The real reason why Paramount bought DreamWorks.

The numbers behind the industry.
Dec. 19 2005 3:43 PM

Meltdown

The real reason why Paramount bought DreamWorks.

Illustration by Mark Alan Stamaty. Click image to expand.

The true brilliance of Paramount's high-profile acquisition of DreamWorks is that it will serve to divert from, if not totally hide, Paramount's own failure to assemble a full slate of films for 2006-2007. Compared with the public-relations cost of revealing that managerial meltdown, the $1.6 billion price tag for DreamWorks must have seemed a bargain.

Here is what happened, according to people at Viacom (Paramount's corporate owner): In 2004, Sumner Redstone faced the prospect of a massive loss, one that would ultimately exceed $24 billion. The loss was not due to Paramount's blunders but rather to the falling values of Viacom's Infinity radio stations and Blockbuster video stores. Someone other than Redstone or Viacom's Vice Chairman Philippe Dauman, however, had to take the blame for the sea of red ink. Why not the heads of the movie division, who had already been criticized for a long string of box-office bombs in 2003? Following this logic, studio heads Jonathan Dolgen and Sherry Lansing were axed.

Advertisement

The irony of this regime change was that Paramount's movie division had consistently hit its profit targets. Although the old regime's movies had performed badly at the box office, in the old regime, under Dolgen's tutelage, the executives had so perfected the art of the convoluted deal that 75 percent of Paramount's movies, even those that appeared to be bombs to the outside world, made a profit. This happy state of affairs was due to the assiduous use of OPM, aka Other People's Money, which includes the proceeds from "money for nothing" tax shelters, foreign-production subsidies, and foreign presales. Consider Lara Croft: Tomb Raider, the acme of such deal-pyramiding. Its budget was reported as $94 million, but, after the enterprising financial arrangements, it actually cost Paramount less than $7 million to make. While the art-of-the-deal formula didn't always produce award-winning movies, to say the least, the studio under Dolgen and Lansing had a nearly 60 percent return on its invested capital. The disadvantage for Dolgen and Lansing is that such legerdemain works best when it's invisible to outsiders.

Enter the new regime. When Brad Grey took over as studio chief in January 2005, he had a mandate from Redstone and Tom Freston, who now effectively headed Viacom, to totally revamp moviemaking at Paramount. To this end, he brought in McKinsey & Co. to consult on the great reorganization. Grey let it be known that he wanted to make money through movies and not off-the-book OPM deals. When a senior executive outlined five off-balance-sheet tax-driven deals that would have netted $50 million in bottom-line profits, Grey aborted them, explaining to him, "We don't do things like the old management." The executive resigned the next day. One by one, Grey and his new management team canceled almost every project already in process. He also forced out most of the executives who pieced together these deals. As a result, Paramount found itself with almost no viable projects in the pipeline—except for Tom Cruise's Mission Impossible 3 (which Grey came close to killing). It's easy to terminate upcoming movies, but it's extremely time-consuming to package scripts with stars and directors. The studio, faced with rising overhead and falling morale, was headed toward what one Viacom executive described as "a nuclear meltdown."

Desperate for a slate of new products, Grey turned to DreamWorks, which had about 30 movies in the pipeline for 2006-2007. The company had been trying without success to sell itself to NBC-Universal. When Grey started negotiating with David Geffen—the "G" in DreamWorks' full name, DreamWorks SKG—Redstone "went ballistic," as one of his associates put it, over the $1.6 billion price tag and had Grey pull out of any talks. Then, Spectrum Equities Investors, a private equity firm specializing in media and telecom deals, came to the rescue. It offered to put up about half the $1.6 billion price in return for the cash flow from DreamWorks' library assets. This contribution allowed Paramount to justify the remaining $800 million outlay since DreamWorks' slate of movies in production would fill the gaping holes in Paramount's 2006-2007 schedule.

