The Hollywood Economist (11 page)

Eisner’s solution: Generate the illusion of outside distribution while orchestrating a deal that allowed Disney to reap most of the profits. Here’s how the dazzling deal worked. On paper, the Weinstein brothers bought the rights to
Fahrenheit 9/11
from Miramax. The Weinsteins then transferred the rights to a Disney corporate front called Fellowship Adventure Group. In turn, that company outsourced the documentary’s theatrical distribution rights (principally to Lions Gate Films, IFC Films, and Alliance Atlantis Vivafilms) and video distribution rights (to Columbia Tristar Home Entertainment).

Because of the buzz now attached to
Fahrenheit 9/11
, Harvey Weinstein extracted extremely favorable terms from these distributors, about one-third of what distributors typically charge. Their cut amounted to slightly more than 12 percent of the total they collected from the theaters. As a result,
Fahrenheit 9/11’s
net receipts, what remains after the distributors deduct their percentage and their out-of-pocket expenses (mounting an ad campaign, making prints, dubbing the film), would be much higher than those of a typical Hollywood film.

Fahrenheit 9/11
, now an event, took in more than $228 million in ticket sales worldwide, a record for a documentary, and sold 3 million DVDs,
which brought in another $30 million in royalties. After the theaters took their share of the movie’s gross (roughly 50 percent) and distributors deducted the marketing expenses (including prints, advertising, dubbing, and custom clearance) and took their own cut, the net receipts returned to Disney were $78 million.

Disney now had to pay Michael Moore’s profit participation. Under normal circumstances, documentaries rarely, if ever, make profits (especially if distributors charge the usual 33 percent fee). So, when Miramax made the deal for
Fahrenheit 9/11
, it allowed Moore a generous profit participation—which turned out to be 27 percent of the film’s net receipts. Disney, in honoring this deal, paid Moore a stunning $21 million. Moore never disclosed the amount of his profit participation. When asked about it, the proletarian Moore joked to reporters on a conference call, “I don’t read the contracts.”

What of Disney? After repaying itself $11 million for acquisition costs, it booked a $46 million net profit, which Eisner split between two subsidiaries, the Disney Foundation and Miramax. With his $21 million, Michael Moore had perhaps the happiest ending of all.

While Disney made a profit on the paranoia in
Fahrenheit 9/11
, it led Eisner and other Disney executives to question whether Harvey Weinstein was worth the trouble he had caused the corporation. While Weinstein told journalists how much money he had made for Disney, an internal audit showed that Miramax under Weinstein, rather than adding to Disney’s profits, actually was hemorrhaging rivers of red ink. This reversal of fortune proceeded from a loophole in the original deal that Jeffrey Katzenberg, then Disney’s studio head, negotiated with Weinstein in 1993. The Weinsteins had demonstrated a superb gift for finding, shaping, and marketing independent films like
Sex, Lies, and Videotape
and
The Crying Game
. To give the brothers a powerful incentive to ferret out similar arty winners, Disney agreed to give them a performance bonus of between 30 percent and 35 percent of their film profits, a bonus that would be calculated each fiscal year. The deal also tied Miramax’s capital budget for acquiring and producing films to its annual performance. So, the more money Miramax made in a fiscal year, the more money the Weinsteins made and the bigger the capital budget of their Miramax division. The loophole was that
Disney agreed to calculate Miramax’s profits in a fiscal year solely on the films released that year. In making what seemed like a minor concession to Weinstein so that he could use his discretion in timing the marketing of art films, Disney did not foresee how brilliantly he would game the calendar to create the illusion of profits for Miramax and the reality of huge bonus payments for himself and his brother, Bob. He simply shifted potential money-losing films into future fiscal years so that they didn’t reduce either his bonus or Miramax’s capital budget. To prevent Weinstein from overspending, Eisner later imposed a further condition on the deal: For every dollar Miramax exceeded its capital budget, a similar amount was deducted from the Weinsteins’ annual bonus. To avoid this penalty, Weinstein could delay releasing high-budget films in years in which he was close to exceeding his capital budget. As a result, even more films got dumped into Weinstein’s limbo of unreleased movies. For example, Zhang Yimou’s
Hero
, which had been acquired at Sundance in 2002, was held for more than two years so that its nearly $20 million cost would not count against the Weinsteins’ bonus.
Hero
was released in 2004, a year less profitable for Miramax in which no bonus would be paid anyway.

