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August 28, 2006

Cruise-Paramount Split, Part 1

Given all the publicty created by the split between Tom Cruise and Paramount, I thought I'd offer some impressons from the perpsective of the stock market. The following post is my first impressions, while a second post due to go up later this week provides greater detail on the economics of Tom Cruise as a "subsidiary" of Paramount's owner, Viacom (VIA, VIA.b).

It is hard to say much that is relevant to stock prices as far as the Tom Cruise-Paramount split is concerned. I do think that this is much more about money than Tom Cruise's behavior. The two are linked, apparently tightly linked in the mind of Viacom (VIA, VIA-B) chairman and controlling shareholder Sumner Redstone. Redstone and many others think that Cruise's bad press led the latest Mission Impossible film to fall short of box office expectations. It is hard not to agree with that assumption. The bigger question is whether future Cruise films were likely to suffer the same fate. And that is important because despite his hefty paydays, prior to this film Cruise has been a huge money maker -- arguably the only huge money maker -- for Paramount.

Cruise appears to have had a very generous deal at Paramount, providing his production company funds for overhead and a percentage of the worldwide box office gross. Importantly, the gross points came whether Paramount made a profit on the film or not. Consequently, the real problem here is not Cruise's behavior but the fact that production and marketing costs have gotten completely out of control. Mission Impossible III grossed $400 million worldwide at the box office and is likely to bring another $150 million to $200 million plus in DVD revenue and TV rights. A project with up to $600 million in revenue likely won't make any money for Paramount because the studio allowed the production budget to go over $150 million and spent another $100 million on marketing....

Remember studios only collect about 55% of each box office dollar. So for Mission Impossible III , Paramount's share might be around $215 million. Subtract the off-the-top take of Cruise's production company (rumored at anywhere from 10%-20% of total box office), and Paramount is left with $155 million against a production and marketing expense of $250 million plus. Oops. And with a slowdown in the DVD profits due to higher marketing and distribution expenses and a falling ratio of DVD revenue to box office revenue, Paramount's hopes of making decent profits on Mission Impossible III look bleak, while Cruise's production company walks away with $60 million or more.

Thus, despite press reports playing up Cruise's "behavior," I think the split was a business decision by both sides. The contract between Paramount and Cruise was up. Paramount wanted a better deal. Cruise felt the deal being offered wasn't good enough. End of story -- except that Redstone took it to another level with his aggressive comments about the split.

Does this episode represent a change in how studios will deal with stars? Maybe. Will Cruise's new, self-financing strategy represent the future? Maybe. Will studios finally attempt to better control budgets so that $500 million or more in worldwide gross isn't break-even? Maybe.

Is there a lesson for investors in stocks of companies that own movie studios? Yes. It's a tough business with erratic profits, high risks and impossible-to-analyze financials. So the next time you see an analyst report that puts a premium multiple on EBITDA produced by a studio, be skeptical.

Posted by Steve Birenberg at August 28, 2006 08:44 AM in Media