Disney-Lucasfilm Deal Part VI – Television Revenue

(This is Part VI of a multi-part series answering the question: “How Much Money Did Disney Make on the Lucasfilm deal?” Previous and future sections are here:

Part I: Introduction & “The Time Value of Money Explained”
Appendix: Feature Film Finances Explained!
Part II: Star Wars Movie Revenue So Far
Part III: The Economics of Blockbusters
Part IV: Movie Revenue – Modeling the Scenarios
Part V: The Analysis! Implications, Takeaways and Cautions about Projected Revenue
Part VI: The Television!
Part VII: Licensing (Merchandise, Like Toys, Books, Comics, Video Games and Stuff)
Part VIII: The Theme Parks Make The Rest of the Money)

So film is dead. TV reigns supreme. We know this.

Except, it’s not?

I mean, we just calculated that Disney made back 63% of their initial investment on Star Wars with four movies, and has many more in the future. At its peak, nothing can challenge the feature film.

Though some gigantic TV shows have come close. Game of Thrones is a juggernaut in ratings, home entertainment purchases and merchandise sales. The top TV shows can command sales figures in the billions of dollars years after their initial broadcast. I’m thinking of Friends or Seinfeld. And not just in America, but overseas, like The Simpsons, which travels well because it is animated.

Of course, now seems like the time to mention that the future of TV isn’t in international sales, but streaming. (That’s semi-sarcastic.) Streaming will play a key role in Disney’s future and, as Disney CEO Bob Iger has put out, new Star Wars series will be a centerpiece of that.

So let’s value two more pillars of Disney’s empire today: adult and children’s television.

TV – Adult

Being frank, this is much more complicated than calculating projected revenue for films. With movies, we know how well they did at the box office and roughly in home entertainment, so we can assume a lot of the other windows. We can also use box office data sets to gauge ranges of outcomes.

We don’t have that luxury with TV anymore. Subscription services like Netflix, Amazon, HBO and Hulu can hide online ratings. They don’t release the costs of the shows. Other windows are more complex than film: Netflix won’t release in DVD if it doesn’t have to, Amazon hasn’t decided, and HBO will release its shows on DVD, merchandise and even sell to other networks. Even Nielsen data is available, but expensive. (I don’t have it since I’m not in a corporate setting.)

I don’t know what Disney will decide, which makes calculating the value for television series so difficult. Given the variability in the rest of the model, I’ve had to make some simplifying assumptions.

To start, how many series will Disney make? I’m going to assume that since Disney has said they are working on a “few TV series” this will mean three series released per year from 2019 (when the service launches) to 2021. And we’ll give each a three year run. Likely, some will do better, some will do worse. (Better meaning 5+ seasons, worse meaning one season. In between is 3 seasons.) Since they’ll keep making TV series, my model has two new series premiering after that through 2028.

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The Economics Behind Not Making More “A Star Wars Story” Films

I love Han Solo.

To put out my Star Wars bonafides—as if proving I’m a hardcore nerd makes me cooler—I’m the type of Star Wars fan who read the both the Han Solo trilogies, one from the 1980s and the other from the 1990s. Don’t believe me? Here’s my collection of just Han Solo books dating from again 1980 to 2015:

IMG_3549

So it isn’t a coincidence that I chose the Disney-Lucasfilm acquisition for my first “analysis article”. And it’s partly why I can’t stop writing about the disappointment of Solo: A Star Wars Story at the box office. As a hardcore Han Solo fan who loves the business of entertainment, sort of combines two loves into a just overall intriguing topic.

Today’s article is a response—in as near real time as I get—to the Star Wars issue of the day: the future of Lucasfilm’ business slate. First, Collider revealed that Lucasfilm was putting spinoff films on hold. Then The Hollywood Reporter clarified that Lucasfilm was just being careful with future development. Then other outlets jumped in to comment or repeat the news.

I’m not a traditional journalist so I don’t have those inside sources. But I do have expertise in the business ramifications of these decisions. And having spent the last four months analyzing all of Lucasfilm’s finances, I have a complicated model on how their movies perform. This model will allow me to answer some questions about why Disney is slowing the pace of production for Star Wars.

Questions sound like a good way to go. So I’m going to set this up as a fictional Q&A:

Question: Can you explain in one chart why Disney/Lucasfilm are slowing development?

Sure. Here’s the “hockey stick” shape of box office performance from my article on the economics of blockbustersslide-17-e1529621369496.jpgThe take away is pretty simple: the spin-off movies are doing about half as well as the “episode” films. If you look at this chart, you’re tempted to say, “Hey, we should just make Episode films only, and not make spin-offs.”

Question: Do you buy this explanation?

Not really. We’re in the realm of small sample sizes. Ten movies, to be exact. So just assuming that calling something an “Episode” film will make it perform better doesn’t make sense. We need a deeper explanation of the underlying forces.

Question: What are the underlying forces?

Well, as I tried to model, the “economics of franchise blockbusters”. I created a comparable films data set of 75 films, but then trimmed it down to answer specific questions. I modified it in four different ways: Star Wars films since the beginning, Star Wars films since 1999, all blockbuster franchises since 2008 and finally any franchises that showed “fatigue” since 2008. Again, I used adjusted US gross to even these out. Here are those four categories:Slide 28The takeaway of this is that Star Wars does really well. In just the films since 1999, 43% have been “super-hits” (over $700 million in US adjusted box office). But franchises that start to show fatigue didn’t have any super-hits. So we can see that keeping box office performance strong can have a tremendous upside.

