Film Incentives West & East

We commented recently about the introduction of filming incentives in California. Despite being the home of Hollywood and modern movie-making, California has been losing productions year on year to other locales offering advantageous tax or rebate deals, and film-makers had long been calling for the state to introduce some kind of incentive scheme to level the playing field and allow them to continue making movies in California.

So, last year's announcement that California would indeed provide incentives for producers not to join the “Runaway Production” bandwagon was greeted warmly by all involved in the industry. Of course there were a few gripes that the big studios were better positioned to take advantage right away, and some hoops had to be jumped through to get to the money, but in general it looked like a good thing to keep film and TV production in California. Well, today the LA Times announced that the “state of California’s much ballyhooed film incentive program has run out of cash – at least for the next six months.” The program had set aside $500 million in tax credits over five years but it has so far allocated $200 million to 60 projects, effectively eating up the first two years' worth of money. There was no shortage of demand for the 20%-25% tax credits but there won’t be any new allocations granted until before June. We don’t think anyone expected the money to go all that far but the fact that California stepped up to the plate was enough for a lot of participants to look into maintaining productions in and around Hollywood.

Meanwhile in Beijing, Variety tells us that China has announced a 5-year plan to encourage a Great Leap Forward in its domestic film business. With financial and regulatory assistance to encourage locally-made movies the plan seeks to ensure that Chinese cinemas devote at least two thirds of screening time to Chinese films. While not exactly encouraging to foreign film-makers trying to overcome the existing barrier of only 20 permitted foreign films a year, there may be some light in the tunnel as the overall cinema pie grows in China. And, just as the WTO has ruled that China must open its doors to foreign content, this plan is intended to allay domestic fears by encouraging Chinese film-makers to compete with established international studios on what might not be exactly a level playing field, but perhaps a less skewed one.

You never know quite what the business landscape’s going to look like next in China, but we’re still excited about getting back over there to have a look and see for ourselves.

The Out Of Obscurity team.

China Opportunities?

We always like to keep an eye on what’s going on in the movie business around the world and lately there’s been a lot. Over the course of 2009 movie revenues have continued to rise in almost every country, continuing a now long-established trend. And some places are expanding faster than others, in particular China, where they’re in the process of building thousands of new movie screens around the country. More than half of all box office revenue is earned by Chinese-made movies, and income is growing by more than 40% annually, according to the Wall Street Journal.

However all is not as it seems, since new screens doesn’t mean increased access for Hollywood movies and the state-controlled China Film Group is the sole arbiter of which foreign movies are allowed to play in the country. For years Hollywood has complained that China limits the access of foreign movies – currently only 20 titles a year, up from the previous 10 – and just last week Chinese cinemas were ordered to stop showing 2-D versions of Avatar, the runaway global box-office behemoth. Avatar, apparently, was doing too well in the lead up to the Chinese New Year holiday and was replaced by a local language biopic of Confucius.

A December ruling by the WTO stipulates that China must open up its market to foreign films within a year. Going back a decade or more China was concerned that flooding the market with foreign movies could hinder the local movie sector, but the demand for locally produced movies is now strong and the quality has risen considerably. China is on target this year to overtake Korea as Asia’s largest movie market and will surpass Japan within five years. This exponential rise in movie-going and the likely opening up of the market to international films means the opportunities are too exciting to ignore.

One key factor to doing business in China has always been having the right local partner. Recently, we were approached by a well-connected Chinese group seeking to co-produce 3-D films for the fast-expanding 3-D and IMAX sector, as well as to co-manage a new film fund targeting the Chinese market. We’re well aware of the challenges of accomplishing such goals – the right partners, administrative red-tape, differing expectations and cultural idiosyncrasies – along with the time it can take to get things done in a country where they definitely take the long view. Our Movie Portfolio Fund is an international vehicle with its roots in Asia, so we’re comfortable doing business in the region and the challenge of getting something new done right in China is too great to pass up.

We were invited to work on a China fund a few years back and all in all we spent more than a year in planning, discussing, and structuring the right sort of investment vehicle, and in making presentations back and forward with a different government-linked group. The fund didn’t fly, our partner changed their priorities as time passed, and the opportunity was missed. However we’re optimistic this time that we can get something done. Gong Xi Fa Cai!

The Out Of Obscurity team.

What Crisis?

We’re always reading that some crisis or other is about to engulf the movie business. Whether it’s the withdrawal of the latest round of easy money from hedge funds, banks or German tax funds, the decline in DVD sales or piracy in developing markets, something’s always just about ready to eat the studios’ lunch. However with the movie business posting the biggest year ever in international revenue for 2009 and the prospects going forward looking very strong, we believe that there’s never been a better time to be making money in the movie business.

