SAG’s Risky Business: Still No Profits at Hulu

As I first reported here a few days ago, SAG’s contention that online video site turned a profit in 2008 is wrong. SAG has made the example of Hulu’s profitability a central example of how quickly the new media environment is gaining momentum. 

In fact, Hulu is likely losing substantial amounts of money – and that is at it should be in a start-up venture. And sure enough, as we explain below, one of the leading analysts of Hulu, Henry Blodget at Silicon Alley Insider, thinks likely operating losses at Hulu last year were roughly around $22 million!  That’s a $34 million delta from SAG’s $12 million in profits.

The unfortunate thing is, if SAG had gotten it right they might have even a stronger argument in favor of a better deal from the Producers. Instead, their activists, like the pro-Membership First blogger and SAG member Arlin Miller, have compounded the mistake with new mistakes.
And it turns out that under the new media deal that other guilds have taken residual payments can be generated for shows that otherwise might never see the light of day, something that could be a read advantage for older SAG members.

Perhaps even more unfortunate SAG made its unsubstantiated claim as part of its campaign for a Strike Authorization Vote, or SAV, that could, if it passed, quickly lead to an actual walkout by 120,000 SAG members across the country. Given the potential magnitude of that action, it borders on irresponsibility for the Guild to have gotten this wrong.

I emailed SAG’s Pam Greenwalt for a comment but did not receive a reply.

Right now, as Vallywood readers know, the SAV has been put on hold by the Membership First controlled Negotiating Committee pending a meeting on Monday, January 12, of the National Board of SAG. Rumors are flying that a change of direction for the Guild will be taken by the new non-Membership First majority on the Board including the possibility of firing their NED, Doug Allen, and restructuring the negotiating team.

In light of the significance of the new media issue to the current situation in the SAG contract saga, I decided to dig into this urban myth to find out what happened here and try to explain it to Vallywood readers. It is an interesting tale.

First, what is Hulu?

Hulu is a limited liability company, or LLC, jointly owned by three groups: News Corp, the Rupert Murdoch-led conglomerate; General Electric, the parent company of NBC Universal; and Providence Equity Partners, a private equity firm that specializes in media. Although details about the joint venture are not public it was reported in the New York Times that Providence invested $100 million in Hulu at a valuation of $1 billion. That means that Providence likely owns 10% of the company and that GE and News Corp each likely own 45% of Hulu (in fact, News Corp’s 10-K confirms their stake at this amount).

LLC’s are relatively rare in the high tech world where I come from because they are seen as unwieldy and difficult to transition to the public markets. And sure enough when Providence made their investment they were criticized for it by Roger McNamee, a prominent Silicon Valley investor at Elevation Partners. Of course, Elevation just dumped $100 million into Palm, so what does he know, right?
Hulu is set up to showcase content found in the film and TV libraries of major producers such as NBC and Fox, but is also building a diverse portfolio of relationships with 3d party content providers from Ford Models to the NBA.  In other words, most of the content on Hulu is “move over” content – created originally for TV or Theatrical release and now streamed onto the web for easy access any time.
That means that older content gathering dust in studio vaults can now find new audiences. It creates huge new opportunities for advertising revenue and thus, potentially, income for actors. 
The question for SAG is how to get the right amounts to the right people.
The content is ad supported and that, along with the avoidance of lots of user generated content as at Google’s YouTube, distinguishes Hulu from the rest of the field.
Second, how successful is Hulu?
Well, success in any startup is a relative question. In the late ’90s during the dot com boom I had a front row seat as a lawyer in Silicon Valley and then as a law professor. It was amazing to see the types of metrics used to justify sky high valuations. The Providence investment in Hulu puts a $1 billion valuation on Hulu. But Hulu very likely makes no money now at all. 
What could possibly justify such a valuation?
Well, in some sense that “valuation” is only a back of the envelope number that will be adjusted over time if the entity actually begins to make money and a mature business model emerges.
That could be a very long time indeed, if ever. I worked as an advisor on cell phone giant Vodafone’s $150 billion acquisition of  Mannesmann in 1999-2000. Vodafone tried to justify the huge price tag for the company based on its estimate of the mobile telephone franchise inside Mannesmann. That, in turn, depended on widespread adoption of 3G mobile phone usage – not ten years later but in the first few years after the deal.
Of course, as the recent 3G iPhone roll out indicated, 3G has taken much longer to come on line and has been far less lucrative than Vodafone predicted.  In fact, the analysis I wrote on the deal for a group of labor unions and pension funds made that argument and it turned out to be right. Over the next few years Vodafone was forced to write off tens of billions of dollars in value and the CEO who did the deal was forced out.
In fact, one key analyst of Hulu disagrees with the more optimistic analysis summarized below. Henry Blodget of Silicon Alley Insider argues that Hulu is just another middleman and that it is bleeding cash so badly now that it is bound to fail. He puts their operating losses last year at <35%> of revenue, or $22 million! 
(This result is consistent with the results estimated by Global Media Intelligence we discuss below. GMI reported $12 in net revenue but not operating results. Blodget estimates 50% SG&A so on $65 mn in revenue that’s about $30 mn or so leaving Hulu bleeding $22 million last year.)
This is a risky business indeed.

