Fancy a negative pickup?

Superman, The Empire Strikes Back, Never Say Never Again and Lone Survivor. What do these films have in common?

They were all financed and distributed according to a negative pickup arrangement. Even Terry Gilliam’s Brazil, a negative pickup for Universal Pictures produced by Arnon Milchan: in this particular case, the studio had creative disagreements with the director over choice of star, content, and duration, and failed to resolve these issues to its satisfaction, because the negative pickup had essentially granted Milchan final cut.

The negative pickup is a type of film financing arrangement, an interparty agreement in which the parties involved are bank, completion guarantor, producer, and distributor, usually bank financed with the collateral being a Distribution Agreement from a trusted and creditworthy Distributor or Studio then owning distribution rights upon delivery of a completed film negative by a stipulated date and in accordance with the terms of the agreement, where the pickup price shall include cost of budget (which has to include a completion bond which premium usually amounts 3-5% of the production budget and contingency), cost of interest, origination fee, bank and legal expenses.

superman-1978

Superman (1978)

The Producer, having agreed to sell distribution rights for certain territories to a Distributor (or two, in the case of a split rights deal where one gets domestic and the other international rights) who has in turn agreed to pay on delivery within the Distribution Agreement, borrows funds for production to be repaid on delivery from a Bank within the Loan and Security Agreement, whereas a Completion Guarantor oversees production and has right of takeover within the Producer’s Agreement, and agrees to guarantee delivery per Distribution Agreement or repay the bank within the Completion Guarantee.

The interparty agreement defines effective delivery, inspection, quality control (usually 10-14 days), cure periods (usually 10 days) and arbitration procedures (a period of time that bears interest) as defined by IFTA if Distributor, Producer and Completion Guarantor argue over whether effective delivery has occurred or not, and thereby who repays the Bank, the Distributor if effective delivery has occurred or the Guarantor if it has not, and at that point the Guarantor owns the film. Therefore the Guarantor has both Preliminary (Production Analysis) and Balance of Requirements (Document Analysis) and reviews all the related documents before issuing the bond: the Guarantor does not like essential elements (e.g. stars), and also can stop enhancements (additional items added to production) and force the producer to pay from his own salary.

Pre-sales is a variation of negative pickup in which distribution rights are sold territory by territory resulting in multiple Distribution Agreements that are used as collateral for the loan, where there is usually a Minimum Guarantee plus revenue share arrangement for each primary territory (secondary territories are usually not accepted as collateral), an advance paid immediately and the rest upon delivery, there is usually one or more sales agents who get a 10% fee collectible once the bank has been paid back (so agents usually oversell till 120% to get their fees), unsold territories can be added up as collateral paying an extra interest on the gap and usually only if they are worth twice the financing gap and such gap does not exceed 20%.

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Brazil (1985)

A negative pickup arrangement reduces the downside risk for investors that the film does not find a distributor at all, perhaps because it is not as good as anticipated, from the studio’s point of view it is not taking much risk because if the negative is not delivered or delivered not exactly as agreed, then the studio has no obligation, and safer also for the producer because such requirements are purely contractual and not regarding artistic value of the work. Furthermore, the distributor does not share the risk that the film goes over budget, since a completion guarantee will have been provided, the producer may get a better deal from competing distributors upon a potentially good film, and it enhances foreign sales potential. However, the producer still has to obtain financing from sources other than the studio or distributor that is a bank or other investors; also, the arrangement embeds a risk/reward ratio in the sense that the more risk the producer assumes relative to the distributor, the better deal the producer will be able to negotiate, and is potentially less rewarding for the producer and less expensive and somehow speculative for the distributor, requiring complex transactions and high therefore high transaction costs, thus definitely belonging to producers with a proven track record, major and trusted distributors and a relatively small circle of qualified professionals and financiers.

