Private Equity's Hollywood Flops

Providence Equity Partners' MGM stake and Goldman Sachs' investment in the Weinstein Co. are reminders that betting on movies is a treacherous business

By Ronald Grover

What's worse? Sitting through Will Farrell's brain-dead comedy Land of the Lost or a board meeting of a Hollywood studio if you happen to be one of its private equity investors? No contest—it's the board meeting. Just ask the folks at Providence Equity Partners, who plunked down $525 million as part of a group that bought MGM for $5 billion from billionaire Kirk Kerkorian in 2005. Or the people at Goldman Sachs (GS), who the next year put together a private equity group (and invested Goldman money) to back the Weinstein Co., started by Miramax founders Harvey and Bob Weinstein.

Simply put, those investors can kiss most, if not all, of that money goodbye. Both MGM and the Weinstein Co. recently acknowledged that they have hired financial advisers to explore refinancing options. That's usually code for "Line up, fellas, for your haircut." Both companies are swimming in debt, have lower cash flow than anticipated when the deals were struck, and are facing an uncertain future. Forget Will Farrell. This is comedy in its blackest form.

How did some of the savviest investors find themselves taking this kind of a whipping? It's easy to say the market changed: DVD sales are off, financing dried up, etc. Or that they were investing high-risk money, hoping for a home run to help them deliver the double-digit returns they promise their investors. But what really happened is that they forgot the cardinal rule of investing: Never trust your bucks to Hollywood.

The investors at Providence, Goldman, and their partners are learning that lesson now. MGM, the home of James Bond and the Pink Panther flicks, has hired investment banker Moelis & Co. to help it refinance its $3.7 billion in debt. Within the next two weeks, MGM's auditors at Bank of Montreal must decide if the company's library is still worth what it was back when the deal was done. That could trigger questions about whether the company is a "going concern" and set off covenants that force MGM to repay its debt. (MGM wouldn't comment, but in a conference call with creditors the company said its cash flow is still sufficient to satisfy its obligations.)

exploring financial options

The Weinstein Co., which has had a string of flops, hired financial consultant Miller, Buckfire & Co., a firm with considerable experience handling bankruptcy as well as refinancing. The studio said in a statement on June 6 that "we have always worked with financial institutions to explore our options with respect to equity and possible investments" and called it "an ordinary course," similar to what the Weinsteins did at Miramax. A source with knowledge of the hiring says the studio brought in Miller Buckfire with an eye to future potential cash needs, not because there is an immediate crisis, and that its $500 million in debt doesn't come due until 2014.

Despite statements to the contrary, these are troubling times for MGM and the Weinsteins. And according to the private equity folks with whom I've chatted, it seems some investors weren't paying close attention when they took a flier on Hollywood. What did they do wrong?

Well, let's start with MGM, which was bought by a consortium headed by Sony (SNE) that included cable giant Comcast (CMSA), and private equity players Texas Pacific Group and DLF Merchant Bank. What's painfully obvious is that the consortium members were betting on the iconic studio's library of 4,000 films to continue minting money and grow in value from the $5.5 billion projected at the time of the deal. Of course, since then DVD sales have tanked, digital sales have been puny, and sales of new Blu-ray high-definition disks have hardly taken up the slack. Sony, which acquired the right to make some James Bond flicks with MGM, probably got its money out.

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