‘The Hobbit:’ Inside Peter Jackson and Warner Bros.’ $1 Billion Gamble

This story first appeared in the Oct. 26 issue of The Hollywood Reporter magazine.

On a sloping slab of artificial woodland surrounded by enormous green screens stands an old wizard and 13 elaborately bearded dwarves. Bilbo Baggins — played by Martin Freeman, known to American audiences as Watson in the BBC’s Sherlock and, before that, the lovelorn salesman in Ricky Gervais‘ original The Office — eavesdrops from behind a tree as dwarf leader Thorin Oakenshield (Richard Armitage) scornfully denounces him for deserting his comrades in arms. “We will not be seeing our hobbit again,” sneers Thorin at Gandalf (Ian McKellen). “He is long gone.” At an imposing 6-foot-2, Armitage doesn’t look especially dwarfish, but it’s only late July. By Dec. 14, when The Hobbit: An Unexpected Journey unfolds on the big screen, Armitage and the others will look appropriately small thanks to a bag of old and new cinematic tricks.

PHOTOS: The Hard Road to ‘The Hobbit’

Watching on a monitor, tucked out of sight, is Peter Jackson, the magician of Middle Earth. He had to overcome many reservations and obstacles before occupying the director’s chair on this massive project, among them the challenge of competing against himself. The Lord of the Rings trilogy grossed nearly $3 billion, and the final installment, 2003’s The Return of the King, swept up 11 Oscars, including best director and best picture.

If ever a wager on a project seemed like a safe bet, The Hobbit would be it. Otherwise, no studio would have found the will to tackle the enormous problems involved in getting these movies made. (Originally intended to be two, now there will be three.) Not only was Jackson long unwilling to commit, but the rights to the material were bound in a decades-old Gordian knot. Getting it all sorted out involved epic battles matching any spectacle that Jackson previously had put on the screen — if you substitute executives and lawyers for elves and orcs.

The films are based on a 1937 novel by J.R.R. Tolkien (who followed with the trilogy The Lord of the Rings). The Hobbit, which recounts the adventures of Bilbo Baggins and his quest for treasure guarded by the dragon Smaug, has sold more than 35 million copies.

As the actors finish a take, Jackson’s voice booms, godlike, through speakers on the set. Fortunately, he’s a polite deity. “Can you just be a lot more panting at the beginning?” he asks the dwarves. “All of you are puffed.” After all, they have just escaped the jaws of death. On cue, their chests start to heave. “OK,” says Jackson. “Panting, panting, exhausted and action!”

Panting, exhausted and action. That could be the motto of the making of The Hobbit.

STORY: Ian McKellen Almost Didn’t Return as Gandalf in ‘The Hobbit’

In the easygoing harbor city of Wellington, New Zealand, the 50-year-old Jackson is the unassuming master of all he surveys. His empire is spread throughout the modest suburb of Miramar: The Weta Workshop (named for an outsized New Zealand bug) creates armor, costumes and weaponry. It also has engineered vehicles for games and movies, including a working Panzer; it even creates public art works. Jackson’s Weta Digital has done effects work on Avatar, Rise of the Planet of the Apes and the Narnia movies; Park Road, set in an impeccably appointed arts and crafts-style building, is Jackson’s state-of-the-art postproduction facility.

Jackson’s brilliance is made manifest in this empire — as is his penchant for control. Not that Jackson isn’t collaborative — up to a point. On 2005’s King Kong, says an insider, Jackson surprised Universal by delivering a three-hour cut after the studio had thought a shorter version was locked. Jackson included 20 unexpected minutes, requiring $20 million worth of additional effects. The director split the expense with the studio, and the fact that he was reducing his own profit participation was immaterial to him. “It wasn’t a big drama,” says Jackson’s longtime manager, Ken Kamins. “He’s immensely collaborative — final cut or no.”

Of course, Jackson is among the few who have earned the right to exercise an auteur’s prerogative. So he lives on the far edge of the world, thousands of miles away from meddlesome studio executives, encircled by a group of longtime collaborators, including wife Fran Walsh (with whom he has two teenage children who cameoed in Lord of the Rings) and Philippa Boyens, who serve as his co-writers and co-producers. This community might be a bit clannish, but the motives are pure. “They don’t seem corrupted even though they are power conscious,” says an executive who has worked with Jackson and his team. “They do love movies. They work around the clock.”