Question: Can we quantify what the upside is?

Yeah, I can. Here’s the financial models I made for my “comparables” at each level:Slide 23As you can see, a super-hit isn’t worth just a bit more, it’s worth over four times as much as just a “median” blockbuster hit. (And flops cost you $40 million or so dollars.) In other words, you can attempt nearly 20 franchise blockbusters to try to get a hit.

(One note, the comparable numbers are lifetime numbers. In my model I condensed revenue to a four year period, but the point is Disney, with the blockbuster that is The Force Awakens will make money off of it for decades with resales, DVD sales, or putting it on its own SVOD platform. My numbers seem high, but for a film with a huge box office you make money off of it for years.)

Question: So can we combine the performance and comparables models?

Absolutely, and we get the “expected value” per film. In other words, if you make a franchise blockbuster, what is the expected value? Here is the a combination of the two charts, with the expected value.Slide 38Calculating “expected value” is easy, just multiply the probability of the various performance by the net profit. Once you do that, you see that if Star Wars can sustain at it’s historic level, it’s worth $731 million per film, whereas if it decays into franchise fatigue, that’s only $284 million per film.

(Side Question: Does this expected value apply to all blockbusters?

No! My franchise blockbusters are films in an already established franchise. Attempts at new franchises (which is what most blockbusters are nowadays) can differ in two ways. First, when they lose money, it isn’t just $40 million dollars. Even Solo had a gross of $375 million. And it is lumped in for sales with other Star Wars films. Flops like John Carter from Mars or The Lone Ranger can be in more of the $280 million dollar range. I was going to put The Mummy from last year in this, but it still did $400 million in total box office globally, with only $80 million in the U.S.

The other factor is the new blockbusters have a naturally lower hit rate then established franchises. These two factors make blockbusters riskier than established franchises, but less risky then lower budget films. This table is why, though, I said that Legendary could be doing “moneyball” with movies. They have seen this math, so their key was getting enough capital (billions) to back large movies like this to see the return. Back to the questions.)

Question: So Lucasfilm can’t lose money on these movies? Is that what you’re saying?

In the aggregate, yes. If you make enough films, and your movies perform according to the historical pattern, yes you won’t lose money. Of course, once “franchise fatigue” sets in, a film studio will chose not to keep making as many movies. And if it were on a true, sustained downward trajectory, then the value could drop further. Moreover, all these expected values are just one input into a model with a lot of uncertainty. If you deliberately made a lot of bad movies, yeah Lucasfilm could figure out how to lose money.

Question: So knowing this, how many Star Wars films should Disney make?

To answer that, I really need to go back to my model. (I explained how I got these numbers here, here or here.) To figure out how much money Disney will make on Lucasfilm, I needed to model the expected value over the next ten years. This needed to account for different production issues and different box office performance. Put it all together and I got 8 scenarios. This chart is new, though, and only calculates what Disney could make on Lucasfilm movies over the next ten years, discounted back to 2018 dollars.

Pic 7.jpegWhy discounting to 2018? Well, we’re looking forward so unlike my analysis that is partially backwards looking, we’re evaluating the value of Lucasfilm into the future. Since 2018 is the year Disney/Lucasfilm has to make the decisions about new films, that’s when we need to time our dollars.

(Question: Does the above chart include Episode 9 or Indiana Jones 5?

No included them in my overall analysis of the deal, but not here since I am assuming Disney is already committed to them. They’re sunk costs so don’t effect the planning for the rest of the future Star Wars films.)

Question: Okay, that’s a lot of numbers, any takeaways?

Yeah, first Disney doesn’t lose money in any scenario going forward. In the one scenario where they could—making a ton of films as fatigue set in—they would pull the plug on that course of action, as they are contemplating right now.

But the biggest takeaway is that sustaining the “Star Wars is Star Wars” scenario is more valuable than any production decisions. Accelerating to “MCU style” definitely has higher up side, but if you can’t hold onto the audience, then you lose 40-66% of the value. Even a troubled production slate (“Issues”) achieves a higher return than going to MCU-style if you can keep “Star Wars is Star Wars” at the box office.

(So if you’re a Star Wars fan who’s disappointed in Disney for making too many Star Wars films, here’s you counter-argument to show to Disney execs. Say, “See, Disney if you make fewer films you can make more money.”)

Question: Do you buy this?

It all hinges on is correlation. Is the number of films causing the franchise fatigue, or is it unrelated? The model I have here shouldn’t be interpreted to say that franchise fatigue is caused by increased film output. I consider these two things independent in the scenarios.

That said, as I wrote in the Solo: A Star Wars Story post, yeah, I do think they are related. There is a reason why only one franchise has been able to release multiple films per year and not decay, and that’s Marvel. (And that reason is Kevin Feige.) Otherwise multiple films in a year or even more than every three years tends to yield a decline at the box office eventually. In short, hardly any film franchises can sustain sky high box office if they release a film every year.

