As a new financiers to the movie industry, Hedge Funds are  attracted by the potential returns on diverse portfolios of movies especially from DVD sales. Given, Hollywood has a bad reputation for parting star-struck investors from their cash hedge fund managers will need to stay sharp and structure their investments carefully. Helen Avery reports.
Film finance was often a high-risk/high-return investment proposition with a reputation for burning investors. Now, though, hedge fund managers are finding ways to mitigate risk and penetrate opaque film industry accounting practices

Frank Yablans is the Warren Buffett of Hollywood. Former president of Paramount Pictures and former chairman of MGM, the 71-year-old has more than 300 films, including blockbusters such as The Godfather, Serpico, Paper Moon and Murder on the Orient Express. Back in the early 1970s when Paramount made the original version of The Longest Yard, Yablans remembers, third-party financing came from tax-shelter deals. Now Yablans is running his own film production and distribution company, Promenade Pictures. With investment advisory firm Bluebay Capital, Promenade is seeking finance from the most recent investor base to hit Tinseltown – hedge funds.This sophisticated investor base has invested an estimated $4 billion into Hollywood in the past three years in investment vehicles that, like Yablans’s operation, and are attempting to create a high-returning asset class with speculative investment in the film industry.

In the past it has been a commonplace expectation that if you put money into Hollywood, you might not get it back, let alone a return on it. With an endless supply of investors keen for a brief spell in the sexy film industry, Hollywood can perhaps be forgiven for taking advantage of the naïve and star-struck. Returns were almost secondary
to them That’s not so for hedge fund managers. The possibility of making an annual 30% on investments (in the case of equity slate financing) is not the only appeal. Film financing offers uncorrelated returns. During economic downturns, people still go the cinema or rent movie DVDs. To mitigate and spread the risk and achieve high returns – is slate financing. Merrill Lynch, Credit Suisse, Deutsche Bank, Goldman Sachs and JPMorgan have all arranged co-financing deals with studios investing in slates of films, raising money from hedge funds and private equity firms among other investors. Hedge funds themselves, such as Dune Capital and Stark Investments, have also created
co-financing vehicles (Dune Entertainment, and Virtual Studios).

Spreading the risk
The importance of diversification is very important. Backed by hedge funds/private equity companies including ABRY Partners, Columbia Capital, and Falcon Investment Advisers, Legendary Pictures has invested $500 million in a slate of 25 Warner Brothers movies. The first two off the slate – Batman Begins and Superman Returns – have
proved successful; subsequent films – Lady in the Water and The Ant Bully – have been disappointing.

That’s true enough, but hedge fund managers are still finding ways to deal with Hollywood studios’ strategies for cutting deals to their own advantage. Stark’s films are with star cast, The Assassination of Jesse James by the Coward Robert Ford, starring Brad Pitt; 300, with Gerard Butler; Blood Diamond, with Leonardo DiCaprio; and The Good
German, with George Clooney and Cate Blanchett, though, investors have yet to see any returns.

Production costs also rise as films stars get millions for acting. But investors should not be focused on the big budget blockbusters to make money. Sometimes Smaller-budget movies with greater audience appeal can offer good rates of return.

Intrepid Pictures similarly has a financing vehicle investing in lower-budget films, (under $25 million) aimed at 15- to 25-year-olds. The seven-bank syndication of the deal was arranged by JPMorgan, with hedge funds and other investors providing equity or mezzanine financing.

Independent film production companies can offer investors phenomenal returns on low-budget films. For example, The Blair Witch Project and Napoleon Dynamite were produced by independent companies, and in the
low-budget genre of documentaries, independents have also had success. The Oscar-winning March of the Penguins had out-grossed all five best picture nominees at the time of the 2006 Academy Awards. However, investors should exercise caution in the lower-budget area, says Yablans. Yablans’s vast experience in the business mitigates risk for investors in his production company, but he advises managers wanting to invest in films with independent makers to do their due diligence. “People may boast that they appeared in film credits, but they might not have had much to do with the film,” he says.

 The quest for transparency
The due diligence that the hedge fund managers are conducting in Hollywood is helpful for complete transparency. Death by a thousand cuts Mead Welles, president and CEO of hedge fund Octagon Asset Management, invests in film financing across various parts of the risk spectrum
but is also wary of slate deals because of the lack of transparency and advises to be prudent. One executive with a co-financing vehicle on Wall Street laments: m“Studios are just not transparent. It’s hard to see fine details but we try to control operations.
Recognizing this risk in co-financing Hollywood, Yablans and Bluebay have structured their fund to ensure investors complete transparency with a hedge fund-like structure and, therefore, the returns they are rightly due. De Lazlo says: “We’ve brought in Goldman Sachs to handle cash management, we have other service providers to track and handle all operations to ensure transparency and expected returns. The transparency is in interest of both Hollywood and hedge fund investors.

Beyond the box office

Ultimately whether Hollywood can continue to rely on its new financing partner will depend on the performance of the new slate financing deals. DVD sales indeed can make very good profits.

It is argued that film quality has suffered as studios now have a vested interest in getting films out of the theatre and onto DVD as quickly as possible. Owning the copyright to the picture is therefore essential for any investors in film to make constant return.

Source- http://www.outofobscurity.com/downloads/Euromoney-Hedge_funds_and_film_finance-Oct06.pdf