Not all investors do make money or get the right access to movie assets. The structure of your deal, or investment into the business, has to be right. There’s no point sitting on a “profit” participation deal on a one-picture slate when we all know movies rarely make what the real world of business calls “profit”. Investors need to be sure that they’re invested across a slate of movies over time with reputable producers, on which they’ll be sharing all revenues (a different beast from profits) on an equal basis with the producers. In this way everybody benefits from the capital that gets the movies made in the first place.

However, people always want to be a part of the movie business, and when one source of money dries up Hollywood always finds another. The wave of hedge fund slate finance deals with the studios has receded lately but we’re now seeing new deals from motivated investors using sophisticated structures, and cleverer equity investments ensuring that that participation by a principal financier actually means something. Movie investors haven’t always made smart investment decisions, and even the best and brightest had the wool pulled over their eyes by the studios as the majority of their slam-dunk blockbuster movies such as Spider-Man and Harry Potter were held back from third-party financier deals.

There’s always a smart way to make an investment and with a little less money on the table now there’s surely even better opportunity for investors to strike advantageous deals. Film-makers just want to get their movies made and they’re generally amenable to working with financiers to get the job done. Studios have a little more luxury since they have much deeper corporate pockets and some have walked away from what they felt were less than favourable investment and banking deals recently. But the experience of the recent wave of slate deals was that it helps the studios a lot to have co-financing partners, not only to lay off the basic risks of making big movies, but to help them focus their businesses on the part they actually make the most money from, distribution. So we’re going to continue to see different co-financing arrangements with some or all of the studios maintaining slate deals with financing groups.

In today’s Los Angeles Times, James Cameron commented that Hollywood exec’s will always claim some crisis or another, but historically that’s always been the way. In the 1950’s the scare was that TV would replace movies, in the 1980’s it was VCR’s, but now there are more movie theatres around the world than ever. So some sources of money dry up like the German funds, and others will take their place. In the last week alone we’ve seen a new $100 million film fund set up in Europe, and the announcement of a couple of $1 billion funds in the US. The opportunities for smart movie investors are too good to be ignored.

The Out Of Obscurity team.

Section 181 Revisited

Film producers are always looking for ways to raise money to close the gap in their production budgets, so they seek to utilise any and all incentives, credits and allowances they can get their hands on to get their movies made. In recent years you can’t get a movie financed without making maximum use of these incentives which can form quite a significant portion of a movie’s budget. Producers will go to any reasonable lengths including relocating their production to Eastern Europe, Australia, New Mexico, Louisiana or Canada to take advantage of such schemes.

One incentive that hasn’t had as much press is Section 181 of the Internal Revenue Code, a nifty little scheme originally approved in 2004 allowing investors to claim 100% of their investment into film or TV productions (the first $15 million on any film, $20m in deprived areas, or the first 44 episodes of a TV series) against income tax in the same year. Now, we know from experience that the hardest question to overcome when dealing with a potential investor is “Will I lose my money?” And of course it’s a fair question as most investors will consider first not “How much will I make?” but “Can I lose this money?” By showing your investor that he can immediately deduct the full cost of his investment from his taxable income you’re giving him a significant reason to write that cheque. He immediately saves a chunk of cash on his tax bill and maintains the same potential to gain from your movies, so his upside multiple has just increased significantly.

Section 181 was originally set to expire in 2008 but was extended as part of the Federal Bail-out Plan for one more year until the end of 2009. However, we hear it on good authority from a senior source at the IRS in Washington that not only do they expect the provision to be extended further, as it has been passed in the House and is awaiting Senate approval, but that it will be retroactive when finalised. And, our source tells us that they recognise how beneficial this provision is and they wish more people knew about it. Another source tells us they think that perhaps the major studios and TV companies have been monopolising the provision – as well they should – but that mainstream producers should intensify their efforts to get 100% deductions for their investors too. Sounds like a no-brainer to us.

The Out Of Obscurity team.

Distribution Is Key

Things always seem to take a while to get going in January, so we’re doing as much as we can to get the ball rolling on a few movie projects right now. It’s also a good time of the year to clean house and get the PC in order, unfortunately our computer took it upon itself to crash for most of the festive period and it’s only now coming up for air with, we think, everything back in order.

