Pic biz surfs next wave

Private equity steps up as Germans, Brits shift schemes

HOLLYWOOD — As with most every financial tool in the pic biz, once it’s overused or abused, it gets taken away.

That seems to be what’s happening in Britain and Germany soon, where tax shelters of various stripes are being stripped or taken down.

The U.K.’s sale-and-leaseback setup is under scrutiny and will look very different a year from now.

The German situation looks more dire. The nation’s finance minister recently proposed to do away with loopholes in the tax system that allowed, among other things, public media funds to invest in film productions. A large portion of the allocated money flowed to non-German pics (read: Hollywood) — a reason why the issue has become such a political hot potato. Now the funds could be eliminated altogether, though some observers say parts of them could be saved.

Whatever the outcome, these important sources of financing aren’t as reliable as they once were, and it’s forcing the pic biz (indies in particular) to seek out greener pastures.

“A substantial number of films we finance rely on this soft money to get projects going,” notes Jared Underwood, senior VP/manager at pic lender Comerica Entertainment Group. “But my guess is that, as always in the indie film business, when one door closes another one will open.”

“There’s a huge opportunity in the marketplace right now for equity money to participate in indie film,” says Matthew Thompson, a partner at law firm Stroock & Stroock & Lavan. “A lot of other financing has gone away, like insurance-backed finance. Presales have scaled back, and soft money is in a state of flux. So there is a big hole that can be filled with equity, and the people who can fill that hole can make a lot of money off it.”

Hollywood already has seen the influx of high-net-worth individuals — including Bob Yari, Jim Stern, Jeff Skoll, Bill Pohlad, Mark Cuban, Todd Wagner and Sidney Kimmel — but now there seem to be even larger forces looking to invest in the film sector.

Not only are private equity funds sniffing around Hollywood, but hedge funds and other types of mezzanine players are joining the party.

“What’s different today over five years ago is that you now have financial investors who are looking at the film industry and interested in finding the right deal,” says Isaac Palmer, senior VP of corporate development at Paramount Pictures. “That’s a change because for a long time you couldn’t get Wall Street invested in the film industry. ”

Observers point to Texas Pacific Group and Providence Equity Partners’ involvement in Sony’s purchase of MGM as recent evidence that the financial community’s interest in film is a growing phenom.

They also list Paramount’s landmark Melrose Investors deal, a multi-million-dollar slate financing arranged by Merrill Lynch that included a mix of institutional investors.

And, as if neatly underlining this trend, Palmer will be exiting Par in July to head up a newly established Los Angeles outpost of Fortress Investment Group, a $15 billion asset management firm that will be looking at entertainment and media.

Palmer has worked on many of Par’s German funding deals over the years and also was a key negotiator on the studio’s Melrose deal. “There are a number of film deals, though not exactly structured like Melrose, that are winding their way through the market right now,” he adds.

In a separate development, Merrill Lynch just concluded a deal to finance a Marvel pic slate to the tune of up to $525 million over seven years. (Paramount was assigned as the domestic distrib in the deal.)

But what’s behind this new vote of the confidence from the financial community?

Most observers point to the lackluster stock market as a big reason why investment firms and hedge funds are looking elsewhere. And since the coming (and going) of the Internet gold rush, many wealthy individuals and groups are looking to place their money.

“We have a lot of hedge fund managers in Endgame,” notes Stern, clarifying that his company is backed by a group of investors, not just his own capital. “People have done well financially over the last few years. There’s been a rebound (since the dot-com’s bubble burst). And, you have to remember, some people didn’t invest in Internet at all.”

Meanwhile, investors in all areas are more secure in the thought of pouring money into Hollywood because there have been a few precedent-setting deals and there are numbers to work off.

Film libraries — and their potential exploitation over myriad (and multiplying) distribution platforms — are judged as viable assets, and potential deals now can be rated. DreamWorks’ recent film securitization deal and Par’s Melrose got credit ratings, indicating that the senior debt in the deals was investment grade.

“With each deal, Wall Street, big banks, mezzanine funds and private equity funds get more comfortable with films as an asset class,” says Palmer. “They’re applying economic modeling techniques, where you can look at a film library and assess the risk of loss.”

With every new wave of money, however, industryites caution that it won’t be around for long, unless it is treated with due deference.

Says Stern, “People who are able to commit, protect and respect the money stay in the business.”

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