As great as its performance has been at the box office so far, readers and pundits appear to believe that Viacom's (NYSE: VIA ) Paramount Pictures stands to gain more from Marvel's The Avengers than does parent studio Walt Disney (NYSE: DIS ) , which produced the film via its Marvel Studios subsidiary.
Could that really be the case? Answering that question requires a bit of number crunching, which I've provided below. Yet we don't need a calculator to know this is a huge win for Marvel and Disney CEO Bob Iger, who orchestrated the theft...I mean purchase of Marvel Entertainment in 2009 for a mere $4 billion. Well done, sir (golf clap).
The story so far
All signs point to The Avengers joining the elite ranks of billion-dollar box-office hits. According to Box Office Mojo, Time Warner's (NYSE: TWX ) The Dark Knight took in $238.6 million in its first week in U.S. theaters. The Avengers is at $244 million as of this writing, and its first week isn't yet over.
For Paramount, eager audiences could result in a huge and highly profitable haul. Reuters reports the studio is due 8% of the gate, DVD sales, and Internet showings as a consequence of its 2005 deal to distribute Marvel movies. Paramount has already received $57.5 million of $115 million promised as an advance on distribution earnings.
Does that mean Viacom is getting a better deal than Disney? Unlikely. Marvel amended its distribution arrangement in 2008 in exchange for committing more upfront capital to its studio productions. In exchange, Paramount cut its fee from 10% to 8%, guaranteeing the comic book king a larger slice of profits for any future hits. Disney gets the same benefit.
Paramount wins, too, of course. A follow-up to the 2005 deal signed two years ago reportedly guarantees 9% of the proceeds from Iron Man 3, but what happens after that is anyone's guess. Disney's Buena Vista Pictures generally handles distribution for its in-house movies. Marvel productions should shift to this format at some point in the future.
Until then, what can Disney shareholders expect in terms of a cash flow contribution from The Avengers? Will it be any more than a rounding error? Some of you appear to be wondering.
A not-so-heroic attempt at deciphering studio math
The easy answer is that Disney gets a 50% cut of the gate and then writes a check to Paramount for any fees earned above $115 million in promised advances. Lop off another, say, 5% of gross participation for talent and then figure a fair cash flow margin and you've got a decent estimate for what The Avengers might contribute on a total dollar basis. Sounds easy, right? It would be if we knew what makes for a fair cash flow margin, and that demands some math, starting at the corporate level and working our way down. Take a few deep breaths first. Ready? Have your calculator? OK, here we go. According to figures compiled by S&P Capital IQ:
- Disney's studios tend to account for 16% to 22% of total revenue, and 9% to 15% of operating income.
- Disney's overall operating margin tends to run from 16% to 20%, with 19.5% as the average in its best studio years (2007, 2008).
- Companywide, cash from operations has recently come in at around 90% of operating income.
- Therefore -- and really, this is only a very rough guide -- we might say that Disney's studio cash contribution is likely to be 90% of its maximum operating profit contribution, which is 15% of 19.5% of overall revenue. (Still with me?)
Now, let's take this same formula and project forward:
- Analysts believe Disney will take in $42.71 billion in fiscal 2012 revenue.
- 19.5% of that is $8.33 billion, which is our rough estimate of current-year operating profit.
- 15% of that is $1.25 billion, which is our rough estimate of studio operating profit.
- And 90% of that is $1.12 billion in operating cash contribution from the studio operations.
What would The Avengers' piece of that contribution be? Back to the calculator, Fool. We know that Disney's top grossing films accounted for 22% of domestic gate receipts in 2007 and 2008. Yet that might not be a fair comparison. The Avengers looks like an outlier, more comparable to The Dark Knight than anything else. In 2008, that film accounted for roughly 30% of Warner Bros.' domestic gate, according to box office tracking site The Numbers.
Assembling profits, slowly
Using the same ranges as a proxy for cash contribution, it seems possible a $1.12 billion box office performance by The Avengers would account for somewhere between $250 million and $340 million in cash from operations during the current fiscal year and much more than that in succeeding years thanks to Blu-ray, DVD, and digital sales via the likes of Apple's (Nasdaq: AAPL ) iTunes, which already sells digital DVD equivalents packed with bonus features. Overall iTunes sales are on track to eclipse $8 billion during the current fiscal year.
Meanwhile, Paramount's 8% cut of The Avengers gate could reach $90 million this year, and a bit more than that down the road when you include DVD and Internet sales. Good, yes, but still well short of Disney's minimum haul.
Finally, what would a $250 million contribution from The Avengers mean? The House of Mouse has already collected $7.5 billion in operating cash flow over the trailing 12 months. Presuming that number doesn't change too much over the full fiscal year, Marvel's epic team-up could be responsible for -- wait for it -- 3% of Disney's fiscal 2012 organic cash generation.
Call it a rounding error, a blip, or even a non-event if you like. That's not really the story, nor is Paramount's cut. The truth is that, for Disney, The Avengers is the beginning of a long-tail opportunity that could add billions in revenue from park rides and merchandising while teeing up further profits for the studio operations. But it would have been an even bigger win for Marvel had the company remained independent.
Give Iger credit for recognizing the opportunity and moving to capture the profits. Identifying long-term winners isn't easy, especially those with the sort of disruptive DNA that Marvel possessed. Yet there are rebels still out there, and some -- like this potential multibagger -- are still trading on the cheap.