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The Hobbit takes two steps forward, one step back

Tolkien Trust trustee Christopher Tolkien, son of J.R.R., has issued a statement, saying, “The Trustees acknowledge that New Line may now proceed with its proposed films of The Hobbit.”

The statement came after an out-of-court settlement between New Line and the Tolkien Trust (and Harper Collins) earlier this week. The settlement was reported to be in excess of US$100 million. It’s a lot of money, but not that much as the claim was based on an agreement for 7.5% of gross receipts. The trilogy grossed US$3 billion worldwide and did the same again in dvd, broadcast sales and merchandising.

Peter Jackson and New Line have already settled a similar issue surrounding non-payment of monies owed by New Line in 2007 for US$20-40 million, depending on which unconfirmed report you choose to believe.

A new bearded director has been appointed to replace the old one. A script for the first film has – reputedly – recently been delivered to New Line. Rumours are flying around about who’ll be cast in what role. The ducks are lining up (metaphorically speaking, not for the role of Bilbo). It’s all good, then, right?

Well… Movies are not cheap to make (shock horror), so New Line, which has become part of Warner Bros. since this whole business got under way, entered into a deal with MGM for the two Hobbit movies. Roughly speaking, the deal split the cost of making the movies and established distribution rights, Warners taking the US domestic market, MGM the rest of the world.

Nothing wrong with that. Share the risk in the project (not that there’s a great deal of that in Peter Jackson revisiting Middle Earth, even if it’s as producer rather than director) and share the return. There is no shortage of similar deals floating around between studios in the US. Unfortunately, what there is a shortage of, is money – at least at MGM.

The studio is, to use technical financial jargon, in deep shit.

It has been drawing on a US$250 million fund, set up by Merrill Lynch at United Artists, to fund its own production slate, and has a further US$250 million credit facility funded by JP Morgan Securities, which expires in April 2010. (It also has a US$3.7 billion – yes billion – term payment due to the Bank of Montreal in 2012, but that’s a long way away and the only people worrying about that at the moment are the bank.)

The total MGM company is valued at $4.9 billion, which is interesting since its film library was valued (by the Bank of Montreal) at over US$5.5 billion.

MGM currently has 150 creditors, led by JP Morgan Securities, who have been pushing hard for a restructuring deal at the studio. New MGM Chief Exec, Steve Cooper, recently told creditors, “The debt owns the equity.”

What that means is that a restructuring deal is likely to give equity (not cash) of US$2.5 billion to creditors. That’s bad news for the present investors, including Comcast and Sony (which reported its own loss this year). They’re likely to end up owning less than 10% of the company.

Just to make matters worse, MGM’s slate is not that full at present. It has the remake of Fame releasing later this month, then nothing of note until February, when a couple more films be released. It’s unlikely these will generate the US$250 million required to pay JP Morgan by April.

What’s all this got to do with The Hobbit?

In short, it means that MGM can’t afford to pay its share of production costs, which start to climb substantially next year if the project stays on its current track.

Either MGM has to sell its interest in the films, which would possibly delay production while a new partner is found (and, once in place, has its say on the films), or MGM has to raise further capital to stay in the game.

This isn’t one that’s going to be solved quickly, as a final decision isn’t likely until the restructuring is complete. A preliminary prestructuring plan is due to be presented to creditors by the end of next month.

If a decision is taken to sell MGM’s interest in The Hobbit, New Line might “buy back”, although Warners has a reputation for being risk-averse – perhaps a strange quality in the film industry, but then they don’t have nine red zeros on their balance sheet.

The picture could be further complicated if another organisation decides to make a bid for the restructured organisation. In the wake of last week’s purchase of Marvel Comics by Disney, other companies are looking to bolster their own position. With reduced debt but still requiring an injection of cash to move forward, MGM would certainly be attractive to cash-rich companies.

Time Warner has $7 billion in cash and is considering a strategy of becoming content-focused. ComCast has over US$1 billion, but as it’s about to lose one shirt at MGM, it might prefer not to gamble another.

So … don’t hold your breath. The settlement between New Line and the Tolkien Trust, welcome though it is, hasn’t removed the only obstacle in the way of a return to the Shire.

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