Ventures in kid capital: U.K. indies contemplate life after Ofcom

On July 17, three years of wheeling and dealing in the U.K. media sector ended with the passing of the Communications Act 2003. In a far-reaching piece of legislation, Parliament tore up the U.K.'s existing regulatory regime, relaxed TV network ownership rules and introduced a range of tenets designed to redress the balance of power between broadcasters and independent producers.
January 1, 2004

On July 17, three years of wheeling and dealing in the U.K. media sector ended with the passing of the Communications Act 2003. In a far-reaching piece of legislation, Parliament tore up the U.K.’s existing regulatory regime, relaxed TV network ownership rules and introduced a range of tenets designed to redress the balance of power between broadcasters and independent producers.

Some changes have had an immediate impact – notably the decision to allow ad-funded network ITV’s dominant players Granada and Carlton to complete a US$6.9-billion merger, creating an ownership structure that should allow ITV to compete more robustly with the license-funded BBC and pay-TV platform Sky.

Aside from the ITV merger, however, it’s too early to say for sure what commercial impact the Act will have on producers, particularly those operating in the kids arena. While the rule changes were envisaged in part as a way of bolstering the indie sector, the broader commercial context in which U.K. kids studios operate makes crystal gazing difficult.

Part of the reason for the current uncertainty is that the new regulatory regime put in place by the Act has only just launched. Ofcom, the new super-regulator that replaces five pre-Communications Act bodies, only opened in late December. Prior to that, Ofcom chief executive Stephen Carter spent a lot of time explaining the body’s structure, regulatory style and priorities to the TV and radio sectors. Based on what he has said so far, Ofcom’s 1,000-strong workforce has its work cut out for it.

Carter says Ofcom’s big-ticket items for 2004 will be public service television broadcasting, spectrum trading and telecommunications – in particular broadband. However the body also has to find time to police developments designed to create a level playing field for indies. The first of these is a requirement under the Act that all British terrestrial broadcasters (the BBC, ITV, Channel 4, Five and Welsh-language network S4C) draw up a code of practice to govern their terms of trade with independent producers.

At press time, these codes had not been finalized, but U.K. production trade organization Pact says the underlying presumption ‘is that intellectual property rights stay with the producer. The codes will aim to ensure that terms of trade between broadcasters and indies are fair and foster an economically sound independent production industry. Ofcom will have sanctions (i.e. fines) if broadcasters fail to comply.’

Because the codes have not yet been put to the test, it’s impossible to be specific about their content. But the aim is to prevent the BBC and Channel 4, in particular, from using their power over the U.K. commissioning process to quietly coerce indies into using their in-house distributors BBC Worldwide and Channel 4 International.

Instead, the Act intends to make it possible for an indie that comes to a broadcaster with a great idea to secure a basic TV license fee only, and then handle its international and ancillary rights itself or sell them to a third party like RDF International or TV Corp. The idea is that transparent access to the market will allow indies to secure a greater share of revenue from their intellectual property. By corollary, a report commissioned by Pact suggests the BBC will lose US$30 million as a result of the changes and C4 will be down by US$12 million.

Andrew Zein, managing director of indie studio Tiger Aspect, has been chair of Pact during the latter stages of the Act’s passage. He says the fundamental thing to realize is that ‘indie producers are recognized by law for the first time. Before, we weren’t given protection by media legislation. Now Ofcom can consider our interests. The importance of that can’t be over-stated.’

Zein says the codes will oblige broadcasters to set a scale of tariffs for what they will pay producers – a kind of rate card for commissions. ‘It means indies can plan ahead. We can invest in our development slates already knowing what a network will pay and what rights we can retain.’

There’s still some uncertainty about the practical benefit of this freedom to trade, but Pact also won some quite clear-cut concessions under the Act. Key among these were the Act’s decision to apply the U.K.’s 25% independent production quota (which obliges broadcasters to source at least 25% of their content from indies) separately to BBC1 and sister network BBC2. In effect, this means the BBC cannot bump up low-cost BBC2 indie commissions to keep prestigious BBC1 commissions in-house.

