Is this the biggest show in town?

The major players

Trading on the wide screen

Losing teams need not apply

“On my desk I have the documents for securitizing the writers’ and publishers’ future royalty income on a set of record masters. And in my briefcase I’ve got one which deals with the royalty stream from an author’s copyright.”

So says David Pullman, head of the structured asset sales division of Fahnestock in New York. It’s not quite a boutique (“The bank employs 1,400 people,” says Pullman), but neither is it well known. What put it – and him – on the map was the $55 million deal he arranged for rock star David Bowie at the start of 1997. This deal is regarded as the first securitization of future royalty income, and is based on a portfolio of 300 of Bowie’s tracks. But while such deals attract the headlines their proportion of total securitizations remains relatively small. According to a March 1997 report from consultants Arthur Andersen the total volume of securities backed by intellectual property assets issued since 1991 stands at just $1.6 billion, and many of these were in part backed by tangible assets, compared with $200 billion total securitized issuance in 1996 alone. The many problems involved in securitizing intellectual property mean that a market take-off is still some way off.

In April this year, Pullman followed up with a deal for songwriters Edward and Brian Holland and Lamont Dozier. For those who have never heard of them, they are the creative talent behind the Motown record label. They have registered 70 billboard hits over their career – more than any other writer – and are responsible for hits such as The Four Tops’ Baby I need your loving, Marvin Gaye’s How sweet is it to be loved by you, and Stop in the name of love by the Supremes. Overall, their entire assets have been valued at over $100 million. Pullman put together a deal which draws on just one aspect of those assets, their publishing rights, and it centres on a $30 million loan extended to the songwriters by Fahnestock, which was then repackaged as a securitized private placement. And unlike the Bowie deal, the Holland, Dozier and Holland deal is based purely on the assets – Bowie’s benefited from a guarantee from his record company, EMI.

Pullman has also been working on the possibility of structuring a similar deal for songwriters Crosby, Stills and Nash, and says that he has many other music catalogue deals in the pipeline. But music is not the only avenue he is considering. Other intellectual property assets which he feels are ripe for securitizing include the television syndication rights to various programmes – the one he is linked to is the hugely popular US comedy show, Seinfeld, which drew in a record 108 million American viewers for its final episode in mid-May. The end of the original series should be no barrier, though. “Desi Arnez sold his rights to I Love Lucy for $2 million back in the 1960s,” Pullman points out. “But it’s so popular that the series is still being shown.” Book royalties are another possibility. “Look at authors such as John Steinbeck. He died in 1968, but his book sales still bring in a steady revenue.”

The Bowie deal set off a wave of excitement and hype about how the securitization of intellectual property would take off. Other banks joined in, but, in the music field at least, the Holland, Dozier and Holland issue was only the second which he has managed to conclude.

Others have had similar difficulties. At a conference in June last year on high-yield bonds and leveraged finance, BT Alex Brown’s head of securitization, Lemy Gresh, enthused about the prospects for using intellectual property as assets. He already had several deals in mind, which he won’t make public. But by the end of the year he was less enthusiastic.

Nomura Securities in the US is also finding the going tough. In August last year, the Japanese bank announced that it was to set up an entertainment-finance division, and Ethan Penner would run it. He had established his reputation in asset-backed securities at Morgan Stanley, and at Nomura was responsible for the success of its real-estate finance division, which had lent out over $26 billion to the commercial real-estate industry, warehousing the loans and securitizing a portfolio of them. This was also the plan for the entertainment finance division.

Penner and his team of about half a dozen bankers planned to warehouse loans to musicians, writers, sports stars, independent movie companies and others, to the tune of up to $1 billion. In September news of their first potential deal was leaked to the press – a loan to rock star Rod Stewart, a deal which Pullman says he had declined earlier in the summer. Towards the end of 1997 they were still confident of issuing a package of loans worth $500 million by the end of the first quarter of this year; by February, that had been reduced to $250 million. At the end of May they were still some way off. This is now explained as being the period in which all the groundwork was laid. “We have been researching the industries we want to be involved in, and creating a series of databases in music, films, writing and publishing income, and the like,” says Steve Williams, executive vice-president in what will shortly be renamed the Capital Company of America. “So we have not been actively marketing ourselves in that period.”

Pool of intellectual assets

There are distinct benefits to securitizing intellectual property in this way. One is that the diversification of assets takes away the risk of investing in single names. Second, it allows for a broader range in the amount lent – the general feeling among bankers is that stand-alone deals of less than $20 million are not viable. “By collecting the loans in a pool we are able to identify a broader range of opportunities which simply could not be done as stand-alone deals,” says Williams.