Question: You just said that franchise fatigue is both related and not related to the number of films. So which is it?

The better way to say it is franchise fatigue is related to film quality. To go back to the Marvel example, the films keep being excellent. Dr. Strange is the worst reviewed movie in 18 months, and was still well-received. Before that you’d have to go back to Ant-Man. So when Marvel says we can do more movies and keep them great, then franchise fatigue doesn’t set it.

The last two Star Wars films both had mixed customer or critical reactions. That’s what causes low box office more than anything. Increasing the number of films increases the odds of more bad films, which causes fatigue. Very, very few franchises can keep the quality sustained at a high rate for that long, besides Marvel (and again Kevin Feige).

Question: Any other concerns with the model?

Well, the “Star Wars is Star Wars” version is a very small data set. Only 10 films so far. And it is a franchise that is unique in that there were two large gaps between initial films and the prequels (15 years) and the new films (10 years). This built up massive enthusiasm. This is why I don’t model another hit the size of The Force Awakens. I think Disney knows meteoric hits are rare, and as dependent on quality as they ever were.

Question: So after all that, why is Disney making this decision from a business perspective?

Disney is slowing to one film per year, roughly, to keep the quality high. It will also avoid risking bad films and hence franchise fatigue. At the same time, decreasing below that rate leaves money on the table, as our expected value chart and scenarios show. So expect Disney to keep one film per year.

Question: Do you have any other concerns?

Well, the worries about fatigue will only amplify is Lucasfilm releases one or multiple TV series aimed at adults on Disney’s new streaming platform. Even dialing back the movie releases won’t mean Star Wars isn’t in the culture. If the TV series aren’t good or the marketing machines over hype the new series, cutting back on the number of films may not matter.

Also, the TV shows bring up another issue I haven’t really addressed yet, which is the other lines of business. Keeping Star Wars relevant impacts the toy sales, the streaming service, the kids TV and the theme parks. That’s another reason to focus on quality movies.

Question: What is the biggest assumption in this analysis?

The big assumption, and I assume Disney believes this to be true, is that development executives at Lucasfilm can indeed improve quality by slowing down production. Of course, that assumes that development execs are skilled at development and can indeed make better movies, they just might have been spread to thin.

I actually don’t believe this. Assuming that you can simply make better films with the executives you have by trying harder…isn’t really a data-based position. I have a ton of thoughts on how to improve development—most of which Hollywood doesn’t do—but not enough time in this article. Keep reading this site and I’ll get to it.

Question: Do you have any creative concerns?

I do, but this is me putting on my “development executive” hat.

As I was researching Solo I read that Rian Johnson’s new trilogy due in the 2000s will close out Rey and Finn’s arcs. While critics praised The Last Jedi, they tended to gloss over the larger plot: the Resistance lost. I mean, the Resistance is basically 20 people on a ship and the First Order took over the galaxy. With such a deep hole, and knowing that Rian Johnson is making three more films to close out the story, the key question for Episode 9 is this:

Will the good guys win?

If they don’t, and it ends on another “cliffhanger” a la Empire Strikes Back, I think you could see another negative fan reaction. Or at least, it will have to be a pyrrhic victory, where the good guys win, but the First Order is still in charge.The fans want closure to this arc; if they don’t get that, it could impact future box office. This is one of those creative decisions that could impact the business, but is super hard to model.

Question: Fine, just for fun, what would you do if you were Lucasfilm?

Make a Tales of Mos Eisley TV show. It’s still in the core world, but exploring possibly the best short story collection in the larger Star Wars universe. Which is to say, spinoffs shouldn’t be dead quite yet.

Weekly News Round Up – 29 June 2018

Welcome back to another week of my read on the most important story of the week and some other reads or listens to keep you informed on the business of entertainment.

Most Important Story of the Week – Box Office is Strong in 2018

As I wrote after the Solo: A Star Wars Story opening, I don’t follow weekly box office updates too closely. Or more precisely, I don’t consider them the “most important story of the week” most weeks since there is a lot of noise. Instead, I recommend waiting to judge the box office until we have a large enough sample size to draw a conclusion.

Which we had this week in this Variety article analyzing the box office of the first six months. Yeah, six months is a good time to sit back and observe the trends. So far, driven a lot by the surprise monster hit of Black Panther, the unsurprising Avengers: Infinity War performance and solid openings for Deadpool 2, Incredibles 2 and Jurassic World: Fallen Kingdom, box office is up.

The one question, which I’ll reference in a few seconds, is the “MoviePass” of it all. Is MoviePass bumping up attendance by offering artificially lower prices? As the podcast below says, MoviePass claims to sell 5% of all box office tickets in the US. If the MoviePass effect disappears–if it is real and does disappear–could that hurt box office?

Other Contenders for Most Important Story

First, the Justice Department signed off on the Disney-Fox merger if Disney spins off Fox’ Regional Sports Networks. Again, we’ve covered this deal before, but this step does make the merger immensely more likely. (And as the above article on box office highlights, combined the movie studio would have 48.5% of box office this year, which seems…high.)

Second, another social media platform launched more original video. This time Instagram. I want to shrug mainly because everyone making original TV and we don’t have any real metrics to judge success. Which is a topic for a future article. But this does mean more potential capital flowing into Hollywood.

