Movie Crazy On Wall Street

Investors are lining up to pay first and get paid last

Like Sandra Bullock's disaster-prone character in Speed 2, Twentieth Century Fox Film Corp. has spent the summer bouncing from one mishap to another. The studio, a unit of Rupert Murdoch's News Corp., released a pair of big-budget moneylosers in Volcano and Speed 2. To make matters worse, Titanic, with a budget approaching $300 million, has been delayed from July 2 to around Christmas. Despite the flops, there's an eerie calm on the Fox lot. "We're not pushing any alarm bells around here," says one studio exec.

Why not? Fox, like many studios, is refining the art of using other people's money. The latest gambit sweeping through Tinseltown is "off-balance-sheet financing." In the past year, studios have raised more than $2 billion by bundling up as an asset three years' worth of their entire slate of movies and shifting ownership of these films to outside investors. After five years, when revenues from overseas, video, and tv sales have been collected on those releases, the studios buy the films from the outside investors.

It's a sweet deal for the studios. "We spend the largest amount of our resources on [moviemaking], the area that's riskiest," says one top exec of a major entertainment company. "That's pretty stupid." Now, with off-balance-sheet financing, they get to make movies at little financial risk and even recover most of their costs and collect big fees from the outside investors for marketing and distribution. And if any of the movies are hits, the studios still collect the lion's share of any net profits (table).

While it's clear why studios would jump at the deals, it's less clear why outside investors are pouring money into them. The two biggest securitizations have been arranged for Fox and Universal Studios Inc. by Citicorp Securities, Citibank's investment-banking unit. Over the past year, it has helped both studios create paper companies: Fox's is New Millennium Investors llc, and Universal's is Galaxy Investors llc. Citicorp found wealthy individual and institutional investors to contribute all of the paper companies' equity capital.

HAPPY RETURNS? Citicorp then arranged for New Millennium and Galaxy to borrow hundreds of millions against that equity and the potential asset value of all the movies each studio will release for a three-year period. Galaxy has $44 million in equity capital and $1.06 billion in debt, while New Millennium has $40 million in equity from outside investors and $960 million in debt. Studios get all of the money that is raised, and none of the debt shows up on their balance sheets. That's a huge boost for News Corp. and Universal, which are using freed-up capital to make other acquisitions. The debt is backed by Citicorp, which gets big fees and is positioned to do other studio deals.

This is nirvana for the studios. They get access to cheap money and the outside investors and banks have no power over how the movies get made. What's more, studios will recover most of their costs and collect those big fees, before outside investors see any net profits, which are often elusive in the movie business. And while banking industry sources say Citicorp has told outside investors that the studios will refund some of these marketing and distribution fees in the event of a string of flops, misunderstandings commonly occur in the treacherous world of studio accounting.

So why do investors continue to line up? Citicorp declined to discuss its marketing pitch or name its clients. But sources familiar with the deals say Citicorp tells its investors that statistically, each major studio will have one monster hit over three years. Banking on the statistical probability of such a hit, Citicorp forecasts a minimum annualized rate of return of 15%. But the possibility that the studio will beat the odds and deliver more hits is what's drawing investors. "There is always someone who thinks they can do a little better by taking on more risk," says New York financial planner Richard L. Jaffe, who hasn't seen the offering but wonders "why anyone would invest in the film industry."

Both studios have already delivered big hits for investors, with Fox's Independence Day for New Millennium and Universal's The Lost World for Galaxy. But how much the investors will actually get is unclear. The marketing costs for both films were huge, and The Lost World director Steven Spielberg took a big piece of the studio's gross on the film. Moreover, the huge profits from hit films get put in the overall kitty, so profits from a monster hit like Independence Day, where outside investors' cut to date is about $16 million, is eaten away by losses on expensive duds like Speed 2.

PARTY TIME. As long as Citicorp keeps the money flowing, other studios can be expected to join the party. But so far, Citicorp is the only bank to have sold equity to outside investors. Other banks are issuing credit lines secured by a studio's upcoming films. Sony and mgm are exploring such deals, while PolyGram and Time Warner Inc.'s New Line Cinema have recently closed deals worth hundreds of millions.

Hollywood doesn't have the greatest record with outside investors. Film-production limited partnerships flourished in the mid-1980s, until a change in tax law killed them off. But just last month, investors in one such decade-old limited partnership sued Walt Disney Co. over how much Disney paid the partnership for ownership of 19 films that included Who Framed Roger Rabbit? and Three Men and a Baby. Such conflicts could haunt investors in New Millennium and Galaxy as well: After five years, Universal and Fox must buy back films held by the newly created companies. And what those movies will be worth by then could be subject to dispute, though Citicorp's offering pegs the price tag to a formula tied to the film's revenues, not more subjective net profits.

Of course, studios don't like to talk about such unpleasantness, flush as they are with billions of dollars in fresh cash. "We've learned that if you fleece your partner, there won't be many partners around after awhile," says Casey Silver, chairman of Universal Pictures' film unit. For now, they just keep coming.

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