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How Failed Studio Talks Left Rhythm & Hues Adrift

South Korean bidder for vfx firm behind 'Life of Pi' is out, claiming lack of studio support

What may simply seem like a buyer walking away from a deal to salvage struggling Rhythm & Hues Studios is turning out to be a lot more complex.

Just a few days ago, JS Communications could hardly have been more sanguine about the prospect of acquiring the vfx outfit. Managing partner David Shim was spending his days at its headquarters in El Segundo, Calif., poring over the books and trying to hammer out a plan. He was impressed with its work on Oscar-winning “Life of Pi” and felt it was a jewel Hollywood should be nurturing.

But JS left itself an escape hatch: Its bid was non-binding, which is almost unheard of in bankruptcy proceedings. JS used that escape hatch Tuesday night, missing the deadline to lock in its stalking-horse bid.

In an interview Wednesday with Variety, Shim said he approached Universal Pictures and 20th Century Fox to seek “some sort of an order in the working relationship” with Rhythm & Hues. “I think it’s a problem inherent in this industry, and the type of cooperation I was seeking wasn’t working out,” he said.

Fox and Universal declined comment.

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Both studios had passed on the opportunity to acquire R&H outright before bankruptcy, and neither was interested in partnering to acquire R&H. But what happened next is unclear.

Shim says he asked Universal and Fox to agree to make “best efforts” to send a total of $60 million of work to R&H over the next three years, while R&H would be repaying their loans. During busy years, Fox and U sent far more than $60 million a year in work to R&H, but last year that figure fell off to just $18 million.

Essentially, he said, the studios wanted “just patch it up, like it was a bad accident,” and return to the same business relationship they had with R&H before the bankruptcy.

But a source familiar with the negotiations said Shim asked for a binding assurance for a figure higher than $60 million,  something the studios can’t do because they can’t project their slates with assurance that far in advance.

Shim denies he asked for a binding contract.

Whatever the exact request, U and Fox  refused to make such a commitment. At that point, Shim says, he declined to go forward.

“It’s unfortunate that it didn’t work out,” said R&H principal Lee Berger. “But there are many other interested, and interesting investors and we looking forward to a positive outcome to what has been a difficult situation.”

The behind-the-scenes machinations around R&H have been intense, in part because it can’t stay in bankruptcy very long and remain a going concern. So the process has been accelerated. Activity is also intense because R&H is viewed by potential investors as a company with fantastic skills and people but poor management.

See also: Rhythm & Hues Bidder: “I Won’t Liquidate” (Exclusive)

Among management errors: Becoming too dependent on movie vfx, a notoriously low-margin business even in the best of times, and just two studio clients, Universal and Fox.

The new owner, whoever it is, will have to repay debtor-in-possession loans from those two studios over the next three years, but even so, R&H will probably find a suitor.

Eleven potential bidders are doing due diligence. Animation and design studio Psyop, which inquired before bankruptcy, is interested, but lacks deep pockets and is seeking financing.

Prime Focus, which had a deal on the table to acquire R&H before bankruptcy but couldn’t assemble the financing, is working on a bid. It got a small equity investment from AIP Partners, a Hong Kong private equity group, and is seeking more cash.

Prana Studios, which is doing the animation for Disney’s “Planes,” is also interested. Prana is an American company with an Indian subsidiary. Three Chinese companies are also considered serious bidders.

It is likely that some bidders will seek informal assurances from the majors similar to those JS wanted, especially if they already have relationships there.

The majors aren’t blind to what’s happening in the visual effects business. The vfx industry has evolved to a state that favors the majors: big, desperate and pliant. There’s vast capacity worldwide, which drives down prices and makes it possible to postpone creative decisions until weeks before a picture is due. Vfx companies frequently deliver work for less than their cost; essentially, they’re donating to the pic’s budget.

They have opened facilities in areas with favorable tax policies, absorbing the costs themselves while passing the benefits along to the producers and studios they work for. The vfx companies have no negotiating leverage and dare not even insist on payment for changes and postponements that’s already in their contracts.

But this state is unsustainable, and the vfx execs at the majors know it. They also know that it’s not to their advantage for the vfx industry to implode, because then the last men standing might get real market power. And if Peter Debruge’s review of “Olympus Has Fallen” is any indication, they majors are about to learn that once you’ve shown auds what good vfx look like, cut-rate vfx are as laughable as bad acting.

As for David Shim and JS Communications, they’re not done with Hollywood. JS is connected to CJ Entertainment, one of Korea’s biggest conglomerates, and to Samsung. Shim and his group were among the original investors in DreamWorks SKG. They’re experienced, they have a great deal of money, they want to invest, but they don’t want to be passive partners. They want to create and own their own intellectual property. If they skip the R&H opportunity, they’re likely to find another one.

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