The Bail Out

No matter our behavior, the economy fluctuates from boom to bust on a fairly predicable basis. However, the severity of a bust is based in part on group (read: global market) psychology and bad, unregulated choices (don’t get me started on so-called “free market” thinking!).

Right now, the group think is pretty pessimistic and we’re in dire need of the equivalent of a global prescription for Prozac. A downturn is not a question at this point; only the extent of the damage and the timing of the recovery remain up for grabs.

The bail out measure before Congress will by no means prove to be a panacea. I keep hoping they will find a better way since the legislation – despite all the money – will not alter the landscape of losses or willingness to lend. However, it will remove a barrier to lending and mitigate some of the negative thinking. So, the sooner Congress works it out, the better for all of us.

I was recently assured by an elder statesman in the business that the industry will continue to flourish as it has in prior recessions and during the Great Depression since people continue to spend on entertainment as an escape from bad news. Peter Bart smugly approved in his column in Monday’s Variety:

Compared to the turmoil on Wall Street, Hollywood seems like an object lesson in prudent management. That’s why billions keep flowing into the movie business even when other industries are starved for capital.

OK, I know that’s really not the reason. Sucker money traditionally flows to Hollywood because investors want to meet girls, attend parties with movie stars and say they’re business partners with Steven Spielberg. Nonetheless, it’s still surprising to count the big bucks involved in the DreamWorks deal or in Ryan Kavanaugh’s Relativity Media or in Media Rights Capital’s portfolio at a time when the rest of the economy is locked in a liquidity crisis.

Suddenly, Hollywood’s managers seem downright austere compared with the crazies at Lehman Brothers. And movie-star salaries are pathetic relative to Wall Street payouts.

I’m not sure I agree since the entertainment business – like most businesses – requires access to credit to run. MGM is already struggling to service its existing debt and like the banks and other financial businesses, may be unrecognizable from its present form down the road.

Even before the current market crisis, Dave McNary wrote in last week’s Variety :

Start with plenty of labor unrest, add in the global credit crunch along with the consequences of too many movies in the market, and combine that with foreign distributors getting cold feet for anything but blockbuster Hollywood product.

“Any one of these factors would depress the business, so having all of them at once was something of a perfect storm,” notes Charles Heaphy, senior VP at City National Bank’s entertainment division. “This is like being in a rowboat while there’s a hurricane going on.”

With respect to startups, Jason Calacanis wrote:

It’s my believe [sic] that the economic downturn will be much worse than it is today, and that 50-80% of the venture-backed startups currently operating will shut down or go on life-support (i.e. 3-4 folks working on them) within the next 18 months.

Make a list of every Web 2.0 startup to raise an A or B round and cross 80% of them off the list, because they will not make it to their next round of funding or profitability.

Tough times like these will require media and entertainment companies as well as startups to rethink their strategies for investment and growth for the foreseeable future.

It all sounds really, really bad.

It’s not enough that it’s hard to finance movies or a good idea; contend with getting distribution or vacillating VC’s; now you’ll have to work that much harder to even find potential investment let alone actual investors.

But the news may not be all bad. Money abhors a vacuum. There’s a lot of money out there sitting on the sidelines and plenty of people looking for places to put it; some of it from the most unlikely of places.

I’ve spoken to personal money managers whose sole duty is to make at least 20% on client money in good times and bad. Some of this money previously invested in oil, gas and securities but with these markets in turmoil, these investors are now looking for new investment opportunities. If bank financing dries up, private equity (e.g., hedge funds) – already a big player in motion picture financing – will likely replace it. Moreover, I recently had several discussions at the Toronto Film Festival and elsewhere with several emerging market financiers who all viewed the current US economic situation as a unique investment opportunity.

Let’s hope their optimism is contagious.

  • Jennifer Morrison

    Great points, and it does seem that the silver lining to this economic cloud is the investment opportunities for entities and individuals looking for (dare I say) less risk. After all, depending on the structure of the deal, the elements of the project, and the stage at which the money comes, an investment in a film is comparable to an asset-backed security in that the film itself is valuable intellectual property. Plus, even if the film is aborted due to certain circumstances, the investment is insured.

  • pkzip5

    Yes, but only if the movie is produced. Otherwise, you have a really
    expensive screenplay with minimal resale value.

  • If anything, Web 2.0 startups will have to be, you know, good.

    Let's stay optimistic, folks!

  • I think that the entertainment biz, especially the music biz, is generally recession-proof. when times are good, people spend money on such things. when times are bad, they cut out vacations instead of movies.

  • True. What's different now compared to other economic downturns is that there is no viable access to the credit markets. The entertainment business (like the textile business) needs to be able to bank its commercial paper; to obtain money from lenders based on the secured contractual commitment from another party (e.g., a studio) to pay on delivery of a picture. Without that, there could be a freeze of most of these transactions. The good news appears to be that the Fed's tactics (and those of other governments around the world) appears to be working albeit slower than we would like so these funds should be available soon (whatever soon means).

  • Dan,

    I tend to agree with you but not necessarily for the most obvious reasons. Many VC's take a shotgun approach to investing. In the current economic environment, I think that VC's will be more cautious and conservative. I also expect them to be more aggressive in negotiations. So yes, the Web 2.0 startups as well as others will – by necessity – have to be good.

  • Dan,

    I tend to agree with you but not necessarily for the most obvious reasons. Many VC's take a shotgun approach to investing. In the current economic environment, I think that VC's will be more cautious and conservative. I also expect them to be more aggressive in negotiations. So yes, the Web 2.0 startups as well as others will – by necessity – have to be good.