Ofcom also has the power to measure the indie quota by value as well as volume (i.e. hours). Again, the aim is to prevent broadcasters from giving indies long-running commissions on low budgets instead of more profitable high-end productions. For good measure, the Act introduced targets for regional investment for commercial network Five and a new regional target for Channel 4. It also brought in rules to prevent Rupert Murdoch’s digital satellite service BSkyB from launching a blitzkrieg bid for ownership of Five.

So what is it all likely to mean in practice? Well, for indies in the factual, drama or entertainment arenas, the omens look good. Not only might they get their budgets, they stand a good chance of retaining rights. But for kids producers, the situation is more complex. While creators of inexpensive kids formats could prosper (because these shows may get fully funded), any broadcast tariff for kids drama or animation is likely to be so low that there will still be a huge funding gap once the domestic TV deal is done.

For kids specialists, the next question after winning a domestic license from the BBC, ITV or Five is not where to go to exploit rights, but how to get the outstanding 70% to 80% of the budget. That’s very different from the financial model in adult TV, where producers usually aim to make a profit on production in addition to retaining rights.

Tell-Tale managing director Karl Woolley, whose company provided BBC Worldwide with one of its biggest preschool hits in Tweenies, says on one level, the Act won’t affect kids indies because ‘funding a kids production is so complex that the idea of taking rights onto the open market holds no fears for us. We’re all used to sourcing money from distributors and co-producers in foreign markets.’

On another level, however, Woolley backs Zein’s view that the simple fact of distinguishing between TV licenses and secondary rights is a philosophical shift that will work in the indies’ favor. ‘The Act makes it clear that producers come to broadcasters with a complete set of rights that they are entitled to make the best use of. If a broadcaster wants to fully fund a show (as the BBC did with Tweenies), then it’s reasonable for them to take all rights. But the presumption that producers are free to strike a rights deal with any third party is a concept that didn’t exist in law before now.’

The theory is fine, but Woolley’s underlying presumption is that there are places to go to get that money – a view greeted with some skepticism by other producers/distributors in the market. Decode Entertainment co-founder Neil Court, whose company’s slate depends on a mix of co-pro financing from the U.K., Europe and North America, says: ‘If the BBC commissions a show, but the producer doesn’t want to work with BBC Worldwide, where does it go? Hardly any distributors are deficit-financing other people’s projects because there’s so much oversupply that international networks don’t tend to acquire shows until they have a slot for them.’

Woolley is more upbeat, however. In recent months, his company has been working on animated series like Sprogs and Ella for the BBC, then taking the secondary rights to distributors including Carlton International, Universal Video and licensing agency CPLG. He has also been in talks with indie distributor Target Entertainment, which has already indicated its interest in the kids sector by backing Elephant Productions’ Willo the Wisp.

Wark Clements head of children’s and youth Richard Langridge, who has constructed some smart co-pro deals in kids drama, is less certain about the future. ‘It’s possible to put a positive spin on the Act, but there is a lot of uncertainty for indies. If you go into negotiation with the BBC saying you want to keep your rights, that may impact the license fee they give you. But how do you evaluate the potential of the rights you hold onto? I can envisage the BBC paying less, but the indie being left with rights it can’t exploit in secondary markets.’

TV-Loonland COO David Ferguson shares some of Langridge’s concerns: ‘Distribution is so costly that a small indie really has to ask itself what it would do if it held onto its rights. There’s always a fear that your show will get lost in the mix at BBC Worldwide, but as a sales agency, it’s hard to beat in the U.K. because of its ability to cross-promote ancillary rights exploitation.’

Concerns about broadcasters beating indies down on price appear to be borne out by comments made by C4 chief executive Mark Thompson at a conference in November. When quizzed on the Act, Thompson argued that if C4 International’s contribution to Channel 4′s budget drops because indies are retaining more rights, then the number of indie commissions it’s able to award will be reduced. As a result, Thompson believes a few big indies with the ability to market their rights will prosper, while smaller production companies will suffer.

Zein admits implementing the Act will not be easy, but he rejects Thompson’s assessment. ‘The reality is that the bigger indies have enough muscle to bargain effectively on rights. It’s the small companies that need some kind of formal structure that allows them to trade fairly.’

