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A Marvel-ous Movie Plan

http://www.fool.com/investing/small-cap/2005/05/11/a-marvelous-movie-plan.aspx

Lawrence Meyers
May 11, 2005

"Millions are to be grabbed out here, and your only competition is idiots. Don't let this get around."
--Herman Mankiewicz, telling Ben Hecht about Hollywood

A long time ago in a galaxy far, far away, a fellow by the name of George Lucas worked out a legendary deal with 20th Century Fox regarding the merchandising rights for what was then expected to be a flop -- a film called Star Wars. In short, Lucas got to keep all the rights, and the result has earned him billions. It has also permitted him to make the other Star Wars films independently, without any interference or "notes" from any studio.

On April 28, Motley Fool Stock Advisor recommendation Marvel Enterprises (NYSE: MVL  ) announced a deal that, if executed properly, could make the company so much stinking money that it'll make George Lucas look like a pauper. Up until recently, Marvel's very successful business plan had involved licensing its character rights to movie studios in exchange for fees, or for a cut of the box-office and ancillary revenues. The theory was that Marvel would profit in a limited manner regardless of a film's performance but would take zero risk in the production costs. As many of you know, film productions can be hazardous to the pocketbook, because so many unpredictable things can happen.

But now, the plan has been altered. Marvel has made an arrangement with the new management at Paramount Studios, a subsidiary of Viacom (NYSE: VIA  ) . Under the deal, Marvel will produce films using a package of 10 characters from its archive, and Paramount will market and distribute them for as-yet-undisclosed fees. Under this arrangement, Marvel will keep the vast share of the box-office and ancillary revenues while retaining ain the highly valuable merchandising rights. What does this mean for Marvel in terms of revenue? Well, remember that scene from Indecent Proposal where Demi Moore is rolling in money? Multiply those dollars by a really, really big number.

The box-office take from Spider-Man, Spider-Man 2, X-Men, X-Men 2, The Hulk, The Punisher, Daredevil, and Elektra is a combined $1.5 billion. Oh, and that's just the domestic box-office number. The worldwide gross is double that. Now, I don't expect such stellar results from this batch of 10 Marvel characters, but if the company continues to hire good writers, good directors, and name actors, it will be setting the stage for enormous returns in the theatres. None of this even mentions the merchandising or DVD revenue streams.

Specifically, the distribution agreement specifies that Marvel may deliver up to 10 films to Paramount over an eight-year period, with the first titles including Captain America and Nick Fury. Marvel's budgets for each film may range from $45 million to $180 million.

You might ask, "OK, but who pays for the darn movies now?" The answer is. Merrill Lynch (NYSE: MER  ) . The deal calls for Merrill to provide a new, non-recourse debt facility to fund development and production costs. "Non-recourse" means that if the loan defaults, Merrill can go after only the collateral for the loan and none of Marvel's other assets. The collateral? The rights to the above-mentioned 10 Marvel characters, the names of which will all be announced later this year. If Marvel defaults on the debt, Merrill can sell those characters to other Hollywood studios.

Here's why this part of the deal is so sweet for Marvel shareholders and the company alike. First, Marvel doesn't risk its own cash. That's a good thing. Movies are expensive, and their box-office returns are pretty hard to predict. If those Marvel characters do get sold off because of a default, the Hollywood studios that buy them would probably come right back to Marvel to seek the company's expertise on developing the characters into films.

As mentioned, Marvel gets to keep the bulk of the box-office and ancillary revenues. The potential is absolutely enormous, provided that the company continues to make good films. And given the creative team over there -- Avi Arad and Kevin Feige -- I am not a bit worried.

In fact, it is exactly this concept -- making good movies -- that insiders say is a major reason why Marvel made such a move. The gossip out here in Hollywood is that the studio that financed Daredevil and Elektra tinkered ("interfered," if you believe some folks) too much with the scripts, and the films were ultimately not very good. Let me tell you why I think this bit of gossip is true. I read the original draft of Elektra, by Stu Zicherman and Raven Metzger, and it is far superior to what ended up on the screen. If rumors are true that star Jennifer Garn