Steve’s proposal was sitting on my desk in my office at 110 Wall Street for weeks, and the more I read it, the less I liked it. I said to myself: This doesn’t make any business sense!
How is somebody going to invest in an ‘asset’ that doesn’t even exist yet, without a risk profile and expected returns via an analytical framework? Where is the value here? How do you price this? The more I read Steve’s proposal, the more frustrated I became.
But I kept reading, basically because I truly liked Steve. He was (is) such a great guy, very down-to-earth. In the week after the meeting with Steve, we met other producers (in Hollywood, the word that Wall Street guys are looking for exposure to movies spreads fast). Then, we started to hear things like “This will be the greatest film because Brad Pitt’s going to star… you guys just have to meet him”, or “This movie is the next Blair Witch Project”, and many variations of that. I was getting tired of the “You need to meet my producer, he did Unfaithful with Diane Lane” or “He’s the producer who did the first Rocky, and he’s a great guy”. (I actually did meet those two at the Four Seasons in LA. We became fast friends, and they put me on their guest lists at several Hollywood hot spots, and enjoyed some of those premieres at the Grauman’s Chinese Theater and afterparties at the Roosevelt Hotel.)
Coming back to Steve, there was something about him – there was none of the typical Hollywood hype. He understood us right away when we said that if he wanted to raise money from professional investors, he needed to make an investment case, not just an artistic case. We told him we would analyze the structure of the industry and get back to him with a possible strategy. But we didn’t know where to start.
You know what filmmakers do? They find films that they think are similar to their own projects, and of course, pick the ones with the best numbers to show investors the box-office potential of their movies.
Then Ralf sent me an article we saw in Forbes magazine about a guy in Hollywood who was valuing movies and raising capital using Monte Carlo simulations. There it was!!! Finally, a term I could relate to!
After reading the article, I had a lot of questions. What was this “pre-sale” stuff they talk about? Who did the distribution of the movies? How were independent films financed vis-a-vis Hollywood movies? How do you get top actors? Who pays them? How much? What about residuals? I needed clarification.
Then, one night I was going over the term “pre-sales”, and I think I got it. Could “pre-sales” be analogous to stock-options? Specifically, some sort of binary options? Could it be that international pre-sales are just that? So, I kept researching the subject, and found an interesting chart that showed the sources of financing of Angelina Jolie’s “Lara Croft”.
The movie had a production cost of $94.1MM, and foreign buyers “bought” the rights to the movies for those territories, at the prices shown. I am sure that people who have worked in securitization and/or insurance “tranching” will find the graph familiar. It looks remarkably similar to, for example, the tranching of a CDO, where the riskier parts of the the deal are retained by the the CDO manager, and the less risky are (or were), rated and sold to pension funds, insurance companies, etc. The difference is that in the Hollywood case, it was apparently the other way around: the “riskier” parts were the ones sold to foreign investors and the “safer” ones were retained by Hollywood. As you can see, Paramount only “paid” $7 million (7.4%) for an asset whose cost was $94.1 million. Let me ask you this question: If somebody offers you a $2 million apartment on the Upper West Side of Manhattan, and you only have to pay about $150,000 (btw, if you don’t have the $150,000, you could borrow it at 0% interest rate…) and when it is yours you could flip it for its real value, would you do it? You could sell it, rent it, use it as a collateral at its full value to finance another apartment, and many other things in between.
However, did they (Hollywood) really know the “fair value” of the piece sold to the UK buyer? Did they know the value of the Japanese “rights”? Well, as I will explain later, there is no pricing model in Hollywood, and all is driven by the capital constraints of the studios at the moment. If they have money because their corporate parent (Sony or Paramount, for example) allocated capital for production, they might retain all the rights (although this is not necessarily optimal). If they don’t have enough money to produce everything they want to produce, they might start selling rights territory by territory until they raise a target amount (although this is not necessarily optimal), and even borrow to advertise (also, not necessarily optimal), in order to get their movies out.
Could an analytical framework be developed to find out the fair value of each international right by territory? What about the fair value of each type of media (theater vs DVD vs cable vs internet, etc.)? Is there room for Wall Street pricing techniques applied to creative assets? Could there be a way to value and optimize all aspects of a movie, from production to distribution to advertisement? What about arbitrage? Could a movie be “created” at zero cost? What about accounting principles? If in theory, capital for a movie can be raised from selling rights before it is made, and the proceeds from rights is greater than the cost of the movie, where is that “paper profit” booked? Who gets it? The producer? The distributor? The advertiser? The actors? Some Hollywood executive in the form of an “advisory fee”? Could a well-capitalized hedge fund, private equity fund, and/or investment bank set up an operation to optimally finance, produce, advertise and distribute movies? I discussed all those questions with Portfolio Managers and hedge funds and investment banks very involved in asset backed securities (Film Finance) at that time: Elliott Management Associates working with Relativity Media, Goldman Sachs, setting up structured to finance the Weinstein Brothers, and Lehman Brothers, trying to set up their own Film Financing unit in cooperation with Cantor Fitzgerald.
To be continued…