Listen of the Week

Take a listen to The Indicator discussing the implications of MoviePass’ business model. I think MoviePass is one of the more fascinating stories out there, but it remains to see how big of an impact will it have. (Consider this the fill-in for AMC announcing their own subscription service.)

In addition to a business consultant, the good folks at The Indicator interviewed the CEO of MoviePass, Mitch Lowe. This isn’t necessarily a bad thing–CEOs obviously have a ton of knowledge about the company they’re talking about–but it is a red flag on reliability. CEOs and PR folks are well trained in phrasing everything to pass SEC scrutiny, but presenting the best possible case about their company. So you have to have your eagle eyes to spot misleading data.

And I found one glaring one. The CEO of Movie Pass happily passes along this tidbit: the average MoviePass attendee only sees 1.7 movies per month. As a result, MoviePass is confident they can make money with some additional revenue by the end of the year.

But can we take even that “1.7 movies per month” number at face value? Is that the median or mean average? Wait, which month is it from? Is it a rolling average or the number from last month? Or–and this is where it gets potentially shady–was it from a month selected because it looks the best?

He also said at some point that they are “fast approaching 3 million” subscribers. Again, you could take that a lot of ways from they have 3 million currently paying subscribers or they have huge customer churn (or will) when all the annual subscriptions end.

The lesson? Listen to CEOs, but try to hear what they’re leaving out.

An Update to an Old idea

In my first article, I wrote a sentence that critics have bemoaned the number of franchises, sequels and blockbusters going back to when I first started reading the newspaper. But I couldn’t find a lot of historical examples since the internet isn’t great about searching the pre-internet age.

But Sean Fennessey helped me out with this article in The Ringer laying out the sheer volume of sequels coming out. This headline in particular captures the feeling of so many critics: “The Summer of Sequels No One Asked for (or Even Thought Possible)”. He later said,

“It is the first in a series of movies arriving in coming months appearing out of no evident desire, without the breathless anticipation that the studios have churned out for bigger, louder franchises. They’re crypto-franchises, ginned up without anything better to do.

Disney-Lucasfilm Deal Part V: Movie Revenue – The Analysis! Performance, Implications and Cautions

(This is Part V of a multi-part series answering the question: “How Much Money Did Disney Make on the Lucasfilm deal?” Previous sections are here:

Part I: Introduction & “The Time Value of Money Explained”
Appendix: Feature Film Finances Explained!
Part II: Star Wars Movie Revenue So Far
Part III: The Economics of Blockbusters
Part IV: Movie Revenue – Modeling the Scenarios
Part V: The Analysis! Performance, Implications, and Cautions)

Have you ever been on a long hike? Your friends tell you, “Let’s go on this beautiful four mile hike to the top of a mountain with a scenic overview.” So you say yes. You go. It’s long, but you keep trudging.

Midway, you start to count your steps, anything to avoid thinking about the burning in your legs. You imagine the joys of finishing. It just keeps going.

Finally, mercifully, you finish and you’re at the top of the hill. Man, the view is worth it.

Gorgeous.

Then it hits you: you have another four miles to get back down.

It was four miles each way.

That’s a test of fortitude. I bring this up because this article just keeps going. Every time I think I’m finished, well I find another fascinating principle to explain. The “movies” portion alone has kept me busy for four parts and a bonus appendix. (And maybe a bonus article next week on this topic.)

Last time, I explained how I built 8 scenarios forecasting the future of Lucasfilm’s film slate. Previously, I explained how feature film economics work, explained my financial estimates for the first four Star Wars, and explained the economics of blockbusters, which developed a set of “comps” for franchise blockbusters. I brought them together in my 8 scenarios. Today, we’re bringing it home to analyze the results of my model. (See the links at the top.)

Really, this is the fun part. The hard work was building the model and getting some good data to make it accurate. That was the hike up the hill. Let’s gaze out at that gorgeous view, to drive the above analogy firmly into the ground.

Overall Performance

The best way to summarize our 8 scenarios is to calculate the net profits for each outcome. (In my model so far, gross profits are revenues minus costs, and net profits then subtract talent participation.) I’ve discounted them all back to 2012 acquisition dollars since that is when Disney first acquired Lucasfilm:Slide 33Those are a lot of big numbers, so another way to look at it is in percentage terms of the acquisition price ($4.05 billion with a “b”). Here’s that:Slide 34Wow. So in 5 scenarios, Disney makes all its money back with just this line of business alone. Further, even if they only achieve “Blockbuster Average” at the box office, they can even have production issues and still get 94% of the initial price. At worst, with production issues and a franchise fatigue, they still make back 82% of the initial deal price ($3.3 billion in adjusted dollars).

Still, I can hear you, “Entertainment Strategy Guy, just give us a single number! Tell us the average!”

In scenario modeling, the “expected value” is the closest thing you get to an overall “average”. To give that to you, though, I need some probabilities. These scenarios aren’t equally likely. It’s more likely that Lucasfilm has production issues then it is they ramp up to 14 films per year. It’s also more unlikely that “Star Wars is Star Wars” at the box office, as opposed to franchise fatigue or just general underperformance.

