This American Company Brought Wall Street Money to the Movie Business, Tried Nearly Every Fashionable Idea, and Went Bankrupt

Picture an obscure Chinese company that suddenly shows up with piles of hot money and invests in the big studios' films, Lost in Thailand and the Tiny Times series among them. Its CEO is named entertainment figure of the year and promises to change the movie business. His only flaw is a taste for making bad films. Could such a company still go bankrupt?

Relativity Media, one of the world's largest mini-majors (mid-sized film studios), filed for bankruptcy protection in Manhattan at the end of July. Of its roughly 350 employees, 75 got a layoff call placed personally by CEO Ryan Kavanaugh.

Relativity's best-known films include The Social Network, Fast & Furious, Mirror Mirror and Bridesmaids. Founded in 2004, it was once a promising newcomer. It brought large sums of Wall Street money into Hollywood, won a place alongside the major studios within a few years, and at one point claimed it would rewrite the rules of film production. The press called Kavanaugh "the billion-dollar producer." Variety named him its "Person of the Year" in 2011, and he ranked 19th on Forbes' 2013 list of the youngest billionaires.

As recently as June, an article in The Hollywood Reporter ran under the headline "Relativity Media Expects to Go Public Within 12 to 18 Months." Little more than a month later, Relativity was insolvent. Its book value was about US$560 million; its total debt exceeded US$1.18 billion.

Now imagine it in China: an obscure company suddenly rises, backed by hot money, say from a fund with ties to BAT (Baidu, Alibaba, Tencent). It pours money into films from Huayi Brothers, Enlight Media and LeTV, including Lost in Thailand and Tiny Times, and it is in talks with Hollywood. Everyone assumes an IPO is near. Instead, it goes bankrupt.

Relativity's 11 years read like a "textbook of concepts," packed with the "trendiest" moves: Wall Street, digitization, ecosystems, internationalization. This is a good moment to go back over what has been fashionable in Hollywood, and how Relativity did all of it and still failed.

Relativity Media CEO Ryan Kavanaugh

One day the company appeared, with Wall Street's money, a lot of money

In March 2010, Vanity Fair ran an article titled "The Theory of Relativity." It opened: "At 35, proud and charming, Ryan Kavanaugh has become one of the most powerful players in Hollywood. Relativity Media's reported revenue for 2009 was US$2 billion. His secret? Money, a lot of money. Plus an algorithm that Kavanaugh preaches can lower investment risk and take the mystery out of the movie business."

From 2004 to 2010, Relativity raised nearly US$10 billion for the film industry. That is a large number: in 2009, total box office in the United States and Canada was only US$10.6 billion.

Kavanaugh's capital came from Wall Street. He is Jewish, and his first ambitions were not in film. In the late 1990s, while a student at UCLA, he asked his father one day to lend him US$50,000 to start his own hedge fund. "My dad fell off his chair laughing at me," he recalled. In 1997, at 22, he founded his first company, KCI, which went bankrupt after 9/11. KCI did not invest in film, but in those years Kavanaugh got to know people in the industry, including Charles Roven, producer of The Dark Knight.

In 2002 Kavanaugh came back. He used his contacts to broker deals between the film people he knew and Wall Street institutions. At first Relativity was purely a high-end middleman: it introduced Citigroup and Merrill Lynch to film companies and collected production fees, sometimes a share of a film's revenue as well. Then in 2007, Elliott Management, the hedge fund founded by Paul Singer, took a stake in Relativity and supplied it with about US$1 billion. With that, Relativity could invest on its own.

Overnight, a Relativity with money had the whole film industry's attention. "When Relativity entered the market, producers looked at him the way you'd look at a beautiful woman walking into a prison," Vanity Fair wrote.

In 2008 it became a co-financing partner of Universal and Sony, with the right to invest in 75% of Universal's films. In 2009 it paid US$150 million for Rogue, Universal's genre-film label. In 2010 it acquired a 45% share of the distribution rights of Overture Films, owned by the Starz network, and at last could distribute films on its own.

