Film finance market poised for a rebound?

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The mood at the American Film Market Finance Conference on Nov. 6 in Santa Monica, Calif., was surprisingly bullish, with panelists in agreement that the financial meltdown was good for the survivors, and some even projecting that the market for prints and advertising and slate funds might eventually come back.

In the "Current State of the Independent Film Business" discussion, panelists agreed that the myriad tax rebates being offered in different states had been a godsend.

Ryan Kavanaugh, founder and CEO of Relativity Media, said in general he still expects to get about 75% of a budget funded via a combination of international presales and tax rebates, with a range of 65% to 100%. Morgan Rector, entertainment group president at Comerica Bank, said, "60% to 70% is kind of where you top out at, which isn't bad because you've still got upside on domestic." And he said there are nice tailwinds for independent producers because of the strong dollar, tax advantages and fewer players.

The big difference between now and pre-credit-crunch days is that the remainder needs to be financed by equity, not debt. Not all panelists believed this was a bad thing, as films are now being financed in a much more rational way. "The movie industry is odd in that the people who've taken the most financial risk made the least amount of money," said Edward Borgerding, CEO of Abu Dhabi Media Co. That trend will change.

Rector said the studios expected someone else to take all of the risk while they take all of the profits. "I'm curious to see where the studios go over the next two to three years," he said, given that all of the easy money was gone.

"Bad times clear out the suckers," said Modi Wiczyk, co-CEO of Media Rights Capital. "It's been good for us, as we haven't had as many competitors."

"The business had gotten overheated on the finance side," said Rector. "We had our own subprime bubble in the film finance market. This has been a much needed clear out in the market. We really haven't changed what we do in film finance. Historically we have done an appraisal and done an 80% loan-to-value, while others around us had been doing 105% loan-to-values." Similar to the housing market situation, when values dipped to less than the loan-to-value, lenders were in trouble and underwriting standards changed.

"The indie film model lives on debt," said Kavanaugh. "Today very few lenders are left. Because of that, discount rates have been very steep, and deals have required much more equity." However, he said this is weeding out the weaker projects and bringing down talent costs, because studios are less willing to offer gross profit participation, making some films less risky.

"We're going to go back to a more profitable model," said Kavanaugh. "The bidding wars on A-list product were out of control. Deals were getting done that should never have gotten done. Hopefully this leads to pictures that should be getting made at the right price."

Roy Salter, principal at The Salter Group, said senior financing cannot be put together, but there is still demand for junior debt. "There were 45 banks lending to the movie industry, now you've got 12," he said. "You have billions of dollars coming due — who's going to refinance it? That may slow down the market even more."

Kavanaugh agreed, saying that historically, senior debt had been priced at 5% to 7% and junior at 10% to 20%, leaving no return for equity investors. "Targets are no longer 10% to 20%, they are 30%, 40%, 50%," he said. "Debt-structured vehicles aren't the way to finance movies, they should be equity financed."

Despite some doom and gloom on the financing front, Rector said lenders had recently been looking at movie deals. "I wouldn't be surprised if by next year there are a dozen more banks looking at these deals. There will be slate financing deals coming to market," he said.

Salter projected a wave of consolidation among indie film libraries in the next month, and said buyers would be getting good prices. Kavanaugh agreed. "We've done significant analysis on what cycles 2 through 10 can be worth, and it's a lot," he said.

Asked by moderator John Burke, partner at Akin Gump Strauss Hauer & Feld LLP, if the weak home video market was a cause for concern, Kavanaugh said he was not worried, as lost sales would be replaced with digital media revenues.

"Our business has always grown by cannibalization and by turmoil," he said. "The home video business decline forces us as a company and an industry to see where that next revenue stream will come from. There is now a rush to find the next revenue stream."

Salter said electronic delivery is complex. "DVD is doing fine," he said. "There is no indication that electronic delivery will do anything other than replacing home entertainment or TV viewing." He said if there is any threat, the risk will be that distribution of foreign content could cannibalize viewing of U.S. content because of all the international programming made available via the Internet.

Looking at the next source of financing, there was no general consensus. Kavanaugh said players could enter the market from China, but Wiczyk was skeptical, saying companies such as CCTV and Shanghai Media had been coming to Hollywood for years.

Borgerding agreed. "I worked in Hong Kong for five years, and I never saw any dumb money there," he said. "There may be some looky-loos and window shoppers, and I guess that is smart."

Economics of TV & Film is a regular feature from SNL Kagan, offering exclusive research and commentary.