Others are not convinced of the practicability of Nomura’s plans: “There’s a lot of scepticism about their claim to have $1 billion to use on this,” says a London banker whose institution has been forwarding commercial loans to the entertainment business for over a decade. “And some of the deals the borrowers are demanding are structured in such a way that Nomura can’t be making money on them. It does make you wonder if they’re buying their way in.”

Williams is quick to deny allegations of offering loss leaders: “We’re not a credit card to the stars by any means. We look exclusively at the assets and are confident that we can add value in any transaction in which we choose to participate.”

The loan to Rod Stewart was only finalized in April, for $15.4 million. Williams says that although it is the only loan to receive any press, it was not the first they concluded: “We have extended several other loans, all within the music business, and they have been in the range of $5 million to $20 million.”

More banks are considering whether to get involved, more asset classes are being tapped, and bankers, investors and issuers alike are keen to see the market develop. The comment of one delegate at last month’s one-day conference on securitizing music and motion picture revenues and royalties is a good illustration of the nature of this part of the asset-backed market: “There were a lot of bankers there talking about how great they are, without much to show for it, but it was well attended, especially for a conference not tied to an outing to the golf course or something similar. Over 400 people turned up.”

There are several obstacles, however. Timing is one. Most of Pullman’s deals took three to five months to do; the loan for Rod Stewart a year. Also, investors will not have a thorough knowledge of the industry and what is needed to analyze it for the purposes of securitization. “For this they’ll need to rely on the investment bankers and the rating agencies,” says Sean Byrne, vice-president and product manager of asset-back securities at Salomon Smith Barney in London. “And both these groups have to spend a lot of time analyzing the event risks.” These are legion. What if no-one buys Bowie records for six months? What if there’s a lawsuit? Or, on a record company portfolio of song rights, what happens if the company merges with another? Due diligence is designed to cover this for mainstream asset-backed deals, to find out what losses can be sustained while still allowing the interest and, eventually, principle, to be repaid. But intellectual property is different. “It’s not like mortgages or credit cards,” says Byrne. “The sources and stresses of royalty income are different for each deal.”

This also adds to the workload, even for the investor. Byrne worked last year on a proposed $300 million deal for Spelling Productions in the US. The company, named after TV producer Aaron Spelling, wanted to securitize the rights to the TV show Beverley Hills 90210 in order to finance 12 films (not necessarily spin-offs from the TV show).

From one point of view the deal was very interesting to work on. “It’s always nice to find out what these actors get paid, and to run through how various scenarios might affect the revenue stream, such as what would happen if an actor died during filming,” says Byrne. From another point of view it’s a nightmare: “The documentation was huge, inches thicker than that for mainstream deals. And for deals like this investors might be interested, but only in $5 million or $10 million chunks. Too much documentation to work through can put off an investor, especially if a deal yields only a few basis points more than, say, a collateralized bond obligation.” As it was, the Spelling deal never got that far; Viacom, which has a stake in Spelling Productions, was the subject of merger rumours, so the securitization was stopped because of “market conditions”.

Assuming that investors can be persuaded to buy into such paper, the other sticking point is the opportunity cost for the banks. Putting two or more people on these deals, maybe for months on end, costs money, and for the bigger banks there are other deals, larger than the double-figure deals for Bowie and Motown, which can be concluded more quickly, and for more fees. For boutiques and smaller banks such as Fahnestock, or warehouse vehicles such as Nomura’s Capital Corporation, this is not so much of a problem.

Another problem is the clash of the two industries. “It has been a truly educational experience for us since we started,” says Nomura’s Williams. “The whole mindset of Tinseltown is based around creativity. But they have a more, shall we say, liberal attitude towards finance. Combine that with the financial discipline of Wall Street and both have to adapt.”

Never work with artists or bankers

And deals involving the intellectual property of individuals are never easy to execute, especially if they are artists: “We’ve worked on securitization deals for music and film royalties, and even gone so far as to get ratings for them,” says Gresh. “But we’re dealing with creative people, and they can be difficult to predict and are not exclusively financially driven. They probably like the idea of getting a lump of cash, but may be put off by the legal and due diligence requirements.”

And having a lump sum might be attractive to the artists, but the investors will want there to be a decent reason for them to have the cash. Bowie’s reason for raising the money was that he wanted to buy out his manager (who owned a minority of the rights to his music) and get a significant amount of cash up front while still not a UK resident; taxation on royalties in the UK, were they to go straight to Bowie, would be higher than that on the $55 million received in the US from the securitization.

Few artists will have such a need, even fewer own the rights to their work to the extent that Bowie does, let alone be able to boast income streams as consistently high as his. The obvious conclusion is that such deals are unlikely to become the norm. Pullman is aware of this: “Transactions such as those for David Bowie are only applicable for the top 10% of the business at most, so we had to develop other avenues if we were to continue.”

