Arriving early to this year’s Academy Awards ceremony, Ryan Kavanaugh’s guest nearly went unnoticed.
Both men were on the front end of the crowd that swarmed the red carpet outside of the Dolby Theater, and the Relativity Media founder had plenty of time to pose for photographers. He ensured that his guest for the night — an investor named Hugo Shong (pictured with Kavanaugh below) — was included in the shots.
(From the pages of the April 9 issue of Variety.)
A founding general partner at IDG Capital Partners and an investor in Relativity, Shong is a critical figure in Relativity’s kingdom. The SkyLand Entertainment distribution partnership that Relativity runs with IDG and others affords Relativity broader access to the Chinese market, and Relativity is banking on the country’s booming B.O. to add to its pic profits.
Ushering Shong down the red carpet into Hollywood’s glitziest awards fete exemplified the showmanship Kavanaugh has demonstrated in building Relativity into a player in film and TV during the past half-dozen years.
But the redheaded wiz kid who made a splashy entry into Hollywood by funneling billions of Wall Street money into studio slate deals is now dealing with the growing pains of a business that has expanded rapidly in a short period.
Relativity has taken on a significant amount of debt and brought in new equity investors as it has expanded its scope into film distribution, China, television and the sports representation business.
Although the company is privately held, the workings of Kavanaugh’s operations have been exposed to more lenders and potential investors than in its early days when his primary backer was hedge fund Elliott Associates. Today, Ron Burkle’s Yucaipa Co. is believed to be the largest investor in Relativity. He sits on a board that includes Kavanaugh, former WMA chief Jim Wiatt and two reps from investment fund Colbeck Capital.
Kavanaugh himself has been a magnet for media attention for years thanks to his rags-to-riches rise to mogul-dom and high-flying lifestyle (he’s proud of piloting his own helicopter). He’s been called a modern-day Louis B. Mayer, if only the fabled MGM boss spoke the language of complicated financial instruments and film ultimates.
All of that exposure has spurred chatter, inside and outside of Relativity, that the company is overextended, that it is facing a big debt bill in five- to seven-year’s time. Staffers say the company, which has about 225 employees, pays some of its bills late.
Some employees also report that bonuses were not paid in the first quarter; however, a company source insists Relativity has always doled out bonus coin in the second quarter, and intends to do so this year.
Outsiders who have looked at Relativity materials in connection with debt and financing proposals say the numbers don’t add up over the long term for Kavanaugh’s strategy of banking on “singles and doubles” at the B.O.
Variety spoke with more than 30 industry insiders for this story — including top executives, finance mavens and agents who do biz with Relativity — none of whom were willing to go on record with their skepticism.
And multiple sources close to the company strongly deny that it is experiencing financial strains. Relativity declined comment for this story other than this statement:
“Most highly successful companies use debt financing as part of their growth strategy. The major financial institutions we’re in business with know that we are ahead of schedule in terms of meeting our obligations. While Variety’s story reflects a lack of understanding about our business and fl awed thinking about corporate finance, we look forward to their other predictions for what will happen in 2018.”
In a statement, Burkle also emphasized his confidence in the company.
“We are very pleased with Relativity’s growth, and the company is ahead of plan,” he said. “We look forward to being Relativity’s partner for many years to come.”
The Evolution of Relativity: Ryan Kavanaugh and Co. have been making headlines in Hollywood for nearly a decade:
THE MASTER PLAN
For Relativity, the core business is defined as mostly genre pics budgeted in the $20 million-$50 million range that can predictably do about $25 million-$60 million in domestic box offce, and then generate more through downstream windows (homevid, VOD, digital outlets and TV) and ancillary markets.
The company’s risk is mitigated by output deals with foreign distribs that in most cases cover the budgets, and then some, for Relativity releases. Relativity plans to release 11 films this year (so far it has skedded seven), up from five in 2012 and seven in 2011 — a big leap for a company that only got into the self-distribution biz in 2010 after acquiring Overture Films from Liberty Media’s Starz Entertainment.
For sure, many in Hollywood are hoping Relativity continues to grow. The company is poised to greenlight more movies than some of the majors this year. Kavanaugh has said his goal is to get to about 15 releases a year.
