ANZ Finance blog | 007, Licence to Make Money

007, Licence to Make Money

Published 21 January 2022

By Dr Peter J Phillips, Associate Professor (Finance & Banking) University of Southern Queensland

007, Licence to Make Money -- McGraw Hill ANZ Finance Blog

“The scent and smoke and sweat of a casino are nauseating at three in the morning.” This is how readers were first introduced to James Bond in Ian Fleming’s Casino Royale, published in 1953. Fleming would write fourteen books, selling more than 100 million copies worldwide. There have been 27 films, grossing $7 billion (more than $14 billion when adjusted for inflation). Many have been tremendous commercial successes. For example, Dr. No, which is the first film in the franchise, grossed $59.5 million against a budget of just $1.1 million. Compare this to the last of the Daniel Craig films, No Time to Die, released in 2021. It grossed $771 million (so far) against a budget of between $250 and $300 million. Not bad… But the profit margin on the first film was orders of magnitude greater.

"From a finance perspective, though, the question is how all this money, tens or even hundreds of millions, can be raised in the first place."

We read these sorts of figures without much thought, nodding, or perhaps whistling out loud when we read that Dr. No made 60 times its budget and cringing when we read about a commercial flop, like the infamous 1980 film, Heaven’s Gate, which grossed $3.5 million on a budget of $45 million, end is widely believed to have ended the era of director-driven artisan films. From a finance perspective, though, the question is how all this money, tens or even hundreds of millions, can be raised in the first place. Making movies seems like a very risky business and the surprise hits like the first Star Wars film back in 1977—grossing more than $290 million on a budget of $11 million—or 1982’s 48 Hours—grossing $80 million on a budget of $12 million—seem few and far between. How do they decide whether to finance a movie?

Film projects can be evaluated in the same way that we evaluate all other projects in finance. By working out the net present value (NPV) or internal rate of return (IRR) and seeing whether the movie would create value for its investors. To do this, we need a complete set of expected cash flows. Depending on the movie there may be lots of relevant cash flows. There could be merchandise licencing (e.g., toys and computer games). There are DVD and Blu-ray sales. And cable TV or streaming service sales. But the most important cash flows are the expected box office gross and the capital investment required, including marketing costs. If these can be forecast, it is a relatively simple matter to determine whether the project will create value for its investors.

The Israeli artificial intelligence (AI) firm VaultML has developed a system to predict box office success.

The problem is that box office success is impossible to predict with any degree of accuracy. The Israeli artificial intelligence (AI) firm VaultML has developed a system to predict box office success. The AI reportedly analyses between 300,000 and 400,000 “script elements” to generate a prediction! In the end, though, there are always going to be surprises one way or the other. Even well-established franchises like James Bond are not guaranteed investments at the best of times. And while rare, unexpected events can wash away revenues like the snow in the rain. No Time to Die was supposed to be released in 2020 but was delayed almost two years by the Covid-19 pandemic.

Within a studio, diversification across projects is an important risk management tool. Every finance student knows that you don’t put all your eggs in one basket. Even then, the industry relies on other techniques to reduce the risk and, potentially, cover part of the financing. The most important are government subsidies, grants, and tax shelters. Governments will often find it worthwhile to grant concessions to the studios or filmmakers because a movie’s production will come with advantages such as local employment, publicity, ongoing film-related tourism and so forth. If you read a movie’s credits carefully, you will often see acknowledgement made to such schemes.

If you were going to make a film, though, wouldn’t you go where the money is? Wouldn’t you see if the Masters of the Universe on Wall Street are interested? Of course! And they are! Starting in the 1990s, a new type of studio-Wall St. financing alliance has gradually emerged called “slate financing”. This involves bankers, fund managers, private equity managers, and hedge fund managers investing a suite of movie projects (e.g., a multi-film deal), allowing the studios to minimise the use of their own capital while allowing other investors to diversify across films. In some cases, the investment might be relatively low risk, especially if tax breaks can be used to offset much, if not all, of the capital investment. Now, wouldn’t that be a great deal!

Discussion Question

What discount rate should be applied to a movie project?

Further Reading

The investment decision, including capital budgeting, is introduced in Chapter 5 of the textbook.