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Banking on the vaults

Demand for digital deals has banks eyeing the value of film libraries

A few years ago, banks wouldn’t dream of lending against the libraries of indie film companies. Some are still skeptical, but others are starting to appreciate the long-term value of older content thanks to the digital distribution deals inked during the past two years with rising platforms such as Netflix and Hulu.

“Digital media is starting to make independent distribution of films a more viable business for a greater number of participants,” said Stephen Prough, partner at Salem Partners.

At this point Miramax is only a library, with no firm plans as yet to return to production. Since investors purchased the company for $663 million a year ago, it has closed $332 million in new agreements, half of which have been digital licensing pacts. According to its initial offering agreement for its recently closed securitization, Miramax is expecting more than $400 million in cash flow from new digital deals over the next decade – a larger number than its estimates for traditional home entertainment.

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“Less than a year since acquisition and with only 50 people on staff, there’s $350 million of investment grade (debt) available for the library,” Colony Capital principal and Miramax chairman Richard Nanula told Variety.

Miramax’s vast library of about 700 titles gives it a leg up in doing volume business with content-hun gry digital upstarts. But even smaller players are cautiously optimistic that digital pacts and projected values will become key parts of their business models.

Many bankers concede that the sit uation is definitely different than it was two years ago. One of the biggest challenges in valuing library content now lies in reconciling the promise of digital with the decline in packaged media.

Skeptical observers caution that Miramax’s valuation of its projected digital revenues may be too optimistic, and while many lenders take Miramax’s securitization as a positive sign that financiers’ attitudes are changing, others wonder if its size and scope outrun the pace of that change.

“Do I think there will be digital business in a territory where there’s no digital business today? Of course,” said attorney Josh Grode, of Liner Grode, who was Miramax’s lead attorney on its securitization. “Every place in the world is going to have a digital business. That presents a great opportunity for financing the future revenue streams coming off of the new forms of content consumption – that is what this financing represents.”

Miramax recently sold off $500 million in debt, including investment-grade debt, to financiers in a deal driven in large part by the kinds of digital agreements the indie has locked down in less than a year, as well as those it expects to ink over the next 10 years. On the traditional pay TV front, it still has a deal with Showtime and recently cut a deal with the pay cabler to license about 165 older titles.

Exclusive Media, which has agreements with companies including Netflix and Hulu to help exploit its 600-plus title library, is hoping to close a new credit facility in January. Those deals, as well as future ones, will count toward the company’s borrowing base.

And digital contracts have become a significant element in the financial plan for other companies over the past two years. The ground-breaking movie licensing pact that Netflix inked in 2010 with Epix – the joint venture of Viacom, Lionsgate and MGM – was assessed as a significant value-driver for the three companies, with a value estimated at $900 million over its five-year term.

This year, Media Rights Capital put together a $350 million credit facility, at least a small part of which was aided by the company’s deal with Netflix for series “House of Cards.”

For potential investors and lenders, the trick is accurately predicting future digital revenue for a specific deal or library title. Analysts caution that digital exploitation is still in its nascent stages, and the industry is relying on a handful of outlets – Netflix, Hulu, Amazon, iTunes, Facebook, etc. – to push new deals and initiatives forward.

It’s also tough to measure how new revenue streams may cannibal ize traditional ones; some new delivery systems are less a new source of value than a replacement source. Banks, for example, may not feel as comfortable lending against potential homevid value as they might have five years ago. But they are more confident in digital value.

“Banks are still being pretty cautious,” said Christa Thomas, managing director and senior film adviser at SunTrust’s private wealth management sports and entertainment specialty group. Thomas notes, however, that more lenders have entered the entertainment space in the past year, including players like OneWest Bank, East West Bank and First Republic Bank.

The relatively low cost of distributing via digital compared to the cost of physical discs is helping inspire smaller labels to embrace the space. As digital becomes increasingly important, content owners have realized the importance of safeguarding older product.

Erik Pence of Inception Digital Services – which has digitized content for indies including Millennium Films – says that for about $2,000, IDS can create a digital master suitable to a number of platforms. “We help them create a master for the digital distribution era,” Pence says.

That cost, however, could be prohibitive for smaller companies that would have no choice but to partner on a traditional homevid deal but may be thinking of going it alone with digital licensing.

All of this still hasn’t made up for the decline of traditional home entertainment revenue – not even close. That drop has made investors wary, as it turned future DVD revenue – once Hollywood’s cash cow – into an unknown quantity more difficult to borrow against.

Investors have seen what inflated DVD numbers can do to the bottom line. Some analysts say that outdated homevideo data was used in many of the slate financing deals assembled from 2006 to 2008, leading to overblown expectations.

And there’s the rub: Predicting digital revenue is the white whale of the entertainment biz at the moment. The good news, for now, is that at least some of the industry’s underwriters are starting to bank on its long-term potential.

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