Aug. 7 (Bloomberg) -- The crowd of 80,000 revelers went wild as a lifelike hologram of rapper Tupac Shakur took the stage at the 2012 Coachella Music Festival. Six months later, the Florida visual-effects firm that resurrected the deceased musician in the California desert would itself be dead.
Its debt -- $37 million owed by taxpayers -- lives on.
While Digital Domain Media Group filed for bankruptcy protection nine months after moving into a state-of-the-art studio in Port St. Lucie, Florida, local taxpayers are on the hook for the building’s bonds through 2031. The $3.5 million payment due this year amounts to about 4 percent of Port St. Lucie’s operating budget, more than the city spends on police cars.
“We’re done with this type of economic-development program,” said Ed Fry Jr., treasurer of the city of 170,000 about 100 miles (161 kilometers) north of Miami. “It’s been a traumatic experience.”
Florida filed a lawsuit last month alleging fraud by the company, and the city council called a meeting last week to consider selling the now-empty studio for as little as $8.5 million.
Taxpayers from Rhode Island to Michigan have been stuck paying off bonds used to attract startups that later went bust. The ordeal in Port St. Lucie underscores the risks governments take in providing financing for private companies.
The city tapped its general fund to make last year’s debt-service payment for the defunct studio, diverting money that could have been used for police or streetlights. With another payment due Sept. 1, the city has been trying to convince bondholders to approve a refinancing plan that would ease pressure on the budget.
As of the end of June, investors owning 28 percent of the bonds had agreed to the plan, according to a July 18 city memo. That’s less than the 51 percent threshold required for changing borrowing terms.
Studio bonds maturing in September 2031 traded Aug. 5 as high as 102 cents on the dollar, compared with about 97 cents when the tax-exempt municipal debt was issued in April 2010, data compiled by Bloomberg show.
The securities traded most recently at an average yield of about 4.7 percent, or 3.1 percentage points above benchmark debt. Standard & Poor’s grades them A, its sixth-highest level.
“The bonds are trading still pretty strong, not at anywhere close to what you would consider a distressed level,” said Michael Schroeder, chief investment officer at Naples, Florida-based Wasmer, Schroeder & Co., which manages about $3.5 billion in munis. “The market is still believing that the city is on the hook.”
Moody’s Investors Service said in February that the payments could force difficult budgeting decisions, a sentiment echoed by city leaders.
“Debt-service payments on the Series 2010 Bonds are coming too fast, and too soon,” Fry wrote in an April 21 letter to investors.
It wasn’t supposed to turn out this way.
Politicians in Port St. Lucie voted unanimously in 2009 to build a 115,000-square-foot facility for Digital Domain, after the company received a $20 million grant from Florida on the promise of creating 500 jobs.
The city sold $40 million in bonds in 2010, as local officials hailed the movie studio as a salve for a recession-battered economy built on tourism and construction. Unemployment was 13.1 percent when the deal was approved in November 2009, higher than U.S. rate of 9.9 percent that month.
The visual-effects company -- which had worked on such films as “Titanic” and “Apollo 13” -- promised to deliver technology jobs with average annual salaries exceeding $64,000. John Textor, chief executive officer, wowed city council members with plans to build a studio that would produce groundbreaking special effects, such as the hologram of Tupac.
The 25-year-old rapper and actor, who was killed in 1996, has sold more than 75 million albums.
Rent payments by the company were supposed to back the bonds. When Digital Domain filed for Chapter 11, it dismissed more than 200 workers and stopped paying rent, shifting the debt burden to taxpayers. The studio has sat empty for almost two years, costing taxpayers more than $400,000 for maintenance.
Municipalities “get into projects like this that are designed and intended to not be a drain on the budget,” said Schroeder, whose firm doesn’t own the Port St. Lucie bonds. “But that’s in theory.”
Other taxpayer-backed projects have faced similar fates. A movie studio in Pontiac, Michigan, defaulted on bond payments in 2012 after receiving government subsidies. The state’s pension fund had to cover the shortfall.
Rhode Island set aside $12.5 million this year to service debt issued on behalf of now-defunct 38 Studios LLC. The video-game company founded by former Boston Red Sox pitcher Curt Schilling went bankrupt in 2012. Rhode Island sued Schilling and other parties, alleging fraud.
The state of Florida filed a lawsuit last month seeking to recoup the $20 million grant it gave to Digital Domain. According to the civil complaint filed in Florida circuit court, Textor and his affiliates defrauded the state by withholding information about the company’s financial challenges.
The lawsuit alleges that Textor used the state’s grant money to purchase a controlling stake in an indebted California company. That company’s debt weighed down the Florida startup, forcing it to borrow more to keep the doors open, according to the suit. Textor got financing from a group of hedge funds at “predatory” terms designed to send Digital Domain into a “death spiral,” the state’s complaint said.
The lenders, led by New York-based Tenor Opportunity Master Fund Ltd., took short positions in the stock of Digital Domain, which was running low on cash in the months before it failed. The hedge funds received $35 million from the sale of the bankrupt company, the complaint said. Florida received nothing.
A representative of Tenor, who declined to provide his name when reached by phone, said the company had no comment on the lawsuit, in which it isn’t named as a defendant.
“The script had the makings of a big-budget Hollywood blockbuster: greed, corruption, special effects and a star-struck audience willing to suspend belief,” the state’s lawsuit said.
The complaint describes Digital Domain, which was awarded $135 million in state and local-government subsidies, as a Ponzi scheme.
Textor, 48, denies the allegations. He blames the hedge funds for forcing the company into bankruptcy while profiting from declines in its stock. Digital Domain was a legitimate business and the Florida studio helped produce visuals for films including “Rock of Ages,” starring Tom Cruise, Textor said. Its failure was the result of bad luck and a few unfortunate financial decisions, he said.
“The guys that run Ponzi schemes run away with a lot of money,” he said in a telephone interview. “I lost everything. I invested more than the state of Florida did and lost it.”
Textor said he feels remorse for how the company’s failure has burdened the city.
That’s why he decided to base his new company, Pulse Evolution Corp., in Port St. Lucie, he said. The digital production firm has hired 50 people and recently created a hologram of Michael Jackson. The late pop star’s effigy performed a four-minute set alongside live dancers at the Billboard Music Awards in May.
“We’re doing everything possible to meet the promises that we made to the city of Port St. Lucie,” Textor said.
That’s no consolation for Michelle Lee Berger, a city council member who voted for the subsidy in 2009. Last week she listened to proposals from companies seeking to buy the taxpayer-financed studio.
Offers ranged from $8.5 million to $15 million, less than half the $40 million taxpayers borrowed to build it.
The council is considering raising taxes this year to cover the city’s increasing costs.
“People who haven’t even moved here yet will be paying for what happened to Digital Domain,” Berger said.
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