Marvel Comics leaps into movie-making
The comic-book king is tired of taking a safe but small cut from licensing its characters for blockbuster films - so now it's going to make the movies itself.
by Susanna Hamner, Business 2.0 Magazine writer-reporter

(Business 2.0 Magazine) - Bombs burst. Tongues of flame split the predawn darkness. People in bomber jackets, clutching weapons, lurk in the shadows. Then a barrel-chested man in black edges forward and, in a thick Israeli accent, issues a command: "Colossus's hand has to touch Rogue's forehead," he says. "Not her hair. For her to take on his shielding powers, he must touch her skin."

The man is Avi Arad, chief executive of Marvel Entertainment's Marvel Studios unit. The setting is the woods near Vancouver, British Columbia, where 20th Century Fox is shooting its soon-to-be-released X-Men 3, and Arad, as is his habit, is laying down the law according to Marvel.

Marvel-based films have grossed $3.6 billion.
Marvel-based films have grossed $3.6 billion.

He's telling the film's director, Brett Ratner, how the superhero Colossus, a Marvel (Research) comic-book creation whose particular distinction is that he can transform his flesh into an impenetrable cloak of steel-like armor, must transfer that power to fellow mutant Rogue (the one who has a special talent for absorbing other people's psyches). Ratner resists. He thinks Colossus actor Daniel Cudmore's hands will block Rogue actress Anna Paquin's face, ruining the shot. But in the end, Ratner will relent. He, like everybody else in Hollywood, understands that no one on the planet knows more about the peculiar ways of Marvel's gallant mutants and evil freaks than Avi Arad.

More to the point, Arad knows what makes hit movies - and what makes money. His special gift is combining a lifelong fan's obsession with Marvel's 5,000 comic-book characters - the man often wears a Spider-Man pinkie ring - with a shrewd sense of filmmaking and keen business and brand-building savvy. That has made Arad a key force behind Marvel's remarkable corporate resurrection.

For a photo gallery of Marvel Studios' storied history and its coming celluloid attractions, click here.

In 1998, after years of mismanagement by financier Ronald Perelman had left the company bankrupt, toy executive Isaac Perlmutter bought Marvel and put Arad in charge of getting Hollywood to base blockbuster films on its characters. The results speak for themselves: Under Arad, the first seven Marvel-based films - from the low-budget vampire-hunting epic Blade to the first Spider-Man and X-Men movies - each hit No. 1 at the box office. All told, the 12 Marvel-character films made during Arad's tenure have grossed $3.6 billion worldwide. Profit has quadrupled in the past three years to $103 million in 2005, revenue has surged, and Marvel's stock, as low as $3 per share at the time of the 1998 acquisition, trades today at about $20.

But now the plot thickens: Marvel has launched one of the most radical business-model overhauls in Hollywood history. To date, the company has only licensed its characters; film studios like Fox and Sony actually make the movies - and suck up most of the profit. Marvel generally gets 2 to 10 percent of the profit. It's good money, and the risk is low. But Marvel is weary of seeing other companies walk away with most of the loot from megahits built on its characters.

So Marvel is in the process of transforming itself into an independent film studio. It will now make its own movies; among those likely to be first are a film based on Iron Man (the alter ego of a billionaire former weapons designer who dons a suit of armor that gives him superhuman strength and comes with its own repulsor rays) and a sequel to The Hulk (starring the big green guy). Marvel says its debut films are already under development; the first is expected to hit the screen in early 2008.

The move is as fraught with peril as a Spidey showdown with Kraven the Hunter. For one thing, it comes as the movie industry faces declining ticket sales - down 8.9 percent last year - and rising competition for consumer attention from myriad new forms of entertainment, from iPods to Web shorts to coming attractions like first-run movies on home TV.

Beyond that, although the reward may be greater, the risk certainly is. Marvel has borrowed more than $500 million to finance its filmmaking and will have to absorb heavy losses basically on its own if any of its self-made films bomb. Under certain conditions, it could even lose control of the rights to its characters. But to Arad, 58, the risk is worth running, and the reason can be summed up by this fact: The two Spider-Man films have grossed nearly $1.6 billion at the box office; Marvel is estimated to have received just $75 million of that. "Nobody knows better than us how to make our characters come alive for audiences," Arad says. "We just want to get paid for it."

Marvel has had an aptly action-packed history since its founding in 1939. With a stable of brilliant comic-book storytellers and artists like Stan Lee and Jack Kirby, Marvel swiftly became a master of the genre. During World War II, Marvel came up with Captain America and a host of other patriotic, apple-pie superheroes, and the company grew rapidly. But it drifted after the war and was floundering by the late '50s before Lee and Kirby led a historic run that produced massively popular characters like the Fantastic Four, the X-Men, the Hulk, Spider-Man, and Thor - often internally conflicted, reluctant heroes with human frailties to which audiences could relate. In 1989 the company, solidly profitable, was bought by financier Perelman for $82.5 million.