Third, how did SAG conclude Hulu was profitable already?
Well, that’s a very good question. And one I put to an on line forum of SAG members. I never got a straight answer but I got a lot of answers that did not make a lot of sense.
SAG put out a statement on December 14 in response to an ad by the AMPTP. In the response SAG referred to “the already $12 million profitable”
Where did they get that number? 
When I asked Arlin Miller of SAG, who is understood to work closely with SAG’s dominant Membership First party and their leaders David Jolliffe and Kent McCord, he would not tell me but just pointed to the thousands of mentions of Hulu’s alleged profitability on the web.
Well, it turns out, the original source for the $12 million figure is a December 5, 2008, research report authored by Arash Amel of Global Media Intelligence, or GMI. That report caused quite a stir because it was one of the first, if not the first, to suggest that Hulu was succeeding in the race for control of the online new media environment against Google owned giant YouTube.
But Amel’s report, entitled Hulu Numbers Highlight Flaws in YouTube Model, which I obtained from GMI, does not say that Hulu is profitable. 
Far from it. 
The report only says that Amel “estimates” that Hulu achieved gross profit, also known as net revenue, of $12 million. Of course, that just means that Hulu sold ads for its site for an amount that exceeded the cost of licensing in the content it makes available for free to its viewers.
To figure out whether Hulu is actually profitable, in other words whether Hulu has “net profits” not just “net revenues,” one would need to subtract all sorts of operating expenses (like salaries!) and other line items (e.g., taxes, depreciation, interest payments), which Amel makes clear in his report.
It appears that a kind of urban myth emerged once Amel’s report began to be discussed publicly. Thus, Peter Kafka of the Wall Street Journal’s All Things Digital site as well as Robert Ellisberg of the Huffington Post reported the $12 million figure as a profit.  Kafka, at least, apologized later when the error was pointed out to him by Henry Blodget of Silicon Alley Insider.
Thus, SAG likely picked up the same mistake from the press but for some reason did not bother to check with the original source.
But Miller tried to defend the mistake by suggesting, first, that “net revenue” meant profits and then by arguing, oddly, that whether Hulu earns net revenue or profit did not matter at all because actors are concerned about “gross revenues,” which are, in some cases, the key to determing residual payments for actors’ original work.
This question of residuals is a critical one for actors as it helps them survive in the lean times and the producers win, too, because it helps sustain a pool of highly skilled creative labor for all sorts of projects. The flexibility that Hollywood has in this regard is almost unique in high wage, high skill job markets. 
The current contract talks between SAG and the Producers are all about how the residual payments system should work in the emerging world of new media.
Thus, it appears that SAG wanted, desperately, to find an example of a profitable new media company to throw back in the face of the producers. That it turns out was a misplaced effort.
Indeed, the residual formula on the table now for the kind of “move over” content that Hulu uses seems paltry at best: no residuals at all for the first 17-24 days, and then, for the first year of use, a small fee based on a single digit percentage of the original minimum fee paid to the actor when they made the original content. SAG estimates that would be about $46. 
(Currently, if a TV show is re-run on a broadcast network like NBC that payment is about $750 for a day player, though it could be higher depending on some additional factors – but, again, the percentage of archived TV shows that will make it back to a network for re-runs is very small.)
After the first year, however, the new media formula changes to something potentially (much) healthier: 6% of Distributor’s Gross, the same as the current rate for re-runs on Cable as opposed to network; and that means it is an improvement over the current, and much maligned, DVD/home video residuals formula. In theory, that post-first year revenue stream could be quite large: internet technology allows exhibitors like Hulu to make available a wide array of content that would, prior to this, have little or no chance of getting broadcast. 
