Media/Entertainment Deal of the Year
“Private Equity Comes To the Big Screen”

Colleen Marie O'Connor
January 16, 2006

Legendary Pictures, which co-produced the high-grossing film "Batman Begins" and is currently assembling "Superman Returns," was launched following an innovative $475 million capitalization plan that was quickly mimicked. Structured much differently than the typical Hollywood studio, it first struck a 50/50 production and distribution partnership with Warner Brothers Pictures, a unit of Time Warner, putting itself in position to lure a new source of capital into the industry, private equity. The scheme worked, despite plenty of doubters, and inspired several other cash-rich investors to dip their toes into the dicey world of film finance.

"We specifically built a movie studio, but essentially we built one attractive to private equity, and that's never been done before," says Thomas Tull, CEO of Legendary Pictures and a former president of the Convex Group, a media investment firm. "We heard from every person you could imagine, 'You'll never get this done.'"

Following the Legendary deal, an investor group led by CSFB reportedly negotiated a stake in Disney Pictures, and then the Weinstein brothers took their quest for start-up capital for their new film company to institutional investors.

The Perseus Group, a privately held boutique investment firm headquartered in San Francisco, advised Legendary, helping it raise $225 million of equity and mezzanine commitments by the time its first round of financing closed in June. ABRY Partners, AIG Direct Investments, Banc of America Capital Investors, Columbia Capital, Falcon Investment Advisors and M/C Venture Partners all participated.

Aside from ABRY, which led the $87.5 million mezzanine round of financing, executed in the form of senior subordinated notes with a six-year maturity, all of the investors were new to the motion pictures industry, sources involved in the deal say.

M/C Ventures and Banc of America Capital led Legendary's equity round, worth $137.5 million, and Legendary's management contributed a minority investment, the size of which was not disclosed.

In its second round of financing, Legendary locked down a $250 million senior credit facility from JPMorgan. The revolver had been in the works prior to the June release of "Batman Begins," the studio's debut film, and circling the private equity funding was key to obtaining the loan.

Film finance has always been considered extremely perilous, and it has struggled to attract smart money such as private equity funds. Legendary, however, was able to convince these savvy investors that risks in the sector have become "much more diversified than five or seven years ago," when a film's success depended overwhelmingly on how it fared at the US box office, says Clark Callander, a managing director at Perseus Group. Now, film revenue streams also include pay-per-view and DVD sales, along with ancillary items such as T-shirts and lunchboxes. Rising international box office sales are also augmenting domestic receipts. "The international box office adds some stability to the business that didn't exist 10 years ago," says John Watkins, a general partner at M/C Ventures.

When forming Legendary, the founders' first step was not to create a box office hit but to fund an ambitious business plan that includes co-producing 25 films over five years with Warner Brothers. Legendary secured the Warner Brothers partnership in late 2004, then it had to cope with one of Hollywood's worst kept secrets - while few wealthy individuals invest in Hollywood productions, let alone entire slates of films, the number of institutional investors has been essentially zero. But film production has changed a great deal over the past 10 years to "become an asset class that is now worthy of private equity backing it," says Tull.

Given the constantly shifting nature of distribution channels, more investors are becoming interested in owning content. "We believe that owning proprietary content is a good place to be," says Watkins, noting that M/C Ventures was actively looking for content investments when Perseus walked in with the Legendary Pictures deal. "Distribution networks are going to be disintermediated, to some extent, so in a digital world, owning proprietary content is king."

Using sophisticated Monte Carlo simulations, Legendary was able to demonstrate that its model for financing film productions could achieve profitable outcomes on a consistent basis. Expected returns of upwards of 20%, based on the modeling, were cited by sources close to the deal.

Sources from the private equity arena say the initial capitalization involved an investment in the management team, one rife with successful members from both Hollywood and the realm of investment management. Tull's management team includes President Chris Lee, a former head of productions for TriStar Pictures, CFO Larry Clark, former CFO of Creative Artists Agency and a former director at the Carlyle Group, and Chief Marketing Officer Scott Mednick, with marketing experience on more than 170 films. Legendary's President of Physical Production, William Fay, was behind such high-grossing films as "The Patriot," "Godzilla" and "Independence Day."

"We have private equity and the movie business in our DNA," says Tull.

Investors in the deal say the chance to partner with Warner Brothers through Legendary was key. The co-production deal for as many as 25 films is quite unique - Legendary has a say in all aspects from casting and directing to marketing. And the partnership was chosen over a strategy of purchasing a library of characters. The focus for its films will be action, adventure, horror or science fiction; no dramas or "message pictures" are anticipated.

These types of films "are franchises that throw off enormous amounts of money," says Tull. "When you take all the slickness and Hollywood aspects out of it, what you really have is a consumer product."

Traditionally, packages that involved a "slate" of films were not nearly as transparent, one of the largest hurdles to attracting institutional investors.

Aside from having Warner Brothers as a partner, investors say it also adds to their potential exit opportunities. They note that their options include selling their equity stakes to Warner Brothers after five years, or perhaps to other private equity firms. Several sources also hint at the prospects of a Legendary IPO at some point. "There are a number of ways to attain liquidity. Selling to Warner Brothers is one of them, as is an IPO," says one investor in the deal, who did wish to be identified.

Legendary plans to reinvest all of the profits from its films, enabling it to finance its goal of 25 films and build a portfolio of content. So if all goes as planned, the prospects for an IPO remain widely tantalizing. "We're very excited about the ability to build up a mini major," says Tull. Pulling off a deal with private equity "was an unbelievable feeling of pride and we're going work very hard to make sure it all works out."

(c) 2006 Investment Dealers' Digest Magazine and SourceMedia, Inc. All Rights Reserved.