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Welcome to the Alts Sunday Edition.

Hope you enjoyed last week's issue on why cocoa spiked, and what's next.

If you’re looking for an investment with panache, it’s hard to beat film financing.

Investing in movies has enormous red-carpet appeal, with the added hope that the project takes off, there's a big Hollywood premiere, and you're a part of it all.

But while investing in films is sexy and compelling, the chances of success aren't great, and the economics often leave something to be desired.

So today, we’re going to look at film finance strategies that may be more promising — ones that can pay off even if the movie is a flop.

I previously worked for a wealth management firm with an entertainment hedge fund practice. While I was never in a decision-making role within the hedge fund, I picked up a few important things about how this world works.

These are the strategies I saw employed during my time there.

Let's go 👇

​Note: This is a paid issue. Since you have the All-Access Pass, you get the full thing. ✅

The problems with film investing

Traditionally, investors access this space by providing filmmakers with cash in return for an equity stake in their project.

Under this model, returns are closely linked to box office performance.

Here’s the problem — box office performance is notoriously unpredictable, and the cards are usually stacked against individual investors:

• 97% of independent films don't earn a profit. Like with venture capital, you need to take a lot of shots on goal to score a winning project.
• Film investment agreements often (but not always!) include provisions entitling distributors to earn fees and recoup marketing expenses before investors see a dime.
• "Hollywood accounting" can be used to figure out a way to make a film look less successful than it really is when it comes time to repay investors.

Film finance can still be lucrative! But these pitfalls mean the naïve strategy of tossing money at a random indie project and hoping for the best won't work very well.

First, you need to understand is that not all genres are equally promising.

Horror films are scary lucrative 🧟‍♂️

When you think of the most profitable movies, your might think of big-name superhero/sci-fi stuff.

While movies like Avatar and Avengers: Endgame take the cake when it comes to top-line performance (each grossed over $2.5 billion), they’re not necessarily the best projects from an ROI perspective.

Here’s why: while these movies definitely make a lot of money, they’re also incredibly expensive to produce.

Endgame, for instance, had a production budget of $400m. Meanwhile, Avatar apparently cost slightly less than that (although some reports indicate a figure over half a billion.)

As investors, we don’t necessarily care about how much money a film makes overall. Instead, we care about how much it earns per production dollar spent.

When it comes to slim budgets producing high earnings, there’s one genre in particular that stands out – horror.

Low costs, high earnings

As Wyatt wrote about last August, horror films are a goldmine.

Standout films like Paranormal Activity (2007) and The Blair Witch Project (1999) boasted production budgets of just $450k and $600k, respectively.

Despite shoestring expenses, both have cleared at least $200m worldwide and spawned a slew of sequels.

Even horror movies that are less culturally memorable can still perform incredibly well.

​The Gallows (2015) cleared $40m on a $100k budget, although you’d probably be hard-pressed to find people who remember it today.

Considering these economics, it’s unsurprising that some Hollywood studios have dedicated themselves almost exclusively to horror — including Blumhouse Productions.

Blumhouse has been involved with many of the biggest horror films of the past few decades, including Paranormal Activity, Insidious, The Purge, Split, Get Out, M3GAN, and Five Nights at Freddy’s.

And their strategy of backing low-budget horror flicks has resulted in some impressive figures, including a 997% median return on investment (!) which is leaps and bounds above major studios.

How does horror get away with being produced so cheaply?

One big reason is that horror movies don’t need to actually be “good” to satisfy audiences — they just need to be scary.

Case Study: Gone Girl vs Annabelle

In 2014, two movies went head-to-head at the box office, and provided a perfect case study for understanding how horror movies differ from other genres:

1. ​Gone Girl, the psychological thriller directed by David Fincher featuring Ben Affleck, Rosamund Pike, and Neil Patrick Harris, and
2. ​Annabelle, a low-budget horror movie with basically no big stars, and a director whose last film (The Butterfly Effect 2) was described as “an abominable, pointless sequel.”

Gone Girl received rave reviews from critics (87% on Rotten Tomatoes) and is still culturally relevant today. Annabelle, meanwhile, got poor reviews (28%) and was quickly forgotten.

Critically speaking, Gone Girl was clearly the better movie. But which one was the better investment?

You guessed it. Gone Girl cost $61m to produce, and grossed $367m (6x return). Annabelle cost $6.5m, and grossed $256m (for a 39x return!).

So despite having one-tenth of the production budget, Annabelle was vastly more profitable for investors.

See, while bad reviews are associated with negative ROI in genres like action, drama, and comedy, the same isn’t true for horror.

This means horror studios don’t need big-name directors, A-list actors, or expensive locations.

Instead, they just need to terrify the viewer — which isn’t very expensive to do.

This isn’t to say that all horror movies are good investments — they can easily flop like any other film.

But if you’re going around investing money in cheap indie flips, nothing seems to have a better chance of success than horror.

What are the best alternatives to equity financing?

Just because you invested in a horror film doesn't mean you're safe. You’re still dependent on the film getting financial success.

You need to move beyond equity investing to get returns that aren’t dependent on a film’s commercial success.

One completely different strategy (which is rarely discussed) is buying film project cashflows.

The two most popular types of cashflows you can invest in are Tax Credits and Negative Pickups.

This strategy gets a bit technical, but the details help provide insight into how movies really get made — and how you can make money from the process.

Let’s start with understanding tax credits, and why they’re more intriguing than the name implies...

Film tax credits

Tax credits are a huge part of film finance, with 37 US states offering some form of state-wide financial incentive for movie production.

Now, with a name like "tax credits," you may think that film projects simply get a reduction on any state taxes they owe after production.

