The Interview - Brian Gilmore, Palatine Asset Management: "The Black Swan has arrived with the largest transfer of wealth since the Depression"
Brian Gilmore, chief executive of Palatine Asset Management, says the Capitoline Global Media Fund, which aims to exploit capital inefficiencies in the market for asset-based financing to distributors and producers of entertainment content, is set to benefit from the lack of liquidity available from traditional lenders.
HW: What is the background to your company and fund?
BG: Palatine Asset Management is an alternative investment manager registered in Mauritius and with offices in California, and is investment advisor to the Capitoline Global Media Fund. The fund was established in June 2007 as an investment vehicle for pooled investments in the global entertainment industry.
The fund aims to deliver consistently high absolute returns with low volatility and in a manner uncorrelated to the market. Its strategy is to exploit capital inefficiencies in the market for asset-based financing to distributors and producers of entertainment content.
Palatine is owned 80 per cent by myself and 10 per cent each by Gregory Gac and Paul Weir. Since June 2006 I have managed a private equity fund that has invested in media assets generating an annual yield of 18 per cent. In addition to fund management duties, I have spent the past four years active in the origination and placement of media finance products in other funds with strategies and assets similar to those of the Capitoline Global Media Fund.
As chief operating officer, Paul Weir brings extensive fund and operational experience, having spent the past eight years working in the prime brokerage space and a further six years working in operations covering fixed income, equities and foreign exchange. Both Paul and myself have operational expertise in reporting and asset collection as well as a broad range of investors and transaction counterparties.
HW: Who are your service providers?
BG: Our law firm is Appleby, the fund's administrator is Multiconsult, and the accountants are Ernst & Young.
HW: What is the profile of your current and targeted client base?
BG: The fund's investment pool is open to qualified investors not subject to US taxation. We target non-US institutional investors seeking a non-correlated unlevered return in the mid- to high teens.
HW: What is the investment process of your fund?
BG: The fund sources transactions through an exclusive right of first refusal with Capitoline Global Finance, an investment banking firm owned by myself. Capitoline Global Finance has a solid network of relationships in the industry, including banks, studios and agents to support its pipeline, and is viewed as the leading investment bank specializing in asset-backed financing of this type.
Additionally, the management team has contacts, including banks, consulting firms, valuation companies, past and current counterparties, broker-dealers and private equity firms that transact in the media space. The fund managers cultivate new transactions by attending film festivals and music conferences globally along with Capitoline Global Finance, which often co-sponsors events with its film industry producer and distributor clients.
The initial investment is the purchase or refinancing a portfolio of at least USD25m in investments with 12 to 18 months of seasoning.
Once a potential transaction has been identified, it goes into a formal process for initial review by the investment committee. Palatine considers the merits of the transaction and determines whether the deal meets the fund's investment criteria.
If the transaction meets the fund's requirements and pre-approval is agreed, due diligence commences, including an independent valuation of the collateral to be financed, a review by counsel of all collateral chain-of-title and other legal issues, including global tax issues, examination of existing distribution agreements, and an assessment of the counterparty risk. If the results of the due diligence are satisfactory, the investment committee must unanimously approve all transactions.
Following the closing of each investment, the management team monitors it for compliance with financial and other covenants. A collection agent - the remittance address for payments related to distribution, performance, royalty and other media-related rights - is typically employed to collect all cash flows related to the collateral, adding a further level of protection and monitoring on the fund's investments.
Collateral values are tracked for the fund administrator and auditor, with independent revaluations at least annually during the deal term. The investment process terminates upon maturity, prepayment or sale of the transaction.
HW: How do you generate ideas for your fund?
BG: We evaluate opportunities through a network of individuals and businesses in the entertainment and finance industries. Through regular meetings, conferences, and telephone conversations with industry executives, as well as review of industry reporting, the fund maintains a steady stream of investment ideas and opportunities.
HW: What is your approach to managing risk?
BG: Since borrower payment default is unlikely if the collateral is properly valued and modelled, the major risk in any fund investment arises from improperly modelled cash flows. These risks are mitigated by using external valuation firms, by testing models and valuations against the performance required to realise the fund's required return on an investment, and by employing conservative loan-to-value levels.
Fraud risk is contained through background checks, independent examination of the integrity of payment sources, separating collateral cash flows from borrower control (including the use of irrevocable payment instructions and collection accounts), by spot examination of borrower books and records, and by structuring assets in a bankruptcy-remote special-purpose entity. Exposure to flaws in documentation is limited by using recognised legal counsel with expertise in the relevant legal disciplines.
Additional risk arises from technology event risk, such as evolving content delivery and piracy. Historically, advances in technology have increased collateral value by expanding distribution channels, but there can be no assurance that continued advances in technology will not lead to increased levels of piracy or other activities that can reduce income related to the media assets.
HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?
BG: The fund that we have managed since 2006 has been very steady with no losses. We anticipate the net asset value to rise based on certain appreciation events intrinsic to the collateral. Our second fund will look similar to the first except the asset diversification and duration will be shorter.
HW: What opportunities are you looking at right now?
BG: The Black Swan has arrived and with it the largest transfer of wealth since the Depression. This is uncharted territory for everyone. It also means our investment approach will be ever more cautious and sceptical until our due diligence tells us otherwise. However, when we see an opportunity that fits our guidelines and that is priced right we will not hesitate to act.
We are seeing shorter-term assets and in certain cases partial sovereign guarantees once reserved for banks coming our way. With the current lack of liquidity, the banks cannot absorb all the pent-up demand. The market has no choice but to approach the alternatives with these transactions at very attractive levels.
HW: What events do you expect to see in your sector in the year ahead?
BG: We anticipate yields to be in the 16 to 25 per cent range for very solid assets. We also anticipate a certain distressed component to come into the market. This product will be a 'hit or miss' type of exercise.
Only a small group of funds have the expertise to exploit these opportunities, and we are one of them. The media space will not see every major family of funds creating a distressed or special opportunity fund to exploit the asset class. We have the unique product knowledge and skill sets to drill down and identify alpha.
HW: How will these developments affect your portfolio?
BG: We will be able to buy excellent quality assets at severely reduced prices and also gain massive market share.
HW: What differentiates you from other managers in your sector?
BG: Experience and access are Palatine's two major competitive advantages. I have originated nearly USD400 in transactions similar to those to be purchased by the fund, all of which are performing as agreed. As mentioned above, Palatine's relationship with Capitoline Global Finance gives it instant recognition in the film industry, allowing Palatine to review opportunities not available to other managers.
Secondarily, Palatine's strategy involves diversification at the individual investment level. Palatine will not accept investments where repayment is contingent on the completion or success of a single film or other media asset. Although investment proceeds may be used to complete a film, the film, as collateral, will be one of many films in the library actually securing the investment.
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