Global box office inflated by Chinese wind, US suffering

According to the annual Theatrical Market Statistics Report for 2014 by the Motion Picture Association of America, Inc. (MPAA) released yesterday, the global box office increased by 1% to a new record of $36.4 billion. Domestic (U.S./Canada) dropped by 5% at $10.4 billion. The Asia Pacific region was up by 12% overall, whereas China’s total of $4.8 billion (first international market to exceed $4 billion) was up a huge 34%, which alone improved the combined global total. Latin America box office increased 2% (but is up 46% from 2010) to $3 billion, Europe, Middle East & Africa (EMEA) decreased 3% ($10.9 to $10.6 billion) from 2013, due to decreases in larger European markets such as Germany (-7%) and the U.K. (-1%).

Growth-of-Global-Box-Office

As far as the infrastructure, total cinema screens increased 6% worldwide in 2014 to over 142,000, due in large part to continued double digit growth in the Asia Pacific region (+15%) now accounting for more than 47.3 thousand screens against 43.2 in US/Canada, 40.4 in EMEA, 11.2 in Latin America. 90% of the world’s cinema screens are now digital, up 7 percentage points from 2013 (83%), 51% (47% in 2013) of which are 3D. In particular, in the US, the majority of screens (84%) are located at venues with 8 or more screens. The number of screens at venues with seven or fewer screens continued to decline, despite an overall increase in the number of screens.

Looking at moviegoing in the domestic market, what is particularly worrying is the drop of admissions: tickets sold (1.27 billion), and average tickets sold per person (3.7) both declined by 6% in 2014 in US and Canada, which is the lowest level in many decades, while the average cinema ticket price increased by only 4 cents (less than 1%) in 2014, less than the rate of inflation in the economy.

Going more in depth, 229.7 million people (68% of of the U.S./Canada population aged 2+, 52% female and 48% male) went to a movie at the cinema at least once in 2014 (“moviegoer”):

  • the typical moviegoer bought 5.5 tickets over the course of the year (down from 5.9 tickets in 2013);
  • frequent moviegoers (once a month or more) are 11% of the population but accounts for 51% of all tickets sold, a 1.2 million and 3% increase from 2013;
  • the number of frequent moviegoers increased (40-49 and 60+) or remained flat (50-59) among 40+ age groups, but fell or remained constant for younger age groups, including the largest frequent-moviegoing age groups (18-24 year olds and 25-39 year olds are 1.7 and 2.7 million less respectively within the last two years);
  • per capita attendance declined for all age groups under the age of 40, increased for 40-49 year olds (3.6) and 50-59 year olds (3.1), which also had their share of tickets sold at all times high and remained flat for 60+ year olds compared to 2013, even though the 12-17 year old age group (6.4) had the highest per capita attendance, followed by 18-24 year olds (6.2);
  • despite a decline in 2014, Hispanics especially continuing to oversample in tickets sold versus their proportion of the population, while Caucasian and Asian/Other frequent moviegoers increased in 2014 compared to 2013;
  • over two-thirds of all frequent moviegoers (73%) own at least four different types of key technology products, compared to 55% of the total adult population;
  • California and Texas had more moviegoers and the largest number of frequent moviegoers (5.9 and 4.1 million, respectively).

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Other key trends to keep in mind:

  • 3D is less appealing than ever but highest grossing films are released also in 3D. The percentage of the population who were 3D moviegoers in 2014 fell for all age groups, with larger declines for age groups below 40 years old and the format comprising 14% of the overall box office, however 9 of the top 10 and 15 of the top 25 films were released in 3D.
  • More theatrical releases. Films released in theaters by MPAA member studios increased for the first time in five years, reaching 136 in 2014, a +19% compared to 2013. Total films released and films by non-MPAA member studios also increased from 2013 (up to 707 or 7% and to 571 or 5%, respectively),  higher than any other year in the last decade.
  • PG-13 films comprised 14 of the top 25 films in release during 2014.
  • Total film produced for theatrical release with a budget of $1 million or higher were 481 (+6%), of which 110 (+4% were MPAA member studio films.
  • Among the top five grossing films in 2014, Guardians Of The Galaxy, Captain America: The Winter Solider, The Lego Movie (which earned 64% of box office revenue from Caucasian audiences) and Transformers: Age Of Extinction (which drew the most ethnically diverse audience) all attracted majority male audiences. The Hunger Games: Mockingjay Part 1 showed the strongest female attendance of the top 5 films, with 57% of the film’s box office revenue coming from women.

