Film finance

Investment firms and hedge funds are bullish on Hollywood again, sinking millions into production deals with major studios and independents. By Stephen Galloway, Published April 11, 2006 Not long ago, Hollywood was trumpeting the new breed of money men as saviors of the film business, with high-net-worth individuals such as Mark Cuban and Bob Yari infusing much-needed funds into productions around town. Now, Wall Street is following in their footsteps. These days, it seems that investment firms and hedge funds have decided that movies might be worthy gambles after all. "The studio business historically returns around 12% or 13% a year, and the feeling is that, with the explosion of home video and the potential of new technologies, this is probably just the base," producer Michael London says. He should know: London, whose credits include 2004's "Sideways" and 2005's "The Family Stone," is one of many direct beneficiaries of the finance community's renewed interest in film production. His newly formed Groundswell Prods. has raised $55 million and aims to raise as much as $100 million for movie projects, with an eye toward making under-$20 million specialty pictures and genre product. "There has been interest in the past, but it feels we have now hit a tipping point where real money is flowing into the business," London says. That is great news for major studios and the independent-film sector, both of which already have benefited from impressive deals: Paramount in 2004 raised $230 million through the Melrose Partners fund put together by Michael Blum, head of Merrill Lynch's global structured-finance division and the man behind many film-financing deals. The fund was designed to attract investors to pay for as much as 20% of the studio's net production costs on each of its projects, including J.J. Abrams' planned May release "Mission: Impossible 3." Another such deal is in the works. Legendary Pictures, a production company founded by finance and entertainment executive Thomas Tull, signed a five-year, 25-picture deal with Warner Bros. Pictures in June, with Legendary investing $500 million in a slate of films to be jointly produced and distributed by Warners. The partnership's first feature, 2005's "Batman Begins," proved successful, and its planned upcoming releases include Bryan Singer's "Superman Returns" and M. Night Shyamalan's "Lady in the Water." Legendary also will develop its own projects as part of the deal. Credit Suisse First Boston announced in September that it had raised $135 million and created a $370 million line of credit for Kingdom Films, a company CSFB had set up in June to invest in a slate of Walt Disney Co. movies. According to the deal, Kingdom will take a 40% stake in 32 live-action Disney films. Bob and Harvey Weinstein's new shingle, the Weinstein Co., raised about $490 million in equity and secured a $500 million credit line late last year as part of a deal put together by Goldman Sachs, giving the brothers a $1 billion fund with which to make and distribute films. Relativity Media agreed in January to invest $600 million in a slate of 18 pictures from Sony and Universal through its newly created Gun Hill Road subsidiary. Deutsche Bank helped raise the capital. Relativity is committed to financing about 50% of production costs on seven Universal films during the next two years and will split costs on 11 Sony movies during that span. The Relativity/Sony-Universal pact followed a $500 million-plus deal between Virtual Studios and Warners, splitting the cost of six movies. Virtual works in tandem with several Relativity executives. 20th Century Fox has closed a deal with Dune Entertainment, an affiliate of Dune Capital Management, through which Dune will invest $328 million in 28 Fox films. Dune also was one of two buyers that acquired the DreamWorks library from Paramount last month for a tidy $900 million (the other being Soros Strategic Partners, run by financier George Soros). Merrill Lynch recently wrapped a $50 million deal to fund a slate of lower-budget movies and telefilms from Regent Entertainment, which distributes predominantly gay-themed material theatrically through Regent Releasing. "Over the last 10 years, Wall Street has favored asset-backed transactions, beginning with real estate mortgages, and this is an evolution of that," Regent chairman and CEO Stephen Jarchow says. "Ten years ago, you rarely saw real estate mortgages being packaged up; now, it is very common. Wall Street evolved from that toward packaging other types of assets, and in the last two or three years, it has gotten very interested in content and intellectual property. "A number of Wall Street firms have gradually gotten more comfortable with underwriting these assets, evaluating the management teams and understanding the revenue streams and have evolved to the point where they like to do this kind of business and are fairly aggressive about it," he adds.