Moreover, the RelativityReal TV production division, headed by producer Tom Forman, has more than two dozen unscripted shows on the air. It’s a low-margin biz for sure, but the company is making strides in holding on to format and international rights, where the real money is made.
It’s understood that Kavanaugh and investors are strongly considering taking the company public within the next two years — assuming the pic slate performs well and Relativity’s model of limiting its risk on production budgets keeps it from suffering any big B.O. bombs. It also generates distribution fees for handling third-party releases, and it has been active in seeking brand integration deals that stretch across its movies, TV shows and sports clients.
While Relativity’s core film business has been buoyed by pics including this year’s romantic drama “Safe Haven” and 2011 actioner “Immortals,” it doesn’t have a blockbuster under its belt. In the past three years, the company has released four films that have made more than $70 million at the domestic box office: “Safe Haven,” “Act of Valor,” “Immortals” and “Limitless.” Skeptics — some who know the company well, and some who don’t — argue that Relativity’s movies don’t appear to make enough to sustain its current levels of activity.
Relativity’s trajectory has often been compared with that of Lionsgate. One big difference between them is that so far, Relativity doesn’t have a significant cash-generating movie library to offset the naturalvolatility of the film business, although it did acquire the Rogue Pictures vault from Universal in 2009.
Additionally, Relativity has raised hundreds of millions of dollars in debt over the past two years, some of it coming through expensive alternative funding sources and structures. Industry sources said its most recent transaction — a $115 million revolving line of credit set with OneWest Bank and Barclays Capital that aims to expand to $300 million — is targeted to paying down debt and strategic acquisitions such as film libraries.
Relativity also borrowed $350 million last year, most of which came in the form of pay in kind, or “PIK” loans, according to multiple sources with direct knowledge of the deals. It’s understood that $125 million of mezzanine capital came with an approximate 15% interest rate. PIK loans typically defer interest payments until the end of the term, but at a substantial cost. Ideally, they free up cash that companies can use for growth, but because structures can be so much more expensive, they’re often an option when the borrower can’t pay interest at regular intervals.
“You take pay in kind loans because they give you greater financial flexibility, and you take them on when you need to conserve cash,” said David Bank, an analyst with RBC Capital Markets. “They generally don’t come when a company is in a position of financial strength.”
Relativity could have to pay at least $100 million in interest on its PIK loans, knowledgeable individuals told Variety, unless it is able to refinance that debt on better terms. Industry sources said Relativity recently tested the waters in banking circles for a refinancing deal — which spurred much discussion in the industry about the company. Although there were re-fi offers on the table, the company ultimately decided not to do such a deal, for now.
Among the largest holders of Relativity’s high-interest mezzanine-level debt are Burkle and Kavanaugh, and it’s understood that those pacts allow for the option of converting that debt to equity in the company.
Sources close to the company emphasized that Relativity’s board has no concern about the company being able to service its debt, especially with its growing pic slate. And in addition to mulling the IPO plan, sources said another sizable entity is poised to make an equity investment in the company.
Relativity’s expansion has already attracted a substantial amount of investment. It received a $150 million influx from a clutch of investors at the end of last year, and has equity financing from Burkle. It has other ways to pay for things like P&A, including credit lines with Macquarie Capital and the new One-West/Barclays credit line, although those structures are much more safeguarded. The Barclays deal is a typical line of credit backed by receivables and conservative estimates for what Relativity’s movies will earn — estimates generated weeks after a film is released and based on box office performance.
A FAST START
By now, Kavanaugh’s story is well known in the biz: A charismatic young man became a star in two worlds when he played matchmaker between Hollywood and Wall Street, but then fell from grace when some of his investors began losing money.
Between 2005 and 2008, Relativity arranged more than $2.5 billion in financing deals with Warner Bros., Sony and Universal in exchange for hefty producing fees. According to a lawsuit filed by one investor, Aramid Entertainment Fund, Kavanaugh received $1 million dollars and 2% of the gross for films under an arrangement at Sony. According to court documents, Relativity sold its stake in Sony’s slate for at least $14.5 million in 2011. The good parts of this story get trumpeted in interviews, and there have been many: Features have appeared in Esquire, Vanity Fair, Forbes, Variety and other publications over the past few years, many of which tout the company’s meteoric rise and its Monte Carlo simulation strategy for choosing films.
