by an equivalent amount of capital provided by third parties, who, we believed, would include both strategic investors (probably international distributors) and financial investors (i.e., hedge funds, private equity firms and family offices). The targeted total capital raise was $50 million, which is substantial for a specialty film distributor and, based on the financial modelling my firm did, should have been sufficient to acquire and distribute 3–5 films per annum. While the country was still mired in a deep recession, the time seemed ripe to launch a new specialty label. Warner Bros. had just shuttered its two in-house specialty distribution companies: Warner Independent Pictures and Picturehouse, which was a joint venture between New Line and HBO, both Warner Bros. subsidiaries. The studios themselves were downsizing in terms of the number of films they were releasing each year, and more and more were concentrating their attention on high budget, tentpole films. Given the severe economic downturn, we felt that we could acquire high-profile critically acclaimed films that could cross over to broader, more mainstream audiences for DOI: 10.4324/9781003153702-16

214  Distribution versus Production

attractive minimum guarantees. At the same time, we recognized the challenges that specialty distributors faced in terms of coming up with a sufficient volume of commercial fare on a consistent basis. Simply generating the low box office averages that mainstream art films typically realized would not get us a satisfactory ROI. We believed that we had two built-in advantages with Apparition. First, while River Road was not obligated to put its own produced films through Apparition, it was assumed that Apparition would get first shot at most of the River Road slate by virtue of River Road’s majority stake in the company. Accordingly, we modeled Apparition’s business plan to include one or two River Road films a year on a rent-a-system basis—i.e., without requiring the company to pay an advance. Second, we negotiated an output deal with Sony covering home video, pay-per-view, free television and, most important pay television, where Sony was committed to put Apparition films through its output deal with Starz. Having a pay television output deal is crucial to making a distribution model work because you cannot rely on theatrical film rentals alone to turn a profit. At the time we established Apparition, home video was in free-fall and pay-per-view had not yet taken off. Specialty film distributors with pay television output deals typically receive license fees pegged at a lower percentage of box office than what the big studios receive, but it is important to remember that the pay television formula typically starts out at a higher percentage of box office and ratchets down (studios lobbied for this because they relied on pay television licenses fees to cushion their losses on films that didn’t perform well at the box office, where in the case of successful theatrical releases they didn’t really need the pay-television cushion). Given that we were targeting films that were likely to achieve box office results considerably less than studio average, pay television license fees were even more important for us than the big studios. To put this argument into perspective, take a look at Table 15.1, which shows a sample grid of one specialty distributor’s pay television output deal with one of the leading premium pay services. Table 15.1 represents a blended schedule, based on license fees received by several mini-majors who have output deals. As I indicated, you will see the ratcheting-down nature of the formula. I would also point out that if you don’t have an output deal with a premium pay service and are forced to try to do a deal on a one-off basis, you have no leverage with the pay service. These services never need one title, so you are likely to receive bupkis, which is Yiddish for “nothing at all.” It helps to know a little Yiddish to navigate your way among film executives, agents, managers and producers. Other handy Yiddish expressions include ganif (thief ), schande (disgrace), chazer (pig), dreck (shit), meshuga (crazy), naches (pleasure), pisher (a little squirt), schmooze (small talk), schlub (an unattractive person), schnorrer (a person always asking for a handout), tsimiss (disturbance) and verbissener (crippled by bitterness).

Distribution versus Production  215 TABLE 15.1 Specimen Pay Television Rate Card

Domestic Box Office (DBO) Pay Television License Fee

Percentage DBO (%)

$5,000,000 $10,000,000 $20,000,000 $30,000,000 $50,000,000 $70,000,000 $90,000,000

60 50 35 33 28 23.5 20.5

$3,000,000 $5,000,000 $7,000,000 $10,000,000 $14,000,000 $16,500,000 $18,500,000

River Road’s commitment to launch Apparition was rightfully predicated on finding the right person to run the operation. Such a company requires a marketing-savvy guru—unfortunately, Harvey Weinstein was not available— who can create awareness and want-to-see without having to spend big bucks on television advertising. We definitely thought we had the right person when Bob Berney committed to be the CEO. Berney was a highly respected marketing guru who had previously headed Picturehouse and Newmarket Films. His marketing resume included such outstanding successes as The Passion of Christ, Pan’s Labyrinth, My Big Fat Greek Wedding, Memento, Whale Rider, La Vie en Rose and Monster. The catchphrase underlying Apparition’s business plan was “crossover.” The intention was not to distribute art films with limited appeal, but films that, if they were positioned and marketed properly, could achieve meaningful box office returns—not the $2–5 million range that was typical for art films, but more in the $20–40 million range. After all, a number of the films that Berney had shepherded achieved that kind of result, and in some cases much more. Apparition had another advantage versus other newly established film distribution companies: River Road committed significant seed capital to financially support the company’s operations during the “ramp-up” period, so we could have enough time to raise the remaining amount of equity capital we needed to implement the business plan. During this ramp-up period, Apparition acquired its first film, Bright Star, a biopic about the poet John Keats, starring two relative unknowns, Ben Whishaw and Abbie Cornish, but directed by the respected director Jane Campion, who was the second woman ever nominated for an Academy Award for Best Director (The Piano). The film was definitely a prestige project, but arguably did not meet our stated criterion of being a potential crossover film. So why did Berney take on the film? Presumably, he wanted to make a statement to the industry that Apparition was prepared and supremely well suited to market prestige art fare. To make matters worse, Apparition clearly paid an above-market advance for a risky arthouse film. To compound matters even more, hoping for Oscar nominations, Berney chased the film—which opened reasonably well in New York and Los Angeles, but failed to hold up when it went wider—with too

216  Distribution versus Production

much additional P&A. Sony Classics would not have made that mistake. Accordingly, Apparition started off with a glaring loss (“glaring” in terms of a specialty release), which could not have helped the fund-raising efforts. Apparition followed up with another British film, The Young Victoria, which arguably had greater commercial appeal, but still did not break out at the box office (its $11 million gross was quite respectable for an art film, but Apparition clearly hoped that it would generate real crossover results). Meanwhile, the equity raising efforts were significantly hampered by the deep freeze in the financial markets, and Apparition’s investment bankers hit a brick wall in terms of supplementing River Road’s capital contribution. At the same time, River Road was noncommittal about whether it would release its own film (The Tree of Life, starring Brad Pitt and directed by Terrence Malick) through Apparition. While this was going on, Berney, who was clearly disconcerted by the failure to make progress on the raise and probably somewhat embarrassed by his failure to successfully open River Road’s The Runaways, a biopic about the eponymous all-female band of the late 1970s, informed us one day he was going to set up a similar operation with another independent producer, Graham King, with whom we were discussing a possible investment in Apparition. This is a good reason to have non-circumvention clauses in your contracts. Berney’s involvement in that company, FilmDistrict, lasted only 18 months, and 18 months after that, FilmDistrict was folded into Focus Features, the specialty arm of Universal. After Berney’s departure, River Road opted to release The Tree of Life through Fox Searchlight, probably the premier specialty distribution company, which clearly signaled the end of Apparition. FilmDistrict had a different business plan than Apparition. It was headed by a savvy ex-Sony executive, Peter Schlessel, who was largely responsible for the resurrection of Screen Gems, a former Columbia Pictures television label, as a producer and distributor of primarily genre films—action and horror with an occasional comedy thrown in. Screen Gems has been one of the most successful specialty production labels in the business, and, as I mentioned earlier, has undoubtedly generated consistently higher profit margins than its parent studio. It distributed probably the most successful horror franchise in history— Resident Evil—which has generated total worldwide box office of $1.233 billion on an aggregate budget over six films of $288 million. Another successful horror franchise has been Underworld (the fifth film in the series was released in early 2017, and the franchise has achieved cumulative worldwide box office of $529 million on an aggregate budget of $212 million—not as stellar as Resident Evil, but not bad!).1 Given its budgetary discipline, with budgets confined to the $20–40 million range with few exceptions (the last Resident Evil films had budgets in the $60–65 million range, but they had more than justified that level of expenditure), I always suspected that Screen Gems was very profitable. That was confirmed for me when I approached Clint Culpepper, who heads the label, to offer him slate co-financing: he politely declined on the basis that

Distribution versus Production  217

he didn’t want to share the goodies. I received a similar reaction years before from Fox Searchlight, which also has never accepted slate co-financing because of the high cost of capital it implied relative to its historical returns. Schlessel’s intention with FilmDistrict was to emulate the Screen Gems model, mixing it with the potential crossover art film that Apparition wanted to concentrate on. What drove FilmDistrict to merge with Focus Features, the specialty arm of Universal, was not a lack of success in implementing its business plan, but the implosion of its financing partner, GK Films, which had a string of major box office flops. GK Films repeated Carolco’s mantra of delivering high-budget, high-profile films to the international market, which it could presell for a significant percentage of budget. The idea was to cover a big percentage of budget out of a combination of foreign presales and incentives, and hopefully the remaining gap to be covered out of domestic would be limited to 20–25% of the budget, sometimes less. The assumption then was that the occasional hit domestically would make up for the occasional flop and deliver an attractive ROI. But along came Hugo and Dark Shadows—virtually back to back. Hugo received more Academy Award nominations than any other film in 2011 and won five Oscars, but it was a huge commercial failure. Its worldwide box office barely exceeded its budget, and rumor has it that Graham King’s financier, a wealthy Texas oilman, suffered an estimated loss of more than $100 million on the film. Dark Shadows was also a loss maker, although nothing like the magnitude of Hugo. As a result, the Texas oilman joined the ranks of the many eager providers of capital to Hollywood who eventually sneak away to lick their wounds. I suspect the withdrawal of capital to GK Films prompted Schlessel to seek a more secure home in the arms of Universal. But his tenure there did not last very long: the parent studio decided to return Focus to its roots as a distributor of more prestige dramas. There have been a number of new domestic distribution companies that have emerged subsequent to Apparition’s demise. These include Open Road, A24, Broad Green, eOne, Saban, Relativity and Bleecker Street. That’s a lot of new players chasing a finite number of attractive pickups, and by the time I am writing my second edition, Open Road, Relativity and Broad Green are already gone and eOne has withdrawn from active theatrical releasing in the United States. Bleecker Street’s business plan emulates Apparition’s. In reviewing it, it almost looked like a duplicate copy of what we presented to prospective investors. Pawn Sacrifice was its first release, and although I enjoyed it (I am a former chess master and once kibitzed with Bobby Fischer), the film failed at the box office, grossing only $2.4 million 2 —an average art film performance. However, as I have indicated, specialty distributors have to shoot for crossover films if they are going to generate a satisfactory ROI. Open Road had a diametrically opposite business plan. It was interested solely in films that could command a broad national release. In certain cases, it was prepared to put up an advance and commit to a meaningful P&A expenditure which was typically

218  Distribution versus Production

on the order of 20% less than what the studios would put up at a minimum for a broad national release. In other cases, Open Road was prepared to share the P&A with a third party, often the producer. Finally, Open Road was prepared to rent its system to producers who were prepared to put up 100% of the P&A, but in those cases Open Road would have to feel comfortable that the film could do a certain amount of business, otherwise the distribution fees it could earn weren’t worth the trouble. Open Road was founded in 2011 as a joint venture between the two largest exhibition chains in North America: AMC and Regal. Tom Ortenberg, an experienced marketing and distribution executive who cut his teeth at The Weinstein Company and Lionsgate, was brought in to run the operation. Subsequent to his hiring, AMC was bought by the Chinese conglomerate Dalian Wanda, which has significantly reduced its shareholding in the exhibition chain over time under pressure from the Chinese Government, which was very opposed to the overleveraging which a number of Chinese companies pursued to enable them to make substantial acquisitions abroad. The two theatre chains sold Open Road in 2017 to Donald Tang, a Chinese American entrepreneur, who was unable to satisfactorily recapitalize the company, and it declared bankruptcy a year later. Open Road’s library was then sold to a New York based private equity firm, who, in my opinion significantly overpaid. I say that with some degree of confidence because they paid roughly one-third more than the private equity firm of which I am a limited partner offered. Based on my examination of the box office results of its releases before Tang bought the company, I believe Open Road earned a positive, if not exciting, ROI. The company also got a meaningful shot in the arm when its film Spotlight won the Oscar in 2016 and was extremely successful at the box office, generating more than $88 million in ticket sales.3 While none of Open Road’s releases reached the $100 million mark in box office, given its risk profile, where in a meaningful number of instances the company either takes no budgetary or P&A risk or shares the P&A risk, and consistently maintains a disciplined P&A spend, its loss experience was very much contained. Open Road also mitigated its risk profile by entering into a pay television output deal with Netflix, which was replaced by an output deal with Showtime in 2017. Open Road also had a controlled overhead by sub-distributing home video and pay-per-view through Universal. But its upside in the case of the rent-a-system deals was also effectively contained, since the distribution fees it could charge in such instances were significantly less than the levels appropriate to when it was putting up an advance plus P&A. To put fee levels into perspective, a distributor might charge as little as 10% on a rent-a-system deal and as much as 25–30% when it puts up a meaningful advance plus P&A. In addition, on the latter deals, it would not be uncommon for the distributor to share in domestic revenues once the P&A has been recouped. Open Road, following the maxim that the more rights you obtain the better, negotiated a number of output deals with foreign distributors to service films where it had worldwide rights; and