The deal almost brought Marvel to its knees. Perelman went on an acquisition spree, driving Marvel's debt up to more than $600 million to acquire things like a sports-card trading company and an Italian sticker firm. The heart of the company, comic books, was neglected. Licensing was mishandled; for instance, the terms negotiated for Marvel's Men in Black characters were so skimpy that when the movie was made in 1997, ultimately generating about $589 million worldwide, Marvel's take was about a million bucks.

That same year, with Marvel teetering, corporate raider Carl Icahn bought up its bonds and gained control of the company, but Marvel ultimately staggered into bankruptcy nonetheless.

Perlmutter and his team swooped in to bring Marvel out of Chapter 11 for about $320 million in 1998. They knew something about the company; Perlmutter's toy business had been partly owned by Marvel since 1993. Arad was for a time his chief designer. (Among his claims to fame: He helped to invent air hockey.) More important, Perlmutter knew that in Arad, he had a man perhaps uniquely suited to the day-to-day work of saving Marvel.

For starters, Arad is Professor X-smart, trained in industrial management as well as design, and has a deep entrepreneurial streak. But perhaps more significant for his Marvel role, as a kid growing up in Israel, he was completely enthralled by the company's comics. To this day he keeps in his Beverly Hills office tattered Hebrew-language Marvel comic books from his youth.

Arad retains an encyclopedic knowledge of the characters and an obvious love of their stories, going so far as to call them "literature." He can describe Peter Parker's predicament in, say, Issue 42 of the Amazing Spider-Man comic-book line, or expound for hours on the relative nastiness of the Lizard and the Rhino. Indeed, Arad's belief in the value of the Marvel characters was crucial to the success of Perlmutter's bid to buy the company: In late 1997, Arad had given an impassioned presentation to a group of about 40 bankers and lawyers that is widely seen as having swung support to the Perlmutter bid over a competing offer from Icahn.

Arad's animating belief about Marvel was that the company could unlock the maximum value from its comic-book characters only through films, with that medium's potential for huge paydays. Indeed, during the Perelman regime, Arad had shifted over to Marvel's entertainment arm and been tasked with persuading moviemakers that its characters could be box office gold.

He failed back then - he says Perelman wasn't fully committed to the project - but it didn't shake his conviction. (Perelman declined to comment.) While other New York-based Marvel executives worked to revitalize the company's comic-book sales and licensing arrangements with the likes of clothing companies and videogame makers, Arad went to Hollywood to court the film industry.

His early efforts confirmed that he was onto something - and also underscored Marvel's dilemma. The company had been able to license many of its characters to studios, but the sense in Hollywood was that, unlike rival DC Comics's Batman and Superman, Marvel heroes were too complex, conflicted, and fantastical for mass appeal.

A crack in the resistance opened when Arad, after years of trying, finally helped coax New Line Studios into making a low-budget film based on an obscure Marvel line. Blade, released in 1998 and starring Wesley Snipes as a vampire hunting for fellow bloodsuckers, raked in $133 million worldwide at the box office. "Blade was the least likely to succeed," Arad says. "That was the first time it seemed clear to Hollywood that the Marvel franchise was something special."

Yet Arad says Marvel made only $25,000 from the first Blade movie, thanks to lousy licensing terms negotiated years earlier by Perelman lawyers. But the movie's success gave Arad leverage with reluctant studios. Fox, for instance, nearly balked at making the first X-Men film. "They almost didn't buy it as a movie," Arad recalls. "But we told them that if another studio buys it, they're going to look like dorks." Fox bit - and X-Men grossed nearly $300 million globally following its 2000 release. Hollywood jumped on the Marvel bandwagon, pumping out two Men in Black films (total worldwide gross: $1 billion), the Spider-Man megahits, and profitable films based on lesser Marvel characters like Daredevil and the Punisher.

As the hits kept coming, Arad was able to renegotiate some old licensing deals and extract sweeter terms on new ones, but he and Marvel still chafed under the lopsided financial arrangements. It was bad enough that Arad was able to bump licensing fees up to a maximum of only about 10 percent of box office receipts. But studios really cleaned up on ever-increasing sales of DVDs, which now account for more than half of the total profit on a film.

Marvel's share of DVD sales was minuscule - less than a percentage point in most cases. "That was the real impetus" for figuring out a way to dramatically increase the company's take from its characters, says former Marvel Entertainment CEO Allen Lipson. "We were getting such a small share of the DVD revenues. How do you get more?"

After months of furious brainstorming, a Marvel team led by David Maisel, the former top strategic planner at Disney who had been hired as COO of Marvel Studios specifically to guide the process, came up with a handful of options. Last on the list, because it was considered the riskiest, was to create a slate of self-made films.

"I didn't think it could be done," Lipson recalls. "We didn't want to be on the hook for all the costs of doing films." But Arad pushed hard, and eventually Marvel green-lighted a plan to make as many as a dozen films during the next several years while - so Marvel hopes - minimizing the chance that a string of duds could sink the company.