Langridge believes that one inevitable upshot of the Act is that consolidation among indies will accelerate. ‘Indies will need muscle to deal with broadcasters and a distribution arm to exploit their rights. I definitely see a closer relationship between producing and distributing.’

Further down the line, Langridge believes closer co-operation between producers and distributors will transform the nature of content origination. ‘Indies will have to make more commercially driven shows that travel internationally. The more risky and innovative shows will be made in-house because broadcasters have more flexibility.’

Langridge may be right, but a key problem with trying to analyze the Act at this early stage is that it’s impossible to know if broadcasters will seek to circumvent its spirit to protect their commercial position. For example, if a broadcaster is presented with three ideas of similar merit, what is to stop it from going with the company that seems most willing to work with its in-house commercial arm? And how will Ofcom monitor such an approach?

Likewise, with U.K. commissioners getting more and more involved in originating ideas, there’s no guarantee an indie will own the rights to a hit show. It’s not unusual for a broadcaster to develop an idea internally and then invite companies to pitch an approach and price. In such situations, it would still mean indies are little more than guns for hire.

The other big issue to emerge from the new Act is the likely fallout from the Granada/Carlton merger. To date, Granada has flirted uncertainly with the kids business. But there’s a view among some indies that in the post-merger environment, Granada will emerge as the dominant supplier of kids content to ITV. Although ITV is required to take 25% of its content from indies, Granada-owned animation studio Cosgrove Hall could be an obvious beneficiary of the merger – particularly in view of recent Cosgrove successes like Engie Benjy (an ITV commission now sold into 60 countries and poised for a big merchandising push in the U.K. this year).

Annie Miles, a veteran of the kids business who has run a U.K. thematic channel, worked at Granada and now helms the kids division at production company Talent TV, believes it’s too early to tell what ITV will do. ‘They’ve got so much to sort out I don’t think they’ve developed a grand master plan for kids. But I would be surprised if everything was just handed to Granada. I think it’s just as likely that they might end up in a strategic alliance with a U.S. studio like Disney, Nick or Turner.’

As it happens, help from the U.S. may be ITV’s only option. In parallel with other changes, the government is looking at tightening up rules on fast-food advertising to kids under 12. An outright ban on such ads could take up to US$50 million out of the U.K. TV system – with devastating effect on ITV’s commissioning budget.

Of course, it’s important not to place too great an emphasis on the regulatory changes since funding a kids animated or drama series is difficult regardless of the legislative backdrop. Public company TV-Loonland’s financial position is indicative of how tough it is even for established producers. Lack of growth in the market is underlined by the fact that TV-L revenue in the first nine months of 2003 was US$11 million compared to US$20 million in the same period last year. This from a company winning commissions for series such as Metalheads and still selling catalogue titles like Little Ghosts and Pettson & Findus.

TV-L’s Ferguson says financing kids shows is getting harder in a variety of ways. For a start, problems at broadcasters like Kirch have made banks shy of giving advances against production contracts – a common arrangement in the past.

Brit-based producers are also grappling with new government guidelines regarding co-productions that are designed to boost British content, but may actually make local production unviable. Although the thrust of the new rules is aimed at increasing Brit budget expenditure in film co-pros from 20% to 40%, special reference to animation has sent a shiver of anxiety through the kids community.

Ferguson says the problem is that some co-pro treaties designed for film have also been used to govern TV. So there’s a fear that the new guidelines may cover producers of animated TV series. A good example of the type of clause that’s causing worry reads: ‘Animation films can qualify under any co-pro treaty. However, treaties do not allow for co-producers to use animation facilities in third countries (non co-pro countries) to reduce costs.’

In practice, this could mean that benefits available under an Anglo-Canadian bilateral treaty would be lost if an Asian studio is used to keep the budget down, says Ferguson. ‘I’d argue that we use studios in the Far East because the skills and ability to meet a schedule don’t exist in the U.K. But there’s no procedure for getting guidance from the government and no right of appeal. It looks as though none of us will know if these guidelines affect us until someone has actually produced a series.’