Distribution versus Production  219

in the international territories where it did not have an output deal, it had an arrangement with FilmNation, one of the leading foreign sales agents, to sell those territories. The real challenge that Open Road and other distributors who were also not producers faced was where to find attractive product. I half expected Open Road and others to try to emulate the studios by entering into output deals, either first-look or exclusive, with well-capitalized independent producers who could deliver a consistent flow of films on an annual basis, but in general only the studios have been able to attract a number of these output deals. I am definitely inclined to prefer business models that integrate production with distribution. The arrow typically moves from production to distribution, as was the case with River Road in founding Apparition. However, more and more we find foreign sales companies in particular getting involved in financing production to ensure access to attractive product that they can sell internationally and not only earn distribution fees but also keep a meaningful piece of the upside on films they can package intelligently. One of my foreign sales buddies recently laid off domestic rights for $4.5 million gross ($3.5 million net after he paid the placement agent and reserved for residuals) on a film that the foreign sales company financed for $3 million, and the company pocketed a cool $2.5 million after accounting for foreign sales (plus the sales agent retained the bulk of worldwide overages). Keep in mind, however, that up until fairly recently, virtually all foreign sales agents were not financing, or even partially financing, a film. One of the first independent foreign sales agents (i.e., who was not affiliated with a well-capitalized production company) to plunge into financing films on which it could handle foreign was Voltage, which is headed by a real cinephile, Nicolas Chartier, who is willing to put his money where his mouth is. Nicolas put up the equity in last position on The Hurt Locker. I know that for a fact since I provided the gap financing on the film just in front of Nicolas (through a mezzanine fund that I co-managed with my old friend Harris Maslansky and that was capitalized by the giant insurance company Allianz). I don’t know for a fact how much of the equity was provided by Nicolas; I suspect that it was less than $1 million, but that still represented a big bet for a sales agent who was relatively new in the game. The rest is history: the film won the Oscar for Best Picture, although it didn’t do huge business domestically (only $15.7 million—but more than double that internationally). After the film won the Oscar, Nicolas approached Harris and me to buy us out. Because Allianz had just shuttered its structured finance division, of which our mezzanine fund was a small part, we agreed. We doubled our money, but I suspect Nicolas made between five and ten times his investment. He continued to double down with his The Hurt Locker winnings, and today he probably co-finances 8–10 films a year that he can put through his sales operation and earn substantial sales fees. Let me add a postscript to this story: Nicolas, who was not particularly au fait with Academy protocol, lobbied the Academy members through a blanket

220  Distribution versus Production

email campaign to vote for “the little train that could,” namely The Hurt Locker, against the goliath Avatar, which was certainly the favorite to win Best Picture. This was a clear violation of Academy rules, and accordingly the Academy barred Nicolas from appearing on stage with the other producers to collect his Oscar. Nicolas was going to thank Harris and me in his acceptance speech, which he never got to deliver, so Harris and I never got to hear our names on a broadcast that probably reached at least 300 million people worldwide. A few years ago, I seized on an opportunity that the undercapitalized nature of the foreign sales business offered. Many producers can’t afford to wait until the sales agent can make sufficient presales to enable the producer to fully fund his picture. Accordingly, the producer may be willing to accept a minimum guarantee from the sales agent, which may be significantly less than the projected aggregate take prices for the whole of foreign, but which he can immediately bank to cash flow the film. Few foreign sales agents are in a position to put up substantial minimum guarantees, but I could through a new mezzanine fund. So, I partnered with a few foreign sales agents I trusted where I bankrolled their MG. As a result, instead of charging a 5–10% sales fee—which the agent would do if he or she were not at risk—they can now charge as much as 25% and at the same time retain a significant percentage of foreign overages, which they would not be able to do if they were simply representing the film on an agency basis. We split the fee and any overages 50/50, so on my structure the foreign sales agent earns a higher fee than they would otherwise, without any risk; plus, they have genuine upside. I like the deal because the sales agent usually pitches her minimum guarantee at roughly two thirds of the aggregate sales they confidently expect to make, so I keep roughly 50% of 25% of aggregate foreign sales, which represents an ROI of 18.75%, not taking into account my share of any overages, assuming aggregate foreign sales represent 150% of the minimum guarantee provided. Also, since the foreign sales agent’s minimum guarantee is payable on delivery, although I would typically have to secure it with cash or a letter of credit, it should not be out very long since the foreign distributors also pay on delivery (actually, they typically pay a 20% deposit on signing the distribution agreement and the balance on delivery, so I also have use of the float), which means my return on an IRR basis is very high. The foreign sales business is primarily a function of the quality of the product you represent. More and more, foreign sales agents are trying to ensure a continuous flow of high-profile films their international buyers are keen to acquire by investing their own capital in production that they can represent in terms of international sales. Historically, foreign sales agents have been notoriously under-capitalized, as I indicated earlier. One strategy to feed your pipeline with attractive product is to enter into output deals with well- capitalized independent production companies who can guarantee you a consistent flow of product. That is precisely what Patrick Wachsberger, the now retired head of Summit, and arguably the primus inter pares of the foreign sales business,

Distribution versus Production  221

benefited from when he joined Summit. The company was founded by the late Andy Vajna, the head of Cinergi; Arnon Milchan, the head of New Regency; and the late Bernd Eichinger, the head of Constantine—three of the leading producers and financiers of high-profile independent films. Summit handled the foreign sales for its three key shareholders’ films. Within 2 years, Summit started producing and co-financing films itself; and within 4 years the company was fully financing films. In 2007, Summit raised a $1 billion fund through Merrill Lynch, which gave it the ability to become a major producer in its own right, plus it added a domestic distribution capability with the addition of Rob Friedman, the former head of domestic distribution at Paramount. When it produced and distributed the first three films in the Twilight series, it became a serious acquisition target. Not surprisingly, it was acquired by Lionsgate in 2012 in a merger that created a real competitor to the traditional studios. I mention Summit’s historical evolution because I want to point out that Summit and Wachsberger have not forgotten their historical roots. Notwithstanding Summit’s and now Lionsgate’s prolific in-house production schedule, Patrick has maintained his relationships with the larger indies, which have used him to handle international sales on their films, and he continued to represent them until he left Lionsgate in 2019. These included Alcon, River Road, Black Label, Participant and Constantine, among others. I should know because three of them are my clients. While loyalty is considered a virtue even in Hollywood, Patrick’s ability to hold on to his historical clients is more attributable to his ability to deliver on his numbers. Obviously, having the Twilight and the Hunger Games franchises to drive other product through is a huge help in enabling him to get the highest license fees possible; I would also point out that Summit was one of the first sales agents to negotiate output deals with a network of leading foreign distributors that would agree to take Summit’s entire output of product, provided it met certain pre-negotiated criteria. The merged Lionsgate/Summit operation also set up direct distribution in certain key territories—particularly the UK and Latin America—that permitted producers, in exchange for forgoing a minimum guarantee, to benefit from the greater upside that direct distribution could deliver in the case of successful films. This strategy certainly generated much higher returns for my client Black Label Media in the UK on its film Sicario than it would have received had it opted for a straightforward minimum guarantee in that territory. If you are just a mainstream sales agent without access to significant capital and consistent high-profile product, you can still make a nice living if you keep your costs down and have a sufficient network of producers that can supply you with attractive product. It also helps if you have a good reputation with the leading talent agencies, which have a significant say as to where their clients’ films end up. It’s all about trying to move up the food chain, which is a result of not stiffing your distributor clients with inferior films that you overhyped (and also

222  Distribution versus Production

not inflating your asking prices, which should reflect reasonable market values). Of course, it also helps to get lucky once in a while. Distributors remember who has made money for them, and they will come back again and again, not so much out of loyalty, but because they hope that history will repeat itself. As I indicated, I find it hard to justify being in the domestic distribution business, just like the foreign sales business, unless you have access to a consistent flow of product, either your own in-house production or committed product from a producer who has proved he or she can deliver commercial films, or you are focused on a niche market where you have already demonstrated your ability to perform. Examples of the latter include BH Tilt, a distribution label established by the horror maven Jason Blum, which is focused on low-budget horror films that do not merit a broad national release (Blum has a long-term first-look deal with Universal covering genre fare that can command a broad national release) and are more suited for day-and-date platforming; another example is the newly established distribution arm of Pure Flix, which makes films primarily for the evangelical audience. It is best known for the enormously successful God’s Not Dead, which grossed $60.7 million domestically on a mini-budget of $2 million.4 It released the film through Freestyle, presumably on a rent-a-system basis, but I presume it formed its own distribution company to distribute the sequel, God’s Not Dead 2, and avoid having to pay a distribution fee to a third party. We should not forget about the high-end VOD distributors, like IFC, Magnolia, Alchemy (which filed bankruptcy in 2016) and Grindstone, which are looking for titles that can do a certain amount of business theatrically, although their primary revenue generator is VOD. The problem they face is that the major exhibition chains require a 90-day theatrical window before any ancillary exploitation; otherwise, they will not play the film in their theaters. As a result of the pandemic, of course, the studios and the major exhibition chains are aggressively pursuing a shortening of that 90 day window. It seems clear that a 30–45 day window will prove to be the model for the future.5 AMC, as an exception, will permit distributors to “four wall” a number of its screens, so in combination with independent theater owners, a distributor may be able to cobble together 300 screens to release a film, followed by a VOD release as early as 30 days later. A “four walling” strategy is not intended to generate meaningful box office receipts, but it may still make sense if even minimal theatrical exposure drives ultimate VOD revenues higher. Probably the most interesting—and definitely the most ambitious—new integrated production/distribution company (it is too soon to call it a studio) is STX Entertainment, which appeared to be extremely well-capitalized with support from the private equity firm TPG (which also controls CAA), Chinese private equity firm Hony Capital and private equity from scions of the Pritzker and Wrigley families. The management team headed by Bob Simonds (who conceived the idea of STX together with Bill McGlashan, the then head

Distribution versus Production  223

of TPG Growth) included such prominent former studio executives as Tom McGrath, former COO of Viacom Entertainment; Adam Fogelson, former chairman of Universal Pictures; Orin Aviv, former president of marketing at 20th Century Fox; Disney; and Kathy Savitt, former head of digital media for Yahoo. STX has so far not met its target of producing and distributing 12–15 films annually, although with the kind of overhead that STX has taken on, it needs that level of volume, or close to it, to amortize its level of overhead. On paper, STX has constructed a distribution model that appears to make sense. It has forsworn the additional overhead an in-house home video operation would require (plus its projected in-house production slate alone doesn’t justify this) and accordingly entered into a sub-distribution deal with Universal Home Entertainment to handle DVD, Blu-Ray and VOD platforms in North America. It also cut an output deal with Showtime for pay television and, interestingly, rather than pursuing the traditional studio theatrical distribution process, it signed direct distribution agreements with the major North American theater chains—AMC, Regal, Cinemark and Carmike—which hopefully will ensure that it can marshal 3,000 screens for films that warrant such a release commitment. STX is behaving more like a large indie than a studio, however, in its approach to international distribution. Again, rather than investing in an in-house multi-territory distribution operation, it has chosen to enter into output deals with a broad network of territorial distributors, including Tobis in Germany, Sun in Latin America, Village Roadshow in Australia and New Zealand, VVS in Canada, Svensk in Scandinavia and Huayi Brothers in China. Huayi originally agreed to co-finance up to 15 films with STX over 3 years, but, not surprisingly given the upheaval in the Chinese marketplace in the past few years, that agreement never panned out. The presale strategy, as I have pointed out throughout this book, can be a valuable risk mitigation strategy and a financing tool to preserve equity, but it also entails leaving money on the table in the case of successful films. Given that STX does not have the advantage of a large film library and a steady cash cow that the television broadcasting business represents, this probably represented a prudent initial strategy, but it also put pressure on STX to come up with some early winners. STX is focusing on the middle market—budgets of $20–60 million—that the studios have largely moved away from. There are good reasons why the studios are increasingly avoiding films in this budgetary range based on historical returns achieved over the past few years. It’s tough to create franchises in this budgetary range, and if you are relegated to producing and distributing one-offs, you’d better be a good film picker and you’d better run a lean operation. We shall see if STX succeeds on both counts. So far, the company’s track record has been mixed, and, as I mentioned, they have not been particularly focused on cost controls. When I am approached by investors who are evaluating the advantages and disadvantages of production versus distribution, I always point out the benefit

224  Distribution versus Production

of being in control of the distribution of receipts—which, of course, is the position the distributors are in. Probably one of the most annoying characteristics of the movie business, and a major turn-off for investors looking to get into the business, is the ubiquitous presumption that distributors don’t give producers an honest count. I am not talking here just about the well-publicized scandals where talent has not collected a dime of net profits on films that clearly earned a huge amount of profit for the studios that financed and distributed them. Probably the most famous “washing your dirty laundry” in public incident was the Art Buchwald suit against Paramount. Paramount originally optioned a treatment by Buchwald in 1983, commissioned several failed screenplays and then abandoned the project in 1985. However, the studio later resurrected it, and in 1988 produced a film Coming to America, which starred Eddie Murphy. Buchwald received no credit and no payment and sued. The court ruled in favor of Buchwald that the film was indeed based on his treatment, as were the several drafts of the screenplay. In the damages phase of the trial, the court ruled that Paramount’s calculation of net profits, which determined what sums Buchwald was entitled to, was “unconscionable.” To put this ruling into perspective, Paramount calculated that the film was still in the red despite having grossed $288 million in worldwide box office (on a budget of less than $40 million). Afraid of the implications such a ruling would have on its standard accounting practice regarding the definition of net profits, Paramount settled and paid Buchwald $900,000.6 A few years later, another court ruled that the standard studio net profits definition was not unconscionable (in a suit brought against Warner Bros. by the producers of Batman), and the debacle the studios feared would undermine how they accounted to talent never happened. We all know how skewed the studio net profits definition is against talent and producers that don’t finance the film. But I’m not referring to that: I am referring to the treatment that producers/investors who do finance the film receive at the hands of the studios. Arguably, the studios’ behavior may be more egregious than the treatment meted out by independent distributors, but it is only a matter of degree. The term “creative accounting” when applied to studio accounting practices (and as I indicated, the term is equally applicable to independent distributors) is not a term of approbation. But it refers less to outright dishonesty, which I have seen practiced on innumerable occasions, than to applying an excessively sharp pencil. I urge my clients to audit all distributors, both domestic and foreign— foreign in the case of key territories. Obviously, it doesn’t make sense if the film performed below a certain level, since it costs money to hire an auditor. But in virtually all cases we have pursued, the cost was more than justified based on the discrepancies uncovered and the settlements that were achieved. The audit process really begins with the drafting of the distribution agreement. In particular, the wording related to the producer’s audit rights should contain language requiring the distributor to pick up the producer’s audit expenses if