Several key factors are driving Wall Street's newfound interest in Hollywood, but the glamour of filmmaking isn't one of them. "It is irrelevant if it is roads or real estate or bridges or cars," Relativity CEO Ryan Kavanaugh says. "To us, films are widgets." The emergence of the hedge fund, a form of investment company that enjoys wide latitude as to where it can place its money, has created millions of dollars in capital that is now being made available to the entertainment industry. Experts also note that the recent slowdowns of real estate and the stock market in delivering solid returns on investment have helped shift Wall Street's focus to Hollywood. "The pie is bigger in general," Tull says. "You have the growth of the international marketplace, (and) you have home video and markets that were not available years ago." While increasing corporatization might be bad news for those on the creative side of the film business, it is an encouraging sign for investors who previously eschewed Hollywood's Wild West mentality. Not only are seasoned corporate executives in charge at most studios, but also, the fact that the majors belong to publicly traded corporations means that their accounting procedures operate with a greater degree of transparency than ever before. "Previously, you had this maverick, mogul-led Hollywood, where if you were an outsider who came in with bags of money, you left without them," Tull says. "Now, the studios are run by conglomerates, and the reporting structure is much more transparent." Also helping matters is the fact that studios are offering investors an opportunity to back their biggest titles. In the past, investors often were sought to help shore up risky projects that generally were considered B-list; now, the majors are looking for outside partners to help defray costs on summer tentpole releases, including the recent "Batman" and upcoming "Superman" films. "It was important for us to be able to get the very best properties that Warner Bros. had to offer," says Tull, who declines to discuss details of the Legendary/Warners arrangement. The same is true of Relativity's deal with Sony and Universal. Even studio executives admit that they allowed Relativity to select from among a wide array of projects. "In our case, we showed them a list of titles that were either in preproduction or production or early postproduction," says Bob Osher, chief operating officer of the Columbia Motion Picture Group. "They chose the ones that fit within their business philosophy." The only project that was off-limits? Sony's eagerly anticipated Sam Raimi-helmed 2007 release "Spider-Man 3." "You have a very sophisticated Wall Street that does a lot of analysis," Osher says. "They have taken a look at the past performance of films over a number of years and made a determination that if they invest in a large-enough sample of pictures, they will make the return they are looking for." Each investor has his or her own theory about what will work. Legendary invests largely in pictures aimed at 18- to 34-year-old males, while Relativity makes films that fit into a sophisticated computer formula the company has crafted. Others believe that money is to be made not through major-studio releases but through the indie sector. "They're much more interested in splitting (financing), because every dollar counts," Endgame Entertainment chairman and CEO Jim Stern says. Stern is not the only financier with Wall Street backing who is looking at solid indie projects. Intrepid Pictures, backed by hedge funds and run by producers Trevor Macy and Marc Evans, recently signed a nonexclusive co-financing deal for three to five movies a year with Rogue Pictures, Focus Features' genre division. In most cases, though, investors are looking to spread their risk over a slate of pictures. "Their challenge is finding companies other than the major studios to realistically do this business," Jarchow says. Studios are not necessarily thrilled about their new business partners, but with other funding sources drying up and parent companies tightening their purse strings, they must turn somewhere for cash. "The studios are being squeezed by their parents to leverage their capital more, and they want to earn distribution fees," says Hal Sadoff, a former banker who now works for ICM as the head of the agency's International Independent Film Group. "They have these vast distribution outlets that they want to fill with product, and the way to do that is to bring in additional capital to finance a larger slate of pictures." Adds Kavanaugh: "Studios are doing this because they have to. The studios became very reliant on third-party capital -- German tax money, insurance funds, sale-and-leaseback money -- that has mostly dried up, so now the studios are going, 'Where do we get our co-finance?' Well, there is a lot of money in banks and pension funds and these very sophisticated hedge funds. But those guys are not going to be naive about it; they are going to do due diligence and say, 'We want a piece of the good stuff.' And the studios realize, if they want this capital, then they are going to have to be much more open."