It’s time for Hollywood’s periodic wake-up slap in the face from Cowen and Co. analyst Doug Creutz. He’s been warning investors for years to beware of a profit squeeze at the major studios. But his latest analysis, out today, is his bleakest yet.
The outlook for film industry profitability “is looking increasingly dire,” he says. Indeed, “2016 could be a pivotally negative year in the economic fortunes of one of America’s highest-profile industries.”
That might sound alarmist after a year when, by Creutz’s estimate, operating income for the major studios increased by 5.5% to $5.2 billion. His number tries to factor in all of the profits that movies make directly or indirectly — from licensed merchandise and theme parks, for example — and leaves out profits that studios see from TV networks or production.
But he notes that the proceeds increasingly are lopsided. Last year only Disney, Universal and DreamWorks Animation saw their film-related bottom lines grow from 2014. Warner Bros, Fox, Lionsgate, Sony and Paramount saw profits decline. And Disney and Universal accounted for 70.5% of the industry’s operating income, with Disney alone seeing 46.8%. That means the other six split less than 30%.
“When one company gets half of the profits in an industry, it’s kind of scary — and it’s not aberrational,” Creutz tells me.
Studio profits are about to come “under significant pressure, with better-positioned studios fighting to run in place, while other studios experience significant declines in margins.”
That might shock some investors who place high valuations on film studios. Time Warner, Fox and Viacom also project upturns in their film earnings.
Creutz’s view: “Most of these narratives are going to have sad endings.”
The main problem is that too many studios make too many big-budget franchise films. This year studios will release 30 pics that cost $100 million or more to produce, up from 22 last year.
The ones that succeed strike gold. But the increased competition lowers the odds for any one to break out. “Ultimately, we think many of these incremental blockbuster films are not going to work, and incur significant losses for their studios,” the analyst says.
The trend is likely to continue, because it’s in nobody’s interest to stop. Those who do would help their competitors but “have fewer chances of hitting one of the few home runs that arrives every year.”
Those familiar with Game Theory will recognize this as a classic dilemma known as the “tragedy of the commons.” As Creutz puts it: “While everyone would be collectively better off with fewer blockbusters, no one is made individually better off by reducing their slate.”
So where does it end? Creutz sees a potential parallel with the video game industry over the past decade. It also became a hit-driven business, and providers including THQ, Midway, Acclaim, Atari and LucasArts “simply ceased to exist.”
But Hollywood has an X factor: “Decisions aren’t made just on profits,” he says. “People like the prestige and hanging out with Jennifer Lawrence and Tom Hanks. To contemplate giving it up is almost impossible.”
Take Viacom, for example. The struggling company “would be best served by simply selling Paramount to anyone willing to take it off their hands — but that would result in Viacom not being in the movie business, diminishing its importance and reputation in Hollywood.”
It’s now talking to potential partners who might buy a minority stake in the studio.
That means the industry won’t see a lot of consolidation “until well past any normal economic pain point.”