Speculators Kicked Out Of Hollywood’s Lots

By Dom Serafini

While President Barack Obama was busy fending off insurance companies that profited from people’s misfortunes by successfully offering a national health plan, Wall Street financiers and bankers roaming the White House allowed another coup: the creation of two exchanges that would give speculators the opportunity to bet on the performance of films over their first four weeks at the box office.

Clearly, the disastrous laissez-faire philosophy of presidents Bill Clinton and George W. Bush still reigns, and now even Hollywood is being targeted by speculators. The Commodities Futures Trading Commission (CFTC), the U.S. agency that regulates derivatives and futures market, has backed a new scheme that will potentially create the Hollywoodian equivalent of the prime rate mortgage meltdown.

The reason major movie studios have lost their first battle over box-office futures trading could be attributed to the fact that Hollywood was slow in reacting to what is considered the new “Barbarians at the Gate” (from the 1990 book about speculators). At first, the industry did not take the threat seriously. It is also possible that Hollywood relied on the more rule-conscious Federal Trade Commission and Federal Communications Commission, but did not adequately monitor the laissez faire commodities regulators.
After The New York Times reported on March 10, 2010 that New York City-based Cantor Futures Exchange was to open an online futures market to place bets on the box-office revenues of Hollywood’s biggest releases, Washington Post columnist Steven Pearlstein commented, “If nothing else, the movie exchange is an obvious invitation to trading with inside information.”

A former Warner Bros. financial executive explained to VideoAge, “This is an inside trading opportunity of a lifetime.” InvestmentNews called the movie exchange plan “bizarre.”

The scheme ever had the Europeans riled up, with the Italian daily laRepubblica publishing the alarmist headline: “Now Speculators Target Movies, Too.” The Los Angeles Times announced the new futures exchanges with the opening line: “Welcome to Hollywood’s newest version of risky business: movie derivatives.” The only difference, however, is that Hollywood really hates it. “The reputation and integrity of our industry could be tarnished by allowing trading in movie futures contracts in a manner which allows them to be viewed as the economic equivalent of legalized gambling on movie receipts,” said MPAA’s interim CEO, Bob Pisano.

But it’s not only the Motion Picture Association of America that opposes the scheme. Among those who object to the film derivatives are the Directors Guild of America, the National Association of Theatre Owners, the International Alliance of Theatrical Stage Employees and the Independent Film and Television Alliance (AFM’s organizers). Plus, Senator Blanche Lincoln, Democrat from Arkansas, introduced a bill that would outlaw the trading of future contracts based on box-office receipts. Lincoln is chairman of the Senate Agriculture Committee, which has jurisdiction over futures markets.

Greg Frazier, the MPAA's executive vice president, stated, “Anyone who has followed the meltdown of the financial markets, knows how important it is to ensure that the establishment of new financial marketplaces does not open the door to rampant speculation and financial irresponsibility.”

For some observers, it is refreshing to know that in a world controlled by speculators, even big business is seeking more regulations and more government protection.

In 2001, Cantor Exchange bought the Hollywood Stock Exchange (HSX.com), an online box-office market that uses imaginary money (called Hollywood dollars or H$), with the intention of turning it into a real market exchange. Some 200,000 users are said to be playing with HSX.

Similarly, Veriana Networks, a Scottsdale Arizona-based media and technology company, has also been approved by the CFTC to launch Media Derivatives Inc (MDEX), a competing trading exchange. However, the Veriana exchange is open only to institutional investors, while the Cantor exchange would be open to anyone.

Reportedly, in the U.S. there are about 300 movies made every year, and futures can be offered for between 50 and 100 of the A-titles, even though speculators would be betting on between 12 and 16 movies, six months before the movies are released.

In the case of HSX, a “MovieStock” is cashed out (which occurs when the movie is “delisted”) at H$1 per each $1 million of the movie's domestic box-office gross on the first business day after its first four weekends of wide release or after the first 12 weekends of limited release. Box office measurement services, like the Portland Oregon-based Rentrak Corp. or, in the case of HSX, the Los Angeles-based Exhibitor Relations, would provide movie ticket sales data updates. According to a HSX representative, movies get listed in the exchange months before they’re actually released. The IPO price (initial price offering) is set up by the exchange itself based on estimates made with a “proprietary system.”