Relativity invested in Universal's Fast & Furious series

Relativity built a film-investment algorithm and believed it could change Hollywood

In 2015, after the bankruptcy, The Hollywood Reporter asked Kavanaugh: "Given the company's huge debt, did you ever consider that something might be wrong with the business model?" Kavanaugh said: "I stand 100 percent behind our model."

From 2010, Relativity began investing in and producing its own films. Kavanaugh, who idolized Einstein, set out to use science to fix the bugs in the movie market.

"I saw the major studios risking US$250 million to US$350 million on a single film. They can do that because they get US$2 billion a year to invest, so they keep taking risks, and every so often they make a Batman that grosses a billion dollars, and that gives them a 12% return. No hedge fund in the world would sign up for that. Here's US$2 billion, and for a 12% return you accept the risk of losing everything. It's the dumbest business model there is."

On Relativity's production list is a film Chinese audiences know well: The Social Network, the story of Facebook founder Mark Zuckerberg. Zuckerberg, hailed as a "programming prodigy," studied psychology and computer science at Harvard, and in his second year wrote the campus social networking site that became the prototype of Facebook.

What Kavanaugh believed could save the movie market was exactly that: software. His staff used a computer algorithm to calculate a film's risk. They built a database of the past decade's films and used it to assess a new project's genre, production cost and marketing spend. The program ran 10,000 simulated box-office scenarios to calculate the odds that a film would turn a profit, and which scenario would pay best.

"Even if I agree to make a film, if the model doesn't agree, it doesn't happen," Kavanaugh said.

Poster for The Social Network

Relativity wanted to be first to try digital, and was the first to partner with Netflix

Kavanaugh said: "We don't spend money recklessly. But if I said I didn't want my own aces, I'd be joking."

By "aces" Kavanaugh did not mean box-office franchises like X-Men or 007. He meant sales channels and partners that others hadn't thought of.

In July 2010, Relativity signed a five-year contract with the video service Netflix. After a Relativity film left theaters, it would stream on Netflix, instead of going first to pay TV or to DVD.

Netflix was not yet the Netflix of House of Cards (launched in 2013). This was the first time a major film company had given an online video service priority access to a long-term supply of films. "While pay-TV channels such as HBO and Showtime were blocking Netflix from buying film rights, the independent studio Relativity Media became the first to partner with Netflix," the Los Angeles Times reported at the time.

"We are always looking for new ways to grow the business and bring in more revenue," Ryan Kavanaugh stressed. "This is clearly where the movie market is inevitably heading, and it will bring new opportunities to the industry. Relativity and Netflix share a common vision, and our partnership is a change for the film business."

Netflix launched House of Cards in 2013

Relativity had a distribution company in Beijing and saw itself as "both American and Chinese"

Digital media was already among Relativity's partners. What else could count as an "ace"? The international market, for one.

Relativity once planned to list in New York and Hong Kong at the same time. Kavanaugh said: "In a sense we consider ourselves both an American company and a Chinese company."

In 2011, Relativity set up a film distribution and financing company in Beijing, Sky Land Entertainment. According to a Forbes report, that year Kavanaugh met Xiong Xiaoge, Asia president of the Silicon Valley venture firm IDG, at the Shanghai International Film Festival. They negotiated all night, downing a pile of 5-hour Energy drinks, and sealed the deal in the morning. IDG owned an underused distribution company, Sky Land, and Kavanaugh decided to put it to work: "Relativity Media can say that many of its films are co-productions with Chinese companies, which helps in dealing with the government's import quota."

Kavanaugh believed his films would one day earn more at the box office in China than in the United States. In just five years, the number of cinemas in China had grown from 3,000 to 12,000.

Relativity's China office did get things done, above all a good relationship with the state-owned distributor Huaxia Film Distribution. In 2011 and 2012, two of Relativity's bigger investments, Mirror Mirror and Immortals, were released in China through Huaxia and grossed 44.19 million yuan and 80.7 million yuan respectively.

