Free The Hollywood Economist by Edward Jay Epstein Page A

not limited to so-called “current production,” or the theatrical releases, on which studios almost always lose money. Rather, the rate subsumes every penny the studio makes from every source including pay-TV, DVDs, licensing to cable and network television, in-flight entertainment, foreign pre-sales, product placement, and toy licensing. So, even in a bad year, such as 2003, when Paramount released enough bombs to get the studio head fired, its internal rate of return was around 15 percent. This return also included the profits from the company’s copyright lease-back sales to foreign tax shelters. (Palmer himself had structured one such deal that netted Paramount $130 million.) Plus, if the studio has a single big breakout movie, as it did in 1999-2000 with
Titanic
, the internal rate of return could leap to as high as 23 to 28 percent.
    A safe 15 percent return, with a possible kicker in the event of a hit, proved very attractive to Wall Street. Palmer and his associates at Paramount worked out a deal with Merrill Lynch through which the hedge funds put up 18 percent of the capital fortwenty-six consecutive Paramount movies in 2004 and 2005 through a vehicle called Melrose Investors, which then was extended through 2007. What makes this deal asymmetric is that Paramount also took a 10 percent distribution fee off the top on all the revenues, money which the hedge funds do not share. Since this cut comes from the gross, it makes Paramount, but not the hedge fund, a dollar-one gross player in its own movies.
    Other studios had even sweeter or more asymmetric deals with hedge funds. Legendary Pictures, for example, was organized as a vehicle through which hedge funds, such as AIG Direct Investments and Bank of America Capital Investors, could sink a half-billion dollars into Warner Bros. movies. But, unlike the Melrose Partners deal, the Legendary Pictures investors do not participate in the entire slate of Warner Bros. movies, which means that they do not really participate in the internal rate of return.
    In its asymmetric deals with Wall Street studios enhance their own returns by getting a distribution fee on their investors’ share of the revenues. And remain true to the Hollywood tradition of giving civilian investors the short end of the stick.

EVER WONDER WHY THE US LOOKS LIKE CANADA IN THE MOVIES?
     
    In the golden era of the studio system, a studio mainly confined its principal photography to its own highly-efficient sound stages and back lots, where it could deploy its contract stars and technicians, and had whatever exotic material was necessary shot by a traveling second unit. Nowadays, movies are shot all over the world, but in scouting locations, producers are not seeking the most authentic settings or spectacular production values. The lure is government subsidies. As one producer put it, movies, like ladies of the night, go where the money is. Such subsidies can finance up to a large share of the below-the-line budget through a series of maneuvers in which a movie first qualifies for tax credits by employing local actors and technicians, then selling those credits.
    Hence the appeal of Canada. The Canadian federal government provides foreign producers with a subsidy, called the Film Production Services Tax Credit, which in 2008 equaled 16 percent of Canadian labor costs. In addition, British Columbia offers an additional 18 percent rebate on labor from that province. Finally, there is a 20 percent break on digital effects, if they are done in Canada.In order to qualify for this tax credit—which the producer sells through a Canadian partner—either the director or the screenwriter and one of the two highest paid actors must be Canadian, which might partly explain the demand for Canadian actresses, such as Alex Johnson, the star of
Final Destination 3
.
    Heeding the siren call of subsidies, Hollywood moved north over the last decade, outsourcing to Canada no fewer than 1,500 movies and television