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Why Lions Gate Is on the Road to Failure

June 2nd, 2009 by David Kronemyer · 4 Comments

Lions Gate’s fourth quarter results were mediocre, as was its FY 2008 – 2009.  There are several reason for this, including developing softness in the DVD market; over-spending on marketing and promotion; its ill-advised acquisition of the TV Guide cable channel; and a distribution deal it made with the kiddie-video firm Hit Entertainment.  See Joe Flint’s article “Lions Gate swings to loss,” Los Angeles Times (June 2, 2009). 

One factor Flint doesn’t analyze is the cost of taking on third-party distribution deals like it did for the movie “The Haunting in Connecticut” which was produced by Gold Circle Films.  Lions Gate also recently announced a similar deal with Ryan Kavanaugh’s troubled Relativity Media, see Claudia Eller’s article “Lions gate turns to Relativity Media to fill movie pipeline,” Los Angeles Times (April 28, 2009). 

Here’s how these deals work.  The distributor (Lions Gate) has a fixed amount of overhead that it needs to amortize over the number of films it puts out each year.  If it doesn’t have a sufficient number of its own proprietary releases to do so, then it tries to make up the shortage by “renting” its system out to somebody else.  Instead of earning a profit from distributing the movie (or incurring a loss if it isn’t successful), all it gets is a modest distribution fee, typically in the range of 15%.  Typically the producer pays all prints and advertising, which typically runs (or should run) in the range of 10%. 

Let’s analyze how this pertains to “The Haunting in Connecticut.”  Domestic theatrical box office gross is that reported by Daily Variety.  All other numbers are informed estimates based on typical industry outcomes:

Domestic theatrical box office gross:                                    $ 55,389,516

Less 50% to exhibitors                                                                 27,694,758

Gross distributor margin                                                          = 27,694,758

Less 10% P&A reimbursement                                                     5,389,516

Less 15% distribution fee to Lions Gate                                    4,154,214

Gross producer margin                                                              = 18,151,028

Less production budget (est.)                                                 10,000,000

Net producer margin                                                                  =   8,151,028

While the numbers aren’t in yet, Lions Gate also will handle domestic DVD sales, for which it will earn a distribution fee, typically in the range of 15%.  It also may handle domestic TV sales (when that window materializes), for which it will earn a distribution fee, typically in the range of 5%.  In some cases the distributor gets a slice of the net producer margin, however in this situation it seems unlikely seeing as how the Lions Gate didn’t incur any proprietary risk in connection with the property such as putting up P&A funds or paying the producer an advance against anticipated revenue.  Significantly Lions Gate will earn zero on foreign sales, even though a domestic theatrical release considerably enhances the value of those rights.  All foreign sales revenue will be retained by the producer (Gold Circle), subject to whatever foreign sales agreements it has in place.

From the producer’s standpoint I would evaluate this as an excellent result, though of course out of this the producer has to deduct all of its selling, general and administrative costs; together with post-production interest (“Haunting” sat in the can for over two years before being released).  It also has to amortize all of its failures over those films that are successful.  Gold Circle’s “New in Town” with Renee Zellweger, for example, made $16.7 million, yet cost approximately $15 million to make; “Over Her Dead Body” with Eva Longoria made only $7.6 million, with approximately the same negative cost.  Both are subject to the same arithmetic set forth above, resulting in huge losses. 

From the distributor’s point of view, however, these deals are rarely profitable.  The reason why is that the distributor’s services are inefficiently priced.  The value of a domestic distribution relationship to the producer far exceeds the amount the distributor charges for services (particularly with foreign sales, where Lions Gate earns nothing, even though having a domestic theatrical release significantly enhances the value of those rights).  The distributor typically undercharges for its services in relationship to their actual cost.  By the time personnel costs and corporate overheads are factored in, the distributor often spends more than it makes.  Finally and most importantly the distributor loses return on time.  Every property takes a certain amount of effort and energy to market, advertise and promote.  The amount of this activity isn’t scalable to revenue actually received.  Every minute the distributor spends servicing third-party properties, it could be spending on working its own proprietary films, which exponentially greater revenue potential.  For this reason it truly might be said that the third-party distribution deal is the last refuge of a firm on the edge of failure, because in the end it lacks sufficient creativity to develop and produce its own product.