• by Diane Mermigas , May 7, 2008

Everyone loves an underdog-makes-good story, which usually involves defying conventional wisdom and betting on new ways of doing business. It all seems tailor-made for the new digital entertainment marketplace.

Marvel Entertainment's "Iron Man" is the latest example of hit filmmaking outside the studio norm. Having decimated consensus estimates with its $101 million in opening domestic box-office gross revenues, and $201 million in worldwide box-office gross (with a projected potential of $600 million), many are questioning whether Marvel's firepower is sustainable. Many of its valuable 5,000 comic book characters have already been mined by Hollywood studios and video game producers.

The answer may come next month with its second self-produced movie, "The Incredible Hulk," which unlike "Iron Man" is a franchise done to death. Marvel's "Iron Man" sequel and "Thor" films will come in 2010, followed by two "Avenger" films in 2011. Marvel will continue to compete with some of its most famous comic book characters previously licensed to other filmmakers, including "Spider-Man," "X-Men" and "The Fantastic Four."

Lehman Brothers analyst Eric Handler expects Marvel to generate $409.4 million in 2008 revenues and $219 million in earnings--$20 million of which will be generated by its self-produced films, with the remainder coming from comic book publishing, licensing and other related monetization.

Marvel has put it all on the line as an independent film producer, devising complicated but beneficial financial arrangements handled through its Film Financing LLC. Among other things, Marvel must generate three self-produced films yielding more than $350 million in related proceeds before it can begin tapping the cash balance to underwrite future films--a strict financial formula that would benefit others in Hollywood. Its unique early-cash distributions include a producer fee representing 5% of all revenues and retaining all merchandising and consumer products revenues generated from its self-produced movies.

The two cash streams are designed to get Marvel through future production. Since it emerged from bankruptcy in 1997, management has embraced a conservative, tightly contained hold on comic-book publishing and films. Rebuilding from the bottom up has given Marvel what every content producer wants: The luxury to control its characters, story lines and destiny, and retain greater financial upside from its films.

Marvel also is in the sweet spot of future media spending, able to leverage its content stable in all areas of alternative media (video games, mobile and online advertising, word-of-mouth and search marketing), which are expected to grow 20% to $88.24 billion this year and nearly doubew to $161 billion by 2012, according to PQ Media.

While controlling costs and money flow is completely within Marvel's purview, the company of just under $3 billion market cap has to generally spend 30% more than originally expected. Promotion and advertising will range $100 million to $120 million per film. Non-sequel films will cost $135 million to $165 million. For now, revenues and earnings are higher than expected--films being a notoriously cyclical and unpredictable business. All things being equal, Marvel is hoping these chaotic times will make even unknown comic-book characters heroes on the big screen and the balance sheet.

Viacom's Paramount Pictures distributes the Marvel movies, and FX has a cable TV rights deal for "Iron Man," "Hulk" and three other character movies, which could be worth as much as $110 million in incremental revenues over time. It also is expected to increase revenues from third-party pacts to leverage its character franchises--spurred by high production quality video games like "Grand Theft Auto IV."

Marvel's key challenge will be leveraging the initial success of "Iron Man" in virtual word-of-mouth marketing, peer-to-peer sharing and instant global awareness. No need for a costly big studio bureaucracy when thousands of bloggers and social-networking members are working under the radar to do your content bidding for free.

Marvel's hot business model is worth studying because of the number of simple content businesses sprouting from digital media's grassroots. The art of milking character franchises and cults has barely scratched the surface on mobile devices, social networks and special-interest online communities.

The same is true of Lions Gate and other independents. which have film slates and libraries that can be monetized in ways that reach beyond closed platforms like Apple's iTunes and NBC-Fox's Hulu.com. Lions Gate's niche films will be an important component to the new movie cable channel it is launching next year with MGM and Paramount.

Conversely, the big guys also are learning something useful, such as the concept of doing more with less. Lehman Brothers analyst Anthony DiClemente estimates that Sony, Fox, Walt Disney, Paramount and Universal collectively have reduced their box-office production budgets this summer by 21 % from a year ago, including about a 15% decline in film promotion and advertising spend.

That's largely the result of fewer sequels and "road-tested" franchises, as well as hedge-fund-backed independent films. Major studios also remain heavy into shared risk financing with outside investors as well as tighter budget controls.

But the one place where independent moviemakers may have more flexibility is working with talent (in front and behind the camera) without the drag of huge corporate machines. That makes Marvel and its peers an intriguing business model for a digital universe where everyone is a content consumer, producer and distributor.