The
Hollywood Economist
The numbers behind the industry.
MGM,
once the shiniest studio in the Hollywood galaxy, has fallen
on hard times. Last October it failed to make the interest
payment due on its $3.7 billion debt, and even with the
six month forbearance granted by its creditors, it is hovering
the threshold of bankruptcy. Its equity investors —
including three big hedge funds — have been all but
wiped out. The 140 banks that financed the leveraged part
of the leveraged buyout deal are in danger of losing over
$3 billion. With the creditors demanding their money, and
the clock running on its forbearance, MGM had put itself
up for sale, retaining investment bankers Moelis & Company
to solicit offers from potential buyers that were due in
mid January 2010. For a movie studio that was bought for
$4.85 billion in 2004 (which is over $5 billion in 2010
dollars), the bids that have come in so far are shockingly
low. Time Warner, for example, is offering under $2 billion
and the bid from Lionsgate, once the leading contender,
is worth even less.
The secret numbers in the confidential information memorandum
sent out by Moelis explain the problem, which goes to the
root of what is happening to the movie business today. MGM's
main asset, as is true in the case of all Hollywood studios,
is its library comprised of 4,100 film titles, including
all the James Bond movies, and 10,600 television episodes.
The money that comes in through this library comes from
DVD sales — mainly older titles sold in discount bins
at Wal-Mart and other retailers -– and television
licensing packages to Pay TV, cable networks, and television
stations around the world.
The bet that the hedge funds made when they put up most
of the equity for the $4.85 billion LBO in 2004 was that
DVD revenue from the library would hugely increase when
people replaced their standard DVDs with the Blu-Ray high-definition
format that was just being introduced. But their projections
proved to be pipe dreams. Instead of expanding, MGM's DVD
revenue plummeted, according to the confidential memo. MGM's
DVD revenues fell from $394.7 million in 2008 to just $69.8
million in the 2010 fiscal year (which ends March 31).
This huge drop was attributed to a host of factors, ranging
from the worldwide downturn in DVD sales to fewer new MGM
releases. What turned out to be the real killer for MGM's
library was what the memo termed "significant price
erosion." Wal-Mart, pressured by competition from Netflix,
Red Box, and video downloading, drastically reduced the
"price point" that it would buy older (or so-called
"catalogue") DVDs, driving prices down to less
than $5 a copy. So studios' saw the stream of profits from
older DVDs wither away.
As with other studios, the larger part of MGM's library's
money comes from television licensing. At first glance,
these revenues appear remarkably stable, declining a mere
one percent from $535.1 million in 2008 to $529 million
in 2010. But like other phenomena in Hollywood, appearances
can be deceptive. MGM had structured its long-term licensing
contracts so the cable networks wind up underpaying for
the early years and overpaying for the later ones, which
is a common practice at studio libraries. As a result, even
as properties lose value over the course of the contract
(old films are worth less than newer ones), the illusion
of stability is maintained . Of course, when MGM renews
these multi-year contracts, the money it gets will drop
precipitously.
And as impressive as $529 million in revenues may seem,
it is not the amount MGM actually gets to keep since it
must split these proceeds with various "third parties,"
including producers, stars, directors, writers and Hollywood
guilds. For example, the revenues from the 24 James Bond
movies — which are the library's most valuable asset
generating nearly 30% of its revenue — have to be
split 50-50 with Danjaq LLC, the holding company for the
Broccoli family that originally created the franchise. These
participations and residuals (which is what the guilds get
for their pension funds) totaled $235.2 million in 2010.
In addition, there were $33.2 million in other expenses,
such as calculating and issuing more than 15,000 different
checks per quarter to participants.
MGM also had to pay Fox a fee of $22.2 million for distributing
its DVDs. What MGM kept turned out to be not enough to pay
its overhead — $135.9 million in 2010 — and
other costs, leaving it with a negative operating cash flow
of $52.4 million. The bottom line here is that MGM cannot
pay off its $3.7 billion in debt. And even if a white knight
gallops in to carry off the library, the investors and creditors
will take a bath.
See
The Numbers
T
[back to archive]
|