Distribution versus Production  225

the discrepancies uncovered exceed the net receipts reported by more than a standard 10%. Unfortunately, audit settlements do not take into account time value of money. A rights holder typically has up to 2 years following receipt of a distribution statement to ask for an audit. But the distributor will then frequently make you wait for up to several years to commence the audit, depending on who the forensic auditor is and depending on how many other audits that forensic auditor is conducting with the studio at that time. So, the distributor gets to use your cash for a prolonged period of time. During this pandemic period, all the studios have virtually put the entire audit process on hold, to the detriment of my clients, for example. Earlier I contrasted the differences between accounting for video on a gross as opposed to a royalty basis. Historically, home video was accounted for like the record business. Distributors merely attributed a 20% royalty, calculated on the wholesale price, that could be adjusted to accommodate higher-profile talent. This was a simpler way of accounting (and avoided having to audit the company’s expenses), but it short-changed the producers and the talent. If distributors approached home video the way they accounted for other revenue streams—that is, deducting a distribution fee off the top, then deducting manufacturing and marketing expenses and residuals—that calculation would be equivalent to a royalty on the order of 35–40%, depending on the distribution fee imputed and the level of manufacturing and marketing expenses. Hence, my insistence in any negotiation to press for video into gross. The shenanigans become even worse when we consider that some distributors also try to lump in SVOD, which is now frequently a substitute for pay television, as well as TVOD and pay-per-view, into a total home entertainment bucket, which they attempt to account for on a royalty basis overall. Since these revenue streams have virtually zero manufacturing and marketing costs in comparison with physical DVDs, any royalty treatment entails that the distributors are dramatically underreporting the true net revenue streams. What are the most egregious areas where the distributors commonly act in bad faith? Apart from improperly claimed expenses, the area that I find most susceptible to bad behavior is with respect to allocations in television packages. The distributor, assuming he is also a producer, is clearly motivated to allocate as much of the license fee in a television package consisting of multiple films to his own pictures, where he is retaining a much higher percentage of revenues than is the case on third-party films where he is simply collecting a distribution fee. It is important therefore to include language in the distribution agreement that sets objective tests for determining such allocations—the most obvious criterion should be respective box office performance, although it must be admitted that comparative values as television titles are not simply a function of box office performance. For example, very hard R-rated films may not be playable on broadcast television, and even if they are sufficiently expurgated to meet

226  Distribution versus Production

broadcast television standards, their value may not reflect their performance at the box office. In addition, a 10-year-old title could have had the same domestic box office as a 2-year-old title, but the newer title may have much greater value to a television licensor. Another area where the studios in particular can play games is their propensity to farm out as much work as possible on a film to affiliated vendors. Not surprisingly, there is rarely, if ever, a bidding process in such instances, so budgets become needlessly inflated. One of the other common areas of misbehavior in the case of independent distributors is related to arrangements (which were much more common in the past before the days of digital distribution) that independent distributors had with Technicolor and Deluxe—the primary providers of traditional prints. Technicolor and Deluxe were often prepared to provide subordinated loans to indies to encourage them to enter into output agreements tied to a certain level of dollar purchases. Such loans were amortized by Technicolor and Deluxe by charging a higher than market rate on a per-print basis. Thus, the distributor received the benefit of the capital injection but the cost of repaying the loan was in effect built into the distribution expenses charged to the films in question. Again, your lawyer has to draft satisfactory language in the distribution agreements that provide for reimbursement of all subsidies, discounts and rebates received by the distributor—although standard language related to receiving such reimbursements would not necessarily pick up the requirement to compensate for being overcharged on prints. It was not uncommon for independent producers who produced a certain number of films on an annual basis (and thus could be counted on by Technicolor and Deluxe to order a meaningful level of film stock on a consistent basis) to enter into such loan facilities and amortize them by overpaying per foot of film stock. I negotiated such a deal when I was president of Largo. Finally, one of the most egregious missteps that distributors consistently are guilty of is their failure to reimburse rights holders for credits they have received against their US taxes as a result of foreign withholding taxes paid that they customarily deduct from their reported foreign revenue. Not surprisingly, I would argue that a production entity that has an ongoing relationship with a distributor in terms of being a consistent and prolific supplier of films is likely to be treated better when it comes to financial reporting than a producer providing a single picture. That is another argument in favor of my lobbying on behalf of investing in a production company as opposed to investing in a series of one-off films. There are also significant advantages, if you are a well-capitalized independent producer, of having a close relationship with a studio distributor. Irrespective of the terms of your first-look or exclusive distribution agreement, the studio is motivated to keep you in business and help you to succeed. That may often mean, in the case of savvy studios, a willingness to assist in financing selective film projects, particularly where the budgets are

Distribution versus Production 227

sufficiently high as to strain your capital resources. That is not to say the studios are totally benevolent and will exhibit charitable behavior in setting such co-financing terms. If you want this money, you will have to pay a fair price for it—but most important, typically not on the usurious terms that an outside financier with whom you have no ongoing relationship might use his leverage to charge. Plus, the studios may see a definite advantage to open up their own development vaults to let you finance and produce some attractive projects whose development they have funded to date. In the case of slate financiers, it is an unwritten assumption in the business that the studios will go out of their way to keep them afloat (and thus enable them to continue to finance the studio’s slate of films) by making adjustments in the deal terms when the slate is under water. Or the studios may let the slate financier into one or more of the studio’s franchises even if contractually they are not obligated to do so. Warner Bros. did just that when it bailed out Legendary after it started out poorly on its first few films by letting it invest in the Batman franchise.

Notes 1 “Box Office History for Resident Evil Movies,” The-Numbers, www.the-numbers. com/movie/Resident-Evil#tab=box-office; “Box Office History for Underworld Movies,” The-Numbers, www.the-numbers.com/movie/Underworld(2003)#tab=box-office. 2 “Pawn Sacrifice (2014),” Box Office Mojo, www.boxofficemojo.com/movies/?id=pawnsacrifice.htm. 3 “Spotlight (2015),” Box Office Mojo, www.boxofficemojo.com/movies/?id=spotlight.htm. 4 “God’s Not Dead (2014),” Box Office Mojo, www.boxofficemojo.com/movies/?id=godsnotdead.htm. 5 Kay, Jeremy. “Is 45 Days the New Length of the US Theatrical Window,” ScreenDaily, 24 Mar., 2021. 6 Welkos, Robert W. and Pristin, Terry. “Buchwald, Partner Win $900,000 From Studio,” Los Angeles Times, 17 Mar. 1992, http://articles.latimes.com/1992-03-17/ local/me-3895_1_net-profit.

16 THE SINKHOLE OF DEVELOPMENT

Summary—The problems of making a classical development model work are discussed in detail, but the importance of investing in development is also emphasized. Suggestions are given where to source material—in particular, the value of material in the public domain, free of copyright protection. I cannot make the classical film development model work. By the classical development model I mean the process by which a producer options a certain literary property and then commissions one or a series of screenplays, or alternatively simply acquires a screenplay and then works to improve it through one of more rewrites and/or polishes. This is contrasted with late-stage development where a script basically needs a few tweaks, a minor rewrite or polish before it is ready to be greenlit. Late-stage development is not particularly costly, plus you know you are very close to having a “go” project before you engage in it. So, the economics of late-stage development are very much in the producer’s favor. But with regard to the classical development model, my negative comment represents a categorical statement on my part. The mathematics is very simple. Studios probably make one out of ten projects they have in development. That success rate is misleading, however, because it does not take into account the percentage they succeed in laying off to other studios or producers, through turnaround provisions or straight acquisitions. Independent producers cannot afford to be so spendthrift. Let’s be generous and assume a significantly higher success rate for independents—say, an indie manages to set for production one out of five projects it has in development. If you are an outside investor funding that development program, you may be able to negotiate a return of 150% of your expenditure as a budgetary item when a project goes into production, and you also may be able to negotiate an executive producer fee. Let’s DOI: 10.4324/9781003153702-17

The Sinkhole of Development  229

say the executive producer fee is $100,000 on average—which, if you spent $250,000 on the development of the project, would add an additional 40% to your ROI. Plus, of course, you would be entitled to some share of profits—say 5%—after true cash break-even. Let’s assume you spent $250,000 per project on ten projects—$2.5 million in total—and two of them were made. Your return would be $750,000 in reimbursement of expenditure (including your 50% “vig”) and $200,000 in executive producer fees. Apart from profit participations, your total return would be $950,000 on a $2.5 million investment. That’s not very exciting! Your success rate would have to go up by at least 2 ½ times in order to recoup on a cash basis, not taking into account profit participations and leaving aside time value of money considerations. That’s putting a lot of the burden on the value of those profit participations. If you are also funding the producer’s overhead as well as her development expenditures, you will probably also share in her producer fees—but that extended model requires the producer to run a very lean operation and be sufficiently prolific in terms of the number of films she can make annually, plus command sufficiently high producer fees and favorable back-end (which she must be prepared to share liberally with her financing partner) to provide a decent return to the generous benefactor funding her company. Reliance, the huge Indian conglomerate that funded DreamWorks, had a number of development deals with “A”-list talent who were looking to get into production. In virtually every case, it proved to be money down the drain; I believe only one produced film emerged from this exercise. A few years before he died, I advised Michael Jackson and his producing partner, Raju Patel, on establishing a new production company to be financed by a wealthy Chinese group, which frankly was more interested in having Michael’s support for a real estate venture it was championing in Las Vegas. Michael had always wanted to get into movies. It was a well-known secret that he wanted to play Peter Pan. He also told me that he wanted to adapt his werewolf character in Thriller for the big screen. But Michael’s focus was all over the map—it was the beginning of his severe financial problems, which caused him to borrow from Sony against his own ownership stake in its joint venture music publishing company (which, déjà vu for me, also owned Northern Songs). Against my advice, Michael and Raju brought in a production sales company as a partner that lobbied the Chinese to invest in its own projects instead. Michael and Raju were bought out, and Michael’s ambitions to make his mark in the movie business never came to fruition. I did manage to visit Neverland three times, however, and on the first occasion I was greeted by an official greeting party consisting of an elephant, a llama, a deer and a giraffe. This is not to say that I am not in favor of spending money on development— quite the contrary. The point I was trying to make is that it is difficult to raise outside financing to fund a development slate. Having a well-staffed and well-managed development operation is crucial in my opinion to the success of

230  The Sinkhole of Development

an independent production company. If you are funding the development of an independent production company, you should also be prepared to contribute toward the financing of the film; otherwise, you are stuck in the rut a pure development model represents. Too many producers rely on the agencies to feed them material. Let’s address the relationship that production companies have with the agencies. I am constantly asked by producers if I would recommend their becoming a client of one agency, which entails them paying an annual retainer. I want to be clear here: Even if you become a retainer client with one agency, that doesn’t mean you are shut out from any contact with that agency’s competitors. But it does mean that you certainly aren’t particularly high up on the other agencies’ call lists. So, there is no point in becoming a retainer client with one agency unless you get to see attractive projects that the agency controls on a priority basis. Simply paying a monthly retainer won’t guarantee you such priority treatment. Agencies want to work with producers who have significant capital resources and in particular are able to fully finance a certain budgetary level of project without having to cobble the rest of the financing together, which can take time and offers no guarantee of success. They also want to deal with savvy producers who know how to attract talent and command studios’ respect in terms of the studios’ being confident the producer will deliver a quality product. Respected producers with money get the first call. Of course, only one producer can get the first call—but, arguably, if you are a retainer client, it will push you higher up on the call list. I am being deliberately coy here. My relationship with all the key agencies is very important to me, so I never give a categorical recommendation one way or another as to whether a producer should become a retainer client. If the producer is keen, I tell him or her to try it out and see. The contractual commitment is typically for 1 year only, so if the relationship is not terribly productive, he or she won’t be very much out of pocket. Keep in mind that the agencies’ first commitment is to their talent clients. They got into the business of packaging films primarily to ensure employment for the directors, actors and writers they represent. So, caveat emptor: Just because you have been given a script from an agency, doesn’t mean that it is hot off the press and that it hasn’t already been turned down by five other production companies. Your evaluation procedures should be just as rigorous with respect to agency submissions as with respect to any other source of material. I am an alte kocker (I won’t translate that Yiddish expression here), which means I have been in the business for a long time. Most of the writers and directors I know are also relative old-timers. There is a reason, therefore, why capable development executives tend to be in their 20s and 30s—they have the contacts with upcoming young writers and directors and young agents and managers, and they actually read graphic novels, which are a growing source for material readily adaptable into commercial film projects. It is important that a production company not overspend on development—which means hiring

The Sinkhole of Development  231

young, talented writers for the most part, to execute ideas or translate underlying literary material into screenplays, even if they represent passable first drafts that need polishing by more experienced scribes. WGA minimum payment schedule today is $77,495 for an original first draft screenplay (including treatment) and $67,802 for a non-original first draft screenplay (including treatment). Rewrites are fixed at a minimum of $25,424 and polishes at $12,721.1 So if you can hire a writer at WGA minimum, you won’t have to mortgage the farm. Furthermore, if the writer you want to hire is non-WGA, you are free to negotiate any fee you choose. As I mentioned before, I like to stay in touch with the community of young screenwriters in the UK. Not only do they tend to cost less than their American counterparts, but I also find them often more polished, forgive the pun—perhaps I am prejudiced by my own graduate education in Britain. Earlier in the book I talked about the spec script boom in the early 1990s when many writers wrote spec scripts in anticipation of a big payday. When that boom petered out, writers didn’t stop writing on spec, so there are a lot of interesting spec scripts sitting out there waiting for a passionate producer to take up the cause. Frequently, you can option them for a song, or even for free, especially if you are friendly with the writer or you have credentials that are persuasive enough for the writer to think you have a good chance of setting up the project somewhere. A few comments about options: The term of the option is almost as important as the option price, and sometimes more so. It goes without saying that projects almost always take longer to set up than you anticipate. So, in general, never negotiate a short-term option of 3–6 months unless there are extremely extenuating circumstances—like the writer is so hot you don’t think you will have any trouble finding a financier, there is high-profile talent already attached to the project, or practically attached, or if the option is free, then it’s tough to be too hidebound. I even resist a 1-year term if I can help it. I always attempt to secure 18 months with a right to extend for an additional 18 months at the same option price, or only slightly more. Typically, the first option payment would be applicable against the purchase price, while the extension option payment is non-applicable. Don’t get snookered by the agent into thinking the property is so hot, you have to dramatically pay up to secure the option. Option payments on the order of $5,000–10,000 are probably most common for independent projects (and I am not talking about micro-budgeted films here), and anything above $25,000 is probably warranted only when we are talking about best-selling novels or prominent works of nonfiction. Don’t be fooled into thinking that the option price should be 10% of the purchase price, which is an archaic formula still bandied about by agents. Purchase prices are all over the map—the old 3% of the budget formula is also passé, but it does give you a valuable point of comparison. Writers should be treated no differently from actors and directors today, who are frequently asked to take a cut in their fee in the budget in exchange for a higher share of profits or a more favorable profit definition.

