The numbers behind the industry.
true brilliance of Paramount’s high-profile acquisition
of Dreamworks SKG last week is that it will serve to divert
from, if not totally hide, Paramount’s own failure
to assemble a full slate of films for 2006-2007. Compared
to the public-relations cost of revealing that managerial
meltdown, the $1.6 billion price tag for Dreamworks SKG
must have seemed a bargain.
Here is what happened, according to people at Viacom (Paramount’s
corporate owner). In 2004, Sumner Redstone faced the prospect
of a massive loss, one that would ultimately exceed $24
billion. The loss was not due to Paramount’s blunders
but rather the falling values of Viacom’s Infinity
radio stations and Blockbuster video stores. Someone other
than Redstone, the CEO, or Viacom’s vice chairman
Philippe Dauman, however, had to take the blame for the
sea of red ink. Why not the heads of the movie division,
who had already been criticized for a long string of box-office
bombs in 2003? Following this logic, the studio heads Jonathan
Dolgen and Sherry Lansing were axed.
The irony of this regime change was that Paramount’s
movie division had consistently hit its profit targets.
Although its movies had performed badly at the box office,
the old regime, under Dolgen’s tutelage, had so perfected
the art of the convoluted deal that 75 percent of Paramount’s
movies, even those that appeared to be bombs to the outside
world, made a profit due to the assiduous use of OPM, a.k.a.
Other People’s Money. A term that includes the proceeds
from “money for nothing” tax shelters, foreign
production subsidies, and foreign pre-sales. Consider Lara
Croft: Tomb Raider, for example, the acme of such deal
pyramiding. Its budget was reported as $94 million, but,
after the enterprising financial arrangements, it actually
cost Paramount less than $7 million to make. While the art-of-the-deal
formula didn’t always produce award-winning movies,
to say the least, the studio under Dolgen and Lansing had
a nearly 60 percent return on its invested capital. The
disadvantage, for Dolgen and Lansing, is that such legerdemain
works best when it’s invisible to outsiders.
Enter the new regime. When Brad Grey took over as studio
chief in January 2005, he had a mandate from Redstone and
Tom Freston, who now effectively headed Viacom, to totally
revamp moviemaking at Paramount. To this end, he brought
in McKinsey & Co to consult on the great reorganization.
Grey let it be known that he wanted to make money through
movies and not off-the-book OPM deals. When a senior executive
outlined five off-balance sheet tax driven deals, which
would have netted $50 million in bottom line profits, Grey
aborted them, explaining to him, “We don’t do
things like the old management.” The executive resigned
the next day. One by one, Grey and his new management team
cancelled almost every project already in process. He also
forced out most of the executives who pieced together these
deals. As a result, Paramount found itself with almost few
viable projects in the pipeline—except for Tom Cruise’s
Mission Impossible 3 (which Grey also came close to killing).
It’s easy to terminate upcoming movies but it’s
extremely time-consuming to package scripts with stars and
directors. The studio, with rising overhead and falling
morale, faced what one Viacom executive described as “a
Desperate for a slate of new product, Grey turned to Dreamworks
SKG, which had about 30 movies in the pipeline for 2006-2007.
The company had also been trying without success to sell
itself to NBC-Universal. When Grey started negotiating with
David Geffen—the “G” in SKG—Redstone
“went ballistic,” as one of his associates put
it, over the $1.6 billion price tag for Dreamworks SKG and
had Grey pull out of any talks. Then, Spectrum Equities
Investors, a private equity firm specializing in media and
telecom deals, came to the rescue. It offered to put up
about half the $1.6 billion price in return for the cash
flow from the Dreamworks SKG’s library assets. This
contribution allowed Paramount to justify the remaining
$800 million outlay since Dreamworks SKG’s slate of
movies in production and in the pipeline would fill the
gaping holes in Paramount’s 2006-2007 schedule.
The value of these 31 projects was reckoned to be about
$600 million. The remaining $200 or so million could be
chalked up to “key money” or the price for getting
the right to distribute the films of Dreamworks Animation
(a separate company from Dreamworks SKG, headed by Jeffrey
Katzenberg, the "K" in SKG)) and a relationship
with the celebrated “S” in SKG, Steven Spielberg.
However, the distribution fee of 8 percent that Paramount
will receive on Dreamworks films is very low, indeed, a
quarter of what Hollywood studios usually charge, and Spielberg
is already doing Paramount co-productions, including such
hits as Minority Report, Saving Private Ryan, and
War of the Worlds. This is generous key money,
even by Hollywood standards.
After Redstone gave his blessing to the acquisition, Spectrum
found it could not accept some of the terms in the deal,
such as the lack of the right to cancel Paramount’s
contract to distribute the Dreamworks library, and Spectrum
(at least temporally) withdrew its offer. Nevertheless,
Paramount, assuming other private equity investors would
take Spectrum’s place, went ahead with its “coup”
(as the New York Times described it.). The offer prevailed
because the other contender, NBC-Universal, was not in the
same predicament as Paramount. It had a sufficient number
of movies in its pipeline so it did not need Dreamworks’
future slate of movies. Bob Wright at Universal, unlike
Brad Grey at Paramount, to spend $1.6 billion to buy his
way out of looming failure. Because of this asymmetry, Dreamworks
was worth much less to Universal, or any other Hollywood
studio with a full slate of movies, than it was to Paramount.
Indeed, only Paramount could internally justify a $600 million
premium for Dreamworks’ pipeline of future movies.
this deal closes, Paramount will essentially become, at
least for the next two years, Dreamworks. Of course, many,
if not all, of the people who work at DreamWorks will lose
their jobs and the people at Paramount who created the near-meltdown
will take credit for the slate of films they’ve acquired.
But, as they say, that’s show business.
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