Under the plan, Marvel created a separate subsidiary to borrow $525 million from Merrill Lynch for films based on Ant-Man, Captain America, Nick Fury, and seven other characters. Marvel tried to structure the loan to protect the parent company; under its terms, in case of default, lenders are generally barred from coming after the parent company's assets.

Marvel also lined up Paramount to handle distribution of the films. After paying the costs of a film's production, distribution, and marketing, Marvel retains 100 percent of all revenue streams, from box office to DVDs to TV licensing. Analysts estimate that instead of taking 10 percent or less of a film's gross, Marvel could wind up with more than half. (Most of the rest goes to theaters, retailers, and the distributor.)

Some Hollywood critics are already whispering that Marvel is crazy to try this. They say most of its best-known characters have already been cinematized: Spider-Man is one thing; Shang-Chi, a crime-fighting martial artist who's also on the Marvel film slate, another. Marvel also faces plenty of competition: Last summer Batman Begins, based on the DC Comics caped crusader, outslugged Marvel's Fantastic Four, and this summer DC Comics's Superman Returns is expected by some analysts to generate about $400 million in U.S. box office alone.

Others speculate that the superhero film craze may fade by 2008, when the first Marvel films are released. And the Marvel magic has already shown some signs of wobbling, as evidenced by 2003's The Hulk, a disappointment despite being directed by the celebrated Ang Lee, and 2005's Elektra, a certifiable dog. "There could be oversaturation," says Arvind Bhatia, an analyst with Sterne Agee & Leach.

Others, however, suggest that Marvel's timing might turn out to be perfect if today's climate of war, terror, and other menaces persists. "During times of economic and social threat, people want moral clarity," says Smith College psychology professor Bill Peterson, who has studied the cultural impact of comic books. "People want a good guy they can trust, and superheroes can vicariously fulfill this role. It's no surprise that, after 9/11, Spider-Man did so well."

The one undeniably scary prospect for Marvel is that the company could actually lose control of some of its characters. Despite financing terms designed to shield the company, if the movies bomb and Marvel misses payments, Merrill could gain control of the rights to future films based on the characters and could sell them to other studios.

And the Marvel plan seems to have already run into snags. Hollywood insiders say Arad had hoped to make Captain America Marvel's debut film. But that's not happening; Arad says he couldn't line up the director he wanted until 2009. Moreover, two films Arad now says could be among those first out of the gate, the Hulk sequel and Iron Man, aren't covered by the Merrill loan, which means Marvel will need another way to finance them. Arad won't say how he'll do that, but Marvel is not a particularly big company right now, and its resources - and ability to withstand costly flops - are limited. "It's one thing for major Hollywood studios to lose money," says former AMC Entertainment president Robert L. Friedman. "For smaller studios, it's a whole different ball game. Marvel had better keep its budgets in line."

Arad insists he'll do that. The 10-film plan calls for limiting production budgets to $45 million to $165 million, depending on the movie. But making hit films isn't primarily about counting beans. It's about having the relationships to land top talent. Arad has them. "Top directors are going to run as fast as they can to Marvel when it becomes its own studio," says Fantastic Four director Tim Story.

It's about having the creative vision to make sure the characters and their stories connect with the audience. Arad has shown he has that too. He attends nearly every script meeting for Marvel-based films and basically lives on the sets. He suggests dialogue (Mary Jane's "Go get 'em, tiger" in Spider-Man 2, for instance) and explains to directors and actors the dark corners of their superheroes' psyches. "Avi is what makes the characters work," says Amy Pascal, chairwoman of Sony Entertainment.

In his office, surrounded by his Hebrew comic books and an army of Marvel action figures, Arad seems supremely confident that his company is making the right move. "We have the most valuable library in the world," he says. "We've had one bad movie, Elektra, and it was bad because we didn't have creative control. That won't happen again." Soon, Arad is musing about the Hulk, whom many Hollywood observers now believe has the inside track to be the star of Marvel's debut self-made film. It would be an interesting choice, given that Ang Lee's version was a box office disappointment. But Arad thinks he knows what went wrong, and he has a plan for fixing it.

After praising Lee as a genius, Arad observes that "the Hulk movie was a study of anger, and people wanted a popcorn movie." Lee's film focused on the Hulk's origins - Bruce Banner's abusive father, his mutated DNA, the gamma ray accident that gave him the power to transform into a walking steroid attack. It was dark and intense, and Banner didn't even do his Hulk bit until nearly halfway through the film. "Our Hulk," Arad says, "will be a diet Hulk. Lighter. Focusing on the love story, Hulk as hero, and his battle with the villain."

For that villain, Arad has chosen one of his favorite baddies: Abomination, a former Yugoslav spy who has mutated into a 980-pound freak of terrifying strength and unpleasant demeanor. "He's capable of amazing feats," Arad says, eyes gleaming. And if Arad is right and the Hulk sequel or some of Marvel's other self-made films break into blockbuster territory, people will be saying the same thing about him someday.

See a photo gallery of Marvel Studios' storied history and its coming celluloid attractions. Click here. Top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.