MediaTalk | Season 4 | Ep. 41 - The Growing Role of Private Capital in Movies, Music and AI

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Mike Reynolds: Hi, I'm Mike Reynolds, a senior reporter covering the media industry with the S&P Global Market Intelligence Tech, Media, and Telecom News team. Welcome to "MediaTalk," a podcast hosted by S&P Global Market Intelligence, where the news and research staff explore issues in the ever-changing media landscape.

Today, "MediaTalk" is going to take a bit of a different path and take a look at the world of private capital financing and opportunities within the media space through the lens of Crayhill Capital Management, a $3 billion specialty investment firm focused on asset-based finance. Among other areas, Crayhill is actively investing across media royalties, film, and TV, including recently co-investing in a royalty-backed financing deal tied to South Park, and providing $150 million in financing to Rostrum Pacific, parent of the label that helped launch Wiz Khalifa and Mac Miller. Here to discuss some of the developments in the arena is Crayhill's co-founder and managing partner, Carlos Mendez. How are you doing, Carlos?

Carlos Mendez: Mike, thank you so much for having me. I look forward to our conversation.

Reynolds: All right. Prior to founding Crayhill in July of 2015, Carlos was a portfolio manager in the fixed income group of Magnetar Capital, where he focused on illiquid structured credit and asset-based investment opportunities. Before Magnetar, Mendez was a managing director and head of the structured finance group at Sandler O'Neill & Partners LP, where he structured new issue origination and asset-based finance solutions for specialty finance companies and banks.

He holds a Bachelor of Science degree in mechanical engineering, and a minor in Latin American studies from the US Naval Academy. Carlos, tell us about your career before co-founding Crayhill with Josh Eden.

Mendez: I think you highlighted some of the spots that I've worked at. I did come up as an engineer. I did spend some time in the military, and then I hopped into corporate finance. And in the early 2000s, I transitioned into structured finance, and I've been doing that now for the last 26 years or so.

Josh and I had worked together prior to starting the firm. We had been bankers together in a structured finance role, financing all sorts of different assets. Josh, even prior to that, had started doing structured finance investments while he was at Dune Capital. And so, I guess this is now 11 years ago, when we were both at Magnetar working together also on private structured finance investments, we decided to spin out and start our own firm. We did so, and I know a large part of our topic of discussion today is around financing film, TV, and music.

We had been doing that together for about five, six years, and then we've continued to do it here at Crayhill, where we've built up a really diversified portfolio of those assets.

Reynolds: So, are you a music guy, a TV guy? What appealed to you guys about the quote-unquote "media space" in the broadest terms that way?

Mendez: I try to separate our own personal likes and dislikes as it relates to the actual content and really focus in on what matters, which is the durability of the cash flows. A great song or a great show is really one of the few assets that just keeps earning and earning for decades after that work is done and it's released.

And so, when you're able to have access to the underlying data and performance of any one of these assets over time, you start to really recognize how resilient these assets really are. They are part of our daily consumption for many of us, some of it unintentionally, right? When you go shopping and you're in a store or you're in a restaurant—I was in a restaurant the other day, and I was like, "Wow, this music's fantastic. I'll have dessert. I'll hang out and listen to the music a little longer."

Reynolds: Yeah, there you go. That's how it works. Yeah.

Mendez: Yeah, for sure. And so, I think, I know we're going to get into it a little bit and talk about how we underwrite things, but from a perspective of these cash flows, when you can gain access to great teams that own them and nurture these assets, and you can get access to the performance data over time that'll really allow you to do a thorough underwriting, they're just fantastic assets to finance and to own.

Reynolds: Okay, all right. Let's assess a couple of overarching topics, if you will, here. How are streaming content and AI creating new financing needs across the media ecosystem?

Mendez: So, maybe I'll address streaming on the film side. If you look at the total amount of gross generated revenue from the movie industry overall, the theater, from a perspective of box office revenue, is now above what it was pre-COVID. So, as everyone recognizes, nobody went to the movies, nobody went to AMC and Regal, and those stocks reflect that during the pandemic, for obvious reasons. And then it crawled... There were some movies that—yes, people went to Top Gun.

I don't know if you remember Top Gun. That was one of the first big ones where, when it released, the theaters were full, you couldn't get tickets, and that was the first really big blockbuster that came out post-COVID, where we're like, "Hey, man, maybe people do wanna go back to the theaters." And now those total revenues are higher than they were pre-COVID. But what's interesting is that streaming is much higher as well, and so the total dollar amount overall has grown tremendously, to the point that now COVID kinda looks like a bump. And overall consumption of media has increased.