So here is how I would rate the probabilities of each scenario. And to simplify things, I gave each scenario it’s own name to make it easier to refer to. And it’s more fun. So how likely are each scenario?Slide 35Here’s the thing: I don’t have great rationale for the production side of the equation. I had started with MCU-style at 20%, but given the vague post-Solo rumors, Lucasfilm put the spin-off movies on hold. That makes me think they will strive for the one film per year rate. For the performance, I think the odds that franchise fatigue truly sets in is about as likely the high case where Star Wars defies box office gravity forever, especially if Lucasfilm determinedly releases 1 film per year. (Remember, before this, Lucasfilm had a 15 and then 10 year gap in films.)

I used my judgment for these probabilities, but I could tweak them if I found better data to make the forecasts. So with the probabilities of our two inputs, we could calculate the probability of each scenario.

Slide 36

The odds of “Gangbusters”, the scenario where “Star Wars is Star Wars” at the box office while moving to two films per year is only 2%. That makes sense; each is unlikely. On the other hand, the idea that franchise fatigue sets in and they have production issues (“Worst Case”) is 5%, which feels right.

In the downside, in “Burn Out” or “Sub-Optimal” Disney doesn’t make their money back. On the other hand, Lucasfilm makes money in the “Base Case”, “Make Money”, “Make More Money” and really cashes in with “Gangbusters”. They also make money in “Missed Opportunity”, though it contains a good lesson that production issues can really leave money on the table.

With our probabilities and the returns, we can now calculate the “expected value” of Star Wars movie revenue going forward. To take this all the way back to the introduction from yesterday, I can’t tell I “know” how well the films will perform from here on out. (Again, that quote.) But I can tell you this is what I expect just the movie portion of the deal to be worth, in financial terms: $4.3 billion in 2012 dollars from 2015-2028. In other words, I expect the movie net profits, after costs and talent participation, just the movie revenue, without toy merchandise sales either, to account for 106.8% of the value of this deal through 2028. In just one line of business, Disney made its money back.

Slide 37

It does strike me that my “base case” scenario is fairly close to the expected value (only off by about $40 million, or less than 1%. So was it a waste to build all the scenarios? No. Those numbers represent two different things, though it does give me confidence in using the base case in an “average total model” when I finish all the lines of business.

Implications

Overall performance isn’t the only thing we can learn from this model. The great thing about a scenario model like this is we can learn some things from it (assuming our math is right, the data is accurate and representative and our assumptions are reliable):

“Franchise blockbusters” have a low downside.

This was a conclusion from “Part III”, but bears repeating. Blockbusters based off preexisting movie series can usually put up something of an opening weekend and make some money. This doesn’t apply to brand new blockbusters, who can lose a whole lot more when they completely flop (I’m looking at you, John Carter of Mars and The Lone Ranger. I wonder what studio made those?)

For franchises—movies in a series based off preexisting IP, for lack of a better definition—the downside really is limited. For Lucasfilm, you can see why they’ll keep making Star Wars films: it’s a low downside risk. (If you’re a Star Wars fan upset at Disney making so many films, well this is your explanation.)

We can quantify this per film with our “expected value” chart as well. Here is the net profits from the green light model per comparable level. Now we can multiple these by expected probabilities:Slide 38For a franchise blockbuster, like Star Wars or Marvel or Harry Potter, the studio can expect $392 million in expected revenue if it performs like past films. Now they will hardly ever get exactly that, but in a portfolio of films this is what they can expect to earn. (For Star Wars fans who think Disney is driving the franchise into the ground, this is your financial explanation of why.)

2020 is a big year for the model

I put most of Star Wars: Episodes 9’s revenue in this year because it will come out in December of 2019, so Disney won’t collect the cash until 2020. Combined with an Indiana Jones 5—if it stays on track—then the total revenue in 2020 is $2.7 billion. That’s a big year. Combined with a 2019 or 2020 release of a new TV series and Lucasfilm has a lot going on.

The time value of money starts to have a strong effect.

The time value of money has a real effect. Take the $2.7 billion in 2020 dollars. Well, discounted back to 2012 dollars, it’s only worth $1.6 billion.

Assuming Rian Johnson’s first new Star Wars movie comes out in 2021 (the year after Indiana Jones or the Christmas of 2020), if you booked all the profit and loss the next year (2022), well you would only earn $0.50 on every dollar in 2012 dollar terms. Again, not that Disney wouldn’t collect each dollar, but if you’re evaluating the deal in 2012 terms, ten years down the line a dollar is only worth half in 2022 what it was worth in 2012 when discounted at 8%. The easiest way to understand the time value of money (for me) is to multiply the money earned by the discounted rate, as shown here:

Slide 39That’s why literally more than half the value of this deal in terms of movie revenue was baked in when the first four films came out, again when evaluating in 2012 terms. Essentially, huge box office returns from the first three films locked in 63% of the adjusted price. A huge Episode 9 and big Indiana Jones 5 (which I assume in half of the scenarios) yields another 23% of the initial price. By 2028, if the series performs on blockbuster average, the last seven movies only make 20% of the initial price of the deal. Here is how that looks by scenario:

Slide 40In terms of our initial question, it basically says that Disney would have to do a lot wrong with the franchise to NOT make money at this point. It’s possible, just much less likely.

