Hedge fund investment and financing in the Hollywood entertainment industry

Rise of the Hedge Fund in Hollywood

The work of Paul Grassi entitled: "The State of Hedge Funds" published in American Venture Magazine states that: "On the New York Stock Exchange, hedge funds account for more than half of its daily volume and have an equal affect on the global financial market. This growing industry comprises an estimated $1 trillion in Assets Under Management (AUM) in over 8,000 funds. Analysts current predict that the AUD will expand to $2 trillion by 2009." (2007) Since five years ago, hedge funds have doubled "and returns have averaged 13% since then, their best performance since 2003." (Grassi, 2007) the firms on Wall Street are stated to have "...collected $8 billion in fees last year lending cash and securities to hedge funds. Companies like Bear Stars generate at least 30% of their profit from hedge fund business." (Grassi, 2007) Epstein (2005) writes that: "Ever since Hollywood established its powerful hold over the global imagination, its leaders have sought outside investors to help pay for their movies. The problem is that super-rich investors want to participate in the selection, casting, and production of the movies." (Epstein, 2005) Gross (2007) writes in the article entitled: "Hedge Funds in Hollywood: TV and Movies has Rediscovered Wall Street. Time to Sell!" that "Popular culture, which is created by some of the least business-savvy people on the planet, has always been slow to latch onto business and economic trends." (Gross, 2007) the problem is the time elapsing between the first pitch of new sitcoms and the pilot's debut and in the case of books and movies the time lapse is even longer. By the time the movie or book has hit "the business phenomenon it describes has frequently gone bust - which is why the hedge fund manager and their investment-banking cousins should be very worried about the onslaught of Wall-Street themed popular culture." (Gross, 2007) it is stated in the work entitled: "One More Ride on the Hollywood Roller-Coaster" states that the "Hollywood Studio system is preparing for yet another transformation" which is stated to be the "turn of the digital technologies in the production and distribution segments of the movie value-chain." (Spectrum, nd) This creates a threat in shaking up "not only the Studio's prospects but also those of their associated partners and stakeholders. Digital technologies, together with the proliferation of broadband and multimedia devices on the consumer side are enabling more dynamic and cost-effective methods of film financing, production and delivery." (Spectrum, nd) it is related that an extensive examination of the trends impacting the American entertainment sector was conducted by 'Spectrum' and that analysis indicates that "Financing, Production and Distribution are the areas of the movie business system facing the most radical change, while Development and Marketing will undergo relatively marginal evolution. The following chart relates the movie business value change including key activities, today's model, and the drivers of those change.

Movie Business Value Change

Key Activities Today's Model

Drivers

Development Studios

Established LA eco-system and Producers

Some rethinking of the star system

Talent Agencies

Financing

Studios

Pre-sales Equity by brand

Hedge funds advertisers; and Studios

New media funding

Production Contrasted production

Improvements in digital quality;

Houses on Studios and Offsite shooting backlot and facilities

Marketing Studios

Studios dominated skills; and Distributors

Close links with production

Distribution Studios distribution arm

Proliferation of digital platforms;

Local intermediaries

Digital piracy; and D2C models

Theatrical release

Time windows

Spectrum (nd)

Hedge funds are the newest investment vehicle in Hollywood. It is related that there are two new sources of financing that may be "promising and sustainable: (1) equity investment by consumer brands; (2) co-production with digital platforms. (Spectrum, nd) Key stakeholders and opportunities are as follows:

Summary of Key Priorities

Key Stakeholders Priorities / Opportunities

Studios Devise a cross-platform digital strategy;

Restructure release and distribution model

Optimize international operations

Exhibitors Rationalize and consolidate

Innovate the customer experience

Reengineer the business model

Private equity groups Restructure medium size cinema chains

New Media Platforms Exploit content deal to promote core business acquisition, retention, growth)

Extend brand beyond connectivity

Independent producers Leverage end-to-end digital to increase share of Value and decision-making process

Consumer Brands Pursue product integration

Optimize media budgets

Source: Spectrum (nd)

Digital production offers to lower the budgets of movies and creates the opportunity for the Studios to position well in order to "realize the vision of an end-to-end digital supply chain. The Independent producer has the potential to realize benefits from "digital end-to-end, avoiding traditional distribution bottlenecks." (Spectrum, nd)

II. SEC and HEDGE FUNDS

The hedge funds have been viewed as highly profitable even though the investments are decidedly risky strategies and have been: "limited to only IRS accredited investors..." yet still outside the arena of requirements of the SEC which are seen applied to mutual funds and other similar investment strategies. As of February 1, 2006 SEC regulations became effective that made it a requirement that hedge funds are registered as investment advisors as set out by the Investment Advisors Act of 1940. Grassi (2007) relates that this requirement "was challenged and ultimately dropped." (2007) Grassi (2007) relates that registration is considered to be a "viable step" by regulators yet it is believed that this is not likely to prevent fraud. It is the belief of fund managers that "this oversight will open them up to new examination and potential litigation" as related to the following areas: (1) Accountability: There is a requirement for designation of a chief compliance officer who will not take part in operations on a day-to-day basis. This individual will be required to make a provision of the policies and procedures of the company as well as the inclusion of a written code of ethics in order to enforce accountability standards for the company's directors, officers, and company at large; (2) Enormous Fees: The hedge fund industry represents approximately one-sixth of the mutual fund industry "yet it has already provided more revenues. The fee structure of a typical hedge fund includes a 1-2% management fee in addition to 20% of the profit while an average mutual fund charges 1-2% of assets"; (3) Under/Over Valued: Hedge fund securities are difficult to price and has the potential of disaster; and (4) Shareholder Activism: Hedge funds are taking a more central role in the activities of a company. Examples stated by Grassi include "encouraging a company's sale, pushing its bankruptcy filing, share or dividend buybacks, and the scrutinizing of executive decisions and compensation. With this new position comes potential conflict - and litigation - from both minority shareholders and existing company management." (Grassi, 2007) Grassi (2007) relates that both the hedge fund and the hedge fund adviser are protected by: Professional liability insurance; Provision of a hybrid combination of Errors and Omissions; and Directors and Officers (E&O/E&O) liability coverage. All of which protect the hedge fund, hedge fund advisor, and general partner "against losses due to an unintentional negligent -- act, error, omission, breach of duty -- that could rise to a claim." (Grassi, 2007)

III. HEDGE FUNDS REBOUND FROM SUBPRIME SUMMER in SEPTEMBER

It is related in an October 10, 2007 report that Hedge funds "rebounded nicely from the summer of subprime in September, posting one of their months in a decade." (FINalternatives, 2007) Hedge funds rose 3.27% in September in what is stated to be "the largest increase in four years, and the second largest in eight." (FINalternatives, 2007) the gains are also stated to be broad-based gains. The problem is however, that there is simply not a historical track-record of hedge fund returns to utilize in attempting to predict if these gains are likely to remain or be replaced by losses even greater than over the summer of this year. A discussion of the Financial Economists Roundtable's annual meeting reports the rapid growth of hedge funds in the last decade. The Financial Economists Roundtable is comprised of a group of senior financial economists with a focus on microeconomic issues in investments, corporate finance and financial institutions and markets. However, the unregulated nature of the limited partnerships do lead to concerns including the high expenses in managing these funds and the risky strategies associated with investment of hedge funds and the "small probability of very large losses." (Stanford University, 2005) Investors often fail to understand these risks as well as others connected to hedge fund investing. Another problem with