232  The Sinkhole of Development

Sometimes it makes sense for the producer to enter into a “shopping” agreement, which unlike an option means that no rights are conveyed by the writer to the producer; she typically just has the right to set up the property. Typically, no money changes hands in a shopping agreement. If the writer is unwilling to cede control of his property, which an option agreement implies, it may make sense for the producer to try to negotiate a shopping agreement if she is unwilling to make any up-front payment. Where should you be trolling for your source material to come up with interesting ideas for films? Arguably there is a guaranteed audience out there in the case of best-selling novels and works of nonfiction—we refer to them as “presold”—but don’t expect to wait until a hot new novel is reviewed in the New York Times Sunday Book Review. By the time the review comes out, nine out of ten properties that industry insiders consider might make commercial films will already be optioned. The producer who is best known for pouncing on such hot properties (often when the work is in the galley state) is Scott Rudin, who was the first and only producer to win Emmy, Grammy, Oscar and Tony awards. Because such properties can be very expensive to option and frequently may have to be purchased outright, producers like Rudin typically are backed by studios with whom they have development deals. Better you should look for interesting properties in the public domain, which means they are free of copyright protection: No money need ever change hands if you want to adapt a work in the public domain into a film. The formula that copyright protection extends for the life of the author plus 70 years is generally correct, but not always. First, copyright law varies by country. In the United States, all copyrightable works published in the United States before 1923 are in the public domain, but works created before 1978 but not published until recently may be protected until 2047. For works that received their copyright before 1978, a renewal had to be filed for the work in the 28th year following publication with the Copyright Office for its term of protection to be extended. The need for renewal was eliminated by the Copyright Renewal Act of 1992, but works that had already entered the public domain by non-renewal did not regain copyright protection. Therefore, works published before 1964 that were not renewed are in the public domain.2 The complications these rules generated resulted in a landmark decision in 1990 when the US Supreme Court ruled that Universal Pictures and others, including actor Jimmy Stewart, the then-copyright owners of Alfred Hitchcock’s Rear Window, had infringed the copyright of the short story on which the 1954 film was based. As a result, the court ruled that the film’s owners had to pay damages and a portion of the film’s profits to a literary agent who had acquired the copyright on the short story for the princely sum of $650. Rear Window generated more than $12 million in gross revenue during the 1980s. Briefs in the case indicated that 1,000 or more films might be in the Rear Window category. The good news is that Errors and Omissions insurance policies,

The Sinkhole of Development 233

which are mandatory for new films, protect against copyright infringement judgments, but the insurers will have to satisfy themselves that the chain of title is clear of Rear Window possible infringements. I urge you, however, to do your copyright research carefully, even if you are relatively certain a work is in the public domain. For example, I am a great fan of Rudyard Kipling, and I have always wanted to produce a new version of Kim, but I could never fully clear up the issue of worldwide copyright in my mind. Kipling died in 1936, and virtually all of his works were first published in Britain, not the United States. Assuming the copyrights were renewed in 1963 when US copyright law was changed (I don’t know that for a fact), his works would have 95 years of copyright protection—so while the works are in public domain in the UK, we presumably have a long way to go before they enter public domain in the United States.

Notes 1 “Writers Guild of America 2014 Theatrical and Television Basic Agreement,” Writers Guild of America, 2 May 2016, www.wga.org/uploadedfiles/writers_resources/ contracts/MBA14.pdf. 2 Copyright Act of 1976, Pub. L. No. 94-553, 90 Stat. 2541 (Oct. 19, 1976), codified at various parts of Title 17 U.S. Code; Copyright Renewal Act of 1992, Pub.L. 102–307, 106 Stat. 264, ( June 26, 1992), codified at various parts of Title 17 U.S. Code.

17 EXIT STRATEGIES The Value of Film Libraries

Summary—The value of film libraries is discussed, and library valuation metrics are reviewed. The aims of strategic and financial buyers are contrasted. In 2010, Disney sold Miramax, which was founded in 1979 by Harvey and Bob Weinstein, to Filmyard Holdings, a consortium consisting of Colony Capital, Tutor-Saliba Corporation and Qatar Investment Authority for $663 million.1 The Miramax library included more than 700 titles, including such prominent films such as Sex, Lies, and Videotape, My Left Foot, Cinema Paradiso, Reservoir Dogs, The Crying Game, Like Water for Chocolate, The Piano, The Crow, Pulp Fiction, Bullets Over Broadway, Il Postino, Trainspotting, The English Patient, Good Will Hunting, Shakespeare in Love, The Talented Mr. Ripley, Bridget Jones’s Diary, Gangs of New York, Chicago, Kill Bill: Volume 1 and Volume 2, Cold Mountain, Master and Commander, Hero, Shall We Dance, Bridget Jones: The Edge of Reason, Finding Neverland, Cinderella Man and No Country for Old Men— unquestionably the highest quality specialty film library in the business.2 Bob and Harvey broke with Disney primarily over a dispute regarding the distribution of Fahrenheit 911 by Michael Moore and formed a new production/ distribution label, The Weinstein Company. As part of the deal, they took with them Miramax’s genre label, Dimension Films, which had created the hugely successful Scream and Scary Movie film franchises. In sheer numerical terms, 700-odd titles, including both in-house produced films and acquisitions, is a lot of films to have accumulated in roughly 30 years (most were accumulated in the 26 years of Harvey and Bob’s stewardship). No one has ever accused the brothers of lacking in appetite—and indeed, a propensity to take on more product than may be commercially justifiable has plagued the brothers in their various ventures. When we advised Goldman Sachs and Assured Guaranty in restructuring The Weinstein Company in 2010, DOI: 10.4324/9781003153702-18

Exit Strategies  235

the creditors took control of The Weinstein Company’s library, which at the time consisted of 191 titles accumulated over five and a half years—an even faster pace than Miramax had been producing and acquiring titles during the period the Weinsteins had operated the company. As an aside, since the restructuring, The Weinstein Company has produced and acquired films at an even faster clip: more than 300 titles in another five and a half-year period. Not surprisingly, before the company filed for bankruptcy it was rumored that the Weinstein Company board put much tighter limits on the number of films The Weinstein Company could produce/acquire on an annual basis. I strongly believe that we were absolutely correct to advise Goldman and Assured that it would be significantly better off keeping The Weinstein Company afloat as opposed to putting it into bankruptcy. But the whole restructuring process was made much more complicated due to the fact that the creditor in control of the negotiations was Ambac, which had provided a credit default swap to Goldman for the amount of the debt issuance. I guess Goldman didn’t have a great deal of confidence in The Weinstein Company’s ability to repay the loan. At the time of the Weinstein Company restructuring, Ambac itself was in deep financial distress and was in the process of being restructured. So, not only did we have to restructure The Weinstein Company, we had to simultaneously negotiate a settlement with Ambac to let it off the hook on its guaranty (actually on 50% of its original guaranty since it laid off 50% of its risk on a monoline insurance company, Assured Guaranty). Ironically, Ambac was represented by the old-line law firm Dewey & LeBoeuf, which itself declared bankruptcy in 2012. The restructuring required our clients not only to forgive the outstanding debt in exchange for taking ownership of the Weinstein Company library, including outstanding receivables—receiving a cash and stock payment from Ambac for relieving it of its guaranty obligations and being awarded additional incentives based on certain film performance—but we also had to provide a working capital facility to the Weinstein Company to enable it to continue operating and producing and acquiring films. In one sense, Goldman and Assured was being asked to double down on its outstanding exposure (albeit on a smaller scale), but we instituted strict approval procedures before cash could be doled out. So, my company, AEI, was effectively Harvey and Bob’s bankers for 1½ years until we were refinanced out of our working capital facility by a syndicate of banks led by Union Bank. Over time, most of the net outstanding indebtedness (post the Ambac settlement) has been repaid out of licensing revenues from the Weinstein Company library. The Weinstein Company was a much healthier company after the restructuring, and Goldman and Assured were undoubtedly better off than would have been the case if they had forced the Weinstein Company into bankruptcy. Goldman later sold its interest in the Weinstein library to AMC Networks, a diversified entertainment company which owns and operates various cable

236  Exit Strategies

channels, including its eponymous AMC, IFC, SundanceTV and BBC America (through a joint venture with BBC Studios, the art house movie theater IFC Center in New York, several independent production/distribution companies and the premium streaming services Sundance Now and Shudder. Practically everyone in the Western World knows what happened to the Weinstein Company after its co-CEO and larger-than-life figurehead, Harvey Weinstein, was confronted with a string of sexual harassment and rape allegations, which eventually led to his being fired by the board and multiple convictions in a New York court, which resulted in his being sentenced to 23 years in prison. He still faces multiple counts on similar charges in California. The company imploded as a result and filed for bankruptcy in February 2018. My company continues to administer the library, but we are actively looking for a distributor to replace the Weinstein Company. Miramax did not fit in with Disney chairman Bob Iger’s business strategy of focusing on Disney-branded entertainment that could be exploited across Disney’s theme parks, television and consumer products. When Disney acquired Marvel Entertainment in 2010, Miramax became a step-sister and the company was sold for what was then considered a very healthy price—indeed, the talk among industry insiders was that the acquirer Filmyard (whose primary investor is the Qatar Sovereign Wealth Fund) grossly overpaid. But for once, industry scuttlebutt proved very wrong. At the time roughly $1 million per library title seemed a significant stretch, certainly based on comparable transactions. But Filmyard was prescient enough, or lucky enough, to benefit from the dramatic rise of VOD, and Miramax reaped huge rewards from licensing the bulk of its library on various streaming platforms—so much so that I understand the shareholders have recouped most of their purchase price through a combination of refinancings and relicensing arrangements. It didn’t hurt, of course, that the purchase of Miramax also benefitted from cash and receivables equal to roughly half the purchase price. Incredibly, it was rumored several years ago that the shareholders would put the company up for sale at a stratospheric enterprise value of $1 billion. Considering that Miramax has $250 million of 3.34% notes due 2026 outstanding at that time, that valuation implied net proceeds to the shareholders of an amount in excess of what they paid for the company, even taking into account the fact that virtually added no new titles have been added to the library over the period, plus the company has aggressively exploited the library at the same time! Given these two facts, I can confidently say that Morgan Stanley, its investment banker, sold it an incredible bill of goods on which there is no way it could deliver. Perhaps that is why the company eventually was sold to a private Qatari enterprise, moving from one pocket to another. Interestingly, the Qatari company sold a 49% stake to ViacomCBS in 2019, which confirms the value of an extensive film library to a media conglomerate which owns linear channels, premium pay services and multiple streaming platforms.

Exit Strategies  237

I know of another library where the principal instructed his investment bankers to deliver a sale price that was twice what the library was initially valued at, based solely on net present value analysis of future revenue projections. He didn’t care that his target price was virtually unattainable. If a “dumb” money purchaser came in, great, but otherwise he was prepared to sit around and continue to exploit the library. I might mention that you don’t necessarily have to sell your library to get rich. The legendary producer Roger Corman, who practically invented the lower-budget genre business, has famously sold options to various investment groups over the years to purchase his library, and when the deals failed to close, he simply pocketed the forfeited option payments. In general, not too many interesting libraries come up for sale on a regular basis, so there is a tendency for a competitive bidding situation to emerge when they do become available. I have been involved on both sides of the transaction on several library sales, including George Harrison’s production company, Hand-Made Films, and the international rights to King’s Road’s film library, which we sold to Mel Gibson’s company, Icon. I must tell the following story about Steve Friedman, the founder of King’s Road, which in 1980 was one of the first independent production companies to go public. Steve was a New York character of the old school—he often wore his Midwood High School jacket to work. Despite having been a lawyer, he had real taste for material. He produced The Last Picture Show, which was nominated for eight Oscars. Other quality films he produced under the banner of King’s Road include All of Me starring Steve Martin and Lily Tomlin, The Big Easy starring Dennis Quaid and Kickboxer starring Jean-Claude Van Damme, one of the first martial arts hits. Steve had an untimely death at age 59. The year before he died, I was reading King’s Road’s proxy statement and I noticed he had understated his age by 5 years. When I pointed this out to him—I believe making a misrepresentation in an SEC filing is a felony—he told me that he didn’t want any of the women he went out with (he was a perennial bachelor) to know how old he was. I assured him that none of the “sophisticated” women he went out with would ever read his proxy statement. Libraries in general are depreciating assets unless they can be continuously refreshed with new titles. Film libraries, depending on how old their titles are, are primarily exploitable on various free and pay television platforms, plus various streaming platforms including pay-per-view (which differs from VOD in that the broadcaster shows the event at the same time to everyone ordering it) and various VOD platforms, including subscription services like Netflix, Amazon and Hulu, which charge a monthly subscription fee, and transactional platforms where customers can order and pay for shows on a one-off basis. Libraries that control international as well as domestic rights have benefitted over the last few years from the proliferation of international broadcasters, cable channels and premium pay services. But that growth has slowed down recently,

