We constantly hear about the absence of money in this economy. A recession has gripped the United States and the rest of the world, leading to a lot of empty pockets. Jobs are disappearing at an alarming rate, and consumer spending is suffering. And, we've all heard about Bernard Madoff's shenanigans, which cost investors more than $50 billion.
What you don't hear, however, is that there's still plenty of money out there. Smart investors are hoarding cash. When the right opportunity comes along, they'll be ready to pounce.
Of course, none of that money is coming into porn, right? Institutional money never comes into porn, and that's unlikely to change anytime soon. Adult companies tend to be too small and appear to be too risky to attract the big wads of cash that hedge funds and private equity funds have at their disposal. The market is changing, though - both in adult and mainstream institutional finance. The past two years have brought a fundamental shift.
Major funds, including the California Public Employees Retirement System (CALPERS), have held stakes in publicly traded adult businesses over the past two years. Also, we were just starting to talk about mergers and initial public offerings (IPOs) in the adult entertainment space at this point in 2007. Now, we're looking back on several major acquisitions and an IPO filing (however misguided). It's just a matter of time before financial institutions start to make investments in privately held companies.
And, there's plenty of money waiting to come in.
Currently, private equity funds around the world are sitting on absurd amounts of capital. Recent research from London-based firm Private Equity Intelligence, Ltd. (Preqin) pegs the industry's uncommitted capital - called "dry powder" - at more than $1 trillion. While you would expect dry powder to be down year-over-year as a result of the ongoing financial crisis, the opposite is actually true. The cash that is available for investment is up approximately 20 percent from $820 billion at this time last year. The smart money is on the sidelines because there is no good place for it.
There's a problem with this, though, for the private equity funds and their investors. Dormant capital is unproductive capital. If cash is sitting on the sidelines, it isn't generating returns. Of course, the only reason investors bring their money to a particular private equity fund is to chase a return. So, private equity funds want to put all that money to work. Right now, that's not happening. Idle cash may be prudent for now, but this can't last forever, as it ultimately disappoints investors. The private equity community will need to find new opportunities for investment, and they'll have to find them in corners of the business world where they haven't looked in the past. This includes porn.
Our industry has barely been touched by investment institutions. And, we're to blame for some of this. Nothing can change the nature of our industry - and the fact that it complicates efforts to gauge outsiders. But, the efforts at secrecy around business intent, use of funds, and even something as simple as top-line revenues are both problematic and resolvable. A bit of disclosure would go a long way ... or as AdultVest's Francis Koenig put it to me a few months ago, "C'mon, pull down your pants." Let's see the results.
The other major challenge has been working itself out, albeit slowly. When I wrote about outside capital in the February issue of AVN Online ("Get Cash, Now"), I found that most venture capital firms and other private equity institutions found the potential upsides to be too small. Rapid growth in the online space has changed the industry's landscape. With several companies exceeding $100 million in top-line performance, there is actually some fodder for big investors.
The population of businesses of this size is still very small, but it is a sign of where porn is headed - and where institutional finance is headed, as well. As the size of the companies in our industry increases, they will begin to attract the interest of investors desperate for choices. Cash infusions will be made more likely by the fact that larger adult firms will need to develop the infrastructure that will endear them to institutional investors. Boards of directors, outside audits, and disciplined treasury management will emerge from growth, making outside investment (and accelerated growth) easier to secure.
There is another condition that has changed, favoring the adult entertainment industry: the death of leverage. For the past several years especially, private equity firms have loved to borrow heavily to acquire companies. They could commit a small amount of their own cash when making big buys, saddle the target company with the debt, and then reap disproportionate returns. With the days of easy credit in a past that feels so distant, this approach won't work any longer. So, private equity firms will need to allocate more cash to future deals. This means that each deal will require more of its capital - translating to fewer deals.
For adult businesses, the inaccessibility of leverage could be an advantage. Even though some porn companies are getting bigger, they are still tiny in comparison to the mega-mergers of the past decade. Because of this, a private equity fund seeking a piece of an adult business would not have to commit a lot of cash. It could still diversify its portfolio of investments without having to worry about where to borrow money.
The transition is not going to happen overnight. We're still several years away from major financial institution investment in adult entertainment. But, the barriers are starting to break down. Scott Coffman, of Adult Entertainment Broadcasting Network (AEBN), told me that he has had several meetings with large financial institutions. There's always somebody at one of these firms who is willing to consider the adult entertainment industry. Conversations occur. Interest is palpable. But, at some point, the deal always dies, usually at the hands of a senior executive who gets skittish.
Coffman keeps trying, though. The situation will change at some point; all the signs in the marketplace point to it. When the doors finally do open, he'll be among the first in line. And, the payout will be worth it.
Of course, very little of this money would be allocated to adult entertainment ventures. But, if only 0.1 percent of the $1 trillion sitting dormant in private equity coffers is committed to adult entertainment, the industry would be fueled by $1 billion in new capital. This is enough to fuel innovation, launch new products, and explore the next wave of marketing strategies that will support aggressive growth.
Institutional investors are running out of other options. Right now, porn is the ugly girl at the bar. Private equity firms can see that last call is coming, and they will need to find some companionship and have precious little time to do so. There is a shortage of opportunity, which is why investors are sitting on piles of cash. They don't want to do this; they simply have no choice. Structured products (such as the "toxic securities" you see in the mainstream headlines) were the latest financial device to let investors down. At the same time, it seized up credit markets, sending the world's financial markets into disarray. It is left to porn, it seems, to solve the problem.
There are whispers up and down Wall Street of interest in adult entertainment. Nobody will confess to it openly, and it's still a challenge to get mainstream dealmakers to the table ... but the conversations are starting to occur. The next step will be to see a few deals close. Once someone has tested the waters, the rest of the market will rush to follow. It will take time, but this is the future of adult entertainment finance.
So, brace yourselves. Over the next few years, the winners in our community will probably be determined by outsiders with fat wallets and unbridled financial ambition. Tap into this, and you may see a positive change in your net worth.
This article originally appeared in the April 2009 issue of AVN Online. To subscribe, visit AVNMediaNetwork.com/subscribe.