Cautions & Criticisms

I’m not perfect, so naturally I can look at my model and give some critiques. Let’s keep these in mind so we don’t take this model as 100% gospel truth.

Be ready to update your priors…especially with small sample size.

If it seems like everyone is over-reacting to Solo’s disappointing box office, well I disagree. Essentially, I think Solo: A Star Wars Story caused a lot of people, myself included to “adjust their priors” to use Bayesian/Nate Silver-ish talk. We assumed Star Wars films didn’t have flop potential when they clearly did. Solo: A Star Wars Story changed my preconceived floor of box office performance for this franchise. I changed my whole model based off that event. That’s worth the conversation.

And it should provide a warning. Do I have other prior assumptions I haven’t captured in this model? I tried to call out as much as possible, but it’s always the concern. Off the top of my head, a big potential swing in value is the probabilities assigned to each scenario. If instead of my probabilities you just assigned an equal likelihood, then Disney would earn $4.6 billion, or 115% of the initial price.

(Of course, there is always the fact that my model might not match the actual performance. I did a little searching for research on other projections of Star Wars revenue/profits and I’ve found a range of numbers. So again, I went with my best judgement.)

This current expected value isn’t the expected value at the time this deal was signed.

Don’t mistake the current estimate of value ($4.3 billion in 2012 dollars, 106% of initial price) for the expected value at the time this deal was closed.

In 2012, at the time Disney signed this deal, a new trilogy could make over $5 billion in total box office, or it could have made “only” a billion dollars. Or somewhere in between. That’s immensely reasonable. Now, Lucasfilm and Kathleen Kennedy hired the right director for The Force Awakens and that didn’t happen.

Evaluating the deal midstream, we get to look back with hindsight and look forward with our forecasts. But that doesn’t mean the performance for the last five years was guaranteed by any means.

Is “franchise blockbusters” the right data set?

This is the toughest part of the process and I’ve seen really smart people make really big mistakes when it comes to finding the right data set of movies. So I could see quibbles with my data set of “franchise blockbusters”. The worry is I biased the data set positively for Star Wars.

As I wrote before, my notable omissions were Jurassic Park, Star Trek, Fast and Furious, and James Bond. The last two I have no qualms leaving out since they don’t have the kid appeal of Star Wars or Marvel. Same with Star Trek overall. The toughest was Jurassic Park, which would mean Jurassic World, so it’s one movie, but a “super-hit”. Again, I’m fine with this, but I’m monitoring those franchises for future data analysis. (If you’re curious, if we had added all the omitted franchises, it would have pulled down the average for hits and super-hits.)

There is no “terminal value”.

In other words, why did I stop modeling at 2028? Short answer: uncertainty. After ten years, models lose almost all their predictive value.

But won’t these films keep being made on into the future? Don’t I need to account for that? Yes. And I will, when I put it all together. I plan to do that for this deal, but not until the last step when I do it for all the business lines at one time.

Final Questions

Please, can I see the unadjusted gross profits?

Sure, since you asked nicely. Again, I don’t think we should lead with this because they are misleading. The raw numbers just look better because they look bigger. (I’m losing clicks I know by not leading with this in the headline. But fine, here they are: First, the total revenue from 2013-2028, unadjusted:Slide 41Do you learn as much? Again, I don’t think so because I think our brains translate that money into current price/value and not the true scaled price. But again it looks huge.

What is the current value of Star Wars movie revenue?

That’s a good question. First, I’m going to give you the unadjusted revenue for the next ten years. To show you how it can mislead you:

Slide 42

I put the expected value below it. So you could look at this and say, “Look, Lucasfilm is still worth $4.2 billion! In just movies!” But again, let’s discount for the time value of money. But instead of discounting to 2012, we need to discount it to the current value.

Slide 43

In this case, we see the revenue is “only” worth $2.5 billion for the next ten years. Still really not bad, but not as well as the initial deal did. Again, a lot of that is drive by the fact that most scenarios only have one or two “super-hits” whereas Disney came out and delivered three of those in a row.

Where do we go from here?

Back to the analogy. We just finished admiring a gorgeous view of financial prosperity. And we learned some things. But now we need to walk back down the hill.

The movies portion has long been the centerpiece of this deal from a financial standpoint. At least, that’s what I expected when I started on the model and remain convinced by after all this work.

But Disney is so much more than just movies. Toys. TV. Theme parks. Our walk down this hill to arrive at our final conclusion needs to analyze each of those lines of business. And I’ll do that next.

Disney-Lucasfilm Deal Part IV: Movie Revenue – Modeling the Scenarios

(This is Part IV of a multi-part series answering the question: “How Much Money Did Disney Make on the Lucasfilm deal?” Previous sections are here:

Part I: Introduction & “The Time Value of Money Explained”
Appendix: Feature Film Finances Explained!
Part II: Star Wars Movie Revenue So Far
Part III: The Economics of Blockbusters
Part IV: Movie Revenue – Modeling the Scenarios
Part V: The Analysis! Performance, Implications, and Cautions)

Let’s talk about confidence.