PHOTOS: Meet ‘The Hobbit’s’ Key Characters

That commitment helps to explain how Warner Bros. can feel remotely comfortable putting up the better part of $1 billion to make and market not two but three Hobbit films. A knowledgeable source says the first two installments cost $315 million each, and that’s with Jackson deferring his fee. A studio source insists that number is wildly inflated and, with significant production rebates from New Zealand, the cost is closer to $200 million a movie. (The budget on the third film still is a wild card, but one reason a third movie was even discussed was because Jackson had shot more footage than two films could contain.)

Weta Workshop creative director Richard Taylor, among the many here who have worked with Jackson for years or even decades, speaks with awe of the director’s ability to execute these films despite their harrowing complexity. That struck Taylor back when he first worked for Jackson as a puppet maker on 1989’s black comedy Meet the Feebles. “Peter sat on his couch with his eyes closed and visualized what the movie would be,” he says. “His ability to weave together [in his mind] all these invisible elements on a blue screen or a green screen was completely within his repertoire of skills even then.” Jackson “sees” how invisible creatures will fill space and interact with their environment, from a cowering Gollum to Smaug. “This is a very clever filmmaker,” says Taylor. “It’s that simple, in my view.”

PHOTO: ‘Hobbit’ Poster Reveals a Sword-Wielding Bilbo

This time, Jackson is seeing Middle Earth through a different lens. He’s working digitally and in 3D. He also made the now-controversial decision to shoot at 48 frames-a-second, which delivers a larger and sharper focus than the usual 24 frames, creating what Jackson sees as a more vivid audience experience. That provoked some negative reactions when Jackson showed 10 minutes of Hobbit footage at CinemaCon in April, with some critics complaining that the daylight sequences were too crisp and looked more like high-definition video than film. Jackson says the new look just takes some getting used to, but the studio is releasing that version of the film only on about 400 well-equipped theaters (out of about 4,000), where it can be pitched as a premium offering.

Working with the new technology meant that many old-fashioned effects techniques — like using forced perspective to make characters appear larger or smaller — no longer were useful. But restocking his bag of tricks only was attractive to the director. (“The only reason I started making movies was a love of special effects,” he says.) What worried him about making Hobbit was the material. There was the question of balancing the tone: Hobbit is a children’s fable, while Jackson felt he was steeped in the darker shades of Lord of the Rings, which is about the dehumanizing influence of technology and valor in the face of war’s horrors.

More daunting was the multitude of characters in the book — no fewer than 13 dwarves, who had to be distinguishable to audiences even at a distance — as they join forces with Bilbo and the wizard Gandalf. A big part of the solution was not a new computer trick but hair — lots of it. All the dwarves wear wigs made of human hair imported from Russia, which has the right texture for characters that have a Northern European look. For the dwarves alone, there were six wigs and eight beards each (wigs for the actors, wigs for stunt doubles, wigs for stand-ins who are small in stature and who appear in scenes shot to establish scale). “I’ve never done such a hairy movie,” says makeup and hair designer Peter King. “Everywhere you look, there are tables and racks of wigs and beards.”

The digital camera’s unforgiving eye also required production designer Dan Hennah to create hundreds of props that look authentic. “We had bookbinders, musical-instrument makers,” says Hennah. “Pretty much every craftsman you can imagine in Middle Earth was here.” His workshop is a treasure trove of beautifully fashioned items, from Gollum’s macabre boat, made of an orc’s skeleton and goblin skin, to a finely engraved dwarf’s ax stuck in a stump, to slender yellow glass elf goblets. This is the room that obsessed Tolkien fanatic Stephen Colbert when he visited the set last year. (It turns out that Colbert can read Elvish.)

