Hollywood Money

The Motion Picture Association of American held a symposium to educate U.S. lawmakers about the entertainment industry in efforts to highlight its importance, especially in creating jobs (about 2.5 million with about $41.1 billion in wages, and 1.7 million indirect jobs) and having a global trade surplus in these times of recession, in addition to encouraging federal involvement in trade issues such as fighting copyright piracy; Vice president Biden was among those who spoke. All of this information indicates that the entertainment industry is actually an integral part of the American economy and thus can have “a big, important, positive factor to economic renewal,” as said by Dan Glickman, chairman and chief executive of the MPAA. Lawmakers apparently failed to see this point as seen by their recent legislation.

The symposium was held in light of the fact the U.S. Senate took away $246 million in tax breaks for entertainment companies in February, excluding the industry form President Obama’s $787 billion stimulus package. This was an ill-advised move from the Senate, since it did not get much debate, and may prove detrimental for the industry. As said by Eileen Burke, the principal of West End Capital Advisory, “Consistent with the financial markets as a whole, film lenders and investors are taking a much more conservative approach to structuring deals than they previously had.” As a result, it is becoming more and more challenging to get films financed and made. It does not help that the industry has also lost its tax breaks on top of the challenges it is already facing.

Up until 2008, major banks from Merrill Lynch to Lehman Brothers, supplemented by hedge funds, pumped about $15 billion into Hollywood. However, due to some box office duds and the credit freeze, these banks, with the exception of JP Morgan, have all cut back. Though these moves may not directly affect current films being released, they will have an impact on the kinds of deals able to be made for the financing of future films. As reiterated by Tom Adams, president and senior analyst with Adams Media Research, “It’s a different era from four years ago when people were clamoring to be in film deals.”

To justify recent legislation, lawmakers are using better than average box office sales as an excuse to take away tax incentives, saying there is no need for tax breaks, despite the obvious challenges Hollywood is facing. However, they fail to understand Hollywood depends on much more than just the weekend box office to operate. Willing investors are necessary to keep the Hollywood machine running as aggressively as it has been. Because of the recent actions taken in Washington and the condition of the economy, it is very likely the industry will experience a noticeable slow down. Not only is there less money being pumped in, there is more money being pumped out via taxes. A few good box office numbers may be able to sustain the business in the short term, but the situation will look dire further down the road, especially with big-time investors like banks closing their pocket books.

The credit crisis has forced banks to become much more conservative in their Hollywood investments, and to add to the challenge of getting films financed, DVD sales have slipped 6% in the last year. They are expected to fall further due to the maturing market slowly making its transition to high-definition Blu-ray and digital distribution models, both of which offer lower profit per transaction. This is problematic because operating margins at film studios have come to rely on DVD sales. Bankers say falling sales are factoring into financing negotiations between lenders and studios like Warner Brothers, Paramount, Twentieth Century Fox, Sony Corporation, and Walt Disney Company. As said by Burke, “If a company’s business plan relies on robust DVD revenues, it’s likely to be an area where lenders will haircut projections and their lending advance rates. It’s part of the overall analysis you do when determining how much ‘lending currency’ is available for a particular deal.”

In agreement, Stephen Prough, founder of Salem Partners, which advises investors on how to maximize on film investments, said, “The decline of video revenue is something the industry will have to deal with. Economic expectations will have to be adjusted and production costs will have to come down,” noting that studios run “green-light” models to analyze releases. This model means studios determine a film’s ability to turn a profit by calculating potential high and low box office ranges and video and TV revenue. Due to lower video estimates, studios are opting either to scrap films altogether or fix elements on the cost side (most of which are cuts at the expense of talent). While some studios like The Weinstein Company and DreamWorks is seeking financing, others like Paramount are co-financing on a film-by-film basis after many of the big slate deals over the last couple of years failed to delver.

Recent box office hits are not necessarily indicative of the trouble Hollywood might experience in the future, something lawmakers fail to see. The downward economy has clearly affected studios and financing of future projects. The industry deserves fair representation in Washington and the MPAA is taking the appropriate steps to see this gets done. Thankfully, Hollywood is not asking for a bail out, yet.