Among the Christmas and New Year messages we received over the last couple of weeks was this sweet comment from a dear friend in the Bahamas: “movies are the best news - where else can one make a fortune nowadays?”. If you’ve read any of our comments over the last few months you’ll know that we couldn’t agree more. It’s one of our main hobby-horses that investing into movies - a portfolio of movie assets - is just about the best thing you can do with your investment dollars. Movie assets continue to make money in perpetuity and the opportunities to sell movies via multiple formats and territories are continuing to expand, creating lots more opportunities for movie investors to profit. Thanks a lot Minnie!

We’re working with a couple of projects shooting in and around Thailand and Japan, and aiming to close some financing on those from Asian investor groups. There’s a keen interest in movies all around Asia with not only some ground-breaking films being made in Japan, Korea and Thailand, but also some of the highest per capita movie-going in the world happening in places like Singapore and elsewhere. People just love going to the movies and that feeds the growth that we’ve seen in international revenue opportunities for movie investors to profit from.

Different investors have different outlooks: we’re talking to some private investors looking to profit from successful movies as well as some industry experts whose interest is more in securing the rights to distribute the movies in a few countries around Asia. They know that this will cover any investment they make and generate healthy profits. Distributor relationships in particular are important because good distribution is the make-or-break factor for the success of a movie and the success for our investors. Happy investors will invest again, so we’ll be happy to keep good distributors on side if they can bring results across key territories.

A few years back we co-financed a promising Japanese manga movie, an adaptation of a successful comic-book series and a movie which appeared to have real breakout promise. The animation studio and director were extremely hot, there was excellent awareness and anticipation of the story in Japan, and we had brought in a production partner in the US with a major studio deal to take on the movie internationally for theatrical and DVD sales. Our Japanese partner had engaged one of the top Japanese distributors so our hopes were high. We held a launch party at an Asian film festival and anticipated the grand release. However the release came and went with something of a whimper, it fell completely flat for a variety of reasons, none of which made much sense to us at the time. It could have been the wrong time to release the film, they might have allocated some not-so favourable screens for our movie, or our local partners might just have done a less-than optimal deal with the distributor. The truth was probably somewhere in the middle but we felt that the groundwork hadn’t really been done properly in advance. When it came to seeking the US release we found to our dismay that virtually no thought had gone into creating a suitable package for the DVD, leaving us little opportunity to hit the market properly. The whole experience taught us some big lessons, most importantly that it’s vital to know and trust your partners well and to rely on their work as if it were your own. No doubt one reason why so many folks find it difficult to delegate, but in the movie business it has to happen.

The Out Of Obscurity team.

Investment Gold

It’s been a quieter couple of weeks observing what’s going on in the movie world and waiting for people to get back in business mode. It’s encouraging to see that it’s not only Avatar that’s eating up the box-offices around the world but that revenues are up in most territories, with healthy gains in Europe and a 44% increase in China. This is of course on the back of a healthy expansion in screens as new theatres are built, but great news nonetheless.

In recent days new investment deals have been announced, with groups in India and elsewhere making big-ticket commitments to making movies. As we’re fond of saying in this column we strongly believe in the profit potential of movies and the movie business in general as it expands into new formats and territories. Investors into movie content, with the right structure and revenue sharing arrangements, stand to do very well indeed on their investment. In fact with Avatar raising the bar in so many ways we’d suggest that potential investor returns have never been better, even amid the continuing economic turmoil in other sectors.

We run into all sorts of discussions with prospective investors interested in our fund. If you’ve ever been involved in sales it may come as no surprise to you that sometimes potential investors don’t actually do what they say they would do, and in some cases weren’t really telling the truth in the first place. We recently had an inquiry from a North American group of private investors interested in partnering with our fund. All went well till they came back with a few questions, which we discussed, and then finally gave us their considered “no”. It wasn’t their decision that surprised us but the excuse they gave: they said they had done some research into the movie business and come across an occasion where a private investor was disadvantaged in an investment deal with a studio and its star producer. They were shocked to discover that the studio had taken out is distribution fees and participation first, then the producer got paid her share, all before the investor had a look at the profit pie. To their surprise the investor made no money and they claimed this story was enough to put them off investing. Of course nothing about this story is at all surprising and in the movie world you need to be sure you’re getting into the right deal with the right people at the right level. However, investors sometimes look for an easy out on something they don’t have a full understanding of, or when they aren’t prepared to give you their honest reasons for not participating.

The right investors with the right structures recognise the merits of investing in movie assets: sometimes you just have to dig a little deeper to find those gold nuggets.

The Out Of Obscurity Team