Intellectual-property securitizations are therefore more likely to be conducted on behalf of institutions. “The first question which has to be asked about a deal for an individual is do they need the money,” says Goldwasser. “If they can use it better now, and have a plan for it, such as setting up a recording company, or buying back rights, as Bowie did, then fine. But it is much easier to pitch deals to companies, as they have a more diversified series of needs, and ways of funding themselves.”

Companies are also more open to persuasion, says Gresh: “If an equity analyst is not happy with a listed record company’s balance sheet, for example, he can say to it: ‘You’re not exciting enough as an equity bet, and you concentrate too much on annuity income, so I’m going to downgrade you.’ Securitizing music rights would be an ideal option for them.”

But the potential for growth as the media and entertainment sector restructures is enormous. Tapping assets such as royalty streams may also enable smaller companies to maintain their independence. “The money involved in some of these strategic plays will be significant,” continues Gresh. “In the past the solution would have been to sell some of the assets. In the future they might decide to raise the necessary capital by securitizing the asset instead.” Pullman regards this as one of the major growth areas.

“We are specialists at getting hold of sub-investment-grade companies and turning their debt issues into investment grade by the judicious use of their assets,” he claims. “This is particularly useful for small companies which might want to maintain their independence from the big boys but would otherwise not have the means to raise the necessary capital. Handmade Films sold the rights to Monty Python last year, for example. We could have securitized the revenue streams and allowed them to keep those assets.”

The potential is certainly there to be exploited, even for the larger companies: “Look at the companies in the FTSE 100,” says Andy Clapham, head of securitization at Greenwich NatWest. “At least 50% of them have intangible assets such as trademarks and copyright which would be ideal for using as security.”

How to decide which deals to follow up has been taking up a great deal of time. Since the Bowie deal first highlighted the potential, all the banks which have been examining the market have had to sort out the dross from the potentially good deals.

Here Williams says he has been especially careful. “We’re not just brokers. We’re creating loans which go on our own books. I could probably lend $250 million tomorrow, but ultimately we’re the ones taking the risk, so I have to convince myself that the loans we’re making are ultimately suitable for securitization.”

One potential deal last year which had bankers particularly worried involved Death Row Records, which specializes in producing gangsta rap music.

Last October lawyers acting for Death Row sent a standard letter to all the banks involved in entertainment finance – and more besides – inviting them to offer their services. The assets to be securitized were the rights to the music of several gangsta rappers who have recorded on the Death Row label, and three in particular: Tupac Shakur, Snoop Doggy Dogg and Dr Dre.

It is not so much the back catalogue that has put bankers off the deal, although not all are convinced that it is the most viable proposition and the genre has enraged middle America. Rather, it is just about everything else to do with the potential assets. Death Row Records is owned by Marion “Suge” Knight, in jail and the subject of a Federal Rico (anti-racketeering) investigation. One of the three rappers, Shakur, was shot dead in Las Vegas in 1996. And the two surviving artists – and Shakur’s family – were in litigation with Death Row, arguing that they, and not the company, ought to own the rights to the music. (Earlier this year, the courts decided that the rights to Tupac’s records do, indeed, belong to Death Row).

So the bankers were being asked to arrange a deal for a company under federal investigation, whose boss was in jail, and which was locked in a legal battle over the very rights it wants to securitize. What’s more Death Row was requesting a bridging loan of between $6 million and $10 million, without conditions, to be forwarded before last November 25. In other words, delivered in time for “Thanksgiving week,” reads the letter from Death Row’s lawyers, “so that our clients can more fully enjoy the festivities.” The loan would then have been redeemed with some of the proceeds of the securitization, which Death Row hoped would be in the region of $25 million to $30 million.

And any deal could quickly be scuppered if the Rico investigation rules against Death Row. Any deals struck by the company would then be rendered null and void.

“The bankers would lose their commission, and investors who thought they’d locked their money in for 10 years, let’s say, would lose out badly because they would get their money back after just a few weeks or months,” says a banker who refused the deal. “And that’s without even considering the legal battle over the majority of the rights that are to be securitized.” Initially it seemed that all bar Nomura had refused to get involved. Rumours were circulating at the end of last year that Penner’s team was considering a bid, but they, too, have rejected it.

Other asset classes have already been tapped – films and sports receivables being the two major areas (see boxes) – and others, such as future receivables on computer software, are also being considered. If the bankers can continue to spot and throw out the crank suggestions, then intellectual property could become a significant, if not enormous, asset class. Fun at last for a market neck deep in less exotic receivables.