“You can’t think of it as money,” Kavanaugh told Esquire in 2009. “You have to think of it as math.”
But the math on the slate deals didn’t always work. At the same time Relativity was expanding, investors in the Sony and Universal deals were losing money — in part because some of the films underperformed and because of the decline in the homevid market. Lawsuits against Relativity from partners including Citigroup (Relativity also sued Citigroup over interest-rate terms; both suits were eventually settled) and Aramid Entertainment followed, and debtholders like Deutsche Bank struggled to sell off their positions entirely.
The juxtaposition of success and failure has made the 38-year-old Kavanaugh a polarizing figure. And Hollywood has become fixated on Relativity Media’s performance. Sources close to Kavanaugh said he chalks it up to envy over Relativity’s fast rise.
Relativity has long boasted that its movies are nearly riskfree because of its 20 international output partners, who cover almost all (and in some cases a little more) of a film’s budget. (Indie outfits typically cover only about 60% of budgets through such arrangements.) Because of these upfront payments, Relativity typically doesn’t see much of the foreign box office from its pics unless there are significant overages.
This risk-reduction model is one of Kavanaugh’s biggest selling points. A film like “Movie 43” — which grossed a meager $9 million after it opened in January — could still wind up making a few bucks.
Relativity is hoping the inroads it has made in China will grow its international B.O. revenue. The company has released three films so far in China through SkyLand and aims to grow that number to seven or eight per year.
Like all producers, Relativity aggressively seeks out tax incentives and soft money to help mitigate the risk on its films. Its first movie under its partnership with SkyLand, the raunchy comedy “21 and Over,” took advantage of local incentives by shooting the film in China, leading to two different versions of the pic: A raunchy comedy about college life for the U.S. market, and a cautious tale of the dangers of hedonistic Western society for Sino auds.
Its other major division, Relativity Sports, started in 2010, thanks to Relativity co-chief operating officer Happy Walters’ past experience as a sports agent. In a deal last year with Burkle’s Yucaipa Co., the division rolled up three percenteries: Relativity’s existing Rogue Sports basketball agency, SFX Baseball, and football agency Maximum Sports Management. The wing’s big-name clients include New York Knicks star Amar’e Stoudemire, Los Angeles Lakers center Dwight Howard, Detroit Tigers pitcher Justin Verlander and Arizona Cardinals wide receiver Larry Fitzgerald.
Some of Relativity Sports’ clients, including NFL Network analyst Deion Sanders, have lucrative media deals, and part of the sports wing’s strategy is to integrate its athletes into other aspects of Relativity’s businesses.
Those close to the sports agency describe it as profitable, although not as big a revenue-generator as Relativity’s film or television divisions. Still, Relativity sees upside in having access to sports stars who can help promote their movies and TV skeins to target auds, notably young men and teens.
AT A CROSSROADS
Kavanaugh and others at Relativity are clearly touchy about the scrutiny of the company and its management structure. The New Yorker reportedly received a letter threatening legal action for its October profile of Burkle that detailed his business dealings with Kavanaugh.
When contacted about the New Yorker flap, Relativity attorney Carol Genis said the company was “taking legal action,” and offered to help answer questions relating to Relativity’s revenue streams and corporate structure.
“It’s not often that I have the chance to help a writer avoid stepping into a lawsuit,” she wrote in a March 29 text message to Variety.
There is no doubt that Kavanaugh has built an impressive business — defying detractors from his slate-financing days as well as the collapse of investments made through his Kavanaugh Consulting Inc. venture capital firm in 2001. He has often made mention of having been broke in 2002 before his fortunes took off in Hollywood.
In March, the CEO joined Forbes’ annual billionaires list for the first time, ranking No. 1,342 on the magazine’s list of 1,426 people worth $1 billion or more. Kavanaugh is pictured relaxed and smiling above a description of his “singles and doubles” strategy.
Is there a word for the phenomenon in which what you perceive depends on your frame of reference? Albert Einstein called it “relativity.”