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The 1994 movie Ed Wood, starringJohnny Depp, depicts the true storyof a moviemaker who many believeto be the worst of all time. Workingon the seedy fringes of 1950sHollywood, Wood turns out stinkerafter stinker until, in a desperate ployto finance his next film, he convincesthe deacons of a local Baptist churchto back his Plan 9 From Outer Space.Terms of the deal include the provi-sions that members of the cast bebaptised, and that the original title –Grave Robbers From Outer Space –be changed.

While Plan 9 may be held forth asamong the less sophisticated exam-ples of film finance, it contains a plotline that has been seen again andagain in Hollywood – a group ofinvestors, eager to be part of themagic of movies, sets aside reason infavour of artistic vision.

For the record, the slew of profes-sional fund managers to haverecently done deals in Hollywood saythey are not chasing glitter, butreturns. These investors – most ofthem hedge funds participating inequity and debt instruments – believe

they have gotten their arms aroundthe risks of the film business. Theysee an opportunity to partner withmovie industry veterans and to enjoypredictable, moderate returns overthe long term through the bundledownership of filmed entertainmentassets. On paper, it sounds like thekind of risk/return profile that wouldbe particularly attractive to alterna-tive investment money. But thehistory of the film business is litteredwith disillusioned investors whowent in with dreams of backing StarWars and ended up with Plan 9 FromOuter Space.

The latest crop of investing aliensto descend on Hollywood come fromthe alternatives universe. MickeyMayerson, managing partner of theLos Angeles office of law firm Loeb& Loeb and the firm’s co-chair of theCorporate Media and EntertainmentGroup, says he has seen a big uptick

Private investment fund managers are flocking tothe movie industry because they see it as – get this –a business with manageable risk. Are these GPs wiseto the future of filmed entertainment, or have theysimply ‘gone Hollywood’? David Snow reports.

Private equity goesto Hollywood entertainment ip

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in the past 12 to 18 months in thenumber of private investment fundschasing opportunities in Hollywood.“There is a whole load of deals weare working on now involving name-brand Hollywood people and name-brand private equity firms,” saysMayerson.

Unlike previous types of movieneophytes, adds Mayerson, theseinvestors are armed with hard-to-obtain revenue statistics, have seriousreturn expectations, and are focusedon emerging forms of digital enter-tainment, not just the box office.

Gary Adelson, a managing directorin the Los Angeles office of HoulihanLokey Howard & Zukin, and co-head of the investment bank’s mediasports and entertainment group, saystoday’s sophisticated and profes-sional investors sense a “paradigmchange” within the media spacedriven by digital distribution,whether this be video-on-demand,telephony, iPods, or video games. Asa result, says Adelson, “You’re seeinga lot of big, reputable private equityfirms invest in the space. They have aperception that content has signifi-cant value in today’s world. Byowning content, you have value thatyou didn’t have before.”

Movie studios, eager to offset someof the risk of film production, areonly too happy to work with thesenew, return-driven investors, andhave even been granting someconcessions not often seen inHollywood.

package deal

While there are a number of financialstructures tailored for film produc-tion, the one capturing the mostattention now in Hollywood is oftenreferred to as a “slate financing”,meaning financial investors co-investwith a studio to back a slate ofmovies. Underpinning this structureis an assumption that a bundle ofmovies, not unlike a bundle of port-

folio companies, is more likely toproduce the expected returns andguard against loss of capital. In otherwords, the bombs can be offset bythe hits.

The good news about slate dealsfor larger private investment funds isthat their ostensible benefits areaccessible only to parties with lots ofcapital to put to work, given theexpense of producing multiple films.As an industry source puts it: “It canbe riskier to invest a smaller amountin a single picture than it is to investa larger amount in a slate ofpictures.”

A prime example of a recent slatedeal is Legend Pictures, backed by aclutch of private equity firms, whichis in the process of co-financing 25movies over five years alongsideWarner Brothers (see table, p. 69).Legend is the brainchild of ThomasTull, the former president of mediainvestment firm Convex Group. Thedeal was structured in tranches ofmezzanine and equity, with M/CVenture Partners and Banc ofAmerica Capital leading the equityround.

Among the films financed to dateby Legendary is Superman Returns.According to Mayerson, the fact thata group of outside investors gotaccess to the valuable Supermanfranchise is evidence of the studio’sneed to tap into the private equitymarket. “One of the things that goteveryone’s attention was WarnerBros’ willingness to dangle one of thestudio’s family jewels ,” saysMayerson. “Usually, the studios keptthe sure things for themselves andonly offered [investors] pictures theydon’t have as much confidence in.”

