The recent news that foreign currencies depressed Discovery International’s fourth quarter adjusted cash flow by 16 percent has brought currency exchanges back to the forefront of the international TV business.
Many international content sales executives hold the view, supported by some economists, that exchange rates among main currencies should be on par, meaning one-to-one. This is an ideal arrangement and is a win-win situation for all.
Governments the world over, however, tend to think the opposite. They weaken their currencies in order to take advantage of favorable exchange rates. The gain is fleeting and doesn’t promote quality, a long-lasting value.
Betting on a favorable exchange rate is a strategy with a double-edged sword. Yes, a country wins on exports, but loses on critical imports. Plus, it weakens foreign investments, depriving companies of opportunities abroad.
It is said that lower currency exchange rates favor exports. Perhaps, when a currency is very low against others, locally made products are cheaper, but not necessarily good. If the exchange rate is one-to-one, as is preferred in the case of the euro versus the U.S. dollar, the only selling point is the quality of the product sold, which offers advantages both to the exporter and to the importer.
But there are also issues of different natures. Imagine making a four-year deal with a foreign TV outlet in local currency. In the long run the risk is present for both parties. Yes, they could be protected by hedging the currencies (a form of insurance protection explained below), but it does come cheaply.
Then imagine benefitting from the exchange rate, instead of the actual increase of sales. This would present problems later on when the reverse occurs. How could this latter case be explained or justified to higher-ups and investors? Invariably, in these cases, to make up for the reduced revenues, companies are asked to slash their budgets, affecting marketing, which, in turn, affects sales in a vicious circle.
These are issues that are constant problems for companies involved in the international TV business, such as Viacom, AMC and Discovery, that have to account for revenues for program sales, subscription fees and ad revenues from overseas operations.
Foreign exchange (FX) rates can be controlled by governments. Increasing prime interest rates and buying their own currencies with foreign currency reserves raises the value of exchange rates. But more often, FX rates are manipulated by speculators. It is said that for each half penny daily FX fluctuation, profits could be in order of $20 billion. Reportedly, the average daily turnover in global foreign exchange markets is estimated at over $4 trillion.
As far back as 1997, U.S. economist Gregory P. Hopper, then with the Philadelphia Fed, wrote: “The underlying belief is that exchange rates are affected by fundamental economic forces. What is not so well known outside academia is that exchange rates don’t seem to be affected by economic fundamentals in the short run.”
According to the New York City-based Global Policy Forum, only 0.6 percent of foreign currency exchanges can be traced to genuine international trade in goods and services, the rest (at a minimum of 80 percent) is directly attributed to exchange rate speculation. Most currency speculators work for multinational banks, such as Citibank, Deutsche Bank, or Union Bank of Switzerland.
However, fixed exchange rates are not a solution because they are more susceptible to speculative attacks if currencies are at the wrong market value. Often, speculators sell large amount of countries’ currencies, forcing governments to use massive reserves necessary to hold their fixed exchange rates.
Ultimately, multinational entertainment groups can do next to nothing to influence FX rates, but they can take several precautions to hedge the foreign exchange risks.
At times, for example, U.S. studios ask for a license fee percentage increase tied to the foreign countries’ Consumer Price Index per year. License fees can also be tied to the growth in the foreign countries’ TV advertising market, or even tied to increases in LIBOR (London Inter Bank Offered Rate).
Another option is for U.S. companies to enter into U.S. dollar contracts, but this could put buyers at a disadvantage. In one familiar case, an indie American program distributor entered into a U.S. dollar-based output deal with a TV channel in Russia a few years ago when the exchange rate was one U.S. dollar for 35 rubles. Today, the dollar is worth 75 rubles, so while the seller has eliminated the FX risk, the client is suffering.
In the beginning, their per-episode license fee of $20,000 used to cost the station 700,000 rubles. Now, the same $20,000 per episode license is costing them 1.5 million rubles.