When I built my film financial model, explaining it here, and after I reviewed the economics of blockbusters, I did the next logical thing: I built a financial model forecasting the performance of Star Wars films for the next ten years. I called Star Wars: Episode 9 (the next film in the Star Wars franchise being directed by JJ Abrams, Episode 9 from here on out) a “super-hit” and called the next Indiana Jones film a “hit”. (Indiana Jones 5 from here on out.) I decided that no movie from Lucasfilm would be a flop. This is Star Wars after all.

(Again, this was March.)

I liked my decisiveness. I felt confident. Then Solo: A Star Wars Story came out and proved that even a Star Wars movie could flop. (And it’s floppiness mirrored exactly what I set out for “flop” performance, with one analyst forecasting losses nearly exactly what I had forecast.)

So I began to question my confidence in that initial “single model”.

Then I slapped myself in the forehead. And said, “Duh, I need to model multiple scenarios.”

Which is how today’s article came about. See, any one model can be wrong. But multiple models that capture the uncertainty properly can be more accurate, on average. They better describe the range of outcomes and hence improve our confidence.

As they gaze towards 2028, two things will determine how much money Disney makes off the Lucasfilm acquisition, one of which they can control, the other which they can’t: how many films Disney makes and how well those films perform at the box office. These two variables gives us the solid foundation of a scenario plan. Using these discrete scenarios, we can chart out essentially the 90% confidence interval for how well this franchise will do. The columns are the best through worst case production outcomes. The rows are how well Star Wars continues to perform. It would look something like this:Slide 24Today I’m building out that simple table. But as simple as it looks, it will have a lot of calculations driving it. Basically, the film financial model I built here, the specific Star Wars models I built here and the performance of franchise blockbusters I analyzed here can now be combined.

Building a Scenario Model of Future Lucasfilm Movies: Scheduling

Let’s start with the production side of the equation. This is what the studio (mostly) controls. The studio decides what movies to make, how to develop them creatively and then produces them. Disney could keep making one film per year or decrease to one film every three years (the old Star Wars average) or increase to multiple films per year. Hmm.

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Why You Can’t Use Data to Predict Hit TV Series Either

A few weeks back, I explained why “small sample size” dooms any effort to use big data to predict box office performance of feature films. But what about TV shows? What about streaming services? Can’t they use advanced algorithms to predict success there?

Nope.

As “No, Seriously, Why Don’t You Use Data to Make Movies?” explained in  a “mini-statistics lesson” how small sample size and multiple variables combine to make forecasting very inaccurate in movies. Today, I want to take the lessons of that article and apply it to making TV shows in the streaming era.

Here are the key reasons why “big data” can’t solve making hit TV shows.

1. It’s also data poor environment.

To start, TV has long had fewer data points than feature films. Only recently did the number of scripted TV seasons pass feature films (depending how you count it). Currently, there are over 500 scripted TV series per year in the US. As I wrote last time, that’s still a small sample size.

2. It’s even smaller when you factor in returning series.

Most new “seasons” aren’t brand new, they’re returning seasons of TV series that have been on for several years. That kills your forecasting model.

Take Game of Thrones season 8. Yes, you could call “season 8” a unique data point to study. But with TV shows, to have an accurate model, you’d need to introduce a categorical variable, “has had a previously successful season”. The answer for Game of Thrones for that categorical variables is “Yes!” In other words, it’s super easy to predict that subsequent seasons of Game of Thrones and The Walking Dead will have high ratings because their previous seasons had high ratings. (Though not always.)

The challenge is predicting successful new shows, and that data set is much much smaller than the 400 or so scripted seasons produced every year.

3. The number of categorical variables for a TV show at “pitch” is near infinite.

When a TV show is being pitched or is at the script stage, it has a huge number of categorical variables still in flux. Each of these could influence the final independent variable, which is viewership (depending on if you’re a network or streaming platform you could define this multiple ways).

Everything from the director who ultimately directs the first episode or the acting talent who signs on to the story plan for season one could impact the ratings. Even variables most studios don’t care about like “who is the production manager?” or “can the showrunner manage a room of people?” are categorical variables that could affect the final outcome. Without a large sample size, it’s just tough to predict anything. (And some of them are super hard or very, very difficult to quantify.)

Many good or great scripts or TV pitches become bad TV series. For a lot of reasons that don’t have to do with the script. This is why “algorithms” can’t predict things with high confidence. This explanation also definitely applies to feature films, though I didn’t mention it last time.

4. Most pitches/scripts/pilots will never get made. Hence no “dependent variable”.

Most claims to use advanced metrics or analytics or data to pick TV series utterly discount this key fact. Sure you get thousands of pitches and scripts to read, but they don’t become TV series. Replace “dependent variable” with “performance” and you see the challenge. You have three scripts, and you pick one to become a pilot. The other two scripts don’t get made into to TV shows. So can we use them in our equation for forecast success? No, because they don’t have the same dependent variable to allow us to use them as data. All you can say is you didn’t make them into TV shows. But that’s not a data point.

5. Finally, most of the time, you can only control your own decisions.

The best way to control a data-driven process is to own all the data. And for a TV studio or streaming service, that means understanding all the decisions that went into making a TV show. So, if you don’t make it yourself, well, you can’t really understand what decisions were made. So for a streaming service, that “n” is very, very small.