In 2005, Eisner decided not to renew the Weinsteins’ contract. Whereas Miramax belonged lock, stock, and barrel to Disney, the Weinstein brothers had a claim to subsidiary Dimension Films, which Eisner wanted to keep at Disney. So he had to negotiate an exit package for the Weinsteins. Enter Hollywood lawyer (and Shakespearean scholar) Bertram Fields, who got them a $130 million settlement (partially based on what turned out to be Miramax’s phantom profits in prior fiscal years), and allowing Harvey and Bob Weinstein to create a new film company, Weinstein Brothers Pictures.

After their departure, Disney released many of the delayed movies, which produced losses in 2005 alone of over $100 million. Harvey Weinstein, known for his artful films, also demonstrated with Disney that he had mastered the artful deal that amazed even Hollywood.

The principal asset of a modern studio nowadays, aside from its library of movie titles and other intellectual properties, is its human capital, which includes executives with the negotiating skills, judgment,
charm, and goodwill within the industry to get top stars, make favorable production deals, and profitably organize the release of movies. In the spring of 2004, following a string of six box office flops in 2003, Sumner Redstone, the chairman of Paramount’s parent company, decided Paramount needed a new infusion of human capital. In the regime change, Jonathan Dolgen and Sherry Lansing, who had run the studio for the past decade, were out. Brad Grey, a dynamic forty-seven-year-old television producer and talent manager, would replace them. Even though he had no previous experience in running a movie studio, Redstone gave him a mandate to turn the studio around.

But turn around from what? Despite its flops, the Dolgen-Lansing decade was hardly a disastrous one. During that period, 1994-2004, Paramount released six out of its ten highest grossing films in history, including
Titanic
, the all-time biggest money-maker, and in eight out of their ten years their division (which included television as well movies) scored record profits. They set up lucrative co-production deals with Dreamworks SKG, established the
Mission Impossible
franchise with Tom Cruise, and created three profitable distribution labels—MTV Films, Nickelodeon Films, and Paramount Classics. Dolgen’s skill was the art of the deal which reduced Paramount’s risk by using
Other People’s Money, his specialty being offbalance sheet financing and foreign subsidies to pay for a large part of a film’s production costs. Through them, Dolgen and Lansing managed to achieve an average return on invested capital of nearly 60 percent during their ten years. Even in their worst year, 2003, they hit their targeted profit numbers.

Enter Brad Grey. He wasted little time in dismantling the team that his predecessors had built. Within six months, almost every senior executive “ankled,” as
Variety
colorfully describes exiting a studio, including Rob Friedman, the head of worldwide distribution and marketing; Thomas Lesinski, the president of the Home Video division; Donald DeLine, the head of film production; Jack Waterman, the president of pay-TV; Gary Marenzi, the head of international TV; and Tom McGrath, the architect of the studio’s offbalance sheet financing strategy. In all, over 100 executives were either fired or left Paramount in the regime change. “Even by the harsh standards of Hollywood such wholesale bloodletting is unprecedented,” one former Paramount executive said in an email.

Gray also cancelled most, if not all, of the movie projects in process in 2005. Letting it be known that Paramount would place less emphasis,
as part of the regime change, on deal-driven movies, he cancelled five such projects based on German and Spanish tax deals, which would have produced about $50 million in bottom line profits. (The financial vice president working on these deals, getting the message, promptly resigned.) But replacing such projects, and packaging scripts with stars, directors, and financing, takes many months, if not years. And by the fall of 2005, Paramount still did not have enough viable projects in the pipeline to provide the studio’s distribution arm with product for 2006 and 2007. The solution Grey found was for Redstone to buy Dreamworks SKG for $1.6 billion.

To finance this deal, Redstone sold Dreamworks’ movie library to hedge funds for $900 million. As a result, Paramount got thirty-odd Dreamworks projects—including
Dreamgirls
and
Transformers
—to replace the Dolgen-Lansing development projects.

