Guest article written for AllAboutAlpha.com – the official publication of the Chartered Alternative Investment Analyst (CAIA) Association
“…Over the next five years, global spending on entertainment and media is projected to rise from $1.6 trillion in 2011 to $2.1 trillion in 2016, a 5.7 percent compound annual advance….” (PwC’s Global Entertainment and Media Outlook 2012-2016).
This is an astonishing figure, but when you consider the breadth and depth of media, it’s easy to see why. Alongside food, clothing and energy- media is one of the few industries that pervades into the lives of practically every consumer on the planet- delivering content ranging from news to gaming, films, TV programmes and more. As technology has advanced, the number of channels (and types of content) has grown meaning that investors can now access everything from global hits (such as the film Avatar which grossed over $2.7billion in cinemas alone from an investment of around $300million) to niche events and productions targeting specific communities.
Entertainment and media are growing and globalising. Media assets which once would have only been shown or experienced in their country of origin are now global instruments, which can be exploited in markets worldwide. Previously developing economies such as India, Latin America and Asia have also become incredible consumers (and producers) of media. These fundamentals represent a powerful case for investors. Real estate is currently the most popular form of investment due to its lucrative and generally safe nature, with loads of investors looking for the best place to buy a house under 100k, but it looks as though media may soon be overtaking it.
To learn more, I spoke to James Clayton, CEO of Ingenious Investments who- since their debut in 1998- have raised and invested over $10bn in the media and entertainment sectors. Their portfolio includes films such as Avatar, Rise of the Planet of the Apes, X-Men: First Class and TV productions such as Law and Order UK, Monroe and Foyle’s War.
James is the Chief Executive of Ingenious Investments with overall responsibility for the company’s fund raising and investment activities across its target sectors of media, clean energy, sport and leisure. James’s previous roles at the company include Business Development Director and Chief Operating Officer. James qualified as a solicitor in 1999 and prior to joining Ingenious in 2003, worked for a leading media and entertainment law firm specialising in media finance.
Q: What is the case for investing in media?
[James Clayton] Our model is very much investing in media cash-flows. We don’t take positions in quoted media stocks, as that introduces too much exposure to volatile equity markets- and media tends to get hammered more than other sectors when the markets have any degree of turbulence in them.
We tend to invest in project cash-flows. This means you’re not correlated to the market. That, combined with growing global demand for premium content- powered by the rise of middle-classes in emerging markets, and advances in technology that make it easier for us as consumers to enjoy content where, when and how we want to do- all signal upside.
We’re platform agnostic. People tend to see the market in terms of discrete sectors such as film, TV, music, video games, live and so on. We like to invest in content you can view many different ways- and that gives us depth and diversity within our portfolio. It’s also important to make sure that you do invest on a portfolio basis… content is a very hit driven business- and you still need the hits to pay for your misses!
Looking at Film:
Q: What makes a film ‘investable’?
[James Clayton] The first thing I’d say is to quote an old saying by William Goldman which is, “…in this business, nobody knows anything…” – otherwise it would be sure fire and completely fail-safe!
On features we look for two key things. Firstly, the track record of the film making team- next, that the project has access to the best possible distribution. When we’re investing in independent films, we look for market tests in the form of pre-sales. This demonstrates that there are end-buyers for it. When we’re investing in studio-films, it’s about finding the closest possible alignment with the interests of the studio itself and making sure we’re accessing the economics of studio distribution.
Q: What are the risks associated with film investment, and how do you mitigate them?
[James Clayton] It’s primarily performance risk. The great thing about film is that the capital structures allow you to pick where you want to be on the risk-return spectrum. If you’re looking for lower risk, you can sit where the banks used to- advancing money against known collateral (usually in the form of tax-credits or pre-sales). If you want more risk- but equally more return- you give yourself more exposure to the film’s performance, and how it plays in the markets.
Q: Looking at projects in your portfolio such as ‘Avatar’, what made you choose them- and how did they perform against expectations?
[James Clayton] One of the common ingredients in some of our big studio successes is our studio partner 20th Century Fox. In our early days of film investing, we worked with a broad mix of studios. Through no particular intent, it just happened that the relationship that we built with 20th Century Fox- and the success we had with them- earmarked them as a fantastic partner. They take a very long term view to looking after their financing partners because they realise that co-financing is a very important part of sharing risk and reward- and it’s not easy money to come by!