And, arguably, a show that is attractive to viewers and therefore to advertisers in its first year of re-use, such as, let’s say, a Miami Vice (one of my favorites – Edward James Olmos makes that show), is going to be popular in subsequent years as well.
But SAG rarely discusses the possible positive “long tail” effects of the “move over” residual formula. Instead they focus on the minimal payment in that first year, which is precisely what they did in their December 14 response to the AMPTP.
This is odd for two reasons. 
First, SAG has reportedly already conceded to this proposed move over residual formula! It’s apparently off the table, according to Jonathan Handel over at Digital Media Law.
Second, the first year $46 payment is NOT based on whether or not Hulu is profitable. It is a fixed cost of doing business for any content producer that licenses content to Hulu. Thus, unless that producer is willing to eat the cost of the residual for some reason by reducing the revenue they get for the license, Hulu will have to meet it out of its revenues earned from the advertising industry, unless, in turn, Hulu, can pass on the cost to the advertisers.
And even when we get to the 6% of Distributor’s Gross after year one, that has nothing to do with Hulu’s income statement, since Hulu is most likely defined as an exhibitor not a distributor. The 6% hits the the content creator’s distribution arm or a 3d party distributor, not Hulu.
So, there was no basis for Miller’s attempt to minimize the importance of the misstatement by claiming that it’s all about “gross revenues” anyway.
In light of the “long tail” potential for a larger percentage of shows to migrate successfully to the internet and thus perhaps increase the number of performers who can now benefit from at least some residual payments, it is perhaps not as surprising as SAG tries to portray it that the WGA, DGA, AFTRA and the IA have agreed to the very same template.  
And in fact it may very well be if Jonathan Handel is right that SAG also sees the logic here and has signed off on this issue – but that has not stopped it from misusing Hulu’s financial results for other purposes.
Fourth, what else does the GMI report say about Hulu?
It’s unfortunate that SAG did not, in fact, use the material actually developed by GMI in its report on Hulu. 
The critical point of GMI’s Amel is that the Hulu model is proving a success relative to that of YouTube. That should be good news for SAG as, in theory, much more of the content on Hulu is union content than that found on YouTube. 
There are really two clashing models here: YouTube is a “disaggregated” user centric model – an open platform that anyone can post up to.  And of course, garbage in, garbage out. 
But Hulu is a hybrid between the old fixed and, in a sense, zero sum world of Television and that of the open world of the internet. Hulu works with distributors to move content into the more flexible, on all the time, unlimited bandwidth of the worldwide web. 
Consider: an old TV show that might have a large audience for re-runs and thus generate residuals for actors has to fight to get a spot in the limited bandwidth of traditional TV.
But with Hulu there is potentially an unlimited audience that can access unlimited content for a very long period of time once the massive libraries of the producers are licensed into Hulu’s servers. Thus, there is the potential for what are known as “long tail” revenues. That means the much more lucrative 6% residual formula comes into play. Oddly, SAG never mentions this possibility to its members in its “education” campaigns about a possible strike.
In addition, assuming Hulu’s gross revenues are, after all, meaningful in the debate inside SAG about the proposed contract offer from the Producers, GMI says Hulu revenues are set to nearly triple next year from $65 million in 08 to more than $175 mn in 09. 
Further, GMI argues that “Hulu’s model is proving more advertiser-friendly than that of Google’s YouTube, with advertisers showing a preference for relatively new episodic TV content…than for YouTube’s user-uploaded offering.”
So, in sum, the GMI report paints a picture that ought to be attractive to SAG rather than distressing when it comes to unionized content on the web. Hulu appears to be the first serious and successful alternative to the non-union world of YouTube.
And yet, none of this upside at Hulu is discussed in detail by SAG.
My unsolicited advice for SAG? 
Ask GMI for a copy of the report!!