Your author's reaction to the news that Paramount had shown Tom Cruise the door and cited his behavior as the primary reason was probably predictable. The story has driven the Wall Street Journal, among other publications, absolutely mad with print and resulted in any number of articles in other publications. Ironically, Paramount had a reputation for being a difficult place for "top talent" owing to its overly cautious management. The Financial Times was tickled pinkish orange then to relay the news (subscription required) that Brad Gray, who had been hired by Viacom to assist Paramount because of his "...close ties to Hollywood's creative community" (read: actors) did the firing. God damn it Maverick.
A variety of problems plague the industry now. DVD release times have crept, and continue to creep, closer and closer to theater releases. Theater sales, aside from a brief recent blip, have been way down- and why not? Who wants to pay money to be threatened with lawsuits, encouraged, Soviet bloc style, to snitch on your seat mate, and watch 10 minutes of advertisements for coke and cellular service? DVD sales have begun to flag also. DRM technologies, which attempt to solve an unsolvable problem (namely, how you can permit digital data to be played but not recorded) instead impose unreasonable restrictions on customer's use of their own data, not to mention attempt to sell less product for more money, are finally beginning to create serious customer push back (and indeed, outrage). That's not even to mention the ill will the MPAA has been spawning by suing its own customers with a capriciousness that should offend even the most hardened Italian fascists. Of course, the MPAA is just an anachronistic force, desperately trying to hold together a distribution model that is simply outdated and broken.
The signs of strain are beginning to show. Disney has cut workforce. Time Warner has followed suit. Universal has lost its chairman. Cruise is forced to go crawling to the dark side of financing: hedge-funds. Or has he?
Apparently, it is often said that Cruise is one of the most certain "sure things" for large blockbusters (the last 7 films of his each pulled $100 million). Says the Financial Times of his star power at its peak:
Mr Cruise had become one of the industry's best-paid stars, with a so-called "20 and 20" contract that gave him $20m up front for each film and 20 per cent of gross ticket sales.
Paramount's deal with Cruise was more complex than it seemed. Technically, Cruise did not even work for Paramount. Instead, Cruise and his partner, Paula Wagner, own Cruise-Wagner Productions which, in exchange for having their overhead covered (apparently about $5-$8 million per year) and a spot on the Paramount lot, gave Paramount first-bid on their projects. The trade off is that Cruise-Wagner were taking 22% of theater and television revenues and 12% of DVD revenues. This is, according to the Financial Times, unusual in the business, where even the brightest stars get their cut of DVD sales after 80% is already taken off the revenue line. This held until the recent release of Mission Impossible III, whereupon, according to the Financial Times (subscription required):
After the DVD industry began altering Hollywood's profit landscape, and because it was complicated to track all the expenses, Mr Cruise revised the deal with Paramount. His cut of the gross was increased to 30 per cent and, for purposes of calculating his share of the DVDs, he accepted a "royalty" but it was doubled to 40 per cent. So, he would get his whopping 12 per cent of DVD receipts with no expenses deducted by Paramount. From the DVDs alone, Mr Cruise gained more than $30m on Mission: Impossible II. With Mission: Impossible III, Mr Cruise still got his huge percentage of the gross. Both he and Paramount were, however, disappointed with the theatrical gross - $393m (£208m) - even though it has been Paramount's highest grossing film in 2006. Mr Cruise blamed Paramount, whose new regime, headed by Brad Grey, had fired a number of Paramount's top marketing and distribution executives in Europe, and Paramount blamed Mr Cruise's tiffs with the media. The bottom line was that Paramount could not make much of a profit from even a high-grossing film such as Mission: Impossible III. Faced with this disaster, Mr Redstone turned it into a morality play, with himself in the role of Mr Morality. with Mr Cruise getting a 40 per cent royalty of DVD sales. When Mr Cruise refused to reduce his cut, Paramount "played hardball", as an executive put it, and lost the Mission Impossible franchise.
