Private Equity Firms Step Into Hollywood Spotlight

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Is now the right time to be investing in Hollywood?


Despite a recent 19-week slump in movie ticket sales and a rapidly maturing DVD market, a consortium of private equity firms is sticking to a plan to invest more than $500 million in a five-year, 25-film partnership with Warner Bros., a unit of Time Warner Inc.


The co-financing deal has been put together over the past year by Thomas Tull, a former venture capitalist and dot-com executive from Atlanta who managed to convince several large funds that the economic returns of the $50 billion movie industry remain compelling.


The consortium expects a 25 percent return on its investment fairly standard in the private equity world with part of it coming from films produced by a new production company called Legendary Pictures, a unit of Legend Pictures LLC. The group also is counting on returns from up to five films a year that will be produced by Warner Bros.


Outside investors looking to invest in Hollywood is a story as old as the movie business itself. Over the years, money has poured in from Japan, Germany and Britain, as well as from U.S. billionaires like Philip F. Anschutz and Jeff Skoll, the co-founder of eBay Inc. There have been a few success stories but lots of train wrecks for reasons ranging from Hollywood’s exotic accounting ways to simply betting on the wrong star at the wrong time.


The latest slant has involved private equity funds that are flush with cash and looking for higher returns than are available on Wall Street. Over the past year, much of the action has involved outright acquisitions of property, such as Warner Music Group, Concord Records and DreamWorks Music Publishing.


Investing in a production company that relies on a slate of new films and lacks the cushion of a library or other ancillary revenue has been a costly trap for non-Hollywood types looking to invest in the movies.


But Tull, a former president and director of Convex Group that owns Internet content provider HowStuffWorks, insists that this deal is different.


“We went out with a full plan and vision of what returns would be, along with the deal with Warner Bros.,” he said. “We clearly did an enormous amount of work in terms of forecasting, and we told the studio that this has to be attractive to private equity.”


When Tull started raising funds, he emphasized to investors that the growth of DVD sales and the expansion of the overseas box office had “smoothed out” film profits, making the business more stable and predictable.


“At this level, private equity investors start to get interested when they can see returns going north of 18 percent to 20 percent, and there’s a reasonable likelihood of controlling the downside,” he said.


Profit margins for most of the major studios had soared in the past few years because DVD sales had grown much faster than originally anticipated. But DVD sales have slowed and the summer box office is down from a year ago.


Those associated with the Legendary venture are trying to put the spate of bad news in perspective. “You can’t assume that one bad year is the beginning of a long-term trend,” said John Hunt, a partner at ABRY Partners, the first private equity firm to jump into the Legendary investment.


Besides ABRY, a $1.7 billion private equity fund in Boston, the partners include AIG Direct Investments, a unit of AIG Private Equity of Zurich; Banc of America Capital Investors, which is based in Charlotte, N.C. and manages $2 billion for Bank of America, Columbia Capital, a $1.4 billion fund in Alexandria, Va.; Falcon Investment Advisors LLC, a Needham, Mass. private equity firm; and M/C Venture Partners, a Boston firm that specializes in media and communications.


Legend Pictures received $63.2 million in funding in the second quarter from ABRY, Bank of America and M/C Venture Partners.


Hunt said he spent two years shopping around for a film opportunity before hooking up with Tull. “The studios have changed some of the terms and ground rules of what they’re willing to do and not do,” he said, noting that in the past, the deals that were cut weren’t “reasonable and economically fair” to outside investors.


Tull, who is relocating to Los Angeles from Atlanta and will become chairman and chief executive of Legendary Pictures, first got a taste of Hollywood when he put together a deal in 1996 that created Red Storm Entertainment, now a unit of Ubisoft Entertainment SA, which established a partnership with best-selling author Tom Clancy to make games based on his books.


Tull has lined up a management team that includes Chris Lee, former head of production at TriStar Pictures and Columbia Pictures, and William Fay, a producer of “Independence Day” and “Godzilla.” Larry Clark, a former chief financial officer at Creative Artists Agency, will oversee finances.


Scott Mednick, Legendary’s chief marketing officer, who has worked on 170 films, including “Jerry Maguire,” “Coal Miner’s Daughter” and “This is Spinal Tap,” said investors have calculated their returns based on a variety of factors. “We designed a deal that was very rational, and a large part of what we do is related to the DVD market, so we’re awash in data,” he said.


Yet analysts are only starting to calculate what the slowdown in DVD sales means for the Hollywood studios owned by News Corp., Time Warner Inc., Viacom Inc. and Walt Disney Co. whose stocks are all in a slump.


Last month, Dreamworks Animation SKG surprised Wall Street last month when it announced that it will post a second-quarter loss and lower earnings because of lower-than-expected DVD sales of “Shrek 2.” The same thing happened to Pixar Animation Studios, which lowered its earnings estimates based on lackluster DVD sales of “The Incredibles.”

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