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Why investors should have doubted Relativity Media's charming wunderkind

Why investors should have doubted Relativity Media's charming wunderkind
Many who have followed Ryan Kavanaugh's career mention his “charm,” and the seductive if convoluted logic of a financing scheme he pitched that would somehow limit investment risk in the incredibly volatile business of movies. (Michael Buckner)

Hollywood moguls and Wall Street hedge fund operators have a few things in common. They live and work among smart, sophisticated people, while billions of dollars flow through their fingers. They also seem equally susceptible to a glittery line of chatter.

Some might say that's the best explanation for the phenomenon of Ryan Kavanaugh and his entertainment company, Relativity Media.

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After years illuminating the Hollywood firmament, first as a conduit for hedge fund money seeking to invest in movies, then as a "mini-major" studio turning out pictures on its own, Relativity filed for bankruptcy July 30.

What looks to be Relativity's ultimate crash gives us an opportunity to examine what a screenwriter might call the arc of Kavanaugh's career. At the center is the question: Why did people line up to invest money with Ryan Kavanaugh?

Many who have followed his career mention his "charm," and the seductive if convoluted logic of a financing scheme he pitched that would somehow limit investment risk in the incredibly volatile business of movies.

Yet investors who performed due diligence on Kavanaugh might have found grounds for doubt. (My instinct after my own first meeting with Kavanaugh was to verify his claim to have a degree from UCLA; it didn't exist.) In the late 1990s, Kavanaugh operated a Santa Monica investment firm from which sprung a number of lawsuits and threats of legal action from unhappy investors, some of whom accused him of fraud. Hollywood producer Jon Peters, a marquee investor, threatened to sue to recover his $5-million stake; according to a legal ruling, Kavanaugh settled with Peters before the producer could file.

The longest-running dispute involved Los Angeles PR executive Michael Sitrick, who invested $6.2 million with Kavanaugh on the understanding that it would be invested exclusively in publicly traded companies. After discovering that some of the money was going into private companies, Sitrick sued to get his money back and in 2002 won a $7.7-million arbitration judgment. The judgment went largely unpaid, as Kavanaugh claimed the dot-com crash had left him almost penniless and his business essentially worthless.

Kavanaugh soon resurfaced in Hollywood. His pitch to hedge fund operators had several elements. One was that by investing in "slates" of a dozen movies or so, they could dilute the risk that a single bomb would torpedo the whole portfolio. The deals would be structured so the investors could collect years of revenues from ancillary sales of TV and DVD rights. Finally, there was the magic dust — an algorithm that could gauge the prospects of a film project based on such inputs as its cast, writers, director, genre and what Kavanaugh told a Vanity Fair writer was data from "every single film that's come out in the last 10 years."

Hedge funds had started jumping into slate deals in 2006, enticed by projections of annual returns of 18% or better. The studios happily hoovered up the proffered cash; Kavanaugh's Relativity announced a deal with Deutsche Bank to pump $620 million into productions at Sony Pictures and Universal Studios.

Reality soon intruded. A few box-office bombs proved to be sufficient to sink even a slate with a few hits. One Relativity slate examined by The Times in 2008 was headed for a loss despite the inclusion of the Will Ferrell blockbuster "Talladega Nights." Three bombs on the list, including the Ferrell stinker "Stranger Than Fiction," were on course to lose $84 million among them. Kavanaugh's formula didn't seem to be an infallible gauge of audience taste after all.

Investors began to see that the slate deals heavily favored the studios, which were able to load down the investors' portfolios with uncertain projects while keeping the surest blockbusters, and their profits, to themselves. Meanwhile, DVD sales were flatlining, cutting the overall profitability of the Hollywood product. Hedge funds, including some that invested with Relativity, quietly began looking for the exits.

But Kavanaugh's business footprint kept expanding. Glossy magazines and trade publications bought into his projected image as a wunderkind. They slavered over the delicious incongruity of this young thruster mixing it up with gimlet-eyed corporate lawyers, and winning. The short-lived Portfolio Magazine depicted him as a "red-haired and impish" 32-year-old conducting a 22-hour negotiation in a New York law firm's conference room. Three years later, Vanity Fair noted: "Most promising of all," Kavanaugh has just sewn up distribution rights with Universal for "James Cameron's Sanctum, his 3-D follow-up to Avatar." (That 2011 underwater thriller sank beneath the waves.)

In his lifestyle, Kavanaugh seemed to follow the advice of Max Bialystock in Mel Brooks' "The Producers": "Baby, when you got it, flaunt it!" There was a collection of vintage cars, beautiful women on his arm, parties with movie stars. He flew his own helicopter from his home in Malibu to his Beverly Hills office (irritating West Hollywood neighbors with the noise). He gave keynote speeches around the world, collected industry plaudits and even an award for philanthropy. He talked about arranging an initial public offering for Relativity.

Financial backers came and went. In 2012 one longtime backer, the hedge fund Elliott Management, started to bail out by selling some of its stake to supermarket magnate Ron Burkle's Yucaipa Cos. Yucaipa eventually invested as much as $300 million, but has gotten all its money back along with a healthy return, according to a source close to the deal. Burkle remains on Relativity's board, according to the bankruptcy filing. But Elliott, through its affiliate Manchester Securities, still is owed $137 million by Relativity.

Bankruptcy documents and a lawsuit by a major lender, RKA Film Finance, indicate that Relativity was heavily leveraged and "cash-strapped." More than $330 million in loans were maturing June 1, with much more coming due if Relativity failed to make the payment — this for a firm whose film business had brought in revenue of only $346.3 million in all of 2014. The films tended to be heavily mortgaged to lenders, leaving little wiggle room.

In its lawsuit filed in New York state court, RKA, which made loans to cover postproduction spending on specific films, portrays Kavanaugh trying desperately to raise new financing during the spring while fending off questions about what had happened to some $70 million of its money.

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RKA, which labels Kavanaugh a "con man," says it eventually concluded that Kavanaugh and his fellow executives used its loans as "their own personal piggy bank," covering Kavanaugh's "personal indulgences, such as the five personal helicopters purchased by Kavanaugh for his daily commute," among other things. Relativity denies the money was diverted, but acknowledges the loan proceeds went into its general corporate accounts until it was needed, a system it says RKA understood.

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What happens next? The fate of several Relativity films, with stars such as Halle Berry, Kristin Wiig and Colin Farrell, is unclear. Someone presumably close to Kavanaugh has floated the idea that he might try to buy the firm out of bankruptcy himself. That may sound dubious, but it's a safe bet that even if we've seen the last of Ryan Kavanaugh, we haven't seen the end of his type. The next brash wunderkind undoubtedly is already polishing his pitch, ready to watch money and glory come cascading his way.

Michael Hiltzik's column appears every Sunday. Read his blog, the Economy Hub, every day at latimes.com/business/hiltzik, reach him at mhiltzik@latimes.com, check out facebook.com/hiltzik and follow @hiltzikm on Twitter.

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