Private Equity's Hollywood Flops

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Comcast has a deal to show MGM films on its video-on-demand channel. But what the other investors didn't count on was how aggressively Kerkorian and the prior management had mined the library, selling off all the better vintage titles.

At the Weinstein Co., investors who plunked down $490 million clearly were betting on Harvey and Bob Weinstein continuing their hit-making track record when they ran Miramax for Walt Disney (DIS). Harvey and Bob, as they're called, had other big plans. They bought pieces of an online social network, a cable channel, and even the Halston fashion brand, which the company acquired along with another private equity fund. The Weinsteins also took control of a video-distribution company called Genius Products that was soon producing losses that soaked up money. Without many hits after launching their own company, the Weinsteins' fortunes sank dramatically.

banking that there's a hit on deck

What will happen to these companies is unclear. MGM will eventually be sold, probably for far less than the price paid by its private equity investors. The future could be even more dire for the Weinstein Co., which has a much smaller library. For now, both companies are gearing up their film slates with the old Hollywood hope that a moneymaker lurks in every future release. The Weinsteins are banking on the September release of the Halloween sequel H2 and November's musical Nine, starring Daniel Day-Lewis and directed by Chicago director Rob Marshall.

Meanwhile, MGM's private equity owners brought in longtime media executive Harry Sloan (who has built and sold two companies) and former Universal production chief Mary Parent to jump-start the company. Sloan has beefed up the company's TV operations, and Parent has lured talent, including comedian Kevin James and Jim Carey, for future films. MGM has high hopes for a film version of its 1980s TV show Fame in September and is finishing production on the low-budget horror flick Cabin in the Woods and others. It also holds a half-interest (along with Warner Bros.' (TWX) New Line label) in The Hobbit, a "prequel" to the mega-hit Lord of the Rings.

Clearly, the game plan for both companies is to make enough profitable films to live to fight another day. But it costs money to make and market films, and neither company has much of that in reserve. MGM, which has a $200 million revolving fund for its advertising budget, needs to find a lender to refinance a $250 million credit line that comes due next April. To help fill its coffers, the Weinsteins revamped their distribution deal with Genius in January, cutting their controlling 70% stake to 10% and taking $43.3 million for money owed to it for distributing films. Genius also hiked the distribution fee it had been paying the Weinstein Co.

If you're a private equity investor in one of these companies, you're probably squirming a bit in your seat right now. MGM's debt holders recently formed their own committee, a clear sign that the restructuring the studio envisions will pit lenders against equity holders. The Weinstein Co.'s equity holders, which control half the board seats, are said to have increased their oversight of the company's operations in recent months. Representatives of Providence, Texas Pacific, and Goldman did not return calls or make executives available.

Dilution is Possible

Equity players are likely squirm even more. In the coming months the Weinstein Co. is likely to hit up investors for a stake in its animation studio, which made the 2005 animated hit Hoodwinked. That could dilute existing private equity players. And there's buzz in finance circles that private equity funds such as Qualia Capital, which is run by industry veterans Amir Malin and Ken Schapiro, are kicking the tires at MGM and might consider making a play for the studio. Malin and Schapiro know their way around Hollywood, having built tiny Artisan Entertainment into a company with a 6,000-film library they sold six years back to Lions Gate Entertainment (LGF). Their résumé as private equity investors includes low-budget hits.

The picture for MGM and the Weinsteins doesn't look as if it will end well. Qualia wouldn't comment, but those guys know what MGM is worth—which is a heck of a lot less than what its private equity owners are going to want to hear. Yup, it's not only Will Farrell that's making folks cringe in Hollywood these days.

Grover is Los Angeles bureau chief for BusinessWeek.

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