Hollywood has always done a pretty good job taking on the business world, and it is not too much of a reach to think there have been a few private equity pros whose career choice was inspired by Wall Street’s fictional corporate raider Gordon Gekko. The success of Donald Trump’s television show, The Apprentice, and the subsequent knockoff that have followed only underscores Hollywood’s fascination with business.
However, private equity has turned the tables in recent years, and is now returning the affection in the form of some blockbuster LBOs in the space. There have been some major entertainment deals that nobody has overlooked, such as the separate purchases of Warner Music Group and Metro Goldwyn Mayer, but there have also been some smaller transactions that may have slipped under the radar. In music, for instance, both Concord Records and Dreamworks Music Publishing were snapped up by private equity firms in the closing two months of last year, while two film studios, the Sunset-Gower Studios and the Manhattan Beach Studios, were each acquired by financial sponsors during the last quarter, as well.
Most assume that private equity pros would indulge in shopping for entertainment assets. To take nothing away from the returns that can be found in the chemicals or manufacturing sectors, the glitz of Hollywood seems like it would provide a welcome relief for firms that are normally poring over six sigma efficiency models or enhancements to distribution channels. But to buyout pros, there really isn’t anything too entertaining about the space unless there is a way to make money.
In fact, chasing down transactions in entertainment can be even more burdensome for sponsors when one considers the media attention these deals can generate. Private equity has never been known for its comfort in the spotlight. Additionally, the personalities of the management in entertainment companies can sometimes rival the bipolar characteristics of the stars they manage. One pro, when asked if it can be difficult dealing with these personalities, remarked bluntly, “That’s an understatement.”
Geoffrey Rehnert, whose first investment upon launching the Audax Group was the firm’s acquisition of movie house Artisan Entertainment, said, “The industry has more lines of print and gets more attention per dollar of revenue than any [other industry] in the world. There is also a glamour factor. The risk is that the fun becomes a distraction from staying focused on making money, and there is a long list of outside investors who have lost their shirts and been taken to the cleaners by Hollywood insiders.”
One stinker that made headlines in the late 1980s was the $5 million investment by the Massachusetts state pension plan to bootstrap movies from Weintraub Entertainment. The fund backed such titles as “My Stepmother is an Alien” and “Troop Beverly Hills,” which resulted in losses for the pension plan and probably a shameful walk back up the red carpeting upon exiting the premieres.
The difference between that investment and the areas of entertainment private equity firms are looking at today is that buyout shops are chasing properties with recurring revenues and strong cash flows, and not placing a bet on finding the next pair of Olsen Twins.
In the Time Warner purchase it was the company’s catalog of music titles that attracted the investors, while MGM’s index of movies held the same appeal to its buyers. With regards to the film studios, the primary attraction is the recurring revenue from rent and other satellite business services that serve the film industry. It is these aspects that keeps cash flows high whether a new CD or movie finds Titanic-like success or disappointment on the scale of Waterworld. “It is critical to have a predictable base of reliable recurring revenues as a base or platform,” Rehnert says, citing the firm’s investment in Artisan as proof.
Artisan, for the record, had the benefit of a stocked library, but when the company found a surprise hit in The Blair Witch Project, Audax was also able to realize additional upside and ultimately exited the investment with a 6x return on its equity.
Thomas H. Lee Partners Co-President Scott Sperling, who took part in the Warner Music Group purchase, confirms that it is more the dynamics of certain entertainment assets than the industry itself that is attracting private equity dollars. “We’re really driven by looking at the free cash flow characteristics of companies, regardless of industry. And certain entertainment businesses-particularly music-can have very high free cash flows.”
Sperling adds that piracy concerns, which have primarily influenced the music business, have done enough to disrupt the industry that valuations have come down to within reach for private equity firms. “Historically, you couldn’t buy these assets at multiples that would make sense for an LBO,” he said, identifying that traditional multiples usually ranged from 20x to 30x free cash flow. “Today you’re seeing a return to the lower end of 18x to 20x multiples… When we bought Warner, we acquired it for a number that was less than 10x free cash flow.”
Another factor that has cut into valuations is that the conglomerates have turned into sellers, and are now unloading assets rather than snapping them up. Vivendi and its sell-off was well documented in private equity, and the sale of Warner Music was the result of some difficult decisions at AOL Time Warner. Additionally, Dimensional Associates acquired the assets of DreamWorks Music Publishing, which was the music catalog of Steven Spielberg’s Dreamworks SKG.
The Sporting Life?
One other area in entertainment that has attracted private equity pros for years, although not necessarily private equity dollars, is sports. Tom Hicks is better known among the general population for signing Alex Rodriguez to a record contract that eclipsed any LBO investment he has ever made, while Steven Pagliuca, of Bain Capital, is starting to get comfortable in the owners’ box at Boston Celtics home games. But these are more hobby purchases and for the most part are generally not made with capital from limited partners.
However, that has not stopped some firms from looking at sports as an investment. The Quadrangle Group was rumored to be capitalizing the Miles Prentice bid for the Red Sox in 2001, while Chartwell Investors had agreed to a deal in principle to acquire the Buffalo Sabres. Neither transaction went through, although, Chartwell was able to make a minority investment in NASCAR’s RCR Enterprises race team.
The most notable sports team investment, has been the purchase of Maple Leaf Sports and Entertainment by Teachers’ Private Capital. Maple Leaf Sports owns the NHL’s Toronto Maple Leafs, the Toronto Raptors of the NBA, and the Air Canada Center, which houses both teams.
While most sports team owners are in it for fun, Teachers’ approaches this investment as strictly business. James Leech, the Vice President of Teachers’ Private Capital, says, “Sports and entertainment is a major part of the gross national product in Canada. We had the opportunity to invest in the cornerstone franchise in hockey, and Canada’s only basketball team. Couple that with a brand new arena, and you have a very profitable enterprise.”
That is not to say it has been an easy investment, and with labor strife becoming an issue, Teachers’ might argue that athletes are biggest divas in entertainment (see story page, 30). But despite the trouble, the pension plan has seen the valuation of the investment rise with each new year.
And as proof that Teachers’ is not in this business for the glamour of it, Leech disclosed that he and the rest of the investors do not even receive free entry into the games, which at least keeps ticket requests to a minimum.
Going forward, private equity is expected to maintain its standing as a player in the auctions for certain entertainment properties, and as long as the risk is commensurate with the price tags, it should come as no surprise that deals in the space will continue to flow.
Most pros anticipate that the high-cash-flow entertainment assets will continue to attract attention, and a number of firms have staffed themselves to scan the space for deals. Ripplewood Holdings, for instance, has teamed up with Strauss Zelnick, the former head of BMG Entertainment, for purchases in the past and it wouldn’t be a shock if the pairing is still eyeing new deals in the space. Additionally, Roger McNamee has enlisted the likes of U2’s lead singer, Bono, to join Elevation Partners, which is sure to be scanning the Daily Variety for investments.
Meanwhile, in the middle of 2003, Vivendi was on the verge of divesting its Hollywood assets, but the $14 billion asking-price was enough to scare off prospective buyers. It’s not inconceivable that the company could revisit that sale. Also, Crown Media Holdings is looking to divest its international operations, which include the non-U.S. rights to its catalog of 700 TV shows. And most recently, Lions Gate Entertainment, which acquired Artisan from Audax, has reportedly put itself on the block, inspired by the enthusiasm surrounding the MGM sale. The company is said to be seeking around $1.8 billion. Should that sale go forward, who knows what other entertainment company will be inspired to put itself on the block.