China was not the only market Relativity added to its map. In 2010, with the help of Asian billionaire Keyur Patel, it entered India and set up Relativity Media India to distribute its films there. In 2012 it also co-produced two films with EuropaCorp, one of France's largest film companies.

Relativity hoped that overseas distribution would squeeze more revenue out of cheap films that did only so-so at home. Movie 43, for example, grossed just US$4.8 million in the United States in 2013, but went on to earn US$23 million worldwide. Overseas presales alone covered the production budget, and selling the home video rights brought in a good deal more.

Mirror Mirror

Not just a film company: it had to connect the whole "entertainment ecosystem"

Open Relativity Media's website today and you will see eight sections: film, television, international, sports, digital, music, education, and the restructuring unit that appeared after the bankruptcy.

Once Relativity had some scale in film, it began building an ecosystem around it. Most of the branches revolve around film. It turns hit film IP into TV series, for example, trading on the name recognition and skipping the expensive pilot. For reality shows, the company keeps ownership and keeps budgets low, so a show can make money even with mediocre ratings. The music arm produces soundtracks for its films. The education arm targets profitable film-focused high schools and universities.

Relativity Sports, its sports subsidiary, represents 300 athletes from the NBA, NFL and MLB, handling business negotiations, entertainment deals and public relations for them. The sports division is still operating and is not part of Relativity's bankruptcy.

Arthouse films or moneymaking bad ones? The CEO picked the latter, always

Kavanaugh has a famous line, said to a reporter from Elle: "Do you know how many people saw The Assassination of Jesse James by the Coward Robert Ford (an arthouse film, Oscar-nominated, US$3.9 million at the US box office)? You and seven other people. Paul Blart: Mall Cop grossed nearly US$200 million (a comedy co-produced by Sony and Relativity, IMDb rating 5.3, budget of a little over US$20 million, box office of US$180 million). I will always make movies like Paul Blart: Mall Cop. Always."

"This guy with a lot of money who knows a lot of people showed up. But the question is still what films he made. Look at those films and you'll see the problem," film studies professor Wheeler Winston Dixon said of Kavanaugh.

Cheap, liked by audiences, reviews beside the point: that is the film Kavanaugh wants, and it has a lot in common with the so-called "bad film." This Jewish businessman from Wall Street also keeps a very tight grip on budgets; every million dollars counts. If a budget runs over the price he has in mind, even by only US$3 million, he turns the film down.

Take Movie 43, mentioned above. Released in 2013, it is a collection of comedy sketches by 11 directors, made for only US$6 million. It had big-name stars such as Emma Stone, Chloë Grace Moretz and Hugh Jackman, yet Relativity talked them into taking tiny fees (an impressive feat in itself). The stars did all kinds of bizarre things for laughs. The film has an IMDb rating of 4.3, and at the 34th Golden Raspberry Awards it won three prizes: Worst Picture, Worst Director and Worst Screenplay.

Movie 43

Hollywood was split on the CEO: "the billion-dollar producer" versus "a cancer on the industry"

In November 2009, the film Brothers premiered in New York. In the room were its stars Natalie Portman and Tobey Maguire, Universal president Ron Meyer, Lionsgate CEO Jon Feltheimer, and Harvey Weinstein of The Weinstein Company. The center of attention was Relativity's Kavanaugh, freshly crowned "the billion-dollar producer." He introduced the film and called everyone over for photos.

Weinstein said: "Kavanaugh has a real gift for socializing. At a party, if you introduce a banker to Nicole Kidman and Penélope Cruz, an hour later the two women want to kill you out of boredom. But if the man is Kavanaugh, they fall in love with him. An hour later everyone is signing contracts, singing Dean Martin songs, and flying off together to Capri, though a moment ago they were in Los Angeles."