238  Exit Strategies

and the value of international television rights in general has suffered from an increased propensity of international broadcasters to reduce their airing of American films in favor of local-language product. To the extent that remake and sequel rights are included in a library, the resale value of the library can go up dramatically. In particular, with the recent explosion in serious dramatic television series, the value of libraries with remake rights to reboot feature films as television series has contributed to a significant uptick in library valuations above and beyond simple net present value projections of future licensing revenues. MGM has been a major beneficiary of this trend given its vast library, which consists primarily of very seasoned titles that it has culled to come up with, for example, the highly rated Teen Wolf series, which played for six seasons on MTV, and the critically acclaimed Fargo, which played for four seasons on FX and now can be viewed on Amazon Prime and Hulu. Thus, the first question you should ask about a library that has just been put up for sale is, which titles carry with them remake rights? This is not only with regard to feature film sequels, prequels and remakes, but television spin-offs as well. There is no question in my mind that Amazon’s recent decision to pay a hefty price of $8.45 billion for MGM was driven to a large extent by the great potential for sequels and remakes from the MGM library. There are multiple benefits to library ownership above and beyond the lack of correlation to traditional financial assets. Income streams from libraries are relatively predictable, but it must be said that we still don’t have sufficient experience to judge a library’s long-term value with regard to various streaming platforms. Libraries also have relatively low maintenance costs once they are fully digitized. In addition, the cost of libraries can be leveraged at fairly low rates today, significantly increasing returns to investors. As there is considerable uncertainty in today’s market as to how consumers will be consuming and paying for film and television content, we have noticed that many strategic buyers have been trying to increase the amount of content that they control in hopes that new technology will bring increased revenue opportunities for older titles. In valuing libraries, my company always starts with historical revenue data. We then attempt to project future revenue through first cycle, which is typically 10 years following theatrical release. We may create those “ultimates” projections ourselves based on our own database or we may rely on forecasts done by professional valuators. In order to estimate each film’s cashflow beyond 10 years, we generally apply two parallel methodologies based on (a) total revenues and (b) home video and television revenues. We can also apply a third method that tracks individual license renewals on a film-by-film and license-by-license basis, but this is possible only when copious amounts of data are made available to us. While the total revenue methodology places primary weight on the overall success of each film, the home video/television methodology favors revenues that each film is most likely to continue generating. With regard to

Exit Strategies  239

the total revenue valuation methodology, we have seen institutional lenders use 3–5% of first-cycle gross revenues as a terminal value for film libraries after first cycle (not taking into account remake rights that institutional lenders typically give no borrowing base credit to). Based on our recent studies of film libraries, we find that frequently 80% of the value is generally concentrated in about 20% of the titles. Accordingly, we find it useful to differentiate among three separate classes of films: “A,” “B” and “C” titles. In a recent library that we valued utilizing the total revenue valuation methodology, we applied 5% of first-cycle gross revenues for “A” titles, which were defined as US box office over $50 million; 4% for “B” titles, which were defined as US box office between $10 and $50 million; and 2% from “C” titles, which were defined as US box office less than $10 million or no theatrical release. The other main variable is the applicable discount factor used to calculate the net present value, which is a function of whether the buyer is a pure financial investor who must rely on one or more distributors to exploit the library, or whether the buyer is a strategic buyer who is in a position to self-distribute all, or a portion, of the rights. In the former case, the discount rate will be higher than the latter, since strategic buyers can charge distribution fees as opposed to paying third parties, plus they are more in control in terms of how they choose to exploit the library and whether they can use it to leverage other titles they control. In the current interest rate environment, we have observed financial buyers employing a discount rate on the order of 15%, while strategic buyers may be closer to 12%. Of course, the library valuation also has to take account of the availability of remake rights, to the extent such rights are attractive to the buyer. Generally, remake rights are more attractive to strategic buyers who are more able to put together remakes and sequels. Strategic buyers, we find, are more frequently using only historical home video and television revenues as indicators of library values, since they are the markets where they expect to receive continuing revenues. In the past, we have used a percentage of net home video and television revenues, although the home video percentage, which includes streaming platforms, is a more variable percentage depending on how exploited the titles have been on VOD. As is the case on the total revenue valuation methodology, we break down the films by category. In recent valuations we have broken the films down into “A,” “B” and “C” titles and valued each title according to varying percentages of its historical and projected first-cycle home video and television revenues, using a slightly higher percentage for television than for home video. Similar discount rates would apply depending on the nature of the buyer. We have had the ability in some cases to compare both the total revenue valuations and the home video/television revenue methods both against each other and against the method that uses individual license renewals, and we have been very happy with the consistency of the methods and their prediction of observed transactions in the market.

240

Exit Strategies

Libraries, however, are not simply valued for their future revenue streams. In the case of strategic buyers, rights availabilities play an equally important role. Libraries, for example, that have presold foreign for an extended period of time (sometimes as long as 20–25 years) are less interesting because strategic buyers are not in a position to package these titles with their own current slate throughout most of the world—so they can’t leverage its new titles to increase the value of their library titles. Thus, libraries where there is a long average life before licenses revert are typically not attractive to strategic buyers, or indeed even to financial buyers who are looking for a meaningful cash flow straight away. The converse equally applies: libraries where the bulk of existing licenses are close to expiring became more attractive candidates for purchase. Libraries with a significant number of evergreen titles—films that continue to appeal to moviegoing audiences over time—also command higher purchase prices. Imagine what Gone with the Wind continues to generate 81 years after it was theatrically released, although political correctness issues are beginning to impact the film’s value today. As new platforms come on stream, evergreen titles can see a big spike in revenue. I remember that my shareholders at JVC, which was a major home video distributor in Japan, told me they earned a totally unexpected windfall when they released Roman Holiday on VHS long after the original theatrical release.

Notes 1 Cieply, Michael and Barnes, Brooks. “Disney Sells Miramax for $660 Million,” New York Times, 30 July 2010, www.nytimes.com/2010/07/31/business/media/31miramax.html. 2 “Miramax Catalog,” Miramax.com, http://miramax.com/catalog/.

18 NEW DIRECTIONS The Digital World

Summary—Financial models for content production in new media are presented. In particular, the chapter focuses on streaming content for YouTube and other digital platforms. The potential of virtual reality and the kinds of content that are suitable for that technology are discussed, recognizing that we are still in the early stages of this technology rollout. Probably the stupidest business decision I ever made occurred when one of my co-workers at AEI, Michael Lewis (no, not the author), approached me over 20 years ago to tell me that he wanted to leave to set up a company to develop 3D technology for feature film projection. He left with my blessing and established RealD in 2003, which has become the dominant player in bringing 3D technology to the screen with its digital stereoscopic projection system. I had the opportunity to be a start-up investor in RealD and join the board. But I was very busy with my core business, and besides I had doubts about the commercial prospects of 3D technology given its failures in the past. But Michael, with his then-partner Joshua Greer, developed a much superior projection system and ease-of-use throwaway glasses, and the technology was championed by Jeffery Katzenberg, the chairman of DreamWorks Animation, whose support really put the company on the map. The company went public in 2010 with a raise of $200 million, and was later taken private by Rizvi Traverse, the private equity firm, on a valuation of $551 million!1 So I clearly missed the boat. I vowed not to ignore developments in tech or new media again. In 2014, Variety commissioned a study to see what celebrities were most admired by American teenagers. The surprising result was that the top five picks were all YouTube stars, not high-profile film and television celebrities. Smosh ranked number one, followed by the Fine Brothers, PewDie Pie, KSI and Ryan Higa. The first mainstream celebrity to make the list, at number six was the late Paul Walker, who had tragically died in a car accident the previous year. DOI: 10.4324/9781003153702-19

242  New Directions

The comprehensive survey revealed that YouTube stars were judged to be more engaging and—what is even more interesting in my opinion—more relatable to than mainstream stars, who were rated as being smarter (who cares?). I was surprised, however, that in terms of sex appeal, the two groups of celebrities finished about even.2 Teenagers clearly valued the more intimate authentic experiences they enjoyed with YouTube stars whose public images are not carefully crafted by PR mavens. The Variety survey also indicated that teenagers appreciate YouTube stars’ more candid sense of humor, lack of filter and risk-taking spirit, characteristics that are often damped down by Hollywood handlers. The message is clear-cut that producers who work to leverage the popularity of YouTube and other social media celebrities on multiple platforms have to be careful not to come up with matters and creative approaches that are too homogenized. My company helped structure a new digital studio, SuperGravity, which was designed to partner with top social media talent to create a broad range of entertainment, feature films, series, documentaries, stand-up comedies and so on that could find releases on such platforms as YouTube, VIMEO, iTunes, Hulu, Netflix, Amazon Prime and other transactional and SVOD platforms. The founders of SuperGravity were pioneers in the digital space: Max Benator was the producing partner with the Fine Brothers and Marc Hustvedt was the founder of Tubefilter and the Streamy Awards, the Oscars for streaming media. He also produced the breakout digital hit Camp Takota, which was a 95-minute comedy. Camp Takota’s performance on iTunes was nothing short of astounding. Released on Valentine’s Day 2014 and starring such YouTube celebrities as Grace Helbig, Hannah Hart and Mamrie Hart, it reached number three on iTunes independent film chart, trailing only Oscar frontrunners Twelve Years a Slave and Dallas Buyers Club. The film was made for less than $500,000 and virtually recouped before principal photography even commenced through the sale of related merchandise.3 The budget was designed based on projections of how many fans would pre-order the film and pay for merchandise. There was virtually no marketing spend, and the film made a significant profit that, given the low budget, represented a huge ROI. SuperGravity’s first production, Man Up, starring Justin Chon (best known for portraying Eric Yorkie in the Twilight Saga film series) and Kevin Wu (the YouTube celebrity known as KevJumba), was released in May 2015 and was followed soon after by The Chosen, starring Kian Lawley (who won the Teen Choice Award for Choice YouTuber). Both films were significantly profitable on an ROI basis. The economic model for this new area of filmmaking is still a work in progress, but it clearly offers extremely attractive potential returns, assuming—and this is an important assumption—budgets can be held in check. SuperGravity initially was focused on budgets in the $250,000–$1 million range, but soon after it was founded, there were signs that some larger motion picture companies

New Directions  243

that were also trying to play in this space, like Lionsgate and Legendary, feel the need to push budgets to a $2 million ceiling. This was to counteract the negative impression that the films were lower quality from a production point of view just because they featured online talent. Also, traditional stars were starting to join the casts. Clearly the next step in the evolution of this model was to see if some of the films could warrant traditional theatrical releases. Pressure on budgets immediately came from talent’s representatives. To date, talent had been prepared to regularly take fees below $100,000 in exchange for as much as 15% of the backend. In some cases, the talent pool could command as much as half of the film’s profits. With this caveat in mind, potential returns on films that can be made for under $1 million with high-profile YouTube celebrities were very compelling. The bulk of revenue on these projects are generated from transactional VOD. Viewers can typically download them on iTunes and Vimeo for about $10. The SuperGravity model was predicated on hitting singles consistently, so in that sense it was very different from the feature film model we have examined in this book, which is predicated on keeping losses at a minimum and hitting the occasional home run. Even though their model was reluctantly unproven, Max and Marc completed a start-up venture capital round of capital raising with some savvy venture capital investors, led by Otter Media, a joint venture between Peter Chernin, the former president and COO of News Corp, and AT&T, and finalized a four-picture output deal with Vimeo as a first step in setting up formal working relationships with a number of major digital platforms—a key objective in the company’s business plan. Otter Media acquired SuperGravity in 2017. The intersection of television and feature films that is becoming increasingly evident in the original programming strategies of Netflix and Amazon as well as the premium pay-television services is also a fundamental characteristic of viral content production in general. Short-form digital clips can morph into web series, typically 3–15 minutes in length, that can themselves morph into streaming series that encompass more ambitious pilots and series that typically run 30 minutes to 1 hour. A few years ago, a highly successful feature film, Lights Out, which was based on a 2-minute viral film from Sweden, directed by an unknown director Paul Sandberg, grossed an enormous $43 million in its first 10 days of release, more than 8x what it cost to produce.4 Ironically, Lights Out did not come out of the stable of YouTube celebrities, which indicates that the Internet represents a totally open game for budding talent. Hollywood is desperately seeking new sources of attractive intellectual property. It is important to recognize that microbudgeted shorts can provide proof of concept that can be developed into successful feature films—examples include Mama, Saw and even the Oscar-nominated Whiplash. An entrepreneurial producer, Lawrence Grey, was introduced by a friend to the underlying short of Lights Out, which had no dialogue, just a woman (played by the director’s wife) terrorized

244  New Directions

by a shadowy apparition. The film went viral on the social media site Reddit. Grey optioned the material and worked with the director to flesh out a story. He also had the sense to attract James Wan (who created the Saw and Conjuring franchises) to sign on as a producer, giving the film name recognition in terms of pitching it to studio financers. With Wan’s endorsement, Warner Bros. and its New Line Cinema unit agreed to fund the $5 million budget and provide the necessary marketing and distribution costs. One of the key selling points was the video’s huge popularity on YouTube, where it eventually attracted 200 million views, indicating a strong built-in audience for the film. The rest is history, and I relate this story because it reveals there is no standard series of steps a producer has to follow to set up his project. YouTube is an incredibly diversified and not well understood service. Available content includes video clips, TV show clips, music videos, short and documentary films, audio recordings, movie trailers, live streams, video blogging, short original videos and educational videos. Most content is generated and uploaded by individuals, but media corporations including CBS, the BBC, Vevo, and Hulu offer some of their content on YouTube as well. As of May 2019, there were more than 500 hours of content uploaded to YouTube each minute and 1 billion hours of content being watched on YouTube every day. This dwarfs Netflix’s numbers, for example. YouTube and selected creators earn advertising revenue from YouTube’s parent Google’s AdSense, a program that targets ads according to site content and audience. In that sense, YouTube can be considered the pioneer of the AVOD market as well as the use of AI-driven algorithms to measure audience preferences. The most talked-about new technology, at least in the California enclave between Silicon Valley and Los Angeles, is virtual reality. In the next few years I suspect that virtual reality, at least the high-end systems, will appeal mainly to gamers and tech enthusiasts based on their current high price point, although we know, if the history of technology manufacturing is any guide, that prices will come down, and quickly if consumer demand takes off. Facebook, which acquired Oculus for a stratospheric price of $2 billion, in cash and stock, released its original Rift headset in 2016 at a retail price of $599, or approximately $1,500 when bundled with a computer.5 Under its ownership, Oculus has been promoted as a brand of Facebook rather than an independent entity and has increasingly integrated Facebook platforms into Oculus products. In September 2018, Facebook unveiled Oculus Quest as a new higher-end headset as part of a goal to reach 1 billion VR users who were looking to download games and applications. In the first 2 weeks after Oculus Quest was introduced to the market, Facebook announced that it sold $5 million worth of content for use on the system. Facebook established Oculus Studios as a division of Oculus to focus on funding, publishing and giving technical advice to third party production

