Film Finance - The Main Challenge

The Main Challenge

It is difficult to predict with any accuracy the revenue that any one film will generate. The main factors determining the commercial success of a film include public taste, artistic merit, competition from other films released at the same time, the quality of the script, the quality of the cast, the quality of the director and other parties, etc. Even if a film looks like it will be a commercial success "on paper", there is still no accurate method of determining the levels of revenue the film will generate. In the past, risk mitigation was based on pre-sales, box office projections and ownership of negative rights. Along with strong ancillary markets in DVD, CATV, and other electronic media (like streaming video on demand -SVOD), investors were shown that picture subsidies (tax incentives and credits), and pre-sales (discountable-contract finance), from foreign distributor's, would equalize potential losses. Financiers are now seeking a higher degree of certainty as to whether they will actually have their investment repaid, and if it is repaid, what return they will earn. Some interesting developments have occurred since 2012, as many past film slate's poor performance records are showing up in public court documents.

Property and casualty companies (P&C) like AIG had once offered insurance against film slates and the bonds issued to fund them, but now fully refuse to cover film slates any further. This ended in many lawsuits, starting in early 1999 (with Steve Stabler's Destination Films $100M bond fund failure and subsequent lawsuit), and continue to this day with Aramid's lawsuit on Relativity's Beverly-1-Sony film slate and the Melrose-2-Paramount slate. It is also well known that Citigroup attempted to wrap the Beverly-1-Sony slate with a property and casualty insurance wrapper (from the now bankrupt Ambac Assurance, Corp.). After these "uninsured" slate financing arrangements (SFA) failed to return even the original principal to investors, the market has sought solutions. An alternative to such loss was patented in 2007 by Geneva Media Holdings, LLC (originally as risk mitigation for affluent individuals and "direct investors" under USA tax incentive IRC 181). Business patents for Geneva Media Holdings, LLC now use CAIC (Cash Accumulation Insurance Contracts), which do not suffer from lack of liquidity like property casualty policies previously offered by AIG or Ambac Assurance, Corp. Insured media funds are now being carefully reviewed by risk analysts at major hedge funds, banks and institutional pension plans specializing in investor risk mitigation. However, CAIC as a form of mitigation has been presumed to be based wholly on tax credits, government incentives, pre-selling of the distribution rights to different international markets and so forth, but Geneva Media contends this is not the case. As stated, performance or loan guarantee policies are no longer available. Therefore, only the contractually guaranteed risk mitigation contracts like those using CAIC might one day provide liquid, cash reserves for investors when studio film slates underperform.

Many outside of Hollywood fail to realize the longevity of film and television after-market income streams. Many commercial films and network television shows will make money for decades. For the investor who pays for part of the negative costs, the time value of money is important. For many movie investors the required rate of return for this "risky" investment may be 25% or more. This means that while there may be TV revenues for an additional 10 years after the movie is released, the PV (present value) of those revenues is diminished by the required rate of return and the time it takes for these revenues to accrue. Ancillary revenues (VOD, DVD, Blu-ray, PPV, CATV, etc.), tend to accrue to the studio that purchased these residuals as part of their overall distribution deal. For many movie investors in the past, the theatrical box office was the primary place to gain a PV return on their investment.

Ryan Kavanaugh of Relativity Media also offers participation in profits to actors, rather than up-front fees, to lower production costs and keep profits protected. Kavanaugh has used data from major studios like Sony and NBC/Universal to build a complex Monte Carlo system to determine movie failure rates prior to production. The box office results of his movies have been mixed, as t here is no set ratio for projecting movie revenues or investor risk.

Epagogix has developed a system using neural networks to assess factors that contribute to box office success. They assess a wide variety of movies of different box office returns. Steve Jasmine uses factor analysis of billion dollar grossing movies to develop a set of factors required for box office success. This system quantifies the creative elements of billion dollar grossing movies to determine what audiences are most interested in. This system has found around 1,300 common creative factors in the 19 billion dollar movies studied. It predicted the $2B+ box office revenues of Avatar and, based on movie trailers alone, predicted the box office performance (or lack of performance) of many recent $150m+ budget movies. This factor analysis approach differs from Epagogix and Relativity, who study movies of differing revenue levels, rather than Steve Jasmine, who focuses only on billion dollar grossing movies.

A final consideration is securing title. Since the collateral for film financing arrangements can be based on the ownership of intellectual property rights, film finance transactions generally commence with a title analysis.