Another solution is to “defer” a portion of their license fees. For example, if a series is licensed to a Russian TV station at U.S. $100,000 for the entire season, the seller will defer a portion of this license fee until a time when the FX rate hits a certain “trigger.” In this case the seller could be “deferring” 35 percent of the license fee. So, the buyer would be paying $65,000 now and would not have to pay the $35,000 balance until the ruble recovers to a more sustainable FX rate.
The FX “trigger” could be, for example, 45 rubles for one dollar. Once the ruble returns to this level (usually for 20 consecutive days during the license period) the $35,000 will be due.
Yet another option is for companies to use “currency pegs,” when entering into contracts with foreign buyers. Here is how this would work with a contract with a license fee of $100,000: The Russian buyer would “peg” the FX rate at 35 rubles per dollar. When the payment becomes due, the buyer checks the current rate –– let’s say it is 65 rubles per dollar. Then, the $100,000 is converted to rubles at the fixed rate (peg rate) of 35 rubles per dollar (or 3.5 million rubles). In the next step, the 3.5 million rubles are converted back to U.S. dollars at the prevailing exchange rate. So, 3.5 million rubles at 65 rubles per dollar become $53,846 and the buyer only pays 3.5 million rubles or $53,846, instead of having to pay 6.5 million rubles.
Usually, U.S. studios don’t use currency hedging for individual contracts, but the corporate headquarters’ treasuries do the hedging for the entire groups.
To explain how to further “hedge” the exchange risk, VideoAge contacted industry executive Ryan Friscia.
“The most common practice is to hedge with forward contracts,” said Friscia. “The forward fixes the exchange rate for a future transaction. In a hypothetical scenario, if a Canadian TV outlet signed a contract to license a series from a U.S. company in local currency in 2015, let’s say the equivalent of U.S.$200,000 (or C$254,000 at the then exchange rate of C$1.27) paid over one year, with 50 percent due upon execution of the agreement and the balance of C$127,000, due one year after the execution.
“In order to be protected from depreciation of the currency, in 2015 the seller entered into a ‘forward’ agreement with a bank to ‘fix’ the rate for 2016, for example, at C$1.35. When the balance became due early this year, the Canadian dollar was traded at 1.40 to the U.S. dollar. That meant that the seller received directly from the buyer about U.S.$ 91,000 instead of $100,000”.
“But, with the forward agreement, the bank exchanged the C$127,000 for U.S.$94,000, therefore the exchange loss to the distributor was reduced to U.S.$6,000 (and the bank lost U.S.$3,000). If, on the other hand, the exchange rate would have returned to the 2013 level of C$1.03, the seller would still receive U.S. $94,000 as they have the forward agreement in place with the bank. However, in this situation the bank is the beneficiary of the appreciation in the currency. The bank would profit U.S. $29,000. While this may look like an unfortunate outcome for the seller, the seller remains satisfied with the rate given in the formated agreement because they knew the forward rate ensures the deal would be profitable.”
“Companies can also hedge with ‘futures,’ which are traded on the open market. Using the same scenario as an example, the U.S. distributor would sell a futures contract in the amount of C$127,000 at the exchange rate at the time of the contract signed (or C$1.27) resulting in a U.S.$100,000 value,” said Friscia.
“When the balance became due earlier this year, the Canadian dollar was traded at C$1.40 to the U.S. dollar, therefore the seller received payment from the Canadian TV outlet in the amount of $91,000. However, the seller closed its C$127,000 future contract by buying back the contract at the new spot rate of C$1.40, for U.S.$91,000. The total profit from the futures contract was U.S.$100,000, less the U.S.$91,000 paid to buy it back, resulting in a futures profit of U.S.$9,000, and thus recouping the FX loss from the final 50 percent payment from the TV outlet,” he said.
Industry executives who deal with FX could be interested in a recently published new book, “The Money Makers” by historian Eric Rauchway, professor at the University of California, who described a monetary order based on the principles of managed currencies, and “Currency Politics,” by Harvard University professor Jeffry Frieden.
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