Even if the co-pro rules do not impact TV, Decode’s Court believes the U.K. has become a progressively more difficult environment in which to work. Already lacking the appeal of subsidies, the British indie sector received a major blow last year when the government abolished tax breaks known locally as sale and leaseback. The practical effect has been to take money directly out of indie production.

To date, the sale and leaseback changes do not appear to have dented the fortunes of the mainstream indie players, which are confident that the legislative changes will trigger new investment by private equity funds. ‘Most investors aren’t interested in one-off commission,’ says Zein, ‘But for producers and distributors with a diverse slate of shows, I believe there will be interest from outside financiers.’

This claim is borne out by numerous deals struck in the last year. As it became clear that indies would receive legislative protection, private-equity investors piled into the sector. Among the most high-profile deals, investment bank Beringea backed a takeover of Zenith Entertainment (SM:TV Live); Bridgepoint supported Steve Morrison’s US$69-million takeover of Chrysalis TV; Kleinwort Capital led a US$40-million investment in Hat Trick; and Lloyds Development Capital took a stake in Mersey TV (Grange Hill and Hollyoaks).

But Decode’s Court says this rekindled capital market interest is offset by ITV’s reduced clout and changes to tax rules. ‘We look to finance shows a third from Canada, a third from the U.S. and a third from the rest of world. In the U.K., we’ve sold What About Mimi? to ITV, while Five and the Universal-owned video label VVL are good partners on Franny’s Feet. But right now, Germany has more potential for us than the U.K. or France.’

HIT Entertainment director of corporate affairs Simon Forrest is not much more encouraging. His view is that ‘the City [London's financial hub] is still gun-shy about investing in kids production. On an individual project basis, the City wouldn’t touch it with a barge pole, unless it was a gold-plated sure thing, which doesn’t exist. I can’t see any angels out there or high net-worth individuals willing to invest. Paradoxically, the amount of money people want is too small. Companies are often looking for US$400,000 to US$800,000 to develop a project, which is really too small to be of interest to VC funds.’

Part of the problem is that there is already a batch of kids indies sucking up City investment. Aside from publicly traded HIT, money is tied up in Entertainment Rights (which has a big year coming up with Postman Pat and Little Red Tractor) and Chorion (Noddy). What’s noticeable about these companies is that they own proven franchises, substantial catalogues or complementary businesses (also true of TV-Loonland and Contender, which both have a strong base in video distribution). While these are not guarantees of success, they are assets that impress investors.

In September, public kids producer/distributor Maverick Entertainment (The Snailsbury Tales) successfully sold 98 million shares to raise a US$3.5-million tranche of City investment. The money is primarily intended to develop Maverick’s video/DVD business and finance a 26 x 10-minute animated series for the BBC based on classic ’40s character Muffin the Mule. But Maverick CEO John Howson confirms that the underlying appeal of Maverick lies in its broad business base. ‘We own the rights to a number of properties and operate across TV, video and publishing. That range appeals to investors.’

Howson says Maverick’s backers are not in a huge hurry to recoup investment since they understand the length of time it takes to build kids brands. ‘But they didn’t just say, ‘Here’s US$3.5 million. Go and spend it.’ Investors are very selective and only back companies with the right managerial experience. Financing is scarce, so the independent producers that appeal most to investors are those that have executives with proven track records.’

Insiders at Pact acknowledge that the Act is not about to revolutionize the U.K. kids sector. But they are conscious of the dire straits many British animators are in and are planning a broad-based review in 2004. That review should be interesting reading for any company considering a punt on the British kids business – though not everyone sees indies as a good bet, kids or otherwise. In a venture capital magazine called Real Deals, Jeffrey Montgomery of GMT Partners (which has a US$632-million media fund) gives this assessment: ‘TV production is a bad business to invest in. You are always subject to the whims of the public, the commissioner and the creative talent. There are too many variables.’

Then again, the good news for kids producers is that their business is genuinely different. Kids projects may be harder to fund at the TV stage, but if you create a hit, the potential returns in licensing and merchandising are massive. ‘We’re at the bottom of the investment cycle,’ says TV-L’s Ferguson, ‘but kids appeals to investors for the same reason people bet on race horses. There’s always a chance you’ll back the next big thing.’

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