Wall Street eyes indie sector funding

The sudden windfall stands to transform the way business is done.

By Stephen Galloway Jan 24, 2007

The independent film world descends on Park City for the annual industry ritual that is the Sundance Film Festival, running today-Jan. 28, they'll have a major new subject of conversation: a hefty infusion of cash from Wall Street. Two to three years after East Coast-based hedge funds, private equity funds and banks began investing billions of dollars in studio slate deals, these established financial institutions are turning to the indies. And most insiders predict that what has thus far been a mere trickle of funds is likely to turn into a tsunami this year. "There's a lot more coming soon," entertainment attorney Schuyler Moore of Stroock & Stroock & Lavan says. "It's going to be a tidal wave. Hedge funds and private equity funds are open to investing in alternatives to the studios and are willing to accept higher returns for higher risk." Already, Wall Street has made significant investments in a number of companies -- from the Weinstein Co. and First Look Studios to Regent Entertainment, as well as Radar Pictures, the independent company led by Ted Field that last year closed a deal to co-finance 25 pictures budgeted in the $20 million range with private equity partners. Many of these deals (with the exceptions of the Weinsteins' and Radar's) have been relatively modest. Most have been in the millions of dollars or at best the tens of millions -- and that makes them a financial footnote compared to the slate deals worth several hundred million that Wall Street-backed companies such as Legendary Pictures and Relativity Media have entered into with individual studios. Now, high-profile independent producers, executives and entertainment attorneys who specialize in such financial matters say they expect 2007 to mark the year in which Wall Street goes indie. If that happens, the independent business will most likely undergo yet another major transformation, much as it did in the early part of this decade, when "high-net worth" individuals such as Jeff Skoll, James D. Stern and Bob Yari came calling with cash in hand.

Among the most prominent new deals in the works are two involving established Hollywood figures Mark Gill and Michael London. Gill, until recently president of Warner Independent Pictures and before that a longtime executive with Miramax, is in talks to raise some $200 million for his new company, the Film Department, to finance about six movies per year in the $10 million-$35 million budget range. Gill declined to be specific about his financial partners but said he expected a deal would close within the next two months. Similarly, London -- producer of successful specialty fare like 2004's "Sideways" -- is working with Goldman Sachs to raise tens of millions of dollars in production coin, and Robert Friedman, the former vice chairman of Paramount Pictures, is putting together financing for a major new production, marketing and distribution entity. Friedman has been working with Merrill Lynch to raise close to $1 billion for what is effectively a new studio. At the same time, attorneys such as Moore and John Burke of Akin Gump Strauss Hauer & Feld Llp., a leader in the independent finance field, along with agents like WMA's Philip Alberstat, say they are working on a handful of other such deals that would bring many hundreds of millions more into the indie realm. What's intriguing is why Wall Street now has decided to look to the independent arena. Insiders offer several reasons for the change of heart. Chiefly, there's a limit to the number of deals that East Coast money can do with the studios, even though Wall Street generally prefers to work with the Hollywood majors because they have established a financial business paradigm -- known as the Monte Carlo model. Under that model, investors can spread risk over an entire slate of films rather than gamble on one or two productions that might hit big at the boxoffice but could just as easily flop. "There are only so many studios you can do your deal with," Burke says. "And Wall Street, by participating in studio slate transactions, has gained a much deeper understanding of the way the film business overall operates. They have been introduced to the independent world through this educational process and are exploring it as a possible opportunity to deploy more capital." Of course, Wall Street's Hollywood experiment has yielded mixed results so far. Legendary failed to reap sizable returns on its investment in Warner Bros. Pictures' 2006 summer release "Poseidon," though insiders at the company say they made a $50 million profit on that studio's other major summer movie, "Superman Returns." "A lot of people on Wall Street have learned a great deal about studio financing in the last three years," Gill says. "The next thing for them to learn about is the companion piece to that, which is independent film."

