Nomura analyst Nathanson goes deep changes

Nomura Equity Research analyst Michael Nathanson goes deep on changes in new report on film economics

Shrinking release slates, a focus on tentpoles and the emergence of a ‘new normal’ in the homevid market has allowed the largest media congloms to boost the financial performance of their movie divisions. Nomura Equity Research analyst Michael Nathanson goes deep on the changes in a new report on film economics.

(From the pages of the April 16 issue of Variety.)

Even with all the B.O. statistics that are churned out on a daily basis, the profitability picture for films at the major studio congloms is often opaque at best. Michael Nathanson, a respected biz analyst for Nomura Equity Research, did forensic work on studio financials over the past decade to better understand the composition of revenue and earnings that the majors derive from film these days. It’s especially hard to get a handle on the numbers for congloms such as Time Warner and News Corp., since each studio lumps TV content revenues together with pics for financial reporting. Perhaps the biggest revelation from Nathanson’s probe was the degree to which the Big Six studios (Disney, Fox, Paramount, Sony, Universal and Warner Bros.) have successfully reined in costs in order to improve
profitability. Part of that has come from the steady trimming of annual release slates at the majors, and part has come from hawkish management of overhead costs (and the jettisoning of so many pricey producer housekeeping deals).

In the report “Studio Revenue Never a Sure Thing,” Nathanson focused on three encouraging trends for the film biz that solidified in 2012:

  • The reversal in the long-term slide of annual admissions, which grew in 2012 grew for the first time since 2009.
  • The leveling off of declines in the homevideo marketplace.
  • The continued growth of international box office as a share of total B.O.

The focus on tentpoles and franchise releases also has improved the overall performance of film divisions, even with the eye-popping production budgets and marketing expenditures those pics require. In success, they drive more worldwide B.O. and downstream revenue than a midsized movie. And tentpoles tend to travel the globe better than midrange pics — a crucial calculation because of the rising proportion of B.O. returns that come from outside the U.S.

But doesn’t Wall Street frown on the idea of studios routinely making $200 million-plus commitments to a single movie, especially when it turns out to be a flop, a la “John Carter” or “Battleship?” Not as much as you’d think, Nathanson argues, because film in general remains a small part of the picture for the largest conglomerates. The contribution by films to a Big Six conglom’s budget is highest at Viacom, with 30.2% estimated for 2013, followed by Time Warner (25.3%), Disney (12.7%) and News Corp. (11.7%).

“It’d be an issue if movies were a bigger factor as a percentage of a company’s profitability, and if there (was) a greater occurrence of blowups on tentpoles,” Nathanson told Variety.

“If it becomes more of a habitual thing, there may be greater scrutiny. For the time being, having that opaqueness hasn’t really hurt anybody,” he said. “The stocks are all at 52-week highs, and companies like Lionsgate have doubled (share price) in the past year. If you see a greater occurrence of bombs, there will be more time spent on understanding how the studios account for them.”

Looking deeper into film activity at Time Warner, News Corp., Disney and Viacom, Nathanson found that film revenues dropped $3.7 billion from 2007 to 2012, while operating costs fell $3.4 billion, including a $400 million drop between 2011 and 2012. For studios, film profit margins in 2012 were higher than 2007 levels (around the 11% range) and costs are down 18% from 2007. That’s mostly because studios are releasing far fewer films than they did six years ago.

Between 2006 and 2012, the aggregate number of annual releases by the Big Six dropped by 69 titles, a decline of 34%, according to Nomura. The 2012 figure stood at 134 releases, down from 145 in 2011. The focus of studio resources on tentpoles and franchise releases, of course, has come at the expense of other types of movies. As Hollywood’s creative community can attest, the midrange budget studio pic is fast becoming an endangered species.

The year-to-year volatility of film revenue for the majors remains a concern for investors because of the huge fiscal difference between hits and misses at the plexes. Nathanson estimated film revenue for the Big Six studios was down 4.5% in 2012, to $21 billion, compared to 2011, which saw a solid 5.8% gain.

The rebound in admissions last year was a good sign to Wall Street that moviegoers will turn at the plexes if Hollywood’s product is strong enough. From 2000 to 2012, the compound annual growth rate of admissions eased 0.2%. Admissions hit 1.3 6 billion in 2012, up from 1.2 9 billion in 2011, which reversed a two-year trend of declines. But continued declines among moviegoers in the 12-24 age range is cause for concern.

The stabilizing of homevid activity is also a big plus for Hollywood in the eyes of investors. After seven years of declines, homevid appears to have found a “new normal.” Spending on home entertainment products was essentially flat (up 0.2%) at around $18 billion in 2012 compared with the previous year — the first sign that new VOD and SVOD streaming platforms are starting to offset the drop in physical disc sales. Revenue from VOD platforms gained 10.8% in 2012 vs. the previous year to $2 billion, while streaming revenues spiked 45.8% to $2.3 billion.

Nathanson argues that the shuttering of 750-plus Blockbuster stores by Dish Network, and Netflix’s “forced obsolescence” of its physical disc subscription model has pushed consumers to check out new alternatives. If revenue from streaming options is subtracted from last year’s home entertainment spending tally, revenue would have declined 4.2%.

On the international front, Nathanson’s number-crunching reinforces just how reliant Hollywood studios have become on overseas B.O. to improve margins. After calculating the B.O. splits with domestic exhibs, he estimates that domestic B.O. revenue for Time Warner, News Corp., Viacom and Disney in 2012 has dropped $550 million since 2007, while the international haul has climbed $350 million over the same period.

Still, even in a fast-changing marketplace for film, the significance of a pic’s domestic B.O. perf can’t be overlooked.

“Film studios still need to maintain a stable relationship with U.S. theater owners, given this fi rst window sets the vast majority of value for downstream windows,” Nathanson wrote.

2012 BOX OFFICE

Global: $34.7 billion
Domestic: $10.8 billion
Int’l: $23.9 billion
Domestic admissions: 1.36 billion
Avg. domestic ticket price: $7.96
Films released domestically: 677

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