I am sick and tired of people talking about “content” in the media business. It’s so non-descriptive, and de-personalizing, too. Some time ago I started replacing it with the term “work,” as in, a “creative” work, or an “aesthetic” work, which seems less derisory.
I also dislike the term “product,” in the record business. In addition to the above consideration, now there’s another reason for not using it, which is the migration away from finished goods – physical CDs – towards digital streaming and downloading. In these new contexts, “product” makes even less sense.
While these may seem to be strictly semantic issues, I’ve always been of the view that the way you refer to something, ends up coloring the way you start thinking about it. I was reminded of this problem in connection with Paramount Pictures’ recent acquisition of DreamWorks SKG in December 2005 for $1.6 billion, Waxman, S. & Fabrikant, G., “Viacom Seals Deal To Buy A Studio,” New York Times (Dec. 10, 2005).
In fact, it was considerably less – of the $1.6 billion purchase price, more than $500 million was assumption of debt, meaning, that debt now is buried somewhere in Viacom’s balance sheet. This brings Viacom’s true cost down to $1.1 billion. And, “private equity investors” put up $800 million to $1 billion of that, meaning, Viacom’s net cost was as low as $100 million, but in any event not greater than $300 million.
Furthermore, Paramount now will distribute all of the DreamWorks SKG movies, together with those made by the publicly-traded DreamWorks Animation, such as “Shrek” and “Chicken Run.” This will provide plenty of rake-offs in the form of distribution fees, interest on P&A float, the opportunity to trade off demanded DreamWorks films for less-demanded ones made by Paramount (or vice versa), and similar opportunities.
Subsequently, in March 2006, Viacom sold the DreamWorks “library” to a consortium led by George Soros for $900 million, “Viacom to Sell DreamWorks Film Library,” New York Times (Mar. 18, 2006). The library comprises 59 films, including “Gladiator,” “American Beauty,” and “Saving Private Ryan.”
At least $500 million of this is going to stay in the deal, and be used as a fund to finance new movies, Waxman, S., “DreamWorks Deal Played Like a Drama; Universal Hesitated, And a Hungry Rival Made the Right Moves,” New York Times (Dec. 12, 2005). In other words, the private equity component was reduced by approx. $400 million. This means that Paramount’s net cost on the deal was close to zero; Paramount even could have made money as a result of the transaction.
In any event, the library still will be distributed by Paramount, resulting in additional free cash flow to Paramount of approx. $20 million/year, Sorkin, A., “Soros Group Said to Be Near for DreamWorks Library,” New York Times (Mar. 17, 2006). Furthermore, Paramount is retaining ownership of the music publishing rights, together with all merchandising, sequel and re-make rights; it’s also a minority partner in the new company that’s being formed to own the catalog. Not only that, it has the right to reacquire the library, after five years. This means that all the Soros Group really is getting is some kind of rights to the films, themselves – none of the underlying intellectual property rights.
In Mr. Sorkin’s article, Raymond Lee Katz, an analyst at Bear Stearns, observed that Paramount’s strategy of controlling the distribution rights, but not the films themselves, ultimately may be the best way to go. Mr. Katz was quoted as saying, ‘‘If you’re getting a lot of the milk, it may not be necessary to own the cow.” Another analyst, Harold Vogel, said it was likely that Soros and Dune will look to get a return on their investment through licensing the film library’s content on DVD’s, cable and worldwide television broadcasts. ‘‘They’ll project how much each film can generate,’’ Mr. Vogel said. ‘‘The difficulty is, probably only the top 10 films generate 80 percent of the income,” “Viacom to Sell DreamWorks Film Library,” op. cit.
Possibly the only down-side for Paramount is that it doesn’t get Mr. Spielberg’s exclusive personal services; rather, he retains the right to make movies for other studios, Holson, L., “So What’s the Spielberg Magic Worth?” New York Times (Nov. 28, 2005). This same concept later found its way into the Tom Cruise – United Artists deal; despite now being a 30% owner of the company, Mr. Cruise isn’t obligated to make even a single movie there, Holson, L., “Mission: Rescue Operation; Tom Cruise and Partner To Control United Artists,” New York Times (Nov. 3, 2006). Personally, I can’t figure this out, but I guess that’s what you get when you’re Mr. Spielberg, or Mr. Cruise.
The real issue behind the DreamWorks catalog deal is, “what’s it worth?” And the answer is, “not as much as you might think.” Not only is there the 10-80% problem correctly identified by Mr. Vogel, but there’s another more insidious problem, too. And that is, all of these films are hedged with commitments.
On the “input” side, there are deals with actors, directors, writers, producers – all of the above-the-line personnel required to make the film, in the first place. These arrangements have the potential to consume the lion’s share of cash generated by the film’s commercial exploitation, before the studio sees dime one.
