New York and Los Angeles: Welcome to Hollywood's newest version of risky business: movie derivatives.
Two trading firms, one of them an established Wall Street player and the other a Midwest upstart, are each about to premiere a sophisticated new financial tool: a box-office futures exchange that would allow Hollywood studios and others to hedge against the box-office performance of movies, similar to the way farmers swap corn or wheat futures to protect themselves from crop failures.
The Cantor Exchange, formed by New York firm Cantor Fitzgerald and set to launch in April, demonstrated this month its system to 90 Hollywood executives in a packed Century City hotel conference room.
Amid a spirited trading-floor atmosphere, the participants shouted out guesses and made bets on how much Alice in Wonderland might rake in at the box office.
Indiana company Veriana Networks, which says its management includes "veterans of the Chicago exchange community", unveiled the Trend Exchange, its own rival futures exchange for box-office receipts.
Both firms say they expect to win regulatory approval within the next couple of months from the Commodity Futures Trading Commission, which oversees futures markets.
Obsession
With handicapping the weekend box office now a topic around the family breakfast table, Cantor and Veriana hope they can harness the national obsession to create a safety net for the risky and expensive business of producing movies.
If Universal Pictures, for instance, had traded a futures contract for The Wolfman, it might have mitigated its losses on the recent flop.
"There is a tremendous amount of risk in every movie and a need to manage that risk," said Don Chance, a finance professor at Louisiana State University who has studied financial exchanges for the entertainment industry. "I would think a futures market would have great potential to do that."
Reducing the financial risk of filmmaking through futures contracts, a type of derivative, could bring more investment to Hollywood.
The surge of private equity money into the movie business a few years back has dried up because returns were uneven and often lower than promised. "This product could help to even out the volatility of the movie business," said Clark Hallren, a former JPMorgan Chase & Company entertainment banker who is consulting for Veriana.
Reduce risk
Although the backers say the main purpose of the exchanges is to reduce risk, it could also allow a lucky speculator to profit enormously by betting the long odds on a dark horse. For example, someone who bought a contract for the seemingly unlikely outcome that The Hangover, last summer's raunchy comedy, would be a blockbuster could have made a killing.
But the markets, some say, could be subject to conflicts of interest and manipulation by Hollywood insiders. If someone involved in a film saw the results of a test screening or knew how much would be spent on marketing, for instance, he or she might have a big leg up over the public.
"Insider trading seems like it would be a non-trivial issue," said Isaac Palmer, managing director of media and entertainment investment bank Mesa. "If a studio is hedging a bet on its own movie, wouldn't that be insider trading by definition?"
Cantor and Veriana say they plan to guard against conflicts of interest by collecting employment information about each user of their exchanges, closely monitoring big trades and limiting the amount that investors in a specific production can invest in its box office.
The bigger question, however, is whether Cantor and Veriana can persuade professionals in the insular entertainment business to adopt the type of complex financial tool that, as evidenced by the recent mortgage meltdown, doesn't always work smoothly.
