Some Wall Street investors say they’re savvier

Learning from early slate deals

In some spheres, the mere mention of the studio-slate deals elicits responses such as “disaster” and “complete wipeout” around Hollywood.

But what’s the reality?

The apocalyptic outcries refer to the performance of the private equity investments in studio film slates. One of the Warner Bros. deals, Virtual, has been the object of most of the vitriol. And there’s the other Warner deal, Legendary, the Sony/Universal funds Gun Hill I and Gun Hill II, and Disney’s Kingdom, among several others.

Some of the films involved in these slates may have underperformed, but what’s the long-term prognosis?

There are certain investors who know they’ll lose their shirts, but many of these slates have yet to run their course. And there are likely to be varying degrees — good and bad — of repayment in the Wall Street plays around town. Of course, the riskiest tranche is the equity, followed by the middle mezzanine slice and the supposedly low-risk senior debt (banks).

“It takes some time to find out what’s happened to the films and if the equity is gone and where the mezzanine is,” says Stephen Prough, managing director of financial consultancy Salem Partners, “but it hasn’t reached any kind of level of crisis or even that much concern. That’s because the funds have diversified across many different investments, and if they lose a few million here and there it doesn’t make that much of a difference.”

Still, even the fund arrangers will admit that some of the deals haven’t delivered the returns they expected.

When you ask Ryan Kavanaugh, whose company Relativity Media helped facilitate the Virtual deal for hedge fund Stark, whether Virtual was a “disaster,” he’ll give you a yes-and-no answer. The Virtual films may have performed poorly until “300” was released, but the action epic’s boffo results have mopped up a lot of the blood.

Kavanaugh also underlines that he considers Virtual to be in a different category from the slate deals in that it only concerns six or seven films (including poor performers such as “Poseidon” and “The Good German”). “They bet in venture-capital style on a few films. The definition of a slate is a big diversity of films over time,” he says.

“Nancy Drew,” also among Virtual’s Warner bets, has yet to open and could be a good earner.

But in the grand scheme of things, the Warner investment may not matter too much to Virtual. The deal accounts for less than 10% of their business. (Virtual also owns big pieces of foreign sales companies/producers Exception Wild Bunch and IEG.) Plus, Warner has reportedly gone back and adjusted the deal to make it more palatable for Virtual.

Many of the newer deals are much more debt heavy, such as the recently closed $1 billion Summit Entertainment deal that purportedly includes just 10% equity. Where the general mix used to be 25% equity, 50% mezzanine and 25% senior debt, now people are seeing that 25% of the entire capital structure is mezzanine and equity, and the rest is debt.

“There are more financiers chasing fewer deals,” says Imperial Capital Bank’s David Hutkin; his was one of several banks to take a piece of the senior debt in the Summit deal.

“Equity is thin on the ground,” confirms Salem’s Prough.

One of the slate funds that everyone agrees has done well is Dune at Fox. Still, there’s a bit of discrepancy in opinions on how well most of the other funds are doing. Of course, it depends on whom on you ask.

Some in the financial community question the health of Gun Hill I. Yet Kavanaugh, who owns a piece of the deal, says it is “doing well,” adding that neither the first nor the second Gun Hill slates have finished releasing films theatrically.

Gun Hill I includes moneymakers “Ghost Rider” and “The Pursuit of Happyness” as well as disappointments “Monster House” and “All the King’s Men.” Yet to hit theaters is Peter Berg’s “The Kingdom.”

Notes one observer, “Until the initial video release gets reported, there is still so much fuzziness in the numbers — if you want to pretend everything’s OK, you can.”

As with every wave of financing, there are questions about when the other shoe will drop and the money gets chased out of town. If the hedge funds and other sources behind this latest wave of equity start seeing consistently lower returns on their investments, they could opt to go elsewhere.

Kavanaugh, who says his company is now putting up a lot of the equity itself, says the influx will continue but it will require win-win deals.

“This is a long-term business worth billions of dollars, and we need to make good deals to keep it,” he says. “(Studios) might be able to charge high distribution fees and exclude certain films, but that’s short-term thinking. This is not a German tax market that’s here for a year and then gone. This is Wall Street.”

Kavanaugh says he’s adjusted his deal structures, based on what he’s learned from his first deals. His new Beverly Blvd. venture with Sony (and two more studios yet to be announced) is a five-year, 45-film-minimum deal.