New Directions  245

companies to create games and virtual experiences for its headsets. At the time, Facebook pledged to invest more than $500 million in Oculus Studios for games. By 2020, Facebook purchased a number of game companies to integrate with Oculus Studios, including Beat Games, Sanzaru Games and Ready at Dawn. I remember that Brendan Iribe, the former CEO of Oculus, was quoted when the original Rift device was introduced that most people’s reaction to trying it out was that it “was probably the best thing I’ve ever seen in technology in my life.”6 In my case, it just gave me a headache—but then again, I am an alte kocker. Admittedly, my experience was with a much earlier prototype that the company never claimed was consumer ready. Current models benefit from much higher resolution, which should greatly reduce pangs of motion sickness. Oculus continues to face competition in its bid to become the dominant hardware manufacturer in this space, although given Facebook’s piggybank and its need to justify that “blue sky” purchase price, I wouldn’t bet against Oculus’s continued domination of the market. However, there are more than 50 companies already making headsets in China and we have not yet experienced a new technology where China is at the head of the curve, outstripping the United States. In 2016, HTC, a Taiwanese technology company, partnered with Valve (primarily to help with the manufacturing and the distribution/marketing) on virtual reality headgear called Vive, which delivered graphics that were richer and more intense than Rift’s when connected to a powerful computer. Oculus, however, countered with its Touch controllers, which narrowed dramatically the gap between the competing products’ capabilities. Valve is the company that built the Oculus demo, which convinced Mark Zuckerberg to pony up $2 billion to buy the company. Valve felt taken advantage of when Facebook made its purchase of Oculus and immediately reached out to HTC to help it make a competing headset. Samsung has also developed its own virtual reality headgear, which requires inserting a Samsung Galaxy smartphone into the headgear, relying on the smartphone’s screen for video. I would not be surprised if smartphones, rather than fancy but bulky headgear devices, prove to be the key to mass consumer acceptance of virtual reality. Sony is also likely to be a major player with a headset it has developed for its PlayStation 4. Sony’s concentration will undoubtedly be on creating dedicated gaming experiences for PlayStation 4, of which over 110 million units have been sold worldwide to date.7Sony introduced PlayStation 5 in 2020, which offers high- speed data streaming to enable significant improvements in storage performance, much more powerful 4K resolution display at up to 120 frames per second, hardware-accelerated ray tracing for realistic lighting and reflections and hardware-accelerated 3D audio effects. PlayStation 5 along with Microsoft’s Xbox Series X and Series S consoles, released the same month, are part of the ninth generation of video game consoles.

246  New Directions

The jury is out as to what virtual reality hardware will prevail or indeed whether any one format will dominate the market. Samsung’s reliance on smart phones looks like a good bet, but I would not discount the power of the huge embedded base of Sony’s PlayStations. It would be ironic if Sony won out, since Sony’s Betamax videocassette recorder technology preceded JVC’s VHS alternative (actually Phillips introduced the first model). It was probably a better system, but VHS blew Betamax out of the water because JVC was prepared to license the technology to other manufacturers while Sony would not. At the low end of the price range you can slot your phone into a $10 cardboard adaptor (Google’s model was appropriately called “Cardboard”) and download a free virtual reality app for a fraction of the price of the Rift. Even better value was Samsung’s $99 Gear virtual reality adaptor, which transformed a high-end Samsung headset into something far more powerful and comfortable than a cardboard headset. Google launched Daydream to compete with Samsung’s Gear, and it had the advantage of being built into Android itself, but Daydream was not widely adopted by consumers or developers, and Google discontinued it in October 2019. Oculus, Sony and Vive all initially targeted gamers, which makes sense since gamers are attracted to the immersion experience, which is so powerful that the deficiencies in graphics are easily forgiven. Keep in mind that interactive games are an enormous market: As of 2015, video games generated sales of $74 billion worldwide, and were the third-largest segment of the US entertainment market, trailing only broadcast and cable television.8 By 2019 the market had doubled to more than $152 billion.9 Young gaming enthusiasts reported that they felt exhausted and overstimulated after a relatively brief 20-minute session on early prototypes. The number one complaint as far as current-generation headsets are concerned is that experiences are too short at 12–25 minutes. Nevertheless, if virtual reality is designed to be consumed in small doses, not hours at a time, content creators for this new technology will be hard-pressed to come up with narrative-driven content that can tell compelling stories in the time frame that audiences are used to with respect to feature film and television programs. While I certainly think that interactive games can be reconfigured for virtual reality environments—think of the excitement you will feel by being transported to the kinds of rugged jungle, mountain and urban war zones gamers are used to inhabiting—I also believe that virtual reality may be equally well suited to present content that is not based on the linear narrative framework of traditional filmed entertainment. In particular, I am interested in the possibilities that virtual reality opens up to create travelogues that can enable consumers to enjoy the experiences of traveling all around the world from the confines of their own home. I am in fact discussing producing such a travelogue to acquaint tourists with the glorious sights and sounds of a certain Caribbean island. I appreciate that it is not the same thing as luxuriating on a beautiful Caribbean sandy beach, but it

New Directions 247

could prove to be a useful promotional tool to attract increased tourist traffic to the island. I also understand that hotel chains, estate agents and architects are planning to offer virtual tours of prospective wedding destinations and planned condominiums. There are clearly other environments that consumers would love to be transported to via a virtual reality experience. Several studios are developing content for these headsets, including interactive short films and courtside views of pro basketball games. Felix & Paul Studios created a virtual reality series starring LeBron James, and M SS NG P ECES released a 25-minute virtual reality documentary on the 2016 NBA Finals featuring some pretty amazing plays with LeBron. Virtual reality content, if it is to be successful, must be fully immersive, giving the user a vivid simulation of the live experience. Felix & Paul recently released the largest production ever filmed in space. Space Explorers: The ISS EXPERIENCE is an epic four-part immersive series that invites users to join eight astronauts on life-changing missions aboard the international Space Station. Some years ago, a van was fitted out with auditorium seats and headsets that transported viewers into the midst of the Los Angeles Philharmonic. Even medical applications are being pursued to treat phobias and post-traumatic stress disorder, whereby “virtual reality exposure therapy” permits patients with such syndromes to re-experience the situations that caused their trauma within a controlled virtual reality environment. Not surprisingly, the military has already used virtual reality technology to train pilots and tank commanders (although I understand they have suspended these programs because of concerns over the long-term effects on depth perception), and undoubtedly medical schools will find ways to utilize virtual reality technology to train surgeons.

Notes 1 Minaya, Ezequiel. “Rizvi Traverse to Buy RealD in $551 Million Deal,” Wall Street Journal, 9 Nov. 2015, www.wsj.com/articles/rizvi-traverse-to-buy-reald-in-551million-deal-1447085658. 2 Ault, Suzana. “Survey: YouTube Stars More Popular than Mainstream Celebs among U.S. Teens,” Variety, 5 Aug. 2014, http://variety.com/2014/digital/news/ survey-youtube-stars-more-popular-than-mainstream-celebs-among-u-s-teens1201275245/. 3 Manly, Lorne. “From YouTube Renown to Movie Stardom,” Las Vegas Review-Journal, 30 June 2015, www.pressreader.com/usa/las-vegas-reviewjournal/20150630/282325383627493. 4 “Lights Out (2016),” Box Office Mojo, www.boxofficemojo.com/movies/?id=newline0116.htm. 5 Vanian, Jonathan. “Facebook’s Oculus to Build a New Virtual Reality Headset,” Fortune, 6 Oct. 2016, http://fortune.com/2016/10/06/facebook-virtualreality-headset-invest/. 6 Chen, Brian X. “My Virtual Life at Tech’s Big Consumer Electronics Show,” New York Times, 8 Jan. 2016, https://bits.blogs.nytimes.com/2016/01/08/my-virtual-lifeat-techs-big-consumer-electronics-show/.

248

New Directions

7 Barber, Ollie. “The PS4 Has Now Sold 53.4 Million Units Worldwide, With 6.2 Million Sales Over the 2016 Holidays,” Forbes, 5 Jan. 2017, www.forbes.com/sites/ olliebarder/2017/01/05/the-ps4-has-now-sold-53-4-million-units-worldwidewith-6-2-million-sales-over-the-2016-holidays/#3670a38c1cbe. 8 Morris, Chris. “Level Up! Video Game Industry Revenues Soar in 2015,” Fortune, 16 Feb. 2016, http://fortune.com/2016/02/16/video-game-industry-revenues-2015/. 9 Wijman, Tom. “The Global Games Market Will Generate $152.1 Billion in 2019,” NewZoo, 18 June, 2019.

19 ART VERSUS COMMERCE

Summary—The author muses about the chances of success of investing in films. The chapter gives credit to the strategy employed by the independent producer Cross Creek, which consistently manages to lay off most of its risk on other investors. An attempt is made to straddle the emphasis on portfolio diversification versus a selective investment approach. The importance of taking an opportunistic approach to film investment is stressed. A brief discussion of investment opportunities in television occurs for the first time. Finally, the book ends with a plea for integrating artistic and business considerations— neither trumps the other. What do I really think about whether investing in films is a mug’s game? You have probably realized by now that I am somewhat ambivalent about the chances of success. At the very least, to paraphrase the famous musical’s title, I don’t really believe you can succeed at the movie business without really trying. I don’t recommend moving to Los Angeles, hanging up a shingle and transferring a few million bucks to a new bank account at City National Bank. By the time you learn the ropes, you will probably have run through your nest egg. You can, of course, hire me—or someone like me—to keep you out of trouble and help you structure and implement a proper business plan. Or if you are prepared to network 24/7 and can be very cautious about actually writing checks (although you will have to convince some key industry players that you are in a position to write substantial checks), you might actually start to see some interesting deal flow. I know a smart lady who has pursued just that game plan. She’s been in Los Angeles for less than 3 years and she probably knows more agents and studio executives than I do after 30 years. It’s unclear how much capital resources she has behind her, but more importantly she has convinced enough people that it’s substantial enough to take her seriously. I know that she has invested between $500,000 and $1 million in several projects, although I DOI: 10.4324/9781003153702-20

250  Art versus Commerce

suspect she has laid off some of that exposure on some wealthy acquaintances. That doesn’t matter though. Cross Creek, which has been involved in some prominent independent productions, including Black Swan (yes, it really helps to start off with a big winner), Rush and Black Mass, routinely takes responsibility for financially packaging a film and then lays off most of its risk on third parties, enabling it to take meaningful fees in the budget that may even represent close to Cross Creek’s actual exposure on the film. One of my clients invested in a film produced by Cross Creek, which proposed to take what I felt was a totally unjustified producer fee given that it did not develop the project and would rely on a leading production company to actually produce the film. When we pushed back on that fee, it remained adamant (the film starred one of the leading actors in the world, so it thought it held most of the cards). My client really wanted to invest in the project, so I suggested that we let Cross Creek take its fee in the budget, provided it subordinated its equity recoupment to us. We would recoup with a premium before it recouped a dime. In exchange, we would take a smaller share of profits than our percentage investment would normally entail. Not surprisingly (in my opinion), Brian Oliver, who headed Cross Creek at the time, was quite willing to consider such a structure, and we did, in fact, conclude a deal on that basis. I have to give Brian a lot of credit: he has certainly leveraged his success on Black Swan, which has enabled him to attract outside investors to co-finance his subsequent projects (it helps, of course, to have a sizable investment fund behind you, for which he can thank the Thompson family of Louisiana), which means, as I indicated earlier, that Cross Creek can stretch its capital resources over a larger number of films. This strategy, though, is predicated on the assumption that Cross Creek can continue to make reasonably successful films; otherwise, it may find it increasingly difficult to attract equity investors in the future. Brian left Cross Creek in 2017 to form his own company, New Republic Pictures, but I believe he continues the strategy he employed at Cross Creek, namely taking control of a project and then laying off as much risk as possible on third parties. Brian is a producer who clearly thinks outside the box, as evidenced by the first two films he produced at his new company, Rocketman and 1917. The films were nominated for nine Academy Awards and four Golden Globes, including Best Picture, and won all four Golden Globes and four Academy Awards. One of the most successful old-time producers who always seemed to pull a new money source out of his hat was Elliott Kastner. Elliott’s chief claim to fame was his “invention” of the negative pick-up. In the mid-1960s, Elliott approached Jack Warner, for whom he had produced the successful film Harper, to finance a project that was designed to showcase a young actor, Warren Beatty. But Warner demurred because Beatty had a reputation of being uncontrollable, plus he always caused a film to go over budget. So Kastner proposed an alternative to Jack—he, Elliott, would be responsible for financing the film

Art versus Commerce  251

and Warner Bros. would simply pay him a stipulated dollar amount on delivery for worldwide rights (effectively, a negative pick-up, which technically refers to negative film stock, i.e., the film, rather than the opposite of “positive”). I believe the amount Warner Bros. paid was around $3 million, which probably included a reasonable producer fee/profit element for Elliott. Jack Warner was adamant that he would not advance another dime beyond that amount. Elliott ran around Beverly Hills before he found a bank that would discount the Warner Bros. contract, and the negative pick-up structure was born. I suspect this also jump-started the completion bond business because banks soon realized they needed the backstop of an insurance entity to ensure the film they were lending against would be delivered in a timely manner and the pick-up price paid. I haven’t been able to track down the box office for Kaleidoscope, but I suspect it wasn’t an overwhelming success. Elliott, as the saying goes, could sell ice to the Eskimos, but he wasn’t just a glib huckster. He specialized in persuading well-known novelists and playwrights to adapt their works for the screen—like William Inge (Bus Riley’s Back In Town), Iris Murdoch (A Severed Head), Edna O’Brien (Zee & Co.) and Peter Shaffer (Equus)—and got others to deliver screenplays based on the works of well-known authors such as Vladimir Nabokov (Laughter in the Dock), Henry James (The Nightcomers) and Raymond Chandler (The Long Goodbye, Farewell My Lovely and The Big Sleep). Kastner’s most successful collaboration though, was with the adventure novelist Alistair MacLean: Kastner ultimately produced four films based on MacLean’s novels, including the extremely successful Where Eagles Dare as well as When Eight Bells Toll, Fear Is the Key and Breakheart Pass. Richard Burton, who starred in Where Eagles Dare with Clint Eastwood, wound up making more films for Kastner, including Equus. I mention this litany of prominent authors and actors because Kastner was not just selling himself when he pitched new investors—he was also selling his ability to link “A”-list actors with “A”-list writers and literary works. If you are going to lose on your investment in the movie business, you might as well lose on what you take to be a prestigious project. Remember, most potential film investors are middle-aged men and women. They don’t know today’s best-selling video games or graphic novels or YouTube personalities. But they have heard of Vladimir Nabokov and Raymond Chandler. Elliott, of course, didn’t just adapt literary masterpieces and best sellers for the screen. Like any good producer, Elliott tried to package as many films as he could to maximize the quantum of producer fees he could earn. Thanks to one of Elliott’s stinkers, my client Alcon was born. The story behind this is both amusing and instructive. In 1995–96, Elliott produced Love Is All There Is, a take-off on the Romeo and Juliet story (yes, it’s in the public domain) starring a large number of Hollywood old-timers (whom potential investors would undoubtedly recognize), including Joe Bologna, his wife Renée Taylor, Lainie Kazan, Paul Sorvino, Barbara Carrera, Connie Stevens, Dick Van

