In 2001 and 2009 the investment world was introduced to Nicolas Taleb and his two blockbusters “Fooled By Randomness” and “The Black Swan”. Arguing that some investment styles only work in certain conditions and not to confuse skill with luck, the first book schooled investors to look at a manager’s process not just his results. The second book told the story of explorers in Australia discovering black swans when the prevailing wisdom was that all swans were white. Mr. Taleb introduced us to his investment theory of making small bets on rare and highly unlikely events which is exactly what he did before the correlated market meltdowns in 2008 and 2009. In many ways the venture capital business model is a mini-black swan strategy. VC firms make a series of small bets on emerging business models fully expecting to lose all their investment 70% of the time. Whether it is venture capital or black swan six sigma hedge strategies, the common elements of the business strategy are a multiplicity of bets with a low probability of success, low investment amounts and massively high payouts.
Did Blum Read The Black Swan?
I was really excited last week when I listened to Planet Money’s podcast about Jason Blum entitled “The Business Genius Behind Get Out”. Mr. Blum is a movie producer who has introduced a new business model to Hollywood:
- produce an endless supply of really low budget films quickly
- distribute the film only if it has a chance to sell $25 mil of tickets
- leverage movie industry talent who will trade pay for equity
Take, for example, his first major success which is a horror movie called “Paranormal Activity”. According to Planet Money that movie cost $15,000 to produce but grossed more than $193 million at the box office and generated four sequels. Mr. Blum’s share is estimated to be in excess of $20 million! The really exciting part of the business model is Blum often syndicates risk. If he cannot afford Jennifer Lopez’ salary he will offer her equity. According to “The Hollywood Reporter” in an article by Kim Masters Mr. Blum “has become as polarizing as he is prosperous” with many of his talented partners feeling unrewarded:
“While Blum has put films into production at lightning speed, there is disappointment from some who have worked on them for below-market prices. Many were well aware of Blum’s successes but also knew that he runs no-frills productions. What they found, at least in some cases, were work conditions worse than they had anticipated and, when the films went unreleased, no worthwhile credit. Still, Blum continues to attract directors — many veterans — with a promise of creative control. Blum takes pride in being straightforward with cast and crew: The productions are bare, the pay is low, and no movie is guaranteed a release.”
Some Tape Measure Home Runs
There are some really great success stories. In addition to “Paranormal Activity” there are at least 6 movies where the multiple of invested capital is at least 25x. According to Ms. Masters these are some of the big winners:
“Paramount Studios, faced with increased pressure to cut bloat and release more profitable films, salivate over the three franchises Blum has launched in the past four years: Insidious (a $1.5 million price tag) grossed $97 million worldwide; Sinister ($3 million) grossed $77.7 million; and The Purge ($3 million) grossed $89.3 million.”
To Live With The Classes, Sell to the Masses
Most interesting for me, however, is Mr. Blum’s profits waterfall. According to “The Hollywood Reporter” many of the actors and technical talent who produce these low budget films take significant reductions in their normal compensation in return for big shares of the outlier profit returns. It appears that the intermediate returns (2-10x) are often shared with the director and actors. Of course, as a good self-promoter Mr. Blum gets 12.5% of the first dollar gross which is significantly greater than “even A -list producers get”.
Every venture capitalist in silicon valley would salivate at a 12.5% promoted interest on the first dollar of revenue. Every private equity manager I know would be perfectly happy with taking an outsized performance feature on intermediate returns rather than last dollar participation. What Mr. Blum has stumbled on is a highly scalable industry where profits from the masses intersect with an artistic community where production credit for a big hit may often be more important than making money. I immediately think of adjacent territories for music celebrities like Taylor Swift and fiction writers like J.K. Rowling (Harry Potter) and George Martin ( Game of Thrones). Possibly Jason Blum read page 28 of “The Black Swan”—which by the way was published the year he produced his first movie in 2007– where Dr. Taleb talks about scalable professions and identifies recording artists and movie actors: “You let the sound engineers and projectionists do the work; there is no need to show up at every performance in order to perform.” Before Jason Blum, however, the movie industry was locked into a paradigm where a movie’s worth was often tied to its cost as a weighty indicator of success. Notwithstanding great directors, famous actors and magnificent special effects, there were simply too may “Water Worlds” in Hollywood.
A Swing and Miss Model for the Ages?
Mr. Blum has hit a few Joey Gallo dingers in the last six months. First, he is projected to gross $200 million on “Split” which cost only $9million to produce (20x) and maybe as much as $175 million on “Get Out” which cost only $4.5 million to produce (30x). It has probably dawned on Mr. Blum that his business model will invite competition and the barriers to entry cannot be that high. In this case, the first mover advantage might land Jason Blum in the Forbes 500. And while he is obviously hitting a number of impressive home runs, he strikes out 5 times as much as most of the home run hitters in my fantasy baseball league and gets paid even more handsomely for failure than the best clean up hitters. Let me know if you see any more opportunities like this. I am all in.
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