Investors get sweet on niche treats

Speciality outfits help funders diversify profiles

Hedge funds aren’t just for the majors anymore.

While the first round of big fund players — Dune, Virtual, Legendary, Gun Hill — focused on studio slates and would-be blockbusters, investors have a new target in the entertainment business, with potentially lower risks and higher returns: specialized film.

The recent collapse of the subprime mortgage sector may shut down such deals in the future, but a number of firmly established pacts remain unshaken.

Oceana Media’s Myles Nestel, who recently saw a $100 million infusion from private equity juggernaut American Capital Strategies, admits that “it’s now going to be difficult to raise capital from Wall Street, but my investors want to create a diversified portfolio to keep from having one market from blowing up and screwing themselves.”

And with independent films receiving significant B.O. and notoriety, they’ve become an increasingly viable place to funnel money.

“Most of our high net-worth investors have invested in films before,” says Charles Gradante, co-founder of SandDollar Capital, a private equity firm that structures financing for hedge funds. “They all shake their heads and say, ‘We don’t want to be involved; we took that bath before.’ But they invested in blockbusters. When I talk to them about this approach” — investing in lower-budget films — “they understand it,” he says.

As opposed to a studio-scale model — where, Gradante claims, “the chances are one in 10 of returning a profit, so you need to have a profile of 10 $100-million movies in order for that basket of films to return 30%” — the lower-end “ratio of successful to unprofitable (films) is a lot better. And that is what our investors are interested in.”

Mark Gill, co-founder of the Film Department, one of several new indie outfits to benefit from a range of fund and equity investments, says instead of the high-risk/high-reward model of the studios, his shingle promised investors the traditional indie strategy: “to reduce risk by selling off international rights and then having the upside of selling North America.”

Groundswell CEO Michael London, who closed a $205 million financing deal with global investment firm TPG-Axon Capital, says investors also appreciate the greater ownership they have with non-Hollywood pacts. “We afford them a little more control than simply depositing their money with a studio, where the studio gets to do with that money what they see fit,” London says.

“Because our budgets are lower, they own more of individual movies,” he continues. “So instead of owning 5% or 10% of 15 movies coming out of a studio, they own 50%-100% of individual pictures.”

“It’s a very different risk profile,” says Hal Sadoff, head of ICM’s international and independent film division and a former VP in the banking sector. “When you’re dealing with studios, the timing of revenue is pretty far out, because the money is coming from lots of different sources. On the independent side, you mitigate risk from foreign sales and you get out revenue within an 18-month period.”

Former media execs Aaron Kaufman, Ron Hartenbaum and Douglas Kuber launched Barbarian Films, a $50 million fund aimed at financing low-budget films, with specifically that model in mind.

“If you have a budget of less than $10 million, you can mitigate risk with a large portion of your budget coming from foreign markets,” Kaufman says. “We’re not in the (B.O.) performance business. Ultimately, you’re making your money by selling your films to distributors around the world.”

Kaufman also cites increased revenue streams via broadband (VOD), which make independent films a more attractive investment.

SandDollar’s Gradanate, who is backing Barbarian, says: “We think this is a very good way to provide diversification to individuals and hedge-fund managers, because there’s an increased market for the licensing and end use of these films; broadband is getting broader.”

Of course, indies have their inherent risks, too. Kaufman admits their plan is dependent on the health of foreign markets. And while several deals necessitate U.S. distribution in place, there are always equity-backed indies that place their bets on a big film festival.

“If you don’t have (domestic) distribution, it’s more risky,” admits Original Media’s Charlie Corwin, a producer who is working with Barbarian. “On the other hand, your package is your hedge. If you have a certain level of attachable elements, you can pretty much say with relative certainty that you’re not only going to have distribution, but the right distributor. The other way you hedge your bets is that you make the movie for the right price.”

Film Department’s Neil Sacker agrees. “If you’re doing studio-quality, star-driven films in the $10 (million) to $35 (million) budget range — and keeping your films on budget,” the economics make sense, Sacker says.

Even so, the infusion of coin — even in the indie sector — may already be reaching a breaking point. As Sacker admits, “If a lot of money is coming in any industry, it will saturate, and the weaker companies will fall out, and the stronger companies will survive.”

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