Let’s try to sum everything up.

Compared to the previous year, in 2014 the Asian gross box office increase has offset the decline in US/Canada and Europe resulting in a slight global overall growth. Furthermore, there are now more screens, more concentrated in multiplexes and more digital, and more films were released theatrically, despite domestically considerably less tickets were sold on average, to an older audience and the frequent moviegoers (who are also tech-savvy) now totally sustain the market purchasing the majority of the tickets. The highest grossing films are rated PG-13, released also in 3D and attracted male audiences mainly, deviating slightly from the general moviegoers population. Hispanics are more likely than any other ethnic group to purchase movie tickets, while California, Texas and Florida are the most receptive states.

All in all, it looks like the movie theater is becoming, partially due to competition from other forms of entertainment primarily digital VOD, something appealing to a narrower (32% of the population did not go to the movies at all) and older target population of frequent moviegoers, with more films being released in theaters for less time, while China’s growing appetite for American movies comes at a welcome time for the industry.

There is certainly at this point a need for US distributors and exhibitors to analyze these data carefully and come up with new concepts, strategies and business models for keeping up with the demands of their actual and potential moviegoers. Starting from understanding how to adapt to the digital challenge.

Netflix valuation, a House of Cards?

Worldwide fans of Congressman Francis Underwood’s adventures are going nuts for the release of Season 3. Yet the market is not impressed: NFLX share price dropped by 1.68% on the same day.

In fact, analyst widely agree Netflix current valuation (Nasdaq: NFLX) depends heavily on its ability on creating quality original programming and marketing them effectively. The uncertainty on future strategy which causes high volatility and recently determined a fully recovered sharp 26.4% drop needs to be addressed more clearly.

Netflix said its 320 hours of original programming in 2015 actually cost less than most of its licensed content. “We try to make each project more efficient and effective than studio content we’d otherwise be licensing,” the company said in its fourth-quarter investor letter.

house-of-cards-season-3-teaser

For its part, Netflix has been transparent about its ramp-up in spending for original content that brought 45 Emmy, 10 Golden Globe and two Academy Award nominations and several wins in just two years. “We will continue to grow the percentage of our content spending dedicated to originals for the next several years,” the company said. “This will mean more cash usage, which means more debt.” Looking at the number of shows, basically every four weeks we’re going to have something new and fresh to watch on Netflix with House of Cards-like quality. But financially this means using cash and increasing debt for pushing a complicated international growth that is at the moment the most credible growth strategy.

It has also been noted that while concerns over profitability and negative free cash flow appear to be an afterthought for investors right now, at some point that attitude will shift and when that happens, we can expect Netflix shares to trade down significantly from their current levels at 109.84 P/E ratio.

Nevertheless, the recent ruling in favor of net neutrality, the principle that Internet service providers and governments should treat all data on the Internet equally, was a big win for Netflix as product and for the digital distribution sector in general, since ISPs will not be able to discriminate or charge differentially by user, content, site, platform, application, type of attached equipment, or mode of communication.

Season 1 and 2 of House of Cards helped the streaming giant adding globally a total of 3 and 4 million subscribers respectively, whereas the main effect of the new season may be the retention of current customers rather than new subscriptions. The growing curve is slowly flattering and Los Gatos should open up new business opportunities in order to build up new revenue streams if they want to survive the increasing competition, from legal players as well as from piracy, which also causes higher marketing expenditure. One direction could be finding a way to exploit the potential synergies with theatrical day-and-date releases as they are going to do with Crouching Tiger, Hidden Dragon II: The Green Destiny.