If a trader invested H$200 on a movie that is expected to gross $100 million at the box-office (i.e., buys two shares), and the film grossed $150 million, he or she would profit H$100. This is called a “long” position. In addition to “buying” and “selling,” a speculator could also “short” the movie, meaning bet on the movie being a box-office flop.

This is the problem that has Hollywood up in arms. Basically, on top of inside trading, conflict of interest, manipulation and endless opportunity for speculation, Hollywood fears “shorting,” or betting on the movie’s failure at the box office. Indeed, there is a possibility that box-office potential would be hurt by short-sellers. For example, a speculator might leak an early version of a film to the Internet and then profit from its subsequent poor performance at the box office. As indicated by Sony Pictures pushing back Green Hornet due to “negative buzz,” Hollywood is terrorized by the effects that “shorting” could do to a movie.

Futures are often associated with commodities such as corn or oil. But while futures make sense for corn –– a commodity affected by the weather, and oil, which is affected by disruptions like wars and cuts in production –– the success of a movie is due to emotional rather than tangible elements. Therefore, shorting a movie could have a negative effect on the public’s willingness to see it.

“Shorting” movie futures is a complex operation. If a speculator shorts a security, the losses could be much more than the sum initially invested. Shorting a security on HSX, for example, players make H$1 per share every time the security's price goes down one H$. However, the player also loses H$1 per share every time the security's price goes up one H$. So if an investor buys a MovieStock at H$50 and it cashes out at H$150, the investor loses an extra H$100 per share on top of the original H$50 per share invested.

And all this without considering other “options” or derivatives that futures film exchanges would be offering, such as “put” and “call,” which “cashes-out” after a movie’s first weekend of release. A “put” speculates that a movie will have a lower-box-office take for its opening weekend than the strike price (i.e., the dollar amount that a movie is estimated to make opening weekend). To the contrary, a “call” profits if the box-office take is higher than the strike price.

In Washington Post’s Pearlstein’s view, “There is the real possibility that a film that cost $100 million to produce could cause financial losses many times that amount, creating a contagion effect that could dry up funding for the entire industry.” He then concluded, “The truth is that no great economic or social purpose is served by allowing people to profit from assets they do not control or hedge risks they do not have.”
Backers of the box-office exchanges argue that reducing the financial risk of filmmaking through futures contracts, a type of derivatives, could bring more investment to Hollywood.

Hollywood producers have long hedged their risks by buying insurance against bad weather during location filming, for example.

In the case of the movie exchange, they said that if, for example, it costs a studio $100 million to make a film, that studio could use the exchange to protect its investment by shorting the same amount, and if the movie loses money, they could make it back on the short side.

An Expert Challenge to Film Futures

VideoAge asked Tony Friscia, an entertainment industry executive and consultant who has created and maintain Ultimates* at 20th Century Fox, Columbia Pictures and Lorimar, to come up with various technical issues with the film features exchanges:

1) What if a studio is required to write down the “Net Realizable Value” before the picture is released, as required by the rules of the Ultimate*? Will the public be informed? If yes, the box office will be even lower than originally anticipated. What if the public is not informed?
2) Box-Office vs. Film Rentals. Although there is a direct correlation between the two, studios care more about Film Rentals. It is the Film Rental that goes to the studio as revenue. Film Rentals are affected by the release pattern and the deal the studio has with the theater owners.
3) Financing Production. Backers of the film future exchanges also state that this may be a means to finance production. If that is the case, the entire Ultimate may be in play, and if the entire Ultimate is in play, will the studio maximize profits for itself or for the investor?
4) Will the exchanges factor in the other windows? Since most theatrical releases lose money, the other windows are crucial. The other windows almost always have deals already in place.
Most of the deals in the other windows have minimum guarantees attached to them, which are not dependent on box-office, unless and until they reach certain escalators. Once again, deals are known only to studio staff.

*To understand the concept of the “ultimate,” please refer to a front-cover story in VideoAge October 2009 Issue.