Mayerson adds that, given theescalating costs that they face inproducing and distributing pictures,studios are more willing today thanat any other time in recent memoryto share the upside in their currentslate of pictures, even those whichwould have been cons idereduntouchable in the past. Forexample, during the 1980s, Disney’sco-financings with outside investorsnever included its prized animatedtitles.

Still, co-financing deals are stackedheavily in favour of the studios. Itmight even be said that co-financingdeals rival only hedge funds in thedegree to which the economics favorthe sponsor.

Here’s how most co-financingdeals work: whatever gross revenueis produced by a film is immutablysubject to a “distribution fee” takenright off the top by the studio. Unlike

Mayerson: big uptick in movie chasers

“One of the thingsthat got everyone’s

attention wasWarner Bros’ willingness to dangle one of the studio’s

family jewels”

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carried interest, this fee cuts into allrevenue, even if the film flops.Further cutting into investor profits,many films have “gross players” –often star actors involved in theproject – who take a guaranteed cutof the gross revenue alongside thestudio. Then the studio recoverswhatever it spent marketing the film.Then, and only then, do financial co-investors begin to share in the profitsof the film, if any.

An industry veteran notes thatwhile the distribution fee charged bystudios has traditionally been 30percent, this rate has come down inrecent years to as low as 10 percent.He describes the market distributionfee today as roughly 15 percent,indicative of studios’ efforts toattract outside investors to filmproduction.

According to Adelson, studios arenow willing to bring in outsideinvestors as 50 percent owners of afilm’s rights (after the layers of feeshave been taken, of course). Thestudios often retain the right to buyout a partner after a specified periodof time. From the investor’s perspec-tive, this might alter the long-termreturn profile of a film slate, but mayalso create an attractive exit.

Mayerson says that, in general,private fund investors in slate dealsare looking for returns of more than15 percent, with a sweet spot inexcess of 20 percent. “If they’re notlooking for those kinds of returns,they shouldn’t be deploying capitalhere,” he adds.

Another major area of film financethat has lately attracted alternativeinvestment funds has been so-called“gap financing” – the equivalent ofmezzanine finance bridging the gapbetween a film’s bank loan and itsequity capital. These deals havelargely attracted hedge funds, manyof which are already active as buyersof corporate loans. A number of slatedeals, including Legend, haveincluded this type of financing.

Many film projects also include“prints and ads” finance, a fairlysecure form of loan that is backed upthe film’s gross.

gut feeling

Despite Hollywood’s reputation as afactory where naïve money is turnedinto unseen films, professionalinvestors are now more comfortablewith backing filmed entertainmentbecause they have access to whatthey believe is compelling data onhow films make money, which filmsmake money, and through whatstructure.

This approach is the polar oppo-site of the “gut feelings” thatfamously launched both epic screensuccess and epic failures of previouseras.

The fact is, if done correctly, filmscan be relatively low-risk venturesthanks to the many ways their intel-lectual properties can be milked forrevenue. Studios in particular havebecome extremely sophisticated inanalysing where profits come fromin a changing world. Among thefallacies of today’s movie business isthat opening weekend at the boxoffice can make or break a film. Infact, the media’s focus on box officerevenue – people buying tickets atthe local theatre – overlooks theimportance that years of global anddigital distribution and other rightscan bring to a film’s bottom line.

“There isn’t a full understandingof how box office and video revenuetranslate into profits,” says KenSchapiro, a partner at Los Angelesprivate investment firm QualiaCapital, and a veteran of the film-finance business. “There are filmsthat have received big box office butnot profitability, and there are filmsthat have had weak box office butstrong profitability.”

Key to a film’s profitability, saysSchapiro, are the “tremendousnumber of film rights” that come

with ownership of a title. Theseinclude the ability of consumers topurchase film viewings across anexpanding array of digital platforms.But they also include movie remakes,sequels, music publishing cata-logues, video games and televisionspin-offs.

Qualia, formed last year andbacked with capital from hedge fundCanyon Capital Advisors, recentlyacquired for a reported $100 millionthe film libraries of Gaylord Filmsand Rysher Entertainment. Amongthe titles in the deal was Kingpin, a1996 Woody Harrelson comedyabout a one-armed bowler. Schapironotes the many ways the IP of thisfilm could be licensed out. “It wouldmake a great TV series,” saysSchapiro.

Just as private equity GPs jeal-ously guard proprietary data,studios have been less than generousin relating what they know aboutfilm revenues with outsiders. Onemovie market participant holds hisfingers up in a sarcastic quotationgesture when describing how studiosoffer to “share” data with invest-ment partners. Often, a studio willsimply refuse to share its marketintelligence with investment part-ners.

