The plot: Executives for a certain film studio dream about issuing a new investment vehicle to finance their siege upon the entertainment industry. Yet despite the most notorious cast of characters in the business - Steven Spielberg, Jeffrey Katzenberg and David Geffen - structurers managed to tame the beast of insolvency issues, paving the way for rating-managed risk for Hollywood's new war chest vehicle and, inadvertently, "Shrek."
Such was the story that unfolded before the audience at Standard & Poor's New Assets Halloween Hot Topic Conference, where a case study of DW Funding LLC, a special purpose entity (SPE) for entertainment behemoth Dreamworks, captivated attendants with silver screen tidbits and issues of true sale versus licensing.
Dreamworks sought to raise a $1 billion revolving facility though the DW Funding vehicle. Considering that since 1994 Dreamworks has released 35 live action films and six animated films, grossing over $6 billion worldwide, completing this massive film securitization should have been as easy as, well, buttering popcorn.
But how risky is it for investors to bet that an audience will take to a film? Case in point: the inability of "Swept Away", staring pop culture icon Madonna, to fill a single row in the theatre versus the cash cow that the relatively low-profile "My Big Fat Greek Wedding" became this past summer. How do you rate such a risk?
For starters, according to CFO of Dreamworks Anthony Hull, a film that grosses $100 million at the box office generally makes $237.1 million for the studio on average - a figure that includes half of domestic box office receipts as well as video, DVD, network and cable licensing fees.
Then there's the makeup of the SPE itself. In this case, "the SPE gets the low risk, high margin part of the film," said Hull. The pre-production burden for every film falls on the studio's shoulders. After a film's first eight weeks of release, it is then sold to the SPE, which lays claim to all its revenues - overseas box office receipts for example - not to mention exclusive access to receipts from the re-issue or re-licensing of a film.
"By the time the film is sold to the SPE, the revenues are very predictable," Hull added.
Furthermore, this film securitization included 36 Dreamworks films, which carried previously defined television licensing fees. Thus, a network such as ABC would have no say in choosing to pass on a bomb like "Swept Away" in favor of broadcasting the sleeper hit of the summer.
"The broadcaster has to take every film, and that's an important credit enhancement," the CFO said.
The tangle with legalities
Unlike the magic it produces, the Dreamworks' film securitization story does not wrap up nicely in under 120 minutes - not without a nemesis at least. Enter the legalities surrounding what constitutes a true sale; in this case, the sale of a film from the studio to the studio's SPE.
"In the acid test of bankruptcy, the vehicle has to not be pulled into [the parent's] bankruptcy," said James Penrose, managing director and associate general counsel for S&P.
In short, due to the nature of the bankruptcy code, all property of the parent can be pulled into bankruptcy litigation. Given that DW Funding's assets are derived via a sale from Dreamworks, insolvency posed particular peril to the securitization. Was the sale of a movie from the film studio to the SPE enough to ensure the property of the SPE was protected from insolvency issues should Dreamworks fold?
A court opinion involving the 1997 bankruptcy case of the Recorded Picture Co. gave the rating agency its best shot at an answer, from a credit risk perspective. In that case, the court wrangled with the question of whether intent to actually sell the asset is demonstrated when a title passes between parties.
What made the court's opinion novel, said Penrose, was its decision that the transfer of a title was not akin to an absolute sale if the totality of the rights is not sold as well - making a mere licensing agreement out of what used to be a sale.
"The Dreamworks deal is protected by the fact it includes everything but domestic theatre receipts and domestic TV rights," said Penrose, setting up the confrontation between absolute sales and licenses should insolvency issues arise.
Penrose concluded, with the aide of a legal authority outside of S&P, that the ruling in the Record Picture case would not apply to Dreamworks or its SPE; there simply wasn't enough litigation. So they had to draw up clear and legally sound theories of their own.
The securitization vehicle, by its very nature, transfers the risk from the studio to the SPE. "The risk of the loss has been allocated, so Dreamworks is considered to have parted with the property," said Penrose.
However, in the worst-case scenario, the sales would be viewed instead as licenses. Given that a license is considered an existing contract according to U.S. bankruptcy code, an insolvent debtor could argue a void contract (which deals with intellectual property) and the SPE would be protected by what Penrose described as "squatter rights" deriving from the intellectual property classification.
"Due to the existing nature of the contract, [Dreamworks' bankruptcy] could not collapse the DW Funding vehicle," Penrose said.
With all parties firmly convinced that the SPE was not subject to undue risk from parental solvency issues, the securitization moved ahead. And like most any Hollywood story, with the dark cloud came the unexpected silver lining.
According to S&P, when it came down to issuing ratings to the parent and the vehicle, the securitizaition actually helped the bankruptcy profile of the parent, as the proceeds from the transaction were used to retire existing parent-level debt.