Box-Office Betting: Oscars for Speculators

There’s a new futures exchange for box-office results in the United States. Washington regulators have already given it their approval. Critics see it as a new potential risk for financial markets.

There are the big stars, the fake emotions and real money. In front of the camera, the hero conquers all his enemies, love triumphs over everything and good always wins out over evil. But behind the scenes, happy endings are never assured. On average, box-office success or failure for one in 10 movies turns out as a complete surprise.

Before “Titanic” premiered, everyone in Hollywood predicted that the movie would suffer the same catastrophic fate as its legendary namesake. In fact, the melodramatic tearjerker became the most successful movie in history up to that point. The 2001 romantic comedy “Town and Country,” on the other hand, had financial success locked in thanks to a lineup of stars that ran from Charlton Heston to Goldie Hawn. It turned out to be one of the biggest flops to ever come out of the Hollywood dream (or nightmare) factory, losing almost $100 million.

The Game Gets Serious

How long will the box-office lines be next Friday night? That question is often more thrilling for some American moviegoers than the plot unfolding on the screen. Since 1996, people can place computer bets on how much they think a movie will make. It’s all done using play money, but 200,000 movie freaks take part in the harmless fun anyway, even if they’re way off the mark. Most of them predicted the record-breaking “Avatar” would be a flop.

Only a very few among them know who’s behind the cyberspace betting parlor. It’s the financial services provider Cantor Fitzgerald. The firm bought their internet domain in 2001 and began using movie freaks as laboratory rats in their ambitious project: an online futures exchange for Hollywood hits.

Instead of betting on the future price of pork bellies, wheat or oil, this market deals in expected box-office revenues for movies. After a nine-year dry run, it’s ready to operate for real. Movie theaters will now present their ticket sales in a controlled way and in real time.

Integrated Economic Benefits

Washington’s regulatory agencies have, after a suspiciously long testing period, finally given the project their blessing. Starting this week, real money can be used in “Cantor Exchange” (CX) accounts. April 23 will mark the last necessary approval stage and business is scheduled to take off shortly thereafter.

The basic principle is simple: Six months prior to a film’s premiere (a point at which everything has already been filmed and only editing is taking place) the market will determine its contract price. Four weeks after the premiere, if the film has taken in more, the investor wins; if it falls short of predictions, the investor loses. In the meantime, investors can trade contracts on the basis of their expectations.

Cantor will get some competition this summer from a market calling itself “Trend Exchange.” The venture capital fund Veriana will target the usual futures traders like institutional investors, professional speculators such as hedge funds, and the producers of the merchandise — movie studios, producers and distributors.

Neither provider shies away from questions about the economic usefulness of their financial innovations. The industry is strapped for cash because financing has dried up in the economic downturn. They’re now turning increasingly to external sources for financing. The larger studios had already routinely turned to private equity funds in the past.

But their investors also seek to minimize risks, particularly in an industry whose products are full of surprises and unexpected shocks. In a futures exchange, investors would be able to protect themselves against flops with “hedge” insurance by getting access to current updates, giving them information like a Hollywood insider; that would act as an inducement to speculate.

Distributors who fervently believed in the success of their masterpieces (or their schlock productions) would increase their participation if there were futures contracts they believed to be undervalued. Under ideal conditions, less fear of losing money because of a flop would result in higher quality products. Investors would tend toward offbeat scripts, new faces and creative direction instead of always clamoring after the same old stars, special effects and spin-offs.

Say Yes to Insider Trading

In contrast to the stock market, insider futures trading isn’t frowned upon. “Profit from what you know” is the slogan emblazoned at the top of the CX website. But that could increase the risk of participants coming up with dumb ideas. A producer who notices during shooting that his big screen jewel lacks that certain luster might be tempted to hedge his potential flop — and then help it fail by doing things like slashing the advertising budget. In order to avoid conflicts of interest, each company would have their hedge investment limited: A flop would always have to lose more money than a negative bet would yield.

So far, it would not be unlike other futures markets. But Cantor’s idea is new in that it encourages the small-time movie freak to speculate. To do that, the minimum investment — the price of a single contract — is limited to one-one millionth of the box-office take, abnormally low. Cantor scours the country and offers its current website audience the opportunity to trade online for real.

New Risk Potential

The success or failure of a film project is ultimately decided by the public that now simply asks, “Would I pay to see this or not?” So distributors get a lesson in futures prices as well: If it doesn’t meet expectations, maybe publicity needs to be pumped up more, or maybe the trailer needs to be edited better.

Cantor’s critics, however, see new dangers for financial markets from this mass market. Hordes of purely speculative investors inflating a derivative market to several times the value of the basic investment is very reminiscent of the credit default swaps (CDS) that have already earned the dubious distinction of being “weapons of mass destruction.” They’re suspected of strengthening the financial crisis. The difference, of course, is in the far lower volume; compared to the financial world, Hollywood is an economic dwarf.

Stupid German Money

But it wouldn’t be the first time clueless investors took it on the chin investing in movies. The trail leads to Germany, where, during the last decade, investment in film funds was a favorite tax shelter for the serious investor. Production costs could be written off immediately, but oblivious Germans invested in so many predictable flops they never saw any returns. The film studios got a big laugh over “stupid German money.”

That phrase was on everyone’s lips during the financial meltdown, a derogatory reference to German banks naively trusting the U.S. economy and investing in subprime trash. European drama and American farce: Hollywood sets the scene, even if the sequel will be shot on Wall Street.