Among the private funds nowactive in Hollywood, the mostsought-after form of human capitalis a talented former studio executive,who has irreproducible skills fromyears of analyzing proprietary filmrevenue data. According to severalsources, these executives have beenknown to arrive at their first day ofwork in a hedge fund or privateequity fund with reams of usefulempirical data, the source of whichis never identified or asked for.

a few good men

A cold fact for any aspiring film-maker is that most films are neverseen by a paying audience. Indeed,

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the ability to consistently produceprofitable movies is a rare talent. “Atthis moment, there is no shortage ofprivate equity firms looking forappropriate investment opportunitiesin Hollywood,” notes Mayerson.“But there is a shortage of gooddeals.”

Of course, finding good manage-ment is a problem for every segmentof private equity. Qualia’s Schapirosays successful film producers needto understand all aspects of thecreative process, financing andaccounting, intellectual property andtechnology. “Producing f i lmsrequires very special and uniqueknowledge,” he says.

That said, Schapiro notes that thel imited populat ion of ski l ledmoviemakers has historically notbeen given the kinds of equity incen-tives common to private equity deals.Incentives for the people actuallymaking the films have too often beena combination of salary, credits andlifestyle perks. This equals an oppor-tunity. “Accountability has been avery difficult issue in film finance,”says Schapiro.

Hollywood veterans have notedwith great interest the arrival ofprofessional money managers in partbecause for most of film’s history,outside investors have been moti-vated not entirely by profits. Forexample, various country and USstate governments became filminvestors to promote tourism orcreate some vague, artistic societalb e n e f i t . T h e s e i n v e s t m e n tprogrammes are often sold down tothe citizens through tax-breakschemes, as is the case with Germanfilm ventures, which back manyHollywood projects.

Wealthy individuals have alwaysfigured prominently as backers ofmovies. For example, Denver billion-aire investor Philip Anschutz createdmovie production house WaldenMedia in part as a serious investmentproposition, but in part to promote

family values in movies. He wasbehind the recent Chronicles ofNarnia production, based on thebook by Christian author CS Lewis.

“Not that wealthy individuals arenot concerned with returns, but theydon’t always analyse things with thesame emphasis on returns,” says anindustry vet. “You’re more likely tohear words like ‘passion’ and‘vision’. The hedge funds are sittingthere with a calculator.”

As Mayerson puts it: “In the olddays it was all about gut. Now thehedge fund guys are actually workingon the numbers.”

Noting the new analytical rigorthat has entered the film financingbusiness, Harold Flegelman, a Loeb& Loeb partner and also a co-chairof the firm’s Corporate Media andEntertainment Group, mentions arecently completed deal. Flegelman,Mayerson and Susan Williams, aLoeb & Loeb partner, representedCold Spring Pictures in the recentraising of a $200 million facility toco-finance 10 films to be producedby Montecito Picture Company andDreamWorks over five years. Thefacility consists of a combination ofequity and bank debt. Flegelman

notes: “The investors analyzed thestructure and the numbers with agreat deal of care, and we were alldelighted with their enthusiasm forthe opportunity.”

Not every media investor isconvinced about the new merits ofthe film content creation business.During a recent conversation amongprivate equity media investors inNew York, several GPs expressedgreat skepticism at the recent rash ofslate financings, saying that the port-folio theory of film was far fromproven. “It seems that hope springseternal for f i lm f inancing inHollywood,” said Mark Colodny, amanaging director in the New Yorkoffice of Warburg Pincus. “Over thedecades there have been waves ofdifferent types of instruments anddifferent groups of investors –domest ic , European, Asian –attempting to find the secret ofmaking money in Hollywood. But itis extremely difficult even for thepros to do this in a sustained way.”

An added risk for film investors is,as one film industry insider puts it,“going Hollywood”, which hedescribes as such: “The allure of thebusiness becomes overwhelming.Someone s t ra ight - laced f romConnecticut will get here and he’llget a Porsche, he’ll look different, actdifferent and he may see his marriageget busted up.”

Schapiro, who was introduced toprivate equity when he became presi-dent of Bain Capital portfoliocompany Artisan Entertainment,which produced the low-budgetblockbuster Blair Witch Project,describes himself as “immune” to theglamour siren song of Hollywood.“I’m the unique person who findshimself in filmed entertainment notbecause of a deep commitment tomovies. I’m in this business for thebusiness, not so that I can go to apremier. The private equity investorsthat get into this business instilledwith discipline will do well.” n

“There are films thathave received bigbox office but not

profitability, and thereare films that have

had weak box officebut strong profitability.”

Superman Returns: up, up and awaywith private equity money

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