Wall Street's death spiral has claimed its biggest victim so far with the collapse of investment bank Bear Stearns. Like so many other financial institutions engulfed in the mortgage meltdown, Bear Stearns was also a film financer; as is its new owner, JP Morgan Chase. Now the question is, when will Hollywood's massive slate deals be sucked into the same titanic credit crunch'
The dreaded answer is: sooner than you think. Already, hedge funds have all but retreated from the movie business. A notable exception is Elliot Associates, whose pockets are behind Universal's recent co-financing slate deal brokered by Relativity Media. So many others, from Stark Investments to DB Zwirn, a hedge fund that invested in Legendary Pictures and arranged finance for David Bergstein's acquisition of both Capitol Films and Image Entertainment, are no longer actively in the game.
Meanwhile, the banks that largely fuelled this $12bn binge by underwriting film slate deal syndications have themselves been trying to lay off their film portfolios at steep discounts - assuming they can even find a buyer who hasn't been burnt already. According to financier Ben Waisbren, banks have been saddled with half a dozen "hung" deals - and that was in a speech he gave a full month ago (see In Focus, page 6), before liquidity woes really kicked in.
Having jumped with both feet into Hollywood, using those Monte Carlo simulations to analyse risk as their dubious justifications, financial institutions are now licking their wounds. To speak out publicly would be to admit to failings of due diligence and lapses in judgment even in the face of warning signs. There are objective indicators that the market for film deals was cooling even as far back as the summer of 2006; those trying to read the current climate are waiting to see whether Elliot and Relativity are able to bring in another finance house to take on the senior debt in the Universal deal.
For his part, Waisbren questions whether the performance of existing slate deals can even support the capital structures engineered by slate deal promoters and Wall Street. Film is generally considered a high single-digit asset class - meaning its overall cash-on-cash returns are in the area of 8% or 9%. Will there, in fact, be any value left for equity investors in slate deals after the fees charged by dealers and promoters/middlemen, the cost of production and p&a, talent participations, a 12.5% distribution fee, and the interest charged on senior debt and 18% mezzanine debt'
The quick response is "no", particularly given the suddenly increased cost of senior debt borrowing. The bottom line, as Waisbren argued in Berlin, is that something - or better, somebody - will have to give here, and that "somebody" will be the studios.
Certainly, the studios have a vested interest in being more accommodating to their Wall Street benefactors. Their precarious profitability depends on them. The average cost of producing a studio film rose 8% last year, to $70.6m; the cost of producing specialty films spiked even more, rising 60% to $49.2m. But even Mpaa chief Dan Glickman acknowledges that such eye-popping numbers understate the true costs since they ignore any co-financing. Without those hedge funds at their side, major studio films would be routinely budgeted at more than $100m apiece, even before marketing costs.
Wall Street also needs to clean up its act. Bonuses are paid to bankers doing deals and collecting fees, and hedge funds charge performance fees on marked positions. Then, when the bubble bursts, the decision-makers keep their bonuses and collect rich severance packages, and the shareholders and investors foot the bill and are left with the losses on the deals for which the bonuses are paid. Keep this charade up and there is a real danger that film as an asset class will have been poisoned for everyone.
Imagine what would happen if Wall Street and Hollywood were to now lose each other's hard-earned confidence. The studios' only real alternative are those Asian and Middle Eastern sovereign funds whose balance sheets are even less transparent than their own.
Colin Brown, editor-in-chief.