So what's the truth of it? Cruise fired because he is a moron? Paramount using hard-ball tactics to force a better contract? The end of the reign of spoiled star? The decline of "star power" seems in the cards, at least if the New York Times is to be believed (not a sure thing, that call). Says the Times (requires free registration evadeable via bugmenot):
“There is no statistical correlation between stars and success,” said S. Abraham Ravid, a professor of economics and finance at Rutgers University, who, in a 1999 study of almost 200 films released between 1991 and 1993, found that once one considered other factors influencing the success of a film, a star had no impact on its rate of return. Employing a star had virtually no discernible impact on the box office itself. Mr. Cruise would no doubt object to that assertion. And to be fair, there is some theoretical pedigree to the idea that he may be worth every penny. In fact, there is a whole branch of economics that aims to explain how talented people generate so much more money than competitors who are only slightly less good. It’s called “superstar economics.”
Superstar economics, which has been used to explain the astonishing fees of top lawyers and the skyrocketing pay of star chief executives, dates back to the insight in the late 19th century of the British economist Alfred Marshall, who observed that “the relative fall in the incomes to be earned by moderate ability ... is accentuated by the rise in those that are obtained by many men of extraordinary ability.”
The dynamic was explained by a University of Chicago economist, Sherwin Rosen, in a 1981 paper entitled “Superstar Economics.” Mr. Rosen posited that improvements in technology that would make it easier for top performers in a field to serve a larger market would not only increase the revenue generated by stars, but would also reduce the revenue available to everybody else.
Or was it all, as the LA Times speculates, a publicity stunt?
Does it matter? (The street thought so. Viacom shares were up on the news of Cruise's departure). I don't know. But I do enjoy the drama. And, of course, the opportunity to watch a pair of hedge funds take a bath. Enter the Vegetable Capital angle. Quoth the Wall Street Journal (subscription required):
During an internal presentation on film financing last year, Merrill Lynch & Co. executives entertained employees with the famous video of actor Tom Cruise manically bouncing on Oprah Winfrey's couch as he sang the praises of his new girlfriend.
Amid the laughter, recalls someone who was in the room, Michael Blum, Merrill's head of structured finance, asked: "How does one hedge that risk?"
Hedge funds will be the ones to worry about it, according to Wagner. And there are plenty that might line up. Quoth the Journal:
That's a rich vein to tap into: More than $4 billion in new movie financing has poured into Hollywood from hedge funds and other institutions recently. Outside financiers ranging from hedge fund Stark Investments to the private-equity arm of Bank of America Corp. have put large sums of money into movie slates at studios including Time Warner Inc.'s Warner Bros. and News Corp.'s Twentieth Century Fox.
After I thought about it, however, I realized what this move really is. If he gets hedge fund backing, Tom Cruise is doing a management buyout of himself. The key issue with an MBO, is of course, the management. That doesn't bode well for Cruise who, while he might have a stellar track record, is beginning to show more and more symptoms of Howard Hughes syndrome. The absolute worst thing you can have in a MBO is a gifted but eccentric manager. They tend to command deep loyalties and are difficult to remove without creating significant trauma to the organization, even when performance is beyond dismal.
Going Private has noted before that outsiders (and hedge funds in particular) have a particular habit of taking seriously cold baths on Hollywood investments. The combination of preferences to production and studios (or in this case, Cruise) and a lack of expertise in the business tends to spell disaster quickly.
An MBO here with hedge funds at the helm presents some issues. First, the vertical integration of distribution that a deal with a major studio offered Cruise is gone. Those costs will end up passed along at auction now, and the lack of a sure feed into a large studio (Paramount is unlikely to entertain Cruise movies in future) presents additional transaction costs. Further, it is not clear to me that a liquid market for production projects actually exists. There seems to be quite a lot of buyer power in large studios, and one of them has effectively blacklisted Cruise. Any seller power Cruise had is in retrograde now, and I suspect Cruise will find Hollywood studio bosses akin to care bears compared to his new hedge fund masters. In short, I predict disaster.