STORY: Third ‘Hobbit’ Film Sets Release Date

One thing that became easier: hobbit feet. In the Lord of the Rings films, the hobbits wore foam latex feet that had to be glued on laboriously, and maintaining the look was a constant challenge. “We were down on our hands and knees a lot,” says prosthetics supervisor Tami Lane. This time, Richard Taylor devised silicon slip-ons, which go on in about 10 minutes. “And they can actually waggle their toes and feet, so it’s much more believable,” says King. But once again — the hair. There are people in the crew whose only job was to apply hair to hobbit feet. On Hobbit, nothing was really easy.

The tangled web of the Hobbit movie begins in 1969, when Tolkien sold film rights to the book, as well as the Lord of the Rings trilogy — The Fellowship of the Ring, The Two Towers and The Return of the King — to United Artists. A few years later, the studio made a deal with Saul Zaentz to produce the movies — an arrangement that yielded Ralph Bakshi‘s animated Lord of the Rings in 1978 (and that, in turn, inspired the then-teenage Jackson’s interest in Tolkien). An accounting dispute of many years’ duration followed, and under a settlement, Zaentz wound up with the rights to Lord of the Rings. But United Artists still was locked in as distributor of Hobbit.

In 1994, Harvey Weinstein‘s Miramax acquired Jackson’s breakthrough film, Heavenly Creatures. Weinstein wanted to do more with Jackson, and Jackson wanted to tackle Tolkien. The plan was for Jackson to make a Hobbit movie and, in success, follow with two Lord of the Rings films. Given that Weinstein was, at the time, bailing Zaentz out of a financial crisis with The English Patient, it seemed that a deal could be made. But Weinstein found that United Artists was part of the Hobbit equation — a sticky part — so he proposed jumping straight to Lord of the Rings.

The idea was to make two films at a combined cost of $120 million. But Michael Eisner, then-CEO of Disney (which owned Miramax), balked and wanted to finance only one. Now it was Jackson’s turn to balk. Having already spent about $10 million to develop the project, Harvey and Bob Weinstein allowed Jackson just three weeks to find another buyer. Any deal had to give the Weinsteins and Zaentz executive producing credits, reimbursement for their costs and a piece of the gross profits.

Jackson and his team found their way to New Line Cinema — at that point, their last resort. After looking at Jackson’s models and a reel of material, chairman Bob Shaye asked the magic question: If there were three Lord of the Rings books, why not do three films? It was a huge gamble considering that Jackson was a cult filmmaker with a total box-office haul of $30 million.

STORY: No One Knows How Much Peter Jackson’s New ‘Hobbit’ Film Will Cost

New Line rolled the dice and greenlighted the trilogy at about $210 million. The final price tag was more than $300 million, partly because of the complexity of the material and partly because, after the first film in the series, The Fellowship of the Ring, was a massive hit, New Line was willing to spend more money. But as the movies started to generate huge returns, Jackson’s relationship with New Line began to sour. “When you make films that gross hundreds of millions of dollars and are critically lauded, it’s natural to expect more creative freedom and resources,” says an executive with ties to the project. “When those expectations don’t track with the studio’s processes, tension is inevitable.”

In August 2005, Jackson — who also had a piece of the box-office gross — sued New Line, demanding a thorough audit. “I’ve never been involved in a lawsuit in my life before,” he says. (Zaentz already had sued New Line over profits in 2004, and the Tolkien estate would sue in 2008. All these cases settled.) Jackson said he wouldn’t make another film with New Line until the situation was resolved. In a January 2007 interview, Shaye said New Line had paid Jackson a quarter-billion dollars before the suit was filed and vowed never to work with the director again.

Shaye wanted to make Hobbit with Sam Raimi (Spider-Man) directing. But UA — by now part of MGM — still had its rights, and that gave MGM chairman Harry Sloan veto power. “Harry said to New Line, ‘Fix your Peter Jackson problem,’ ” says Kamins. Meanwhile, pressure on New Line was building, as the studio’s rights to Hobbit would revert to Zaentz if no progress was made.

So a few months after his angry outburst, Shaye began to sound conciliatory. And in December 2007, as New Line faced a humbling failure with the costly Golden Compass, it was announced that Jackson, along with Walsh and Boyens, would executive produce and write two Hobbit movies, in partnership with New Line and MGM, to be released in 2011 and 2012. Jackson still had hard feelings about the litigation, but by then, he also wanted a path back to the project. “We felt a certain ownership over Middle Earth,” he says now. “I did think it would be a decision I would regret if I didn’t work with those involved somehow.”