So let’s use Netflix as an example. They made what, eighty TV shows to date? (Not counting the international productions, that again are their own categorical variables.) So the maximum for their sample size is eighty. Break it down even further by separating kids shows from adult shows and previous IP versus new IP and then you can break it down by genre. You see where I am going with this. The “n” is dwindling rapidly.

What about all the customer viewing data they had from the TV shows on their platform? Well, it doesn’t give Netflix that much of an advantage of traditional networks. Even if traditional networks don’t have Netflix streaming data specifically, they have Nielsen TV viewing data and box office data. Netflix uses that data too.

Which isn’t to say Netflix doesn’t have tons of data and doesn’t use it a lot. But they don’t use it to “pick TV shows” they use it broadly. The “data analysis” that Netflix does is pretty simple: it sees what is popular with its user base. So do traditional TV networks and studios. And what has Netflix learned? People like broad based comedies and dramas featuring crime and/or police. It also knows some people like quirky comedies and some others like arty-shows. (Netflix’ key advantage is it just pays a lot more for the same shows with less opportunity to monetize. That’s a problem for another post.)

So is Netflix is “using data” to decide on TV shows? Yes, but it isn’t that much better than the rest of the industry. Do they have an algorithm that tells them which shows will do well on their platform? Yes, but it is wrong a lot of the time.

Weekly News Round Up – 22 June 2018

Enjoy this week’s updates. A little calmer than last week!

The Most Important Story of the Week – Disney Increased Its Fox Bid to $70+ Billion

So I think I mentioned it before, but if you’re enjoying my long “analysis” article on the Disney-Acquisition of Lucasfilm, you’ll love a sequel coming in a few months: “Who Won the Deal, Rupert or Bob? Analyzing the Disney merger/acquisition of 21st Century Fox”. I started it a few months back, and back then the deal was only worth $50 or so billion (with a b) dollars.

Then a judge cleared the way for the AT&T-Time Warner merger, the topic of last week’s update. With ostensibly the path clear for distributors to acquire content creators, Comcast put in a bid on 21st Century Fox (though Comcast itself proved the government wouldn’t stop these deals six years ago). Not wanting to lose, Disney increased their bid.

Honestly, the higher price both makes sense and will likely cause the winner to lose money on the deal. How can both things be true? On the one hand, when I had done my analysis comparing Time-Warner to 21st Century Fox, the difference in value seemed more tied to market capitalization than the value of the existing assets, especially the value of those assets under Disney’s management. (I’ll write about stock prices at some point and whether they reflect economic reality. They do and don’t.)

The downside is paying too much for the underlying assets. Which can absolutely happen in a bidding war and is called in economics the “winner’s curse”. It’s not just an economic theory: when you have multiple bidders on assets with uncertain value, you increase the risk that someone pays too much and it happens all the time. For the winner here, the margin for error in the acquisition has shrunk to almost nothing.

There is one clear winner, though: Rupert Murdoch makes more money either way.

Long Read of the Week – MGM’s $260 Million Payout: Making Sense of CEO Gary Barber’s Eye-Popping Exit

This isn’t the longest long read I’ll ever recommend, but it’s worth it for executives at the top of corporations to really understand the dynamics of this industry. Read Stephen Galloway in the Hollywood Reporter on the $260 million being paid to MGM’s ex-CEO Gary Barber here. Put in complicated terms to put a shine on it: entertainment conglomerates are currently and have always paid top executives well due to market conditions. Put in layman’s terms, top studios bosses get paid a ton, and it’s cause of all the other guys.

I would love to say, “On one hand I get this” but honestly I still don’t. Being a development executive is one of the most in demand jobs in America. There are thousands of qualified applicants. Same with aspiring CEO types. So why are salaries so inflated? And why do they go to executives who aren’t truly revolutionary? As the long read shows, many times these exorbitantly paid people are paid even more to leave.

(It’s also interesting that in this case it wasn’t so much for firing someone for incompetence, but because of a threatened hostile takeover. So it’s not quite the same thing.)

Lots of News with No News

Man, I guess the theme of today’s update is reflecting on future articles. Especially, my long form ones. Well, in another great long form article in progress, I’m going to compare Amazon’s Lord of the Rings and HBO’s Game of Thrones. Trust me, you’ll like it.

So I read a lot of news about HBO and Amazon Video/Studios/Prime, including this one about Jennifer Salke’s new approach to Amazon Studios/Prime Video. My takeaway is she has a ton of relationships so is taking a lot more pitches and hands-on approach then the previous head of the studio. Coincidentally, while reading I saw this article about Warner Bros. new approach to the DC cinematic universe. (As a fan boy I tend to read anything about comics too.)

In both cases I see the same general story that appears in the pages of the trades every few months: a talented and self-confident executive is taking it on their own shoulders to turn around development, and hence the finances, of a movie studio. Ironically, these same stories were written about their predecessors. So, that’s all to say, these types of stories offer a lot of news without a lot of actual news.

Data of the Week

And my final bugaboo, Netflix! Hat tip to BGR for this article from the Exstreamist where they polled how many Netflix users are sharing passwords. In short, a lot of people don’t pay for Netflix and share passwords. This is unlike traditional TV or cable, and honestly, and I’m rare in this opinion, I think this is a bad plan by Netflix. But more on that in future posts.

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