Investors are encouraged by the robust state of the indie world right now, both domestically and around the globe. "Independent film is a very healthy business, and the business models look pretty good," says one veteran indie producer in talks with Wall Street. "And (because of that), there is now a swing back to the independent film space, and a lot of investors are curious about investing in independent production companies." Independent films have several advantages over studio films. For one thing, they do not involve the high overhead of many studio pictures and the multimillion-dollar development fees their producers expect. For another, indie projects can deliver financial returns more quickly because investors don't have to worry about a studio deducting a 15%-20% distribution fee before paying out profits. "The cost of making and distributing studio movies is higher than it has ever been, while the cost of making quality independent films has not increased as rapidly," the indie producer says. "And the home video value of independent movies remains relatively high. A studio movie might cost 10 times as much as an independent movie, but that does not mean its home video value is 10 times as great. If you look at the (revenue of a successful specialty film) in relation to cost, it is probably better." Producers such as London and Gill have a vested interest in touting the advantages of the independent scene, but there are potential negatives as far as Wall Street is concerned. For one thing, the indies have difficulty putting together entire slates of films, and the projects that they do tend to be less commercial -- not exactly guaranteed moneymakers as far as investors are concerned. "In my experience with venture capital money, the way that funds usually work is on slates," says Howard Cohen, co-president of the independent distribution company Roadside Attractions and formerly a UTA agent representing independents. "They want to spread the risk over more than one film. And I always get nervous when people talk about slates because unless you've got a bunch of great scripts, how do you talk about slates? Studios can do that because they are spending an enormous amount of money to develop screenplays, but not too many entities can afford to develop slates." For another, the structuring of independent deals is enormously complicated. Even though attorneys who worked on the studio slate deals say those agreements are far more complex than most observers believe, they pale in comparison with indie pacts. "With a studio deal," one insider says, "you can throw that into a computer and get all sorts of scenarios that give investors comfort, but with independent films, there are all sorts of issues: What if you don't sell (distribution rights in) Germany? What happens if you don't have a North American sale? There are a million 'ifs' in all this." Most important among those "ifs" is the problem of securing domestic distribution. All studios can promise a substantial domestic release, and that is one of the factors that makes the Monte Carlo

model so attractive. Independents generally offer no such security blanket -- though the chances of getting domestic distribution could increase if Friedman's company becomes a reality.

MGM, too, has become an outlet for independently financed films, distributing product for the Weinstein Co. and others. Still, "The Monte Carlo model is based on having a master distribution agreement, which is missing from the independent deals," Alberstat explains. "It's hard to have that same sense of security with independent deals." Few insiders believe the existing distribution companies suddenly will decide to release more films, meaning that unless new distributors spring up, these Wall Street-funded independent films run the risk of never making it to the theatrical marketplace. "There is going to be dumb money, which will allow certain people to make films that shouldn't be made or do deals that don't make economic sense with investors," cautions attorney/producer John Sloss of Cinetic Media. "When there is too much money for production, the people who have the scarce resources will have the upper hand -- and that is the distributors who have the slots." Even if the independents must face the uncertainty of finding domestic distribution for their product, they have a safety net in the form of foreign presales, according to Burke. "If you have a large enough portfolio, then theoretically, the studio model produces better economics," he says. "The selling point of the independent model is, 'We are going to cover our downside risk by preselling international for 60%-80% of the budget; so, the equity risk we are going to take is only going to be 20% or 30%, which means you are gambling with fewer dollars.' And Wall Street is paying attention to this model." If the model succeeds, it could have ramifications for the film industry as a whole. On the independent side, a business that for so many years has had to scramble for cash might soon have more than it needs. Companies that have formed solid reputations will be able to develop slates that rival those of the studio specialty divisions, making them much more serious players than they traditionally have been. The studios could benefit from empowered indies, too: By having access to a supply of the sort of high-quality motion pictures that they increasingly wish to distribute rather than produce, the Hollywood majors could remain more safely in the business of releasing quality material, charging a healthy distribution fee and enjoying the potential of profit-sharing without the upfront risk. "Eventually, the studios are just going to be in the distribution business and get out of the development business," Alberstat says. "It is just about efficiencies: It is more efficient and less risky for them to co-finance things." First, though, Wall Street has to feel comfortable doing business with the independents. "Once investors have gotten comfortable with it, if things go reasonably well, then there will be others," Gill says. "The money is out there -- it is just a matter of getting investors to feel comfortable."