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March 10, 2009

Time Warner is Watching Watchmen

The Weekend box office continued its year long win streak but for the second consecutive weekend there was a disappointment from a highly anticipated film.

Led by Watchmen, the box office rose 12.7% according to BoxOfficeMojo.com. Every weekend since late December is positive and year-to-date total receipts for the North American box office are up 14.4%.

Next weekend will probably break the box office winning streak due to a tough comparison but the news is still good for theater companies Regal Entertainment (RGC), Cinemark Holdings (CNK), and National Cinemedia (NCMI).

At the studio level, so far 2009 looks good for Time Warner (TWX) and News Corporation (NWSA), while Disney (DIS) has struggled. Disney gets another chance this coming weekend with Race from Witch Mountain. Lionsgate (LGF), which has a rough run of bad news, has a winner in Tyler Perry's Madea Goes to Jail, which came in second last weekend and is now the highest grossing film in the Tyler Perry franchise.

Watchmen Profit Analysis

Watchmen grossed $55.6 million for the second biggest March opening of all-time but it fell short of expectations for a $60-70 million opening. It is too early call the total box office potential for the film but based on Saturday's drop and comparisons to similar films the North American take seems likely to be around $150 million. The film opened in most foreign markets and pulled in at another $27 million, again a disappointing figure. Being long Time Warner, I had hoped for a better opening weekend to provide some cushion to 2009 estimates for the Filmed Entertainment segment.

With a rumored production cost of $150 million and Warner Brothers admitting to a marketing budget of $50 million in the U.S., the film is going to have a tough time breaking even. This is a disappointment for TWX but unlikely to change 2009 estimates. In addition, Watchmen is a one-off project as opposed to an attempt to launch a new franchise so if the film disappoints it is not a problem for the long-term....

....Based on a November 16, 2008 article in the LA Times, Watchmen's economics involve four major entities. Warner Brothers (owned by TWX), Legendary Pictures, and Paramount (owned by Viacom) split production costs (25%/37.5%/37.5%). Warner Brothers has North American distribution and marketing and Paramount has overseas distribution and marketing. 20th Century Fox (owned by NWSA) gets a percent of the domestic box office due to its initial ownership of the project.

Let's take a look at potential profitability to Time Warner assuming that North American and International box office totals $300 million, split evenly. These figures could be optimistic based on opening weekend trends, especially the international figure. I developed my own model for this analysis but double-checked it with David Poland of Movie City News after which I adopted several of David's thoughts. David maintains his own blog at The Hot Blog.

If the film does $300 million globally, box office receipts to the studios will be $165 million (45% of box office goes to the theaters). Distribution fees are calculated as a percent of gross box office. Fox's cut will be 8% of the gross or $24 million. TWX gets a distribution fee of 10% on North America or $15 million. VIA gets the same payout on International. Subtracting this $54 million from the studio shares leaves $111 million.

BoxOfficeMojo says production cost is $150 million and the studios are admitting to a $100 million marketing budget split equally between North America and International. We can use those numbers but if history is a guide they are low.

If we subtract the production and marketing costs of $250 million, the film is at a loss of $139 million based solely on theatrical revenue. I think the studios that underwrote the production cost expected to be at least breakeven on theatrical revenue.

All is not lost, however, as most profits in the movie business in recent years have come from DVD sales, TV rights, and merchandising. Revenues from these sources are directly related to box office performance. DVDs, in particular, should be very important given the large and devoted following of the Watchmen graphic novel. Three DVDs are in the works including two premium issues. Watchmen also benefits from reissue of the book, two new "Making of Watchmen" books, and an animated DVD of the book.

I think profits from DVD sales and rentals could run as high as $120 million assuming sales of 6 million units at a wholesale average price of $20 and a 60% margin, and typical popularity at Blockbuster and Netflix. TV rights in the US and abroad and books and other merchandising could bring in another $40 million in profits.

Add non-theatrical profits of $160 million to the theatrical loss of $139 million and Watchmen ends up being modestly profitable to the tune of $21 million. As mentioned, admitted production and marketing costs are too low so it is more likely the film produces a small loss.

TWX Watchmen Exposure

The major player in Watchmen from a stock perspective is TWX. I began this commentary by noting I did not think estimates would come down. The numbers support this, especially in the murky world of movie accounting. TWX is unlikely to ever take a write-off on Watchmen even if worldwide box office ends up closer to $200 million. However, investors and analysts expected more from the film so the margin for error on estimates has shrunk considerably and will fall further if Watchmen has poor legs.

I think TWX's poor performance on Monday (-5%) reflects the Watchmen disappointment but keep an eye this coming weekend's box office, especially outside the US to see if the pressure on the rest of TWX's 2009 film slate gets ratcheted up a notch or two.

TWX is widely held in Northlake client accounts including my personal accounts.

Posted by Steve Birenberg at March 10, 2009 02:43 PM in TWX