And it wasn’t long before Shaye was out of the picture. The faltering New Line — by then a part of Time Warner — was downgraded from free-standing unit to Warners label, and Shaye was ousted. Alan Horn, then-president of Warners, naturally was supportive of what could prove to be a significant piece of business. Hobbit still had no official green light, but it seemed to be moving forward. In April 2008, Guillermo del Toro was announced as director and, though he once had expressed disgust with the world of hobbits, the Hellboy and Pan’s Labyrinth auteur suspended a rich deal at Universal and committed himself to spending four years on the project. He relocated to New Zealand, worked up extensive designs, scouted locations and collaborated with Jackson, Walsh and Boyens on the two scripts.

STORY: Peter Jackson’s ‘The Hobbit’ Trilogy Bypasses Consoles for Mobile and Online Games

But as there was apparent progress on one front, there was trouble on another. MGM was sliding toward bankruptcy. Sloan was fired and replaced by hard-nosed executive Stephen Cooper, who specialized in restructuring troubled companies — not in making movies. As decisions on Hobbit had to be made, executives at Warners and New Line found themselves handcuffed. They started calling Cooper “the Krispy Kreme guy,” a reference to one of his previous gigs. When urgent decisions had to be made, recalls an insider, “Cooper would say things like, ‘Can we think about that and get back to you in a month?’ “

Remembers New Line executive vp Carolyn Blackwood: “The fate of The Hobbit was very tenuous. As we’re financing preproduction, can MGM pay? No one knew.” Warners tried to buy out MGM’s rights, but the cash-strapped studio declined to let go of such a big title. Cooper “didn’t want to sell it, and he wasn’t ready to commit to it,” says a source on the project.

The constant uncertainty took its toll. “We were told a lot of times, understandably, ‘Look, you guys, probably another month and we should resolve this,’ ” says Jackson. “Ultimately, it got a little disheartening, with Guillermo obviously feeling it more than anybody else.” On May 30, 2010, del Toro announced on the OneRing.net website that he was leaving the project, calling it “the hardest decision of my life.” Boyens says del Toro, “an amazingly openhearted, generous guy,” made it clear that Jackson and his team should take over.

Jackson had suffered a setback when his passion project The Lovely Bones opened in December 2009 to weak reviews and disappointing box office (it grossed $94 million worldwide). But if there’s one message that Jackson and his team want to convey, it’s that del Toro left on his own — without a push from Jackson. “Eventually, he couldn’t wait around anymore,” says Jackson. “We got to the point that it was six months past when we should’ve originally started shooting.”

Some close to del Toro suspect the story was a bit more complicated than that. “Do I think Peter wanted to take over The Hobbit? No,” says one insider. “But he was going to be involved one way or the other, and as an artist, Guillermo wanted to make his version of the movie. I think he wondered: ‘How much of an imprint can I put on this? … Do I want to spend years of my life being caretaker of someone else’s franchise?’ “

STORY: FIA 2012: New Zealand’s ‘The Hobbit’ Drama Could End With Local Actors-Producers Deal

In a statement to THR, del Toro reiterates: “Leaving The Hobbit after more than two years in New Zealand was the most difficult professional decision I’ve ever had to make. I put a great deal of love and effort into the co-writing and prepping of the Hobbit movies … with Peter, Fran and Philippa. However, I had a number of other professional and personal obligations that I had to fulfill. I left with the confidence that the Hobbit films were in good hands.”

Although Jackson still hadn’t made a decision to direct the movies, New Line’s Blackwood says the opportunity to get Jackson into the director’s chair was “a phenomenal gift.” Concurs New Line president Toby Emmerich: “It wasn’t clear the movies would survive if he didn’t step in. And certainly no one on the planet was better qualified to do it.”

It was Horn who got Jackson over the hump, telling him that one day, he would be glad he’d directed the entire cycle. “In all our deliberations with Peter, it was never about the money,” says Horn. “It was about what he wanted to do with his life, whether he wanted to dive back in.” Finally, Jackson was willing but wary because the film still had no green light. By then, MGM was about to file for bankruptcy. Horn agreed that Warners — which already had invested $45 million before a single frame had been shot — would foot the bill for the movies and MGM could reimburse the studio over time.