And so, streaming has been super additive to films, yet there's a correlation between how well a film does at the box office and how well it does on streaming. And it's interesting to see the dependency on that. And so, the box office, it's not as important, but it's still a proxy to... we call it the water cooler effect, right? Where people see it, and then we talk about it, and then that starts to create interest, and interest, and then everybody's like, "Oh, shoot, I missed it in the theater, but I get an opportunity to now catch it on my favorite streaming service..."

Reynolds: Yeah.

Mendez: ...of which we all probably pay for too many of them.

Reynolds: But you mentioned Top Gun: Maverick, right? It brought people back into the theaters, and then from the Paramount Plus perspective, it brought people to watch on the screen there or added new subscribers 'cause they wanted to check out Tom Cruise. Maybe not so much in the new movie, but wanna see him as Maverick.

Mendez: Yeah, no, that's right. And, in music, it's a little bit of a different story, where even on new music releases, it all starts and ends on streaming. And so, what we've seen is just more and more access to these streaming platforms. The revenue models of these streaming platforms are not only subscription-based, but also ad-based, and providing access to these applications, or these web apps and phone apps, to just, from a geographical perspective, wider and wider audiences. And so, generally you see, in the industry, people's expectations of 3% to 5% organic growth, and what they mean by that is just, if you do nothing, there's that many more listeners coming online.

And so, the dominance of streaming is, it's holistic, it's encompassing. And there's a tremendous amount of efficiencies around gaining access to audiences for creators and musicians. And there's a tremendously different way to advertise and promote, through influencers and through now social media apps, and also different ways for people to connect with the artists themselves.

And so, again, with the advent of these apps, it's really transformed the entire industry, to depend on the music side on streaming.

On your last point around AI and AI content—I think I started by saying a good song or a great show, right, has just this revenue generation capacity that's fantastic once it settles into the broader culture and the broader audiences. And so, what we've seen generally with AI-generated content is the lack of greatness, the lack of quality, and really the lack of good audiences reacting to it. Will that change? Will there be, as we've speculated, these AI actors and AI singers and AI-derived music that's going to be the next Elvis Presley? We don't really know, but what we do see is AI having a fantastic effect on people's ability to streamline the licensing, streamline the production of films, 'cause when you think about planning and being able to sequence and schedule the productions of film, and allowing people to get better organized and create project plans—so AI is having a tremendous effect on the business of making and managing media, as it has in all other businesses. But we haven't quite seen on the content side any significant uplift from AI-generated content.

Reynolds: Okay, all right. As you look at, from an investors' perspective, the approach for niche assets like media royalties and film receivables, what's the appeal there? Again, it sounds like sustainability and ubiquity are underliers here.

Mendez: Yeah, maybe I'll just focus in on that a little bit more and try to describe what are the characteristics of a durable media asset. We tend to use the word "seasoned" internally. So, what we mean by that is, when these royalty streams and royalty payments have achieved stability around the recurring revenue, so year over year, the expected revenue or expected gross dollar amount that's collected is consistent, and in some cases actually is growing a little bit. And then that's related to, as I described, the audience's growth—let's say on Spotify, it's naturally growing 3% and 4 or 5%. If you own some titles, that growth is reflected in your total gross receipts. So, that's not always the case for music.

Sometimes, on new releases, you'll see big spikes as the advertising and the promotion of that piece of media gets absorbed by the audiences—everybody wants to check it out. You start seeing a lot of streams or a lot of views, and then it settles. And if it catches on and there's word of mouth and people start to watch or listen multiple times, then the slope of that decline in revenues is shallow. If it's not picked up, it's rather precipitous, right? And it crashes.

Reynolds: Yeah. I think you used a phrase called a "decay curve," which is—

Mendez: A cool word, "decay curve," yes. And as that decay curve starts to stabilize, we term that as a seasoned asset, and it becomes much more underwriteable and much more financeable.

So, when you look at the net exposures, or the exposures that we have in our portfolio, the preponderance of it is with seasoned royalties, where we can see year over year their performance, and we can have a level of expectations. In film, the term there is called "ultimates," and what the ultimates are—they still have decay curves associated with them, but the cash flow itself is called an ultimate. You can underwrite that with a high degree of confidence that, year over year, you're going to get a certain set of income. And so, I think that's really the characteristic that you're looking for in any portfolio.

