Stability--Moviedom’s New Order

Much like the big banks that overlent to Latin America, the stock and bond markets are now demanding severe discipline from Hollywood’s ramshackle, Third World-like economy.

In New York’s money centers, it has become commonplace to claim that there is only room for six big companies in the movie business--almost certainly an exaggerated view, but also a sign that there won’t be new money for expansion during the next several years. “The record business got down to six companies, and it mints money,” notes Luis Rinaldini, a Lazard Frere & Co. investment banker who has worked closely with both MCA Inc. and Warner Communications Inc.

“There’s certainly one distribution company too many,” concurs Los Angeles box-office analyst Art Murphy, who currently reckons that more than 90% of the box office, and hence most video revenue, falls to nine principal distributors. Ranked by 1988 market share, they are: Disney, Paramount, Fox, Warner Bros., MGM/UA, Universal, Orion, Tri-Star and Columbia.

With casual brutality, some money men simply predict the end of MGM/UA. “MGM will bankrupt. It will be sold piecemeal,” says an investment banker who has worked on some of Hollywood’s biggest deals.

In fact, it appears that MGM/UA--now run by three investment bankers fresh from Merrill Lynch--will struggle to remain a player, though on severely reduced terms for the foreseeable future.

The studio’s expenditures got well ahead of receipts when it tried to boost production by splitting into two separate film-making units during the movie boom. But the ex-bankers in charge say the company is stabilized by some $100 million in annual income from its 950-film library and is assembling new financing that will let it resume production on a smaller scale.

In the short run, MGM/UA got a significant boost when British Satellite Broadcasting, one of Europe’s new TV ventures, agreed to license the studio’s old movies for $100 million over the next several years.

Others claim that Tri-Star, without a big film library to support it, is doomed unless its parent, Columbia Pictures Entertainment, can find a buyer for the unit. “Columbia probably can’t deliver the films and profits it has promised the Street, and Tri-Star, no matter