But the name is a bit misleading — this is not the whole story. (Especially considering that most studios end up owing little in state taxes.)

There are three basic types of tax credits:

1) Refundable

A refundable tax credit allows production companies to claim a refund of production costs spent in the state, even if no taxes are owed.

In New York, this refund can be up to 40%!

2) Transferable

A transferable tax credit must be used to offset state taxes. But interestingly, it can be “transferred” (i.e. sold) to other parties.

These credits are also usually a percentage of production costs. Georgia offers up to 30%.

3) Non-refundable & non-transferable

Non-refundable & non-transferable credits align with the common expectation for what a tax credit is. You can’t sell it, and you can only use it if you actually owe state income tax.

Critically, these tax credits aren’t paid upfront. You typically have to spend a certain amount in qualified production costs to qualify.

This dynamic (where production companies only get paid after making the movie) makes tax credits similar to the second major form of predictable cashflow: negative pickups.

What are negative pickups?

Indie filmmakers usually need to work with distributors (and these days, streaming services, which are essentially distributors) to get their completed movies in front of audiences.

If filmmakers have a compelling project, they can approach distributors before production, and ask for a guarantee that the distributor will purchase the film when it's done. This arrangement is known as a negative pickup.

There are a lot more details behind the scenes, including completion guarantors, who act as insurers to guarantee the film’s delivery.

But the basic idea is simple: if a filmmaker finishes the movie on time (and in accordance with the script) the distributor agrees to pay them a fixed price for the right to screen (and profit from) the movie.

Buying film receivables

As you can see, both tax credits and negative pickup arrangements give filmmakers the right to collect a predictable amount of cash upon completion.

But here's the problem: to actually produce the movie, filmmakers need money today.

This is where investors can step in. Both tax credits and negative pickup deals can be monetized by selling them to a third party, who can purchase them at a discount.

For example, in the case of tax credits, the counterparty is a State Government. Safe and reliable. So the discount is around 90 cents on the dollar.

(Note: transferable tax credits are easier to sell than refundable ones).

For negative pickups, that discount is closer to 80 cents on the dollar, but it can get lower depending on the credit quality of the issuer. Loans against negative pickup deals are also common.

This discount represents the potential investor returns.

The final, actual return depends on how long it takes the film to get made so you can realize the promised cash flow.

If you squint, this strategy looks awfully close to receivables financing, a time-tested strategy in credit markets.

Film private credit

In addition, there are also shades of private credit here.

Capital lenders like FilmHedge explicitly call themselves "private credit for media."

Investing in film studio space

Finally, let’s discuss investing in studio space and soundstages.

This strategy isn’t about betting on the success of any one movie in particular. Instead, it’s a pick-and-shovel play designed to profit from the voracious content appetite we’ve seen in the past decade.

The basic idea behind investing in soundstages is that this is specialized real estate, which is relatively cheap to build, but expensive to rent.

In their latest financial results, for instance, Hudson Pacific Properties (HPP) noted that the annualized base rent for their Sunset Gower Studios was $48.80 per square foot.

That’s similar to their office properties in downtown LA, at $47.76 — and considering that much of the square footage in a sound stage is made up of giant empty spaces designed to house sets, it’s not hard to see why this can be economically attractive.

In fact, smart money has been all over this trade since at least 2020, when Blackstone bought a 49% stake in HPP’s soundstage portfolio.

Since then, we’ve seen:

• PE firm Silver Lake invest $500m in Atlanta-based Shadowbox Studios,
• Legendary New York studios Silvercup and Kaufman Astoria both get purchased by PE firm Hackman Capital,
• Bain Capital backed a $450 million+ studio complex in Los Angeles,
• And Blackstone is expanding in this space by financing and part-owning the Pier 94 TV and film studio in Manhattan.

And this isn’t just about renting out the stages themselves. Once you get production teams on site, there are many ways to make extra cash, including office spaces, parking, catering, and lumber/materials sales.

To be clear, there is some evidence this trend might be slowing, as “peak content” might already be behind us.

But with soundstages having similar operational requirements to warehouses, there’s a built-in backup plan for media campuses as logistics hubs if leasing demand starts to dry up.

What are the best film investing platforms?

Today, the vast majority of investment opportunities available to individual investors are crowdfunding equity investments into individual film projects.

This includes the popular Reg CF platforms like Kickstarter, Wefunder, and Seed & Spark.

The problem is that many films on these platforms are "passion projects" not designed to generate real returns.

​Slated is a more serious option to consider. It caters toward individual investments by institutional & accredited investors.

But for the most part, film finance is still basically pre-democratization.

​HPP appears to be basically the only REIT with significant soundstage exposure, and you won’t find a mutual fund backed by negative pickup arrangements.

Personally, I think this is a big gap in the market that should be filled.

Ideally, an online platform would allow investors to pool their money to fund film production, backed by cashflows like the tax credits or negative pickups we discussed!

This style of investing would let individuals invest in film finance the same way many institutions do — by pre-purchasing or lending against assets, not taking risky exposure to box office revenue.

Asset-backed film finance could even be an entirely new category on platforms like Percent or Yieldstreet, both of which would be well-positioned to build out the offering.

Until that happens, the best individual investors can do is likely back the most promising indie horror they can find – or fly out to Cannes or Sundance to try and put together a deal themselves.

That's all for today.

Reply with comments. We read everything.

See you next time,
Brian

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Disclosures

• This is a paid issue. To read the whole thing, get the All-Access Pass​
• This issue was sponsored by Portless
• Neither the author, nor the ALTS 1 Fund has any holdings in any companies mentioned in this issue
• This issue contains no affiliate links