Hollywood was split on him, and not everyone admired him as Weinstein did. One person familiar with Relativity put it this way: "Kavanaugh is like a Beverly Hills kid whose money came a bit too fast and in too large amounts. All of a sudden he was doing business with Universal and Sony." Vanity Fair described Relativity and Kavanaugh in 2010 like this: "He has also drawn plenty of envy and hatred. Some say he is a cancer on the industry, others a train waiting to derail."

A company like this in China would probably get the same treatment. On one hand, it is on very good terms with internet tycoons, so good that a fund like Yunfeng Capital sets aside billions for it. On the other, it gets along easily with Fan Bingbing and Zhang Ziyi: one moment they are having dinner in Hengdian, an hour later several films are greenlit, a private jet flies everyone to Bali, and they are singing Jonathan Lee's "Shanqiu" (The Hills). Then Huayi's Wang Zhongjun or Enlight's Wang Changtian sums it up in two phrases: "capital operations, cross-sector connections." It is hard to look at such a company calmly.

Brothers

Relativity wanted to be the market's best player but would not make what the market wanted most

"Kavanaugh said he would change Hollywood, but now the company is bankrupt," the Los Angeles Times commented on July 30.

What turned Relativity from a company about to go public into a bankrupt one?

The surface problem was a lack of money. Financiers kept leaving and new ones kept coming in until the chain finally broke and nobody would trust it any more, because for two years it had not made a big box-office hit. Since 2013, Relativity has concentrated on its own film projects. Earth to Echo took in US$45 million worldwide on a US$13 million budget, and 3 Days to Kill earned US$52.6 million on a US$28 million budget. But its flops are just as easy to list. Relativity cast stars such as Christian Bale and Zoe Saldana in Out of the Furnace, and Liam Hemsworth in Paranoia in 2013; these films all disappointed at the box office.

The deeper contradiction is that Relativity wanted to be the best player in the market but would not make the films the market wanted most. Relativity forecast box office, avoided risk and saved costs. None of that differs in any real way from what the major studios have done for decades. It opened every channel it could, but it was fixated on making low-cost films profitable across the board, could not stomach the high-risk blockbusters that make the most money, and did not care about reviews either.

Relativity's bankruptcy also shows that when the leading companies in a market mostly stay sober and keep their businesses healthy, a company that has neglected its core business will eventually have its weaknesses exposed.

Relativity is now waiting to be auctioned. The Los Angeles Times reported that quite a few companies are considering a bid, including private holding companies, international commercial firms and digital media companies. The likeliest buyer is MGM. MGM has some investment from Anchorage Capital Group, which is one of Relativity's senior creditors. Another report says Kavanaugh has sold his beach house and plans to buy the company back.

"Do you have any regrets?" The Hollywood Reporter asked Kavanaugh.

"My biggest regret is trusting Colbeck (the firm that helped Relativity with its financing, and which Kavanaugh says betrayed him at a critical moment). My second biggest regret is not being more involved in making and marketing the films themselves since 2012," he answered. Relativity is not all he has: he holds stakes in more than 40 other companies, including a private fund he runs with his family and a pet-tech products company.

Out of the Furnace

Relativity's path, in which "every piece of news is tied to a fashionable concept," is not unusual among Chinese entertainment companies. Think of LeTV, which has spent the past two years telling the market an "ecosystem story," or of Youzu Interactive, which claims to "understand every problem in the film market" (it too popped up suddenly, riding the trendy The Three-Body Problem).

So imagine Relativity had been born in China. Over 11 years we would have heard that it was talking to Hollywood and selling films to India, that it was close to the government and tight with the financial giants, that it did music, sports and streaming, and that its boss even ran a pet-tech company, how adorable. It might already have seized a chance at a backdoor listing and watched its share price multiply over the past few months. Ordinary shareholders would not be able to tell its own films from the ones it co-financed with Universal. As for the bad films, nobody would mention them; they are nothing unusual. Judging by the road that took Relativity as far as distributing films in China, it could have pulled off plenty of things nobody saw coming.