Funds may have to hedge H'wood bets

Profits slim for Gun Hill gang

The less than regal bow for "The Kingdom" might just confirm what many industryites had suspected: Investors in one of Hollywood's highest-profile equity funds will take it on the chin with their slate of Universal and Sony movies.

Universal's Middle East-set thriller, which opened last weekend to an underwhelming $17.1 million domestically, is the final release in an 18-picture slate dubbed Gun Hill Road I. A Hollywood bummer for Gun Hill's hedge funds could dampen further interest in film investment by private-equity groups.

Costing upward of $70 million to produce, "Kingdom" is one of six Uni releases in the Gun Hill mix, with the balance comprising Sony films.

The studio "ultimate" — industry jargon for an ever-changing studio projection on profitability — also takes into account forecasts for "Kingdom" revenue from DVD and other ancillaries. But there's gathering consensus that the Jamie Foxx starrer won't generate the kind of profits necessary to make a silk purse return from the sow's ear many claim it represents for equity investors.

For there's one big problem for equity investors: They get paid only after studios take double-digit distribution fees and bankers recoup debt service.

"The odds are always stacked against the investors," confided a former studio exec who helped construct another of the current equity deals. "I mean, if the profit margin is in the 8% range and studios are charging you an 11% distribution fee, it's hard to come out on top."

Ryan Kavanaugh, the financial impresario behind the Uni-Sony equity slate — a $600 million financing constructed in January 2006 — already has lined up a similar financial package for Gun Hill Road II. That may show continued interest in such investments or simply demonstrate the power of studio persuasion.

"Any time you do a second deal, the investors address what really bugged them in the first deal," noted a source with knowledge of such negotiations. "But the studios usually also get something, which makes it effectively a wash. The studios aren't stupid."

Kavanaugh and his Relativity Media get fees running in the millions of dollars for putting together equity funds. Through Relativity, he also has dabbled as an investing producer on individual films, including the currently playing "3:10 to Yuma."

"Investors will make money," Kavanaugh said through a spokesperson. "The investors we are directly in touch with are pleased with the results."

Hedge funds hold most of the mezzanine, or secondary, debt on Gun Hill and also the lion's share of its equity. Deutsche Bank leads the fund's much-safer senior debt consortium.

Still, some equity investors might try to cash out of their positions before final profitability on the first Gun Hill slate is tabulated — a process that could drag on for years.

Knowledgeable sources, speaking anonymously, questioned Kavanaugh's upbeat assessment of investor prospects.

"The people who invested in the equity and the mezzanine debt are very unhappy campers," a source familiar with the deal terms said. "The equity investors are going to lose basically all of their money, and the mezzanine may see some return but certainly not the money they were promised. The senior debt banks are fine, but they always are."

As for how the "Kingdom" bow bears on the investors' fates, the source added: "Some people were sitting there saying that if this film does extremely well, maybe they will make some of their money back. As it turns out, it's not going to add to the pain, but it's not going to help either."

Finance execs are loath to speak on the record about individual funds, but there's no shortage of negative assessments on how Hollywood's recent equity investors are faring.

"Private-equity guys who have been phenomenally successful in other investments over the years don't like to believe they've come to Hollywood and had the studios effectively turn them into the latest round of dumb money," said David Davis, managing director of the FMV financial advisory in Century City. "But once the films have gone through their video windows, there isn't going to be much more uncertainty left, and there isn't any magical revenue that is going to help save them."

Indeed, some view the hedge funds and wealthy private investors pouring money into Hollywood over the past few years as simply the latest in a never-ending succession of star-struck suckers.

German financiers went gung-ho on Hollywood in the 1990s only to beat a quick retreat when things went bad, and a decade earlier thousands of mom-and-pop investors were fleeced in the infamous Silver Screen and Delphi film investments.

In the latest round of equity financings — which now fund slates of varying sizes at each of the six major studios — participants hoped to avoid past missteps by investing in sizable slates of films rather than just one or a few pics.

But even where studios have offered up meaty slates featuring some of their biggest titles, equity investors are having a hard time turning a buck.

Representatives of Uni and Sony declined to specify which films were financed through Gun Hill Road I. But it's believed some of the 18 films include "The Fast and the Furious: Tokyo Drift" and "RV," two underperforming 2006 releases from Uni and Sony, respectively; "All the King's Men," a major disappointment last year for Sony; and "Talladega Nights: The Ballad of Ricky Bobby" and "The Pursuit of Happyness," solid '06 successes for Sony.

Studio reps also declined to discuss any other aspect of the equity funding phenom.

As one studio exec said: "Anybody who wants to give us money, we're more than happy to take it. So for us to explore the weird and wacky world of outside money is to shoot ourself in the foot."
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