The Wall Street funds that have poured more than $10 billion into Hollywood film-slate financing during the past two years are now bracing for a day of reckoning, or so goes the conventional wisdom in this town. But is there cause for apprehension?
Daily Variety got a look at the numbers from Gun Hill I, the first of the latest wave of Wall Street-backed funds to invest in a slate of studio films on a significant scale. Fund was launched in December 2005 by Relativity Media chief Ryan Kavanaugh, a leading matchmaker between showbiz and big spenders.
With the opening of Universal’s “The Kingdom” — the 17th and final title covered under the $600 million Gun Hill I fund — the conclusion is that its investors will make $150 million in profit in the short term, or a roughly 13% internal rate of return on their investment, and an additional $25 million profit over the next three to five years, bringing the internal rate of return to nearly 18%.
According to Kavanaugh, 32, it’s not a smashing success, but it’s hardly a failure.
“These deals, including Gun Hill, generally aim for a 15%-25% internal rate of return in the first two years, and we came close,” Kavanaugh said last week during an interview in his Beverly Hills office.
Under the deal, Gun Hill became a 50% investor in a slate of 17 Sony and Universal films. The pact originally called for 18 films, but a David O. Russell-helmed project never made it into production for U.
Among the conclusions gleaned from the Gun Hill I books:
- Seven films lost money for the fund: Sony’s “Gridiron Gang,” “Fun With Dick and Jane,” “Stranger Than Fiction,” “The Holiday,” “Catch and Release” and “All the King’s Men” and Universal’s “Doom.”
- Ten films will make a profit: Sony’s “RV,” “Monster House,” “Ghost Rider,” “Talladega Nights: The Ballad of Ricky Bobby” and “The Pursuit of Happyness” and Universal’s “Smokin’ Aces,” “The Kingdom,” “Nanny McPhee,” “The Fast and the Furious: Tokyo Drift” and “Inside Man.”
- “All the King’s Men” was the biggest loser for the fund, leaving a dent of more than $28 million.
- “Pursuit of Happyness” provided the biggest boon, adding nearly $52 million in net profits.
- For the 17 pics as a group, investors averaged a profit of $7.6 million per title. In a sign of how eager studios are to making these slate deals palatable to investors, it’s understood Sony rebated tens of millions of dollars to the Gun Hill investors for expenditures on the films that were deemed too high. Sony declined comment for this article, but sources within the studio confirmed the Gun Hill rebate.
Gun Hill I was structured in a unique way that forced equity investors — the riskiest of the three classes of investors because they are the last to be repaid — to invest at the mezzanine risk level also. Every dollar of equity funding had to be matched by $3 of mezzanine funding, or mid-level risk, which earns a more-than-20% return per year and is paid back more quickly than the return for equity players.
Two hedge funds that asked not to be named account for nearly 70% of the mezzanine and equity investors. A representative who spoke on behalf of both hedge funds said: “The investment is profitable. It isn’t a home run, but we’ll get our money back and earn a return.”
The hedge funds rep speculated that much of the negative ink stems from a fundamental misunderstanding of the structure of these deals and how to value them.
“The problem is that they look at what is made from the theatrical revenues and assume that’s it,” he added. “This type of thinking is akin to someone buying a building, looking at the rents they received after a year and saying, ‘Oh, we lost money on the building.'”
In fact, the first cycle of film profits takes five to seven years to be realized and includes theatrical, homevid, pay-per-view, pay TV and network TV revenues. So far, the Gun Hill I titles have generated $410 million in cash flow for the fund, mostly from B.O. receipts and some TV licensing.
In the case of Gun Hill I, investors will receive their coin sooner rather than later thanks to a bank loan that was secured based on studio projections of the total revenue from the films in their first cycle plus an additional loan for the estimated value of the library, of which Gun Hill is a 50% owner. Gun Hill’s share has been estimated at $124 million. The first loan, which was committed by Deutsche Bank, is expected to fund next month and will provide some $234 million to investors.
Universal brass said they are pleased with the studio’s participation in the Gun Hill experiment.
“I’m very happy,” Universal Pictures chairman Marc Shmuger said. “All I know is we had six pictures in the deal. Four or five — depending on how ‘The Kingdom’ turns out — were on the positive. When you get funding to support a slate, you hope you end up with a positive result. And we did. We didn’t bat a thousand, but we did bat pretty damn well. And (the investors) have been great partners. I would do it again.”
The creation of Gun Hill I two years ago ushered in an era that has seen Hollywood’s major players — including 20th Century Fox, Warner Bros., Paramount and Disney — pact with Wall Streeters for nontraditional sources of film financing through such high-profile fund vehicles as Legendary Pictures, Virtual, Dune and Kingdom. Producer Michael London earlier this year struck a $205 million financing pact with investment firm TPG-Axon Capital.
Kavanaugh has been in the thick of a number of megabucks financing pacts, including Virtual’s pact with Warner Bros. That deal looked like a disaster when the studio endured such high-profile flops as “Poseidon” and “The Good German,” but not such a bad bet when “300” (in which Legendary was also an investor) became a sleeper hit.
Not surprisingly, Kavanaugh has his share of critics, most of whom have requested anonymity when speaking to the press.
“Ryan came in and took two of five studios off the market,” a high-level studio source familiar with the Gun Hill deal said. “At the end of the day, a lot of people are resentful.”
Shmuger added, “I don’t know who (the Gun Hill critics) are or where they come from, but they run counter to everything I know about the deal we made.”
Kavanaugh, described by those who know him as a high-finance savant, started a venture capital company when he was 21 that raised hundreds of millions of dollars but then endured a number of lawsuits. His detractors are quick to note his past legal woes involving other people’s money.
“I am so sick of people using my past venture capital days to attack me,” Kavanaugh said. “I went through 2001, the worst market in history, and things for some of the companies went bad. I got sued a few times, and I never lost. I had hundreds of investors; most are still close friends of mine today. The irony is that sitting here today, four out of five companies I invested in and helped build have made money for investors or will make money for investors.”
Indeed, Kavanaugh said it was contacts he made in his venture capital days with senior execs at U and Sony that helped grease the wheels for the path-breaking Gun Hill I deal. Universal and Sony are already in the thick of a second run with Kavanaugh and Wall Street investors.
Gun Hill II was set up to co-finance 18 films from the two studios, four of which have already bowed, including a hit in “I Now Pronounce You Chuck and Larry” and a miss in “Evan Almighty.” Kavanaugh also has designed a third slate financing deal dubbed Beverly — his most ambitious yet with a commitment amount of $1 billion — that already has Sony aboard. Kavanaugh is in negotiations to secure a second studio participant. He’s also becoming active as a producer and exec producer himself, with plans for a slate of eight pics, including the recently released “3:10 to Yuma.”
The rep of the hedge funds involved with Gun Hill I think the anti-Kavanaugh sentiment found in showbiz circles is fueled by competitive factors.
“You have guys out there saying slate deals don’t work to scare other guys away from working with the studios directly. They’re basically defending their turf,” he said.