And understanding that—you mentioned some of the investments that we've been involved in. Every title in there is idiosyncratic, even if it's from the same artist or the same TV series or whatever have you. And in order to make that determination—and I've said this over and over again—it's access to the data. We don't finance just financial aggregators of media, right? These are folks that are outside of the industry. They're not operators, they're just accumulating assets. There's plenty of folks who do that. Our focus has been working with operators, and what I mean by that—as you mentioned—Rostrum is a company that we financed. They're a label, right? They work with artists and have worked with these artists for sometimes decades, to release music and facilitate a career based upon their creativity, and their intention is to continue to do that. And for us to be able to finance the assets of a company that's aligned with the creator and is aligned with the ultimate outcome creates alignment with us.

And think about it—where they own the asset, their interest in the music, their publisher rights, or what have you—that they retain—

Reynolds: And distribution rights as well, right?

Mendez: Yeah, and their distribution rights—they own it at a creation value, right? So, when you think about the financing that they're seeking, to continue to own that asset, and then take the proceeds of our financing—what do they do with them? They reinvest them. They reinvest it right back into those artists, create more content, hopefully as good as the content that we financed, and then come back to us and finance even more of those assets. And so, it really helps those companies grow by using our financing structures, and we are super attracted to that alignment of interest. It really is—what's the word I'm looking for—there's a flywheel effect to that arrangement. Whereas, when you're working with folks that are financial aggregators of these assets, what we find is they end up—they're typically equity investors who are paying high multiples.

And what I mean by a multiple is these assets typically are valued as a multiple to the prior year's gross amount of earnings, gross receipts—so eight times, 10 times those receipts. And in order to get a reasonable return out of them, they use quite a dollop of leverage to generate those returns. And so, there's nothing wrong with that, it's just something that we've not focused on. We've really focused on working with operating companies that are media companies, and whose business is to create these royalties, and whereby our financing could be additive to their growth.

Reynolds: So, you guys—again, we talked music here with Rostrum. You guys are involved with, I guess it's called Partners Group, a consortium of investments in South Park. Again, obviously an iconic show, been around for a long time. There's maybe a bit of a renaissance in terms of its relationship with the president. Anyway, we can stop talking about that. But again, what was the appeal, Carlos, in terms of working with South Park?

Mendez: Wow, they are a fantastic example of everything that I've said thus far, and the characteristics of cash flows in that series. 22 seasons, a tremendous amount of data around the performance, an audience that continues to grow, and interestingly, grows across demographics—young people, old people.

And the story has not ended, right? Whether you agree with their views and their comedy or what have you, but this is something where it brings audiences back because of the new content that they're creating, which then gives people the chance to think about, "Let me go back and think about or watch some of the prior shows."

And so, it is just one of the most dominant TV shows out there in terms of the total wallet. Right now, it's streaming on Paramount, and I don't know where it stacks up in terms of viewers for Paramount who watch that, or even subscribe to Paramount especially for that, but it's a significant number. So, just the durability of those cash streams is just astronomical, and we're just excited to have been part of that.

Reynolds: You mentioned AI before, and one of the things that intrigues me, as a media guy, and again, watching a lot of television—there's always been talk about AI driving all kinds of content, especially on the commercial side, and that we aren't going to see the same ad; we're going to see an ad from Company A, you're going to see one version, I'm going to see a different version. I have not seen that materialize. Is that something that you guys are looking at, again, in terms of working with agencies or AI companies as an opportunity?

Mendez: As I mentioned, AI is having an effect on the efficiencies of how you make content, not necessarily on what the content is. So, I think here, where you're alluding to the distribution of content and how to smartly target folks, it is happening in an enormous way. So, as an example, if you're an advertiser on Meta properties, or an advertiser within the Amazon Marketplace, the way that you take audiences that are already looking at your products and tie them to what they call "like audiences"—audiences that, if this type of person bought the product, or looked at the product, or looked at similar products, could potentially look at your product—that's already embedded in those platforms.

And, in fact, the pickup and the efficiency, the accuracy for that advertising, the lift that people have received in their advertising dollars has been extraordinary, especially those who were doing it early on. And so, the additional bump of then adjusting those ads a tiny little bit in order to reflect the user—now it's like dynamically doing it. So, I think it's already happening, from AI, allowing you to—for a particular consumer, saying, "Hey, I have three choices, A, B, or C," and they said, "This is a better choice for this particular consumer—Choice B."

Reynolds: Yeah.

Mendez: I think what you're going to start to see now is it's B, but B with an orange background, B with like this particular tone, and mixing and matching both audio and visual, where we haven't—I'm not aware of that happening on these larger platforms—but it's just a half a step away.

Reynolds: Are you guys interested at all in the agency or the production realm, again, around advertising? It's not media per se, but it's always been part of media, going back to the Texaco Showcase.