The new regime, at Redstone’s prodding, also ended its deal with Cruise-Wagner Productions, which had produced not only its
Mission: Impossible
franchise but its other tentpole film,
War of the Worlds
. The decision to end Cruise’s contract, despite Redstone’s PR jibes at Cruise, was, to quote
The Godfather
, “Not personal, Sonny; it’s
strictly business.” The real problem was the rich split Cruise had negotiated with Paramount—22 percent of the gross revenues received by the studio on the theatrical release and the television licensing and a 12 percent cut of Paramount’s total DVD receipts.

While Paramount was busy subsuming (and becoming) Dreamworks, the human capital at Dreamworks, including Steven Spielberg and his creative team, exited Paramount to create a new studio, backed by $500 million in Indian financing, which would be the new Dreamworks—or at least the sequel. Plus Ça Change or, as they say in Hollywood, that’s show business.

The gawkerization of Hollywood, entertaining as it may be to the public, blots out much of the reality underlying the movie business. Witness, for example, the treatment of Tom Cruise after
People
asked on its Web site in May 2005, if his relationship with the actress Katie Holmes represented “1. TRUE ROMANCE” or “2. PUBLICITY STUNT.” In this pseudo-poll, in which subscribers with AOL’s instant messaging can “vote”
as many times as they like (paying a charge each vote), 62 percent of an unknown number of respondents chose “publicity stunt.”

Once this statistically meaningless result was sent out on the PR wire, it spawned a frenzy of stories dangling the bizarre idea that the romance had been faked to publicize, in Cruise’s case, Paramount’s
War of the Worlds
and, in Holmes’ case, Warner Bros.’
Batman Begins
. Frank Rich proclaimed in the
New York Times
that the affair was nothing more than “a lavishly produced freak show, designed to play out in real time,” and that “the Cruise-Holmes romance is proving less credible to Americans in 2005 than a Martian invasion did to those of 1938.” As it turned out, Cruise and Holmes were subsequently engaged, married, and had a child.

What is entirely lost in the fog of media gossip, however, is the entrepreneurial role that Tom Cruise has carved out for himself in the New Hollywood. Consider, for example, the
Mission: Impossible
franchise. When Paramount decided to reinvent its TV series
Mission: Impossible
as a movie, Cruise not only starred in it, but he (along with producer partner Paula Wagner) produced it. In return for deferring his salary, he negotiated a deal for himself almost without parallel in Hollywood. To begin with, he got 22 percent of the gross revenues
received by the studio on the theatrical release and the television licensing. The more radical part of the deal involved the video earnings (the deal was negotiated before DVDs replaced video tapes). When videotapes became a cash cow for Hollywood in the 1970s, each studio employed a royalty system in which one of its divisions, the home-entertainment arm, would collect the total receipts from them and pay another one of its divisions, the movie studio, a 20 percent royalty. This royalty became the “gross” number that the studios reported to their partners and participants. The justification for this system was that, unlike other rights, such as television licenses, which require virtually no sales expenses, videos have to be manufactured, packaged, warehoused, distributed, and marketed. So, the home-entertainment arm keeps 80 percent of the proceeds to pay these costs. The stars, directors, writers, investors, actors, guilds, pension funds, and other gross participants get their share of just the 20 percent royalty. If a star were entitled to 10 percent of the video gross, he or she would get 10 percent of the royalty, which, under this system, is only 2 percent of the real gross.

But not Cruise. He insisted on—and received—“100 percent accounting,” which means that the studio, after deducting the out-of-pocket
manufacturing and distribution expenses, paid Cruise his 22 percent share of the total receipts. As a result, Cruise earned more than $70 million on
Mission: Impossible
, and he opened the door for stars to become full partners with the studio in the so-called back end.

By 2000, the profits from DVDs had begun to alter Hollywood’s profit landscape, and since it was now too complicated to track all the expenses, Cruise revised the deal with Paramount for the sequel
Mission: Impossible 2
. His cut of the gross was increased to 30 percent, and, for purposes of calculating his share of the DVDs, the royalty was doubled to 40 percent. So, he would get 12 percent of the total video/DVD receipts with no expenses deducted by Paramount. In return for this amazing deal, Cruise agreed to pay the only other gross participant, the director John Woo, out of his share.