Studios look to outside investors for financing
As a risky business gets riskier, studios are collecting outside financing at a brisk clip. In the past week alone, three major studios announced that they had collectively landed $925 million from private investors.
Every major studio now has a deal with private equity firms — combined they represent some $2.7 billion — to draw on; the money pools are raised largely from Wall Street bankers, hedge funds and major investors in Hollywood’s slates.
Last week, Sony inked a deal to collect $400 million in fund coin, Universal picked up $200 million and 20th Century Fox pacted for $325 million. (Sony and U both are both aligned with Gun Hill Road.)
Latest deals follow similar moves at Warner Bros., which has inked over $1 billion. Paramount is working on a second round of its Melrose Fund and Disney has its Kingdom Fund.
The deals mean more money, less risk for the studios. Even better, the investors are not usually looking for a producer credit — or to land a part for a close relative.
Instead, the deals are a product of their time. Between box office-DVD turmoil and emerging technologies like the video iPod, studio heads cannot tell you with a straight face that they have any certainty about what the movie business will look like one year from now.
Those same execs, under corporate mandates to keep the conglom content pipelines flowing, are being asked to peer into a murky future and make bets at $200 million a pop.
“With all the X-factors facing the business right now, with studios having no way to predict what is going to happen, they’re hedging their risks,” says one dealmaker. “That way, they won’t lose as much if they guess wrong and audience patterns worsen or the DVD marketplace starts to shrink.”
The terms of each private equity pact are heavily negotiated and vary. Some studios are letting hedge funds into some of their top franchises: Warners’ first pic in its $500 million deal with Legendary Pictures was “Batman Begins,” to be followed with “Superman Returns.” Others are leaving their top tentpoles off the list. Sony hasn’t identified which 11 films are in its deal with Relativity, but “Spider-Man 3” isn’t one of them.
Conventional wisdom is that these hedge-fund investors act like invisible partners. But, in fact, they can influence artistic decisions, as execs try to come up with projects that they think will appeal to these moneymen.
There’s also the reality that the funds are expecting certain returns from the movies they’ve bought into. (To see a pretty good caricature of a hedge fund manager who’s just learned a deal is coming in low, check out James Cramer on his CNBC series “Mad Money.”)
Even so, the hedge funds are in a position to absorb more risk than the studios, whose executives have to answer to corporate managers whose greatest goal is a smooth year-to-year financial trend line.
These deals are also freeing the studios from the typical co-financing bind of mitigating downside on projects in exchange for a hefty chunk of the upside.
Traditionally, when outside financiers like Spyglass or Village Roadshow invested in films, they wanted distribution territories in exchange. But in deals now being struck with funds, the studios are typically retaining worldwide distrib rights.
Paramount chief financial officer Mark Badagliacca says, “We like it because it’s a slate deal without giving up any rights. We’re transitioning out of UIP in the major territories and we need product to put through those pipelines.”
And while the costs of producing and marketing movies rises and corporate congloms are stingy about increasing studio budgets, the deals allow the majors to produce more (or bigger) films with less cash.
“It’s a question of how you allocate your money,” says Sony chief operating officer Bob Osher, who adds that the cash freed up by the deal may end up invested in non-film media Sony Pictures Entertainment produces.
Deal terms are also much more favorable for the studios than other co-financing arrangements.
Each deal varies, but the basic template is for a studio and an outside fund to each put up half of a film’s production budget. The two then split any profits after the studio deducts a distribution fee (typically in the 12%-15% range). Often a studio will front the P&A expense and recoup out of the gross revenues, though each deal can differ.
Because of the way the deal is structured, a studio is poised to share more of the profits than the fund. Likewise, if a film tanks, the hedge fund will end up absorbing more of the losses than the studio.
If a studio finances a pic solo, its profits are greater — but so are the risks. So many studios feel that the fund advantages far outweigh the disadvantages.
“This is the sweet spot of motion picture financing,” says Universal Pictures prexy-chief operating officer Rick Finkelstein. “You retain worldwide distribution, you retain complete creative control, you’ve got a financial partner and you’re allowed to take a distribution fee. The economics are quite attractive.”
In part, the studios are able to charge such a hefty premium for access to its projects because they bear all the overhead costs of developing, marketing and distributing films. But since those are fixed costs to the studios, it is still advantageous to get outside investors to pick up part of the tab for those ongoing expenses.
But most important, the number crunchers leading the funds are bullish on the movie business and believe that owning a stake in a movie will generate big returns for its investors.
For outside money, getting into the movie business is notoriously difficult and perilous, a lesson learned the hard way by innumerable mogul wannabes seeking to buy their way into Hollywood.
That’s true even of a savvy outsider like Philip Anschutz. He now looks to be sitting on a huge franchise after the success of “The Chronicles of Narnia: The Lion, the Witch and the Wardrobe,” but he first went through the costly debacle of “Around the World in 80 Days” and a middling result for “Sahara.”
Rather than bet on individual movies, the funds are doing what the studios do: hope that your hits more than make up for your misses. At Fox, the $325 million from Dune Capital is being spread across 28 pics.
Relativity Media has taken the logic one step further, raising a $600 million fund that will be split between both Sony and Universal.
“We wanted to do a two-studio deal because that was something that we thought would be unique to investors,” says Ryan Kavanaugh. “It’s like any other industry: we can model it as long as there’s big enough volume.”
And while studio execs have a sneaking suspicion that the Wall Street money is coming in part because bankers want to hobnob with celebrities at movie premieres, the influx of capital into hedge funds triggered by a slow stock market and low interest rates means that fund managers are sitting on billions of dollars they need to put to work for investors. And doing nine-figure studio deals is one way to move a lot of cash out the door in one fell swoop.
But it is not just a capital glut that is driving the funds to Hollywood. Technological changes in the media business — those same factors that make studio execs nervous about risks — are keeping content properties hot because investors see opportunity in the video iPod and PSP machines.
But with most of the attractive film libraries now in the hands of, basically, the five congloms that own the major studios, anyone looking to own a film needs to invest in making one rather than buying one.
“Owning content is a very good business to be in over the long haul,” says Legendary’s Thomas Tull. “We have some of the blue chip private equity investors, and we all got comfortable that we can hit the numbers that are expected in the private equity market.”