252  Art versus Commerce

Patten and several others, including a newcomer named Angelina Jolie. I have watched the film and, yes, it’s pretty awful. Elliott got one of his former investors, Fred Smith, the founder and CEO of FedEx, to largely fund the film, which admittedly had a reasonably low budget. But when Fred’s lawyer and accountants tried to get financial information about the film (it grossed $32,925 domestically—that’s right, less than $33,0001) Elliott was unreachable—the embarrassment factor was probably too great. The only person Fred’s representatives could track down in Elliott’s office was a recent Princeton graduate, Andrew Kosove, who was developing his own film script in conjunction with Elliott. Thinking fast on his feet, Andrew informed Fred’s representatives that Love Is All There Is was a pretty lame project, but he was prepared to try to recover as much of Fred’s investment as possible if Fred would permit him to prepare a proper business plan based on an intelligent strategy towards film investment. A deal was struck and Andrew, with the assistance of one of his good buddies from Princeton, Broderick Johnson (who had a Wall Street background), managed to negotiate a domestic distribution deal with the Samuel Goldwyn Company. I am not sure how much of his investment Fred ultimately recouped—presumably somewhat less than 50%—but even that was miraculous given the quality of the film. That’s when I came on the scene. I assisted Andrew and Broderick in writing a business plan for a new film venture that was called Memphis Films, since FedEx is based in Memphis. The name was later changed to Alcon Entertainment in honor of an archer in Greek mythology who never missed his mark. When Fred read the business plan, I understand that he thought it was one of the best plans for a start-up that he had ever read—and off the back of that business plan, Alcon was born. But Fred is a very experienced and careful businessman. He did not throw a whole lot of money at Alcon upfront. He carefully doled out capital over time as Alcon continued to meet certain pre-negotiated benchmarks. I strongly recommend such a gradualist approach for funding an independent production or distribution company. Alcon, though, is pretty unique since Fred effectively bet on two smart but totally unproven executives to launch his own label. But Fred is a pretty unique investor—after all he created FedEx, the idea for which, business mythology claims, was totally repudiated by Fred’s economics instructor at Yale. It is my understanding that the story is vastly overblown. It was not the idea of an airplane-delivered cargo service that was criticized, but the amount of capital required to realize Fred’s vision, which far exceeded any sum that start-ups had managed to raise in the past. But Fred was able to raise the required amount of capital, and the rest is history. To get back to Cross Creek, the company’s success to date is also a function of its being in CONTROL. (In contract to a slate investor that might put up 25–50% of the budget on studio-produced films—which is why Legendary is trying to transform itself into a major production company in its own right. Ego is probably also a factor.) By functioning as the senior producer on a

Art versus Commerce  253

project and therefore effectively in control, Cross Creek can choose how much it wishes to lay off its risk on third parties, and, as I indicated earlier, if it continues to churn out reasonably successful films, it should not have significant problems finding such investors, But Cross Creek has one significant issue with its business plan: I believe it is barred by its agreement with the investment fund backing it to invest in development. It must find third parties to fund its development slate—which it did on Black Mass—or it has to rely primarily on talent agencies to supply it with fully packaged, or largely fully packaged properties. So, it is not totally in control of its destiny. In any case, I suspect the reason why the creative producer, Brian Oliver, split from the company to form his own vehicle could be attributed to his propensity to hog the limelight to the detriment of his financiers, the Thompson family. In the end, it never pays to think the “money” guys are happy simply to clip coupons and remain in the shadows. As I indicated earlier, too much diversification entails regression to the mean (i.e., reversion to average performance over time) and the mean as far as independents are concerned, I would argue, typically does not offer interesting enough prospective returns given that investors have to rely on other entities to distribute their films for them—thus giving away a meaningful percentage of its receipts in the form of distribution fees. It should be appreciated, though, that distribution fees paid to the studios do not represent pure profit to the studios, since a significant portion of the fees are effectively applied to recovering the cost of maintaining in-house distribution and marketing operations. The exact profit margins on distribution are difficult to gauge properly since the costs represent largely fixed costs, while the level of aggregate distribution fees represent a variable figure calculated on gross receipts. Thus, the more profitable a studio is in a given year, the greater its distribution profit margins. Independents can compensate for the distribution fees they pay out in several ways. They should be able to run leaner operations than the studios—i.e., their overheads relative to aggregate revenues should be less, assuming they produce enough films in a given year (as I mentioned, Largo’s failure to do this contributed significantly to its less-than-satisfactory profit margins). Selectivity is the key to maximizing returns. Studios have a distribution pipeline to fill, while independents do not, so arguably studios are compelled to greenlight some marginal projects each year while independents can keep their powder dry for really compelling projects. Too little diversification, however, means that you probably aren’t getting up to the plate sufficiently often to maximize your chances of hitting the occasional home run. What is the golden mean? Probably three to four films per annum, which over a 5-year period would enable one to accumulate a library of 15 to 20 films. Producing at a faster clip also creates problems in terms of finding domestic distributors to release your films. To the extent you have a special relationship with one studio, it can probably accommodate you on the scale I suggest—assuming it likes all the projects, of course—but anything more than

254  Art versus Commerce

that entails that you will probably have to find multiple distributors for your slate, at least with respect to domestic distribution. This isn’t a serious impediment in itself, but it will clearly stretch your internal resources if you have to spend considerable time having to nail down multiple distributors. I can’t emphasize enough how long it takes to hammer out distribution deals with studios or even indies. Independent production companies not only have finite capital resources, but they also have finite personnel resources. You want your staff to spend most of their time focusing on producing the best films they can and trying to influence the marketing campaigns to the extent they are able. Thus, selectivity is a necessity if you hope to achieve success over the long run. If you are an independent producer/investor more driven by artistic considerations, the problem, of course, is not wanting to do too many films per annum but being stuck with too few. After all, how many good projects with clear-cut artistic merit are there out in the marketplace? The danger for producers/investors who come to the table with this mission statement is they may be easily tempted to jump into actors’ and directors’ vanity projects. This is a temptation that also faces the studios, which want to keep big stars and directors in the fold. The studios may be less inclined to cater to “A”-list talent in the future after such recent egregious flops as Brangelina’s By the Sea and the Sandra Bullock starring Our Brand Is Crisis. To be fair, actors and directors know they cannot command their usual fees in such projects, and Angelina and Brad for example, are said to have each taken only $1.5 million up front in exchange for a hefty backend that will never materialize. The film probably cost in the order of $25 million, and some sources project Warner Bros. could lose as much as $40 million what is, after all, a low-budget film by studio standards. Warner Bros.’ loss on Our Brand Is Crisis, which cost $8 million to make and only grossed a feeble $1 million 2 —was cushioned by the fact that it laid off a sizable percentage of its risk on two financial partners, Participant and RatPac-Dune (laying off risk on third parties is a viable studio strategy as well as for risk-adverse indies such as Cross Creek). These vanity projects are probably better suited for the indie-financial model, which relies on foreign presales to mitigate risk. Given the star power in such vanity projects, they presumably overindex in terms of aggregate foreign sales, while the studios, which typically will release these films themselves worldwide, are much more dependent on actual box office performance. It is easy for independents to be mesmerized by prestige packages consisting of acclaimed auteur directors and “A”-list stars, and there is a great temptation to greenlight them at excessive budgetary levels. I have the highest regard for producer/financer Megan Ellison’s taste, but her willingness to win the mandate on The Master—directed by Paul Thomas Anderson and starring Phillip Seymour Hoffman, Joaquin Phoenix and Amy Adams—by stepping up to a budget that I believe was on the order of $10 million more than one of my clients was prepared to pay is simply spendthrift. I don’t care how much Megan is prepared to risk irrespective of the commercial

Art versus Commerce  255

prospects of a given art film. In the end, disappointing performance over a slate of films will eventually catch up with you—even if it is your own fortune on the line, or your father’s. The flip side of the coin to selectivity is opportunity. While I have stressed the benefits of being in a control position, I don’t want to ignore the opportunities afforded by third-party projects. In particular, I see several interesting projects a year where there is a hole in the financing and you can step into an attractive equity position where you either have a superior recoupment position in the waterfall and/or you have a superior profit participation relative to your equity risk. These opportunities are not dissimilar from the good deals I can sometimes achieve by waiting until the last minute to book a hotel room at Cannes—except that I need to book that hotel room, I never need to make a specific film investment. The opportunities to which I am referring here are separate and apart from projects that require finishing funds, where the producer has eschewed a completion bond and has simply run out of money before he or she can deliver the film. These opportunities present themselves when the producer is not able to fund to the strike price, proof of which is required before completion bond is operative. Another area where well-heeled investors can be opportunistic is in the acquisition arena—particularly acquiring domestic rights on third party projects. As I have indicated in several places throughout the book, it is becoming more and more difficult to license domestic rights prior to the start of principal photography for an attractive advance. Thus, the producer/financer usually has to assume that domestic risk. Let me give you two examples where one of my clients, Black Label Media, was able to benefit from its willingness to assume what we judged to be reasonable risk. In the first instance, Black Label backstopped a P&A commitment for $5 million on a dramedy that on paper looked more like an art film than a broad commercial release. By backstopping, I mean we committed to put up $5 million to support a reasonably aggressive platform release, assuming the eventual domestic distributor was not prepared to assume that level of risk. Our backstop not only effectively ensured a domestic release on at least 300–500 screens, but it also helped the foreign sales agent to generate higher up-front presales. The film was shot and premiered at Toronto in 2013. Much to the producer’s and our delight, it was an instant hit with the audience, which prompted a huge bidding war among several distributors. It eventually sold for an advance of $7 million, which could be justified only if the distributor was prepared to take it out wide (i.e., 2,000+ screens, which entails a P&A spend in excess of $20 million). You can’t justify a $7 million advance unless you are prepared to swing for the fences. So, our P&A backstop became superfluous (the distributor had no use for only $5 million) but because we had an existing deal with the producer, he had to renegotiate our deal before he could sign off on the $7 million advance. I was up until 5 AM the evening the overall deal was signed, and my client wound up with a small gross corridor from first

256  Art versus Commerce

dollar without having to put up a dime. The film did OK at the box office but actually underperformed the distributor’s expectations. My client will probably earn around $500,000 over time with zero dollars at risk—the only occasion I have ever generated an infinite ROI! In the second instance, my clients screened a British period film by a relatively neophyte director whom they were greatly impressed by. Although such films typically have limited commercial appeal with American audiences, my clients thought this film could do some business. If we could acquire North American rights for a reasonably low minimum guarantee, it was probably worth the risk. We moved immediately and pipped the usual US arthouse distributors at the post. We managed to lay off 30% of our advance on a Canadian distributor for Canadian rights and negotiated a favorable straight US distribution deal with a specialty distributor for no advance, and with Black Label backstopping a minimum US P&A commitment of $750,000. In exchange, Black Label was able to negotiate low distribution fees, and the distributor did not participate in domestic profits. The film did OK business at the box office but significantly overindexed on home video and VOD. In the end, I estimate we will make between 4 and 6 times the advance we put up. Such opportunities are a secondary consideration in my clients’ business plans, but I always emphasize to my clients to keep in mind opportunistic, out-of-the box deals. One of my other clients, Alcon, had unutilized distribution slot under its output arrangement with Warner Bros. Accordingly, it did a deal with Avi Lerner’s Nu Image to acquire domestic rights on two of Nu Image’s films: 16 Blocks, starring Bruce Willis, and The Wicker Man, starring Nicolas Cage and put them through its deal with Warner Bros. The films were cross- collateralized for Alcon (to be safe, since Alcon had much higher hopes for 16 Blocks, which turned out to be right) and Alcon charged an override on the distribution fees it paid to Warner Bros. (because Alcon guaranteed the P&A) in addition to retaining a big piece of the domestic profits on a complicated waterfall. In the end, Alcon made a nice ROI, which added to the profits it earned on its own slate. This book addresses investment in feature films, but I want to make a few brief comments about opportunities in television. I have tried for years to construct a viable slate model for investment in television, without success. The problem is threefold, at least with respect to prime-time network series. First the risk capital required to fund even one season’s worth of shows is substantial. Under the traditional model for scripted television, the network typically pays a license fee for US rights, which represents a certain percentage range of budget. So, the producer of the show—typically a US major studio—has to cover the rest of the budget, so-called deficit financing, which it must recoup (and hopefully earn a profit) on streaming platforms, syndication and cable plus foreign licenses. Deficit financing is often less of an issue with respect to series on cable television and premium pay channels, either because the budgets are