The value of these 30 projects was reckoned to be about $600 million. The remaining $200 million or so could be chalked up to "key money," or the price for getting the right to distribute the films of DreamWorks Animation (a separate company from DreamWorks) and a relationship with the "S" in SKG, Steven Spielberg. However, the distribution fee of 8 percent that Paramount will receive on DreamWorks films is very low, indeed—a quarter of what Hollywood studios usually charge—and Spielberg is already doing Paramount co-productions, including such hits as Minority Report, Saving Private Ryan, and War of the Worlds. This is generous key money, even by Hollywood standards.

After Redstone gave his blessing to the acquisition, Spectrum found it could not accept some of the terms in the deal, such as the lack of the right to cancel Paramount's contract to distribute the DreamWorks library, and Spectrum (at least temporally) withdrew its offer. Nevertheless, Paramount, assuming that other private equity investors would take Spectrum's place, went ahead with its "coup" (as the New York Times described it). The offer prevailed because the other contender, NBC-Universal, was not in the same predicament as Paramount. It had a sufficient number of movies in its pipeline, so it did not covet DreamWorks' future slate of movies. Bob Wright at Universal, unlike Brad Grey at Paramount, did not need to spend $1.6 billion to buy his way out of looming failure. Because of this asymmetry, DreamWorks was worth much less to Universal, or to any other Hollywood studio with a full slate of movies, than it was to Paramount. Indeed, only Paramount could internally justify a $600 million premium for DreamWork's future movies. When this deal closes, Paramount will essentially become, at least for the next two years, DreamWorks. Of course, many, if not all, of the people who work at DreamWorks will lose their jobs, and the people at Paramount who created the near-meltdown will take credit for the films they've acquired. But, as they say, that's show business.

TODAY IN SLATE

War Stories

The Right Target

Why Obama’s airstrikes against ISIS may be more effective than people expect.

The One National Holiday Republicans Hope You Forget

It’s Legal for Obama to Bomb Syria Because He Says It Is

I Stand With Emma Watson on Women’s Rights

Even though I know I’m going to get flak for it.

Should You Recline Your Seat? Two Economists Weigh In.

Doublex

It Is Very, Very Stupid to Compare Hope Solo to Ray Rice

Or, why it is very, very stupid to compare Hope Solo to Ray Rice.

Building a Better Workplace

In Defense of HR

Startups and small businesses shouldn’t skip over a human resources department.

Why Is This Mother in Prison for Helping Her Daughter Get an Abortion?

Politico Wonders Why Gabby Giffords Is So “Ruthless” on Gun Control

Behold
Sept. 23 2014 4:45 PM An Up-Close Look at the U.S.–Mexico Border
  News & Politics
Foreigners
Sept. 23 2014 6:40 PM Coalition of the Presentable Don’t believe the official version. Meet America’s real allies in the fight against ISIS.
  Business
Moneybox
Sept. 23 2014 2:08 PM Home Depot’s Former Lead Security Engineer Had a Legacy of Sabotage
  Life
Outward
Sept. 23 2014 1:57 PM Would a Second Sarkozy Presidency End Marriage Equality in France?
  Double X
The XX Factor
Sept. 23 2014 2:32 PM Politico Asks: Why Is Gabby Giffords So “Ruthless” on Gun Control?
  Slate Plus
Political Gabfest
Sept. 23 2014 3:04 PM Chicago Gabfest How to get your tickets before anyone else.
  Arts
Brow Beat
Sept. 23 2014 8:38 PM “No One in This World” Is One of Kutiman’s Best, Most Impressive Songs
  Technology
Future Tense
Sept. 23 2014 5:36 PM This Climate Change Poem Moved World Leaders to Tears Today
  Health & Science
Science
Sept. 23 2014 4:33 PM Who Deserves Those 4 Inches of Airplane Seat Space? An investigation into the economics of reclining.
  Sports
Sports Nut
Sept. 23 2014 7:27 PM You’re Fired, Roger Goodell If the commissioner gets the ax, the NFL would still need a better justice system. What would that look like?