Mendez: Yeah, a long, long way back, we did do an investment which was specific around ad revenue and the production thereof, of certain advertising. But I would say that our interests have been more towards channels, and these are new channels, where the revenue stream for the media is advertising, it is not subscription-based.

And so, what you're finding is—I remember, just recently, I was in Europe with my family for two and a half weeks, and I ended up doing a lot of driving, and they had this channel that was like American rock, so I hit it, and there was American rock playing for two, three hours while I'm driving, but I've never heard of any of these songs. Never. For two or three hours, it's like the B side—which, I know, for those of you who don't remember records—there's this round disc, and there's an A side and a B side, and you can play music on both sides. And the better songs are on the A side, and the less-good songs are on the B side, typically.

And so, this was like every B side of every band you've never even heard of, and I'm sure they're just streaming it all, all day long. And the cost of that, from a licensing perspective, I would imagine, is very low, but the advertising is very consistent with all other radio-level type of advertising.

And so, my point there is that music, and film, music, film, and TV, is finding all sorts of streaming services globally that are not based upon—we know the subscription model very well, a lot of us have multiple subscriptions, and we forget which ones we have, and we probably all need to cull them down a little bit—but around the world, where that is not the norm, the advertising model is taking over, and it's actually a large part of the growth in the market. So, from that perspective, I feel as if we're already in there, we're exposed to advertising, and want to take advantage of it.

Reynolds: One last one before we get to the very end here. Again, you did an interview, and I think the broad takeaway was that people aren't necessarily interested in AI versions of music. I don't know if you were referring to the avatars that appeared in a concert hall somewhere—I don't know if that was what you were referring to.

Mendez: I was referring to that, and broadly, I just spent a really long lunch—it was about a two-and-a-half-hour lunch—with another group that we finance on the film side. These are producers who have been around now close to 30 years. It was super interesting to hear what they're betting on, where their next set of dollars is, in terms of who are the creative minds, who are the directors for this film, where did the original content come from—and this happened to be a sci-fi book that I love from the '70s—and who were the personalities and the actors. There was just zero talk of AI.

You know, it's nice to be at a lunch where, for two hours, AI does not come up. And so, my point really being that the bigger dollars, the consistent dollars, these seasoned types of cash flow streams, are just, right now today, not being generated by AI-specific or AI-originated type of content. That may change, that may change, but that is just not happening today. And I would remind the audience as well that we did have a big writer strike and a big actor strike, and they very astutely and very early on created protections for themselves and for the industry against using people's likeness, and basically the incorporation of that in production.

I think where the industry has really settled in, and where people are excited about, is—look, if they can lower the cost of making content, that's good for everybody. That's more films, potentially more people employed in the industry, and I like to think that's really where, for the next set of years, people are going to be focused, and where the benefits of AI are going to basically benefit the most amount of people, including the viewer.

Reynolds: Okay, last one. Your assessment of 2026 so far, and what are you guys looking at as 2027 nears, in terms of tailwinds and opportunities?

Mendez: Specifically in media—so, steady as she goes in terms of our interest. I think, for all assets that are long-dated, right, royalties are effectively long-dated assets, and how you price them greatly depends on the longer end of the curve. People always ask us, "Is AI going to kill us?" And it's like, I think interest rates are going to kill AI, and then interest rates are going to come for us.

Similarly, for media and for music and for royalties, which really do depend on the long end of the curve, they're going to get repriced, right? We see that happening already, and valuation models are adjusting to not just where rates are today, but where the expectation of rates is going forward. That's going to cause issues, especially for financial buyers who have had a lot of leverage, and as they come towards refinancing those assets, where now the interest costs are going to be 60% higher, 90% higher, just because they're coming from such a low basis... I think that's going to create, for sellers, a very good asset.

So, I am not hopeful for higher rates—don't get me wrong, I am not—I am not hopeful for higher rates, that's not my position. But I am saying that, unfortunately, that does look like the prognosis or the consensus, and I think that's going to put stress on folks who own these wonderful cash flows in a highly levered way.

Reynolds: All right, that concludes this episode of "MediaTalk." I want you to join me in thanking Carlos Mendez for bringing insights about investment opportunities, and, to use a media catchphrase, in the ever-evolving media landscape. We appreciate you being here, Carlos.

Mendez: Thank you, Mike. It was a pleasure.

Reynolds: All right, and thanks to all of you for listening to "MediaTalk" on CapIQ Pro, Spotify, and Apple. This is Mike Reynolds. We'll catch up on the next installment soon.