Art versus Commerce  257

less, or the sponsoring cable network or premium pay channel may provide a greater percentage of budget. Second, television series are even more of a hit business than feature films. The ratio of losses to profits on prime-time series is much higher than is the case in the movie business. But when the studios hit in television, they hit big. Keep in mind that fewer than 30% of all pilots produced are picked up for series, and roughly one third of those last longer than one season. But typically, you need on the order of 88 episodes (four seasons) to have a shot at syndicating a show—although cable channels will frequently accept a lower number. So, the odds of a pilot making it to syndication are considerably less than 10%. The financial model for episodic television series with streamers is very different. Typically, a streamer will take all of the producer’s financial risk off-thetable in exchange for granting the producer a built-in profit, but in exchange the streamer will own the show outright in perpetuity, so there is no potential for the producer to participate in any backend. The third problem revolves around the time value of money. Syndication revenue, which represents the bulk of network TV profits, is very back-ended. Since one typically needs four seasons of programming to successfully syndicate a show, so the outside investors would have to wait considerably longer than is typical in the movie business to recoup their investment and earn a profit. In an era of lower interest rates, that is less of a problem, but it is still a sticking point for attracting outside capital to the industry. When you hit, syndication can be a goldmine. Friends, which was produced by Warner Bros., ran ten seasons (reaching the number one spot in its eighth season). At the end of its run, NBC agreed to pay Warner Bros. $10 million per episode, the highest price in television history for a 30-minute series. Warner Bros. later licensed the show to several syndication platforms, including TBS and Viacom-owned Nick at Nite for a reported $950 million (this does not include its subsequent licensing of the series to various international television networks).3 As I mentioned previously, the studios are aggressively recapturing popular series which they originally produced. Reportedly, HBO Max, the sister streaming platform to Warner Bros. paid more than $400 million for exclusive streaming rights to Friends. Consider the cultural phenomenon of “binge-watching.” While the practice of binge-watching has been around for many years, dating as far back as the late 1970s, when fandom communities indulged in marathon viewing of imported Japanese anime shows, the word burst into mainstream use to describe the Netflix practice of releasing seasons of its original programs simultaneously, as opposed to the industry standard model of releasing episodes on a weekly basis. Actor Kevin Spacey used the 2013 MacTaggart Lecture to lobby television executives to give audiences “what they want when they want it.” He claimed that high-quality stories will retain audience’s attention for hours on end and will reduce piracy. Binge-watching has been likened to reading more

258  Art versus Commerce

than one chapter of a novel in one sitting, and research has shown that heavy binge-watching, contra popular opinion, can actually result in more social engagement, as such consumers are used by others as sources of opinion about what shows to watch, and their opinions are solicited both offline and online. Binge-watching during the pandemic went up dramatically. Hulu, for example, reported that binge-watching on its platform has gone up more than 40% since the virus hit, with shows such as Lost and Scrubs doubling in engagement since last year. And according to the piracy tracker Muso, visits to film piracy websites rose 41% in the United States during the last 7 days of March 2020 compared to the same time period the previous month. The flip side of the coin to binge-watching is the anticipation that is built up as fan audiences await a new season of an incredibly popular show. But if the new season doesn’t deliver, the fan base can be very unforgiving. The final season of Game of Thrones saw an average of 44.2 million viewers for every episode. Even though the final installment generated record-breaking ratings, many critics and fans were extremely disappointed with how the most prominent episodic series of its kind was wrapped up. As proof, in a Huff Post-YouGov poll, 66% of people said they have not watched or re-watched the show since the start of the pandemic, and they don’t plan to. There is one opportunity in television production that I believe can provide an interesting risk/reward ratio for investors. Basic cable channels, premium pay and streaming services are all much more aggressive in developing their own original programming. The models are different for an AMC versus HBO versus Netflix, but the basic cable channels in particular are very cost sensitive, so they are especially open to shows that can benefit from various subsidy programs. Think Canada: my good friend Jay Firestone, whom I met when I started working with Alliance 30 years ago, is the guru of Canadian television coproductions and Canadian qualified productions (which are even more beneficial financially because they can attract equity investment from Telefilm Canada, which is the Canadian federal government agency that, among other things, provides financing for Canadian qualified productions). Jay obviously does not have the resources of a US studio to provide deficit financing on his shows, but with the assistance of Telefilm in 2010 he launched Lost Girl, a supernatural drama, and the show has run for five seasons. He sold the show in the United States to the Syfy channel and later licensed it to Netflix post the Syfy window. What is most important, Jay effectively owns the show (with Telefilm as a minority partner) and he did not have to deficit finance it. Most of you have probably never seen an episode of Lost Girl, but trust me when I tell you that Jay’s ultimate profit on the series will knock your socks off. So be on the lookout for episodic television investment opportunities that can take advantage of co-production benefits and other governmental largesse. That’s

Art versus Commerce  259

another reason for investors to partner with savvy producers who know their way around the complicated world of co-productions and whom they can trust. It’s not that commerce trumps art or art trumps commerce. I like to tell my clients—at least the ones I prefer to work with, who are trying to be involved in quality fare—that they have to find a workable middle ground between the two objectives. By art in this case, I don’t necessarily mean highbrow films that have limited commercial appeal. When I was discussing whether we should cofinance Brokeback Mountain with Bill Pohlad of River Road, I always believed that the film could have genuine cross-over appeal with a broad audience. Sure, the subject matter represented a big risk, but this was more than compensated for by the uniqueness and timeliness of the subject matter—especially under the aegis of a truly great filmmaker in Ang Lee. Bill Pohlad, of all my clients, is motivated to work with truly great directors; you may not strike gold every time, but you are virtually certain to get a unique take on the underlying material. I feel the same about Denis Villeneuve, the director of Sicario. The script of Sicario was good, but the film is far superior in my opinion to the script and for that we can thank Denis—so I was not surprised that Alcon selected him to shoot the reboot of Blade Runner. What I find hard to justify is a business plan that is totally skewed in favor of either art or commerce. As I have shown, if you are totally in the business to produce works of art with questionable commercial appeal, you will inevitably run out of money—it is a virtual certainty. It is more problematic, though, that a similar fate will befall you if you are strictly looking to produce commercial fare that will appeal to the broadest international audience. On paper, that looks like a very feasible strategy—but I would argue that it often leads to producing derivative films that are not sufficiently compelling to attract theatrical audiences. With the ability to watch films now on so many platforms, there has to be something special to attract audiences into the theater—and I am not just talking about receiving good reviews from the critics. Twitter reviews and Rotten Tomato ratings, at least in the case of broad commercial releases, are arguably more important today than what the critics say. It used to be a lot easier to create buzz. I don’t know whether filmgoers are more discriminating today or whether it is just a case of more instantaneous transmission of opinions. Since it is unlikely that you, the investor, will have access to many no-brainer projects like the sequel to Star Wars, you have to find projects with a sense for what my French former head of international sales at Largo termed je ne sais quoi—the opposite end of the spectrum from William Goldman’s quip that “nobody in Hollywood knows anything.” All you can hope for is an educated guess. So, if this book has refined your sensibilities to make such educated guesses, I will have done my job. Having experienced the “slings and arrows of outrageous fortune” for over 30 years in the movie business, I continue to be energized by the challenges film financing presents. Hopefully, people consider me to be a fair-minded commentator on whether or

260 Art versus Commerce

not a deal makes sense for all parties concerned, recognizing that my principal loyalties rest with my clients and investors, but candidly also wanting to preserve my long-standing relationships with the studios, production companies, talent agencies, law firms, sales agencies and banks. I like to think my reputation in town remains intact.

Notes 1 “Love Is All There Is (1996),” Box Office Mojo, www.boxofficemojo.com/ movies/?id=loveisallthereis.htm. 2 Siegel, Tatiana. “Will ‘By the Sea’ Kill Hollywood ‘Favor’ Movies?” The Hollywood Reporter, 23 Nov. 2015, www.hollywoodreporter.com/news/will-by-sea-killhollywood-842647. 3 Carter, Bill. “Friends’ Deal Will Pay Each of Its 6 Stars $22 Million,” New York Times, 12 Feb. 2002, www.nytimes.com/2002/02/12/business/friends-deal-willpay-each-of-its-6-stars-22-million.html.

INDEX

advertising VOD 90 The Aeronauts 86 AI 95, 244 Allen, Woody 85–87, 192 Amazon 62, 69, 73–74, 77, 82–92, 95, 120, 197, 237–238, 242–243 Amazon Prime 82, 83–86, 92, 238, 242 AMC 36, 63–65, 69, 79, 124, 127, 218, 222–223, 235–236 Apple 83, 88, 89, 90 ARD 133 Avengers: Endgame 126 BBC 133, 236, 244 Beasts of No Nation 87 Beresford, Bruce 132 Berlusconi, Silvio 83 The Big Sick 86 The Birth of a Nation 87 Black Robe 132 Black Widow 69 Blockbuster 34 Boardwalk Empire 79 Bollywood 126 Bong, Joon-Ho 129 Bosch 87 Bridgerton 70 Brokeback Mountain 134 Café Society 85, 87 Call My Agent 70 Canal Plus 62, 82, 129, 133

CBS All Access 83, 89, 92 Celestin, Sean 87 Cheers 89 China Film Group 122 Chi-Raq 85 Cinemark 63, 69, 223 Clooney, George 84, 103 CNC 129 Comcast 80, 89, 133, 137, 149 Coming 2 America 69 Conner, Lindsay 125 Credit d’Impôt 129 The Crown 70, 84 CSI: Miami 89 Dailymotion 82 Demolition 130 DiCaprio, Leonardo 84, 172 Disney Plus 74–75 DTS 133 Dune 73 Eddie and the Cruisers II 131 Elba, Idris 84, 195 Epix 34, 59, 79 Fast and Furious Presents: Hobbs and Shaw 126 Fosun 124 Fox Searchlight 87, 203 Fox Soul 91 Friends 93

262 Index

The Fundamentals of Caring 87 Furious 7 123 Gadot, Gal 65, 84 Game of Thrones 79, 92, 134, 135 Global Village Telecom 82 Godzilla vs. Kong 73 The Good Lie 130 Google Play 90 The Guardian 120, 133 Happy Madison Productions 79 Hastings, Reed 77 HBO 34, 45, 59, 65, 72–73, 78–79, 81–85, 89–90, 92, 134–135, 213, 257–258 HBO Max 65, 72–73, 82–85, 89–90, 92, 257 Hony Capital 124, 222 House of Cards 79 Hulu 82–83, 85, 88–89, 92–93, 237–238, 242, 244, 258 IFCIC 129 IMAX 86, 122 In the Heights 73 Industrial Light and Magic 54, 75, 88 Iron Eagle II 132 Irrational Man 87 iTunes 62, 90, 242–243 Jack Ryan 87 Johnson, Dwayne 84 Judas and the Black Messiah 73 Kavanaugh, Ryan 78–79, 188, 190 Kellman Baxter, Robbie 90 L’ Etranger 130 Lawrence, Jennifer 84 Le Monde 129 Le Transperceneige 129 Lionsgate Paramount 51, 79, 137, 156, 172, 203–204, 218, 221, 243 The Little Things 73 Lo Straniero 130 Lonergan, Kenneth 86–87 The Lovebirds 68 Lucas, George 54, 75 Lucasfilm 88 Lupin 70 Lust, Caution 122 McChrystal, Gen. Stanley 80 MacGyver 89

Magic in the Moonlight 87 Malone, John 80 The Man in the High Castle 87 Manchester by the Sea 86, 87 The Mandalorian 70, 75, 88, 92 Marvel 69, 88, 111, 162, 189, 236 The Marvelous Mrs. Maisel 87 Matrix 4 72 Mediaset 83, 133 The Membership Economy 90 MGM 60, 69, 79, 149, 151, 169, 238 Mi Video 82 The Midnight Sky 84 Moore, Sky 124 Mortal Kombat 73 Murdoch, Rupert 83 The Nation 74 Netflix 35, 62–63, 68, 70, 74, 77–87, 89–95, 120, 134, 190, 218, 237, 242–244, 257–258 New Regency 37, 80, 110, 221 No Time to Die 69 The Office 91 One Platform 91 Orange is the New Black 79 Origo Studios 72 Packer, James 36, 80 Page, Ellen 87 Paramount+ 73, 83, 89, 92 Parker, Nate 87 Peacock 83, 84, 85, 89, 91–92 Persepolis 130 Pitt, Brad 80, 102, 216 Plan B 80, 102 premium VOD 64, 90 The Queen’s Gambit 70 RAI 133 Randolph, Marc 77 Ratner, Brett 36, 80 RatPac 36, 80, 254 Regal Cinemas 63, 69, 218, 223 Relativity 51, 78–79, 188–191, 217 Roadside Attractions 86 Robinov, Jeff 124 RTL 133 Rudd, Paul 87 Saltzman, Stephen 125 Sandler, Adam 79–80

Index  263

SAT 1 133 Showtime 34, 59, 79, 218, 223 Sicario 130 Sky Group 83 Sky Italia 133 Sky UK 133 Snowpiercer 130 Sony 6, 27, 79, 92, 101, 103, 137, 149, 155, 180, 191, 194–195, 203, 211–212, 214, 216, 229, 245–246 Space Jam: A New Legacy 73 Spencer, Octavia 84 Sponge Bob 89 Star Trek 89 Star Wars 88 Starz 34, 59, 78–80, 214 Streep, Meryl 84 Studio 8 124 subscription VOD 62, 83, 88, 90 The Suicide Squad 73 Tallulah 87 Telefonica 82 Tom and Jerry 73 Top Gun: Maverick 69 transactional VOD 90, 243 Transformers: Age of Extinction 123, 126 The Trial of the Chicago 7 68 Turner Sports 89 12 Years a Slave 80

Twentieth Century Fox 8, 54, 109 Twin Peaks 89 The United States vs. Billie Holiday 69 Universal 8, 36, 62, 64–65, 69, 79–80, 83, 89–91, 101, 103, 109, 116, 122, 137–138, 162, 168, 170, 184, 191, 195, 203, 205, 216–218, 223, 232 Universal Music Group 82 Veolia 82 ViacomCBS 73, 89–91, 137, 236 Vivendi 82–83 Walt Disney 46, 80, 84, 88, 110 War Machine 80 Warner Bros. 33, 36–39, 47, 50, 59, 65, 68, 72–74, 79, 85, 89, 90, 99–101, 109–111, 124, 128, 159–161, 168, 197, 203, 205, 213, 224, 227, 244, 251, 254, 256–257 WarnerMedia 59, 93 Washington, Denzel 73, 162 Watts, Naomi 84 Without Remorse 69 Wonder Wheel 85 Xiaomi 82 YouTube 78, 90–91, 139, 241–244 ZDF 133 Zendaya 84