Last month, Marvel Entertainment (NYSE:MVL) executives held a presentation at Merrill Lynch's Media and Entertainment Conference, and their comments were quite enlightening. To give you the inside scoop on what these analysts know, I listened in and wrote up my thoughts.
My spider-sense is tingling
If you get nothing else out of this report, you should gain an appreciation for the extremely light business model under which Marvel currently works, and the company's genuine focus on making great stories. The company's portfolio of comic book characters, coupled with an innovative capital structure, leads to a low-risk, high-reward business model that should leave many competitors gamma-radiation-green with envy.
Vice Chairman Peter Cuneo pointed out that this library contains more than 5,000 characters at various stages of audience exposure, and most of those characters have yet to be monetized beyond the occasional comic book.
He outlined the six essential stages to making money from intellectual property, as the company sees it. Marvel took the first three steps long ago, meaning that it owns, controls, and creates content of its own. A stable of creative talent keeps the hungry content beast well-fed, and there are decades of stories to fall back on in cases of severe writer's block.
Marvel is now moving onto the fourth step, which is to produce content. A novel financing structure that places rights to certain characters as collateral to a large credit facility now lets the company make movies on its own terms, with full creative control and no need to please a partnering studio. Production by committee was arguably the downfall of Marvel's biggest bombs, such as Daredevil and Elektra, both coproduced and distributed by News Corp.'s (NYSE:NWS) 20th Century Fox studio.
What's important, according to Cuneo, is that "Marvel is not using any of its own capital in these production activities. And the fact that we're able to do this, I think, really reflects the tremendous power that our partners and other people see in our brands and our franchises for the future." The Spider-Man franchise is one of the biggest moneymakers in the history of movies, and Sony (NYSE:SNE) subsidiary Columbia Pictures gave director Sam Raimi loose reins in that endeavor.
Now that Marvel itself gets the final say on greenlighting a movie or approving a script, it can take the necessary creative risks, which is exactly how Disney (NYSE:DIS) division Pixar became great to begin with. Stories like Spider-Man and Toy Story cannot be made without a certain appetite for artistic risk, just like American Idol was rejected by every major studio -- some of them twice -- before Fox agreed to let the British originators do their thing in their own controversial way.
The final two steps of Cuneo's ladder will remain the domain of partners like Hasbro (NYSE:HAS), Electronic Arts (NASDAQ:ERTS), and Lions Gate Entertainment (NYSE:LGF), because they are much better at packaging and marketing the final product than Marvel itself is. Marvel got out of the toy business a couple of years ago because it didn't fit its new, lean business model, and both of these final steps are quite capital-intensive.
Look out! Profits!
There's a clear flow inside Marvel explaining how the company makes money. It all starts with an original comic book hero (or villain) and the substantial amount of stories built around that character over the years. Characters like Spider-Man, the Hulk, the X-Men, and Iron Man have very large and very loyal followings around the world, and a wealth of backstory to draw from. Comic books are also a very predictable business, since the company doesn't accept returns from its retailers -- a sale is a sale, and operating margins hover around 40%.
Comic books, however, are just the start for these heroes. The next logical step is into movies, TV series, and direct-to-DVD productions. Marvel's library of comic-book stories makes it easy to find great ideas to build a script around. Most of these efforts have traditionally been animated, but the success of live-action superhero material over the past five years -- much of it Marvel's to claim -- only encourages more of the same. The outsourced movie franchises are made with other companies' money, leaving Marvel to rake in its share of the profits at little financial risk.
Marvel Studios vice chairman David Maisel explained that in the case of the newly launched Fantastic Four TV series, "Lions Gate recoups their costs in the distribution fee, and then we get 60%-70% of the profits. It's a very attractive model for us, and obviously, we get to keep the project in our library and return on capital is very attractive."
The new credit facility changes that game a little bit, but it's all good. "Economically, Marvel will receive 100% of the profits for the movies," Maisel explained. "There are no equity participants, besides ourselves, in these movies." On top of that, the company receives a 5% producer fee of the total revenues generated by these movies. Licensing and merchandising right also remain in-house. The worst that can happen is that a particular movie bombs out at the box office, and the creditor -- conference host Merrill Lynch -- forgives the debt on that movie's budget in exchange for the rights to that character. A $100 million U.S. box office gross makes a breakeven movie for Marvel, according to Cuneo, and the historical $200 million domestic average and $400 worldwide gross taken in by Marvel's movies will put $117 million or so directly in its net profit coffers.
And after the silver screen, the same story becomes a line of toys, video games, toddler outfits, and lunch boxes, all of which contribute licensing and royalty revenue for Marvel at little or no cost to the company. Maisel said that toy and merchandising revenues for its existing films have totaled between $17 and $80 million per film, and it's all gravy.
In total, Maisel drew up a future roadmap of 10 movies produced under the credit facility in the next three years, using average box office and budget numbers for his estimates, and came up with $1.5 billion of pure profits "without any meaningful cash risk to Marvel."
A hero can save us
The first two movies planned for release under the new terms are based on Iron Man and the Hulk. Waiting in the wings are Captain America, Thor, Nick Fury, Ant-Man, and the Avengers, all what David calls "hall of fame characters for Marvel. These rank up with our other characters -- the X-Men, The Fantastic Four, and Spider-Man -- in what we call our top tier of characters." Not all of these characters will get their own movies, but the successful ones will get a healthy dose of spinoffs and sequels, just like X-Men before them.
Maisel's closing remarks really hit home, with the clear focus on genuine creativity they describe. "The creative team are all fans of Marvel," he said. "We're passionate about the characters, we've been thinking about these movies for years and years. We have decades of stories and these are already in storyboard form. And so we can have the luxury of sitting there and looking at all these comics and drawing what we think is the best for the first movie, for the second movie, for the third movie -- many times we can plan them out that far in advance. And many writers in town are big Marvel fans, and directors, too."
That's how you become great in the entertainment business, and it's exactly what Disney is doing, too. Focus on great stories, and the rest follows, including profits and cash flow.
That wraps up our report from this presentation with Marvel Entertainment. Stay on the lookout for more "Fool on the Street" reports that bring you juicy information to which only the analysts have paid attention.
Further Foolishness:
- Will You Like Marvel When It's Angry?
- Marvel's Future Cast in Iron
- The Value of Marvel's Next Act
- Dueling Fools: Marvel Entertainment
Marvel Entertainment, Hasbro, Electronic Arts, and Disney are all Motley Fool Stock Advisor recommendations. Find out how Marvel ended up in the middle of this entertainment keiretsu with a free 30-day trial to our flagship investor service.
Fool contributor Anders Bylund is a Disney shareholder, but holds no other position in any of the companies discussed here. You can check out Anders' holdings if you like. With great power comes great responsibility, which is why we have Foolish disclosure rules.