On the “output” side, the cash flow that the film potentially can generate is only as viable as the ability of its distributor to market and promote the film effectively. With independent films, these means a dog’s lunch of licensees of various media rights in foreign territories, together with a domestic television and video deal (most often these rights are conveyed to the picture’s domestic theatrical distributor, as a hedge against domestic theatrical costs). Often, the “term” (i.e., chronological length) of these licenses is 20 years. A major studio like Paramount self-distributes, or at least has the capacity to self-distribute and commercially exploit all rights, worldwide; in which case, the first scenario (i.e., you’re dependent upon them to do something) pertains.
The paradox is caused by the fact that these various grants of rights encumber the film. However, they’re vital to the film’s success, because without them, there’d be no way to generate cash. There is no such thing as an “unencumbered” film. Rather, the key is to analyze the composition and quality of the various encumbrances.
And this is where the “library” concept gets dodgy. Odd as it may seem, the nominal “owner” of the film’s copyright most often is a minority participant in the revenue stream the film generates. The vast bulk of the money goes to gross profit participants (on the “input” side), and distributors and sub-distributors (on the “output” side). It’s not like the copyright owner gets to sit there at a giant mahogany desk all day and simply count money. The DreamWorks catalog deal seems especially over-reaching, given the nature of Paramount’s retained interests and on-going participations. If I was Mr. Soros, I’d be nervous whether, at the end of five years, I’d be able to get out with the skin still on my teeth.
Here’s the way I’d go about evaluating the worth of the catalog. First, I’d triage the films, in much the manner Mr. Vogel suggests. Second, I’d prepare informed projections as to each film’s anticipated future revenue, then extract all participations and other fees and costs. I would do this over a time horizon of, say, 10 years, which pretty much is the end of any film’s product life cycle (with exceptions comprising maybe one-tenth of 1% of all the movies ever released). Third, I would make certain interest rate assumptions tied, say, to 10-year treasury bonds, which probably is the best-available proxy. Fourth, I would establish the present discount value of the income stream potentially generateable by each film, over its useful life. Fifth, I would add these numbers up, and that’d be the value of the catalog.
In principle, this analysis is the same suggested by the American Institute of Certified Public Accountants (“AICPA”) in its Statement of Position 00-2, Accounting by Producers or Distributors of Films (Jun. 12, 2000). This requires studios to amortize film costs “in the same ratio that current period actual revenue (numerator) bears to estimated remaining unrecognized ultimate revenue as of the beginning of the current fiscal year (denominator).
Significantly, if events cause the denominator to go down – for example, the film isn’t as popular in FY2 as we thought it would be in FY1 – the studio is required to “write off to the income statement the amount by which the unamortized capitalized costs exceeds the film’s fair value.”
This happens all of the time, not so much at the big studios, but rather to smaller ventures like (surprise!) DreamWorks Animation. For example, DreamWorks Animation “expects to take a write-down in the fourth quarter on its latest animated film, “Flushed Away,” which opened just two weeks ago,” “DreamWorks Animation Warns of ‘Flushed Away’ Write-Down,” Wall St. Journal (Nov. 15, 2006). “Flushed Away” cost DreamWorks $142.9 million to make, and, as of the date of the article, had taken in only $40 million at the box office. “Flushed Away” was made by the same producers who made “Wallace & Gromit in the Curse of the Were-Rabbit.” Continues the November 15th article: “That movie, while a critical success, also disappointed both at the box office and in home video release and DreamWorks was forced to write down $25.1 million of its cost, or 15 cents a share.” Fortunately for DreamWorks, “Shrek the Third,” a potentially more-demanded film, will open in May 2007.
These are huge numbers with the capability to reshape drastically a company’s financial statements. To me, at least, they raise the question about the viability of single-purpose “creative” companies, that are publicly traded. Current examples include not only DreamWorks Animation, but also Warner Music Group. These firms are completely dependent upon the capricious success or failure of films, or the unpredictable delivery schedules of “hit” artists.
Furthermore, even the best-laid plans frequently go awry. Not only are there box-office flops, but supposedly “hit” artists may lose favor with the public. For example, this certainly was the case with Mariah Carey, to whom Virgin Records (a unit of EMI Music) paid $28 million to get out of its contract with her, upon the failure of her record+film, “Glitter,” Kuczynski, A. & Holson, L., “Record Label Pays Dearly To Dismiss Mariah Carey,” New York Times (Jan. 24, 2002). This would be, of course, in addition to advances, recording costs, and marketing and promotional costs, to make the record, to begin with.
About the only way to make sense of this is to conclude, with Messrs. Katz and Vogel, that ownership of distribution and marketing assets is more important than ownership of “content,” per se. Mr. Katz’s views recently were seconded by his fellow Bear Stearns analyst Spencer Wang, who is quoted as having “suggested that the much-discussed Long Tail in today’s digital world means that ‘aggregation and context and not (necessarily) content are king,’” Szalai, G., “Content isn’t always king on Wall Street,” Hollywood Reporter (Nov. 28, 2006). Mr. Wang continued: “Our quantitative analysis of the evolution of increased choice in TV suggests that this theory will be true in the broadband world. This increases the value of ‘middle men’ or packers of content that can filter out the ‘noise’ associated with unlimited choice and connect users with content that appeals to their interests.”
Right said, Fred!