Will Legal Challenges Derail Endeavor Group's IPO?

When a company is preparing to go public, it helps to have positive press to back up the narrative found in the investment prospectus. Unfortunately for Endeavor Group, it's currently engaged in a legal conflict with the Writers Guild of America (WGA) labor union. Many of the writers represented by Endeavor are also members of the WGA, creating uncertainty around one of Endeavor's primary revenue sources. Industry Focus host and resident legal expert Nick Sciple explains the situation in the following segment, with help from Fool.com contributor Asit Sharma.

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This video was recorded on July 09, 2019.

Nick Sciple: As we move into these risks...right off the bat, when they go public, there are some question marks there. I want to talk about, when you think about a business like Endeavor, that is in the talent management business, one of the biggest risks that you have is that your assets are your clients that you represent and the talent that they have to content producers. And there's always a risk that those clients may become unhappy with your services, and may move on to other agents. And if you lose that, then there goes your business. In recent weeks and months, there has been a growing controversy between not just Endeavor, but all the major talent representation agencies and the Writers Guild of America, which represents most of the TV and writers in the country. Off the top, I'll go into more detail on this, but Asit, can you give our listeners a brief overview of what this dispute is between the Writers Guild and Endeavor? What is the Writers Guild upset about with agents and the like?

Asit Sharma: Sure. The Writers Guild of America represents the talent side of the equation. There is a traditional, very simple fee equation which has been around for decades in which writers receive a certain amount of each deal once they're represented and go to work for the buyer of the content. Nick, I believe you told me earlier that this goes back to a case from the 1970s, where the WGA was upset to but agreed to a newer fee structure which includes something called packaging fees. Packaging fees basically put out a model where a company like Endeavor is paid out of the production budget of each episode of, say, a TV series, and also retains some of the profits. This is a 3-3-10 model. Three percent of the series license fee, Endeavor or a company like Endeavor would get up front. Three percent of the license fee will be deferred. And 10% of profits will go to an agency like Endeavor if those profits materialize, which will be important in a second. This is versus a traditional 10% commission that a writer could expect.

Now, if you look at the perspective of the WGA, which represents the writers, this is a conflict of interest. The more the writers are paid, the less profitable a show will be, and the less of the production budget is left to pay Endeavor, which affects the rest of that with the packaging fees. So, WGA has basically gone to court, and they are suing not just Endeavor, but the other major talent agencies at the completely wrong time, I should say, for Endeavor. Nick, as we've been working on this episode over the last week, it seems like every day there's a new sally in this, which is not great news when you're getting ready to go one of these road shows and pitch your case to institutional investors.

But I'll flip it back to you. That's the brief overview, the context. Listeners, I will let our resident attorney, Nick, peel the onion back a little bit more for us.

Sciple: You've seen, like I said, in recent weeks and months, this feud between the Writers Guild and the major talent agencies flare up. As you mentioned, the Writers Guild has recently filed lawsuits against the major talent agencies, of which Endeavor is one, saying that, as you mentioned, there's a conflict of interest between these talent agencies getting these packaging fees that get a percentage of the production budget, and that amounts to a violation of the duty of loyalty that a fiduciary owes to their clients. In this case, the agent owes a fiduciary loyalty to the writer in this situation. If you are taking a percentage of the profits of a show, it's in your incentive to not increase the labor costs of said show, therefore, to keep the profits higher. So, there's a clear conflict of interest there.

However, there are some question marks over whether this has really caused a net harm to writers. To prevail on a claim or where you're alleging a violation of a duty of loyalty, you have to prove that there was harm, and that there was no consent by the plaintiff to the agent's behavior. In this case, over the past five years, Endeavor has called out that only five series on ABC, CBS, NBC, or Fox have even generated back-end profits, where those production rights would kick in. So, only for a small percentage of productions is this conflict actually materializing. For the vast majority of cases, Endeavor not taking their 10% traditional commission from their clients actually results in, in most cases, their clients getting a 10% higher payout than they would otherwise. So, it's to be determined how this case is going to play out.

There's also, the Writers Guild is suing all the talent agencies, alleging that they are price fixing, it's a horizontal price-fixing allegation. I don't think that one is going to go forward, it's just very difficult to prove. You need a smoking gun, an email or something that says, "We agreed to fix prices at this price."

But then there's also a third lawsuit going on, also an antitrust lawsuit, where you've got all the talent agencies countersuing the Writers Guild of America. William Morris Endeavor was the first one to do, filing suit in Los Angeles federal court on June 24th. They have an antitrust case going back the other way, alleging that the Writers Guild -- a little bit more background here. The Writers Guild passed a new code of conduct back in April. Part of that code of conduct required that any agency that would do business with the writers would have to sign on to it, and the provisions of that code of conduct prohibited agencies from engaging in packaging fees, as well as -- something Endeavor also does -- producing their own content in-house. When you're producing your own content as well, you can see, you become management as well as representing your clients. Seven thousand writers have left their agents since that has taken place. They say that like 1,500 of those have left from Endeavor. Anyway, related to that lawsuit, Endeavor and the rest of the major talent agencies have countersued the Writers Guild of America, alleging a concerted refusal to deal, a group boycott that even violates the antitrust waivers that traditionally labor groups get from antitrust provisions.

All that to say, all these talent agencies, suing the Writers Guild of America. The Writers Guild of America, suing the talent agencies back and forth. That resulting in Endeavor potentially losing a meaningful number of its writer clients. Coming back to the investing point of view here, when you look at the uncertainty when it comes to Endeavor being able to keep its talent in-house...

One last thing I'll mention is, the WGA is directly going after Endeavor's IPO. On July 2nd, they filed a letter directed at potential Endeavor investors, laying out the conflicts between WGA and Endeavor.

When you see all this playing out, how concerned does this make you for the IPO, and also for the business moving forward as well?

Sharma: Let me take the business first. The business is not as much of a concern. It's to everyone's interest that the WGA -- regardless of the fact that it's in attack mode now -- strikes a deal with the major agencies. Either they'll get some concession and peel back one or two of what they perceive to be conflicts of interests and breaches of fiduciary responsibility in the form of maybe even negotiating smaller packaging fees. They'll have some pullback. The two groups have to work together. The Guild needs the talent agencies, and vice versa. So, long-term for the business, there aren't that many concerns.

However, this has been a strong run in the markets over the last year two for initial public offerings. If you think about it, Endeavor, which is not a tech company, although they are investing in smaller technology-enabled companies, they're not a hot healthcare company, they are a content company, which has a good look in that they are a little faster-growing than your average content company. They're competing for investment dollars. And this is the rub -- when you're pitching this on Wall Street, institutional investors are going to be hesitant to step up in a big way. That can affect the pricing of the issue. And as we all know, the pricing of the issue determines how much you raise. That determines how much you'll have left to shore up working capital and pay down debt. And an institutional investor who thinks through this can see, if he or she looks around and does not see a groundswell of support because of the uncertainty around these legal issues -- if there's not enough groundswell of investment, you can do the math and understand that the IPO itself won't change the complexion of the company. And then, if you're an investor, why would you invest in that case? There's a circular logic that develops when a roadshow is assailed by issues like these. We've seen this story before over the years.

So, I am concerned for the IPO. I think it's within the realm of possibility that the IPO could be delayed or even shelved for some time. As I said, we haven't seen an amended statement yet. This initial statement was filed on May 23rd. It's about time to see that first amended statement that starts punching in numbers where right now, we just have placeholder blanks in the registration statement. So, I think it's sort of a worry.