“I would give Alan the credit for these films existing in the first place,” says Jackson. “It was only his total focus and attention that actually sorted through the issues. … I trust anything that he tells me. And I pay attention to anything he tells me, which is not really the case with some of these people.” Although Horn since has left Warners and taken the helm at Disney, he will have an executive producer credit on all three movies.

Even though Jackson was in place, the troubles hardly were over. A dispute erupted as performers’ unions, including SAG, urged members not to work on the films. Jackson responded with a statement arguing that the project was “a big fat juicy target” for labor organizers in New Zealand and suggested he would move production out of the country. In the end, Warners persuaded the New Zealand government to pass a law that stymied the unions and gave the production another $25 million in government incentives on top of a 15 percent tax break that the project already was set to receive.

A few weeks later, Horn was in New Zealand having dinner with Jackson when the director said he was having some gas pains and politely excused himself. Later that night, Horn learned that Jackson had been rushed to the hospital and was in surgery to repair a perforated ulcer. By now, the media had been speculating that there was a curse on Hobbit, and this just seemed like more evidence.

VIDEO: ‘The Hobbit’ Trailer Takes Bilbo & Company on an ‘Unexpected Journey’

When filming on Hobbit finally began March 21, 2011, almost all of del Toro’s work had fallen by the wayside. “I didn’t want to make Guillermo’s movie,” says Jackson. Not that he tossed out everything, he adds diplomatically. “Certainly some of his DNA is in it still. Some of the things he did I certainly liked and took bits and pieces from it.” It’s just that Jackson can’t name a great many of them. (Final credits still are being resolved, but del Toro will share a screenwriting mention, at least on the first film.)

But Jackson did want to stick with Freeman, who was a lead contender for the title role. Jackson felt that Freeman had an ineffable quality that made him right for the part. “He is very hobbit-y in real life,” says Jackson. “I am, too. I’m proud of it. You do not stray too far from your home, do not get involved in anything too adventurous or dangerous. I largely like to stay at home with my feet up, and Martin has a lot of those qualities.”

But all the delays seemingly had cost the production its leading man. Committed to a second season of the British series Sherlock, Freeman no longer was available. The search for Bilbo continued, but Jackson wasn’t happy with anyone else. “I was lying in bed one morning unable to sleep, watching him on my iPad,” he remembers. “This was right at the point that we literally had to cast Bilbo within a week or we wouldn’t have an actor ready to shoot with us. I just thought, ‘We are in so much trouble.’ “

So Jackson decided to act. “I usually don’t deal with agents,” he says. “But I called Martin’s agent, and I said, ‘Look, do you think Martin would be interested in doing this if we could find a way to actually have a break in our filming so he could do the Sherlock shoot?’ ” The answer was yes.

Still in Bilbo garb during a break in filming Hobbit, Freeman says he’s relieved that it worked out, though he had doubts about being away from his home in England for the many months that would be required. But ultimately, he says, “It was too big a ship. I didn’t want it to leave without me.” Told that Jackson has described him as hobbit-y, Freeman seems to disapprove. “I think he’s more hobbit-y than I am,” he says. “He probably missed the boat on playing Bilbo.”

In late June, Horn and the key New Line executives paid a visit to New Zealand and watched a cut of the first film. Then Jackson and his collaborators pitched the idea of making not two but three Hobbit movies. Horn — by then at Disney — admits that the proposal came as a shock. The question, he says, was “Can each movie be a full meal?” The group agreed that Jackson’s plan worked.

So now, almost miraculously, there will be three Hobbits instead of none — which often seemed like the easier option. But the temptation of going back to the Tolkien well was too rich to resist. “At every junction, someone had to say, ‘I know it’s a problem, but let’s go forward,’ ” says Horn. “Or, ‘I know it’s more expensive than we thought it would be, but it’s worth it.’ “

Of course, Horn acknowledges that it only will become clear whether the struggle was worth it when the movies come out. “The audience will decide,” he says. “But I’ve seen the first movie — and it’s a joy to be back in that world.”