On projects, we run a various different scenarios as there are a number of factors that can affect a film’s performance. We commit before a frame of the film is shot- at the point at which there’s a script and creative elements in place. A lot can happen in the 18 months to 2 years before the film is shown to an audience. You’re talking about equity style returns, and a multiple return on the capital at risk
When it came to Avatar… James Cameron’s track record was just second to none- phenomenal. The creative vision he had to that film, tied to Fox’s commitment in the movie and the advances in technology made it seem- at the time- quite an easy decision.
Looking at TV:
Q: What makes a TV production ‘investable’?
[James Clayton] You’re still looking for the same basic ingredients as you see with film. The track record of the producer, access to distribution, and your own assessment of how well the piece of content will perform internationally. That latter element is what you look for to drive your higher return- this ability to cross-over and travel across borders.
Q: What methodologies do you apply when investing in TV productions?
[James Clayton] TV has a very different risk-profile to film. When you’re investing, for example, in a studio movie- you are taking equity risk. Then it’s all about how the film performs. TV, particularly in the UK, has a much lower risk economic model for investors. We will commit at the point where a producer brings us a programme that has a commission behind it from a broadcaster. Under the terms of trade for the UK, that broadcast commission will often account for a large proportion of the budget- so to a certain degree, provided the producer can make and deliver that programme on time and on budget (which of course, is where your due diligence comes in…)- your financial exposure is mitigated.
You do have some risk about how that programme will perform in ancillary markets, but that’s what attracts us. The demand for premium content globally is increasing, and the quality of UK prime-time drama has improved leaps and bounds in the past decade. It’s a very valuable commodity to invest internationally.
Q: Has the number of channels and competition in the market affected your returns from TV?
[James Clayton] The demand for content is there, and it’s growing. The digital world has become the ‘new norm’. There are new entrants commissioning content all the time. YouTube recently started to commission their own content for the first time. The great thing about TV versus film is that it’s very suitable to mobile forms of consumption.
Looking at TV:
Q: What is the case for investing in live entertainment?
[James Clayton] Live entertainment is an experience you simply cannot pirate or replicate- and that makes it unique.
The UK festival market has been expanding tremendously. Ticket revenues for the marketplace are up 20% in2010 and in 2010/11 our own portfolio ticket sales were up some 60%. It’s a combination of technology and increased sales opportunities for promoters that driving revenues.
Many investors don’t realise this sector is available to them.
Q: What are the risks associated with live entertainment, and can you mitigate them?
[James Clayton] One of the biggest risks is the sector overheating. There has been a 16% rise in the number of festivals, and while new events will come and go- those that can identify consumer needs, resonate with a niche and an audience- will flourish. It’s a sector that’s been outperforming equities.
To give you an example from our live VCT fund. If an investor had put a £1 into that fund 5 years ago, it would be worth £1.30 today. That’s certainly not the case if you had put a pound into the FTSE 5 years ago! Another one of our private equity funds made a 9x return on its exit from a live entertainment venture called Cream which we sold to Live Nation a few months ago.
While it’s our job to make sure we pick the right partners… the fundamentals of this market remain strong.
Looking at the future:
Q: What do you see as the big sector opportunities in the future?
[James Clayton] Content, content, content.
It’s that ongoing demand for content that drives the market. Whether it’s mobile, gaming or otherwise- it falls under the same bracket. All you have to do is look at the project growth in each sub-sector of media, whether it’s film, gaming, eBooks… it’s huge.
From a venture capital standpoint, going beyond pure content- it’s a great time to be investing in UK creative industry companies – why? because it’s the recessionary vintages that make the best wines!
What does this mean for investors and risk managers?
Entertainment and media have typically been seen as high-risk areas for investors, but as James explains- there are solid ways of controlling risk exposure, and generating significant returns. Like most sectors, entertainment and media require an appreciation of the ‘asset‘ and underlying market- but luckily- there are few people on the planet who aren’t consumers of media, and so there is naturally an appreciation for what you are putting your money into.
For risk managers, the ‘models‘ applied to quantifying exposure in an investment may not work as intended when deploying them in this sector. While one can quantify the previous success of a director and production team- and quantify the value of distribution- the fact is, the ultimate risk is that the finished product is not something which engages the consumer, and that’s a very tough nut to put into numbers. In this sense, while risk managers can create parameters by which the investment is seen as good value or not- they must defer to their human side to determine whether it’s a good investment.
Ultimately, media and entertainment is a sector with strong fundamentals- and with a real growth opportunity. That’s rare in this current market, and a reason for investors to take note.