The Superhero business is booming. Marvel Entertainment's (MVL) first self produced movie, Iron Man, dominated the weekend box office, earning an estimated $201m in global receipts in its debut. At the same time, on Wall Street, the company didn’t fare badly either. Marvel posted a better than expected quarter and raised 2008 guidance. These numbers are only a small part of a bigger story.
BY THE NUMBERS
Iron Man’s actual weekend gross according to Box Office Mojo came in just under $100m at $98.6. The receipts, however, were still enough to push the movie into an elite list, housing the top ten opening weekends of all time. Not bad for a company’s first effort at making a film themselves (Paramount is handling distribution).
On the Street, Marvel reported net income of $45.2m or 58 cents a share. That result beat adjusted analyst expectations of 45 cents a share on revenues of $113.5m. The company also raised sales outlook for the rest of 2008. The lower end of the projected net sales range is now set at $370m, up from $360m. Income is forecast in a range of $1.35 to $1.55 a share, up from a range of $1.30 to $1.50.
THE BIGGER PICTURE
Strong as Marvel’s immediate numbers are, the bigger picture isn’t today’s box office or earnings but how Marvel has redefined itself, and where the new version might be headed.
Just 12 years ago, the company founded in 1939 and famous for giving life to characters like the Fantastic Four and Spider Man was in bankruptcy. Despite thousands of characters, a library of comic and superhero icons, the money wasn’t there. Poor deals were partly a factor. Licensing agreements struck in that era were paying Marvel a pittance of an allowance compared to fortunes directed to movie makers.
According to one Lehman Brothers analysis, the first two Spider Man movies earned the company just $62m in licensing fees. That’s not even 10% of the $821million Spider Man 1 did at the box office internationally. Compared to the combined $1.5billion the two movies earned, plus DVD revenue, merchandise tie-ins, and TV licensing income, it’s likely a fraction of a percent.
To try and retake a larger portion of that pie, Marvel needed to have more control over movie making. They needed to be able to control full content development. To that end, consultant Ryan Kavanaugh and his Relativity Management Company and then Marvel executive Ari Arad (no longer with the company) and David Maisel (Marvel’s current Chairman) together hatched a new approach. Marvel’s current successes are partly riding on the back of that strategic plan.
The first step in the reinvention was animation. Rather than relying fully on licensing income, Marvel Studios took all creative development and design responsibilities on titles to build around Marvel characters. They contracted out animation duties to third parties and the releases were issued Direct to DVD.
The second part of the plan was the key: film finance and feature production. Rather than licensing characters to the studios and taking a production credit, Marvel would build a true studio of their own. That would allow them to control development, set release schedules, and more importantly, give them the lion’s share of all non-theatrical revenue (DVD sales and rentals, merchandise and toy sales, video games, and TV licensing). The deal also insures Marvel has the films in their own library – a vault from which future revenue streams will come back to them, rather than enriching some other studio.
A financing deal, alternately credited to the team of Maisel and Arad, Maisel alone, or Ryan Kavanaugh, made the in-house film production possible. The deal in 2005, backed principally by Merrill Lynch, was entirely debt based but unusually structured.
In total, Marvel got a $525m credit facility. $60 million of that money was structured as a mezzanine round to pay closing costs, interest and other expenses. The remaining $465m was characterized as senior and insured by Ambac (ABK). The clever factor is that Marvel has no responsibility for repayment in the event of a failed film. The deal with Ambac instead uses Marvel’s comic characters as collateral. There is no capital outlay. On Marvel’s financials, interest on funds borrowed to finance film production is capitalized through the delivery of the completed film. That Capitalized Interest is amortized then as a cost of production.
For the loan, Marvel is paying LIBOR plus 7% interest and a .935% Ambac insurance premium. That assures them a minimum of 5% of all film related revenue as a producer fee, control of free TV distribution, guaranteed distribution rights for Germany, France, Spain, Japan and Australia/New Zealand (US distribution is through partnership). The only catch is, the films need to be rated PG-13 or better (no R rated films) and be budgeted between $65 and $165m. That… and they need to be successful. If a movie fails to recoup expenses, Marvel can lose film rights to the pledged characters.
All in all, it’s a highly favorable deal. If Marvel can’t make money with a character in the theaters, then having the film rights in the future aren’t going to be worth as much to them anyway.
Chairman David Maisel told the New York Times more than a year ago: there “[hasn’t] been a new studio making $100 million movies since DreamWorks (NASDAQ:DWA),” he said. “We’re going Hollywood, but in a smart way.”
That seems, so far, to be accurate.
The deal runs through 2012/2013 and allows Marvel to make up to ten films.
Iron Man was the first movie out of Marvel’s cleverly financed studio to hit the theaters; the first test. With $100 million on opening weekend, things are looking pretty good. There’s little worry this movie will come up short at the box office.
Just how much it makes, or how big Marvel’s Return on Investment will be, is another question. Movies can be a fickle business. Some titles are hits (Spider-Man), others flop (Elektra), and budget sizing or how substantial the star power is, doesn’t guarantee one over the other. On the other hand, historically, comic book adaptations tend to do reasonably well at the box office. More importantly, superheros and their related tie-ins tend to do especially well beyond the theater.
To benchmark the potential, Marvel set out the financial models underlying their expectations in a 2006 Investor Webcast. According to those materials, much of which rely on historical performances of PG 13 movies made about Marvel characters, Marvel made a handful of assumptions:
•International Box Office Revenue will equal 98% of Domestic Box Office.
•Theatrical Rental Revenue: Domestic will equal 55% of Domestic Box Office. International will equal 43% of International Box Office.
•Domestic DVD Revenue will equal 78% of Domestic Box Office.
•International DVD Revenue will equal 60% of domestic home video.
•Domestic Pay Per View TV Revenue will run at 12.5% of Domestic Theatrical Rentals up to $7.5m.
•Domestic Pay TV (HBO, Showtime etc) Revenue will run at 45% of Domestic Theatrical Rentals up to $17.5m.
•Domestic Free TV Revenue will run at 18% of Domestic Theatrical Rentals up to $40m.
•International Pay TV Revenue will run at 33% of International Theatrical Rentals up to $30m.
•International Free TV Revenue will run at 50% of International Theatrical Rentals up to $30m.
•Toy and Merchandising Revenue per film will run in the range of $45 to $200million per film.
Multiplying these assumptions out, a film drawing $150 million in ticket sales will bring in gross revenue of $393m plus toy and merchandising revenue. That’s a potential income of more than $450m. A film earning $250million at the domestic box office, a reasonable result for Iron Man given the strength of its opening weekend, would earn $594million (again, not including toys or merchandise related revenue).
To the bottom line, these could be big contributors. Less the costs of making the film, including marketing and distribution related fees; the $150million dollar movie could easily yield a $50 to $70million contribution to operating income. A $250 million movie would likely double that.
Those numbers are substantial upgrades over the limited, albeit lower risk, pool that came with prior licensing-only arrangements. And with no cash at risk, it’s not a bad gamble.
[Note: Marvel presold the TV rights for Iron Man, Hulk and three more titles to F/X . That deal, struck in March, reportedly provided a license fee of approximately 11% of the domestic box office up to $200m, or a max of $22million a film. If the number turns out to be accurate, it is not too far off from the assumptions put forth in Marvel’s model]
Iron Man was the first title from Marvel under this approach. The Incredible Hulk will launch June 13th. If it proves a similar success, Marvel’s star will shine brighter. The company will then be back in 2010 with Iron Man 2 in April and Thor in June.
Intelligently, Marvel’s using second tier characters for the majority of these films. If they hit, it’s big money. If they fail, thanks to the financing structure, Marvel loses a title, but not a major franchise. So far, they’re heading in the right direction.