Media/Entertainment Deal of the Year
"Private Equity Comes To the Big Screen"
LegendaryPictures, which co-produced the high-grossing film "Batman Begins"and is currently assembling "Superman Returns," was launchedfollowing an innovative $475 million capitalization plan that was quicklymimicked. Structured much differently than the typical Hollywood studio, itfirst struck a 50/50 production and distribution partnership with WarnerBrothers Pictures, a unit of Time Warner, putting itself in position to lure anew source of capital into the industry, private equity. The scheme worked,despite plenty of doubters, and inspired several other cash-rich investors todip their toes into the dicey world of film finance.
"Wespecifically built a movie studio, but essentially we built one attractive toprivate equity, and that's never been done before," says Thomas Tull, CEOof Legendary Pictures and a former president of the Convex Group, a mediainvestment firm. "We heard from every person you could imagine, 'You'llnever get this done.'"
Followingthe Legendary deal, an investor group led by CSFB reportedly negotiated a stakein Disney Pictures, and then the Weinstein brothers took their quest forstart-up capital for their new film company to institutional investors.
ThePerseus Group, a privately held boutique investment firm headquartered in SanFrancisco, advised Legendary, helping it raise $225 million of equity andmezzanine commitments by the time its first round of financing closed in June.ABRY Partners, AIG Direct Investments, Banc of America Capital Investors,Columbia Capital, Falcon Investment Advisors and M/C Venture Partners allparticipated.
Aside fromABRY, which led the $87.5 million mezzanine round of financing, executed in theform of senior subordinated notes with a six-year maturity, all of theinvestors were new to the motion pictures industry, sources involved in thedeal say.
M/CVentures and Banc of America Capital led Legendary's equity round, worth $137.5million, and Legendary's management contributed a minority investment, the sizeof which was not disclosed.
In itssecond round of financing, Legendary locked down a $250 million senior creditfacility from JPMorgan. The revolver had been in the works prior to the Junerelease of "Batman Begins," the studio's debut film, and circling theprivate equity funding was key to obtaining the loan.
Filmfinance has always been considered extremely perilous, and it has struggled toattract smart money such as private equity funds. Legendary, however, was ableto convince these savvy investors that risks in the sector have become"much more diversified than five or seven years ago," when a film'ssuccess depended overwhelmingly on how it fared at the US box office, saysClark Callander, a managing director at Perseus Group. Now, film revenuestreams also include pay-per-view and DVD sales, along with ancillary itemssuch as T-shirts and lunchboxes. Rising international box office sales are alsoaugmenting domestic receipts. "The international box office adds somestability to the business that didn't exist 10 years ago," says JohnWatkins, a general partner at M/C Ventures.
When formingLegendary, the founders' first step was not to create a box office hit but tofund an ambitious business plan that includes co-producing 25 films over fiveyears with Warner Brothers. Legendary secured the Warner Brothers partnershipin late 2004, then it had to cope with one of Hollywood's worst kept secrets - whilefew wealthy individuals invest in Hollywood productions, let alone entireslates of films, the number of institutional investors has been essentiallyzero. But film production has changed a great deal over the past 10 years to"become an asset class that is now worthy of private equity backingit," says Tull.
Given theconstantly shifting nature of distribution channels, more investors arebecoming interested in owning content. "We believe that owning proprietarycontent is a good place to be," says Watkins, noting that M/C Ventures wasactively looking for content investments when Perseus walked in with theLegendary Pictures deal. "Distribution networks are going to be disintermediated,to some extent, so in a digital world, owning proprietary content isking."
Usingsophisticated Monte Carlo simulations, Legendary was able to demonstrate thatits model for financing film productions could achieve profitable outcomes on aconsistent basis. Expected returns of upwards of 20%, based on the modeling,were cited by sources close to the deal.
Sourcesfrom the private equity arena say the initial capitalization involved aninvestment in the management team, one rife with successful members from bothHollywood and the realm of investment management. Tull's management teamincludes President Chris Lee, a former head of productions for TriStarPictures, CFO Larry Clark, former CFO of Creative Artists Agency and a formerdirector at the Carlyle Group, and Chief Marketing Officer Scott Mednick, withmarketing experience on more than 170 films. Legendary's President of PhysicalProduction, William Fay, was behind such high-grossing films as "ThePatriot," "Godzilla" and "Independence Day."
"We have private equity and the movie business in our DNA," says Tull.
Investorsin the deal say the chance to partner with Warner Brothers through Legendarywas key. The co-production deal for as many as 25 films is quite unique - Legendaryhas a say in all aspects from casting and directing to marketing. And thepartnership was chosen over a strategy of purchasing a library of characters.The focus for its films will be action, adventure, horror or science fiction;no dramas or "message pictures" are anticipated.
Thesetypes of films "are franchises that throw off enormous amounts ofmoney," says Tull. "When you take all the slickness and Hollywoodaspects out of it, what you really have is a consumer product."
Traditionally,packages that involved a "slate" of films were not nearly astransparent, one of the largest hurdles to attracting institutional investors.
Aside fromhaving Warner Brothers as a partner, investors say it also adds to theirpotential exit opportunities. They note that their options include sellingtheir equity stakes to Warner Brothers after five years, or perhaps to otherprivate equity firms. Several sources also hint at the prospects of a LegendaryIPO at some point. "There are a number of ways to attain liquidity.Selling to Warner Brothers is one of them, as is an IPO," says oneinvestor in the deal, who did wish to be identified.
Legendaryplans to reinvest all of the profits from its films, enabling it to finance itsgoal of 25 films and build a portfolio of content. So if all goes as planned,the prospects for an IPO remain widely tantalizing. "We're very excitedabout the ability to build up a mini major," says Tull. Pulling off a dealwith private equity "was an unbelievable feeling of pride and we're going workvery hard to make sure it all works out."
(c) 2006Investment Dealers' Digest Magazine and SourceMedia, Inc. All Rights Reserved.