Reporting from 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, last week demonstrated 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
On Wednesday, 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.
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 & Co. entertainment banker who is consulting for Veriana.
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.
“Obviously the futures industry is new to film, but I look at what it did to the energy market and the agricultural market,” said Richard Jaycobs, who is overseeing the Cantor Exchange after working at a number of futures markets. “There will be a whole bunch of strategies that will develop and make it easier and cheaper to get funding.”
It also remains to be seen whether studios and producers will be willing to bet against, or short, their own films. In a business where relationships and reputation are crucial, such a move carries more risks than just losing money.
“I can’t in a million years imagine someone shorting their own movie,” said David Friendly, a producer whose credits include “Little Miss Sunshine.” “It would be like betting on the ‘no pass’ line at a craps table. It’s not going to make them popular.”
Between the two entrants into the new field, the Cantor Exchange may have an edge because for the last nine years it has owned the Hollywood Stock Exchange, an online box-office market that uses imaginary money. Cantor bought HSX in 2001 with the intention of turning it into a real market exchange, but those plans were delayed when the firm, then at the World Trade Center, was devastated by the Sept. 11 terrorist attacks.
Now Cantor hopes for its exchange to be the first of many complex financing products for the entertainment industry. In one of the more ambitious plans, Jaycobs wants to team with filmmakers to create something like an initial public offering of stock in a specific film, staking out a potential new way to finance production.
Government authorities have generally approved only those futures exchanges that allow for the redistribution of a preexisting risk. Sports betting is not approved because, unlike a farmer selling a futures contract to offset losses from crop failure, neither party involved in the wager has an economic interest in the underlying event.
“You have huge predictions markets like this, but they’re basically on the Internet,” said Menachem Brenner, a finance professor at New York University. “It’s like horse racing, where there’s no other side to the bet.”
Cantor and Veriana have drawn different lines on who can place bets. Cantor will allow anyone to buy a contract for as little as $50, but Veriana will admit only qualified investors, such as studios and Wall Street traders.
“The day that a widow or orphan bets against ‘Finding Nemo 3' -- that’s not a good day,” said Rob Swagger, Veriana’s chief executive.
If the market attracts enough traders, they could provide studios with a useful source of predictive data on how movies will perform.
The wisdom of crowds -- even a savvy one -- is far from perfect, however.
At the Cantor event last week, participants came to a consensus of $230 million for the first month of box office for “Alice in Wonderland.”
But the Disney movie ended up grossing $116 million on its first weekend alone, meaning that it will easily surpass $230 million within a month.
“The thing about movies is that there are lots of people who are entertained by talking about them,” said Eric Zitzewitz, a professor of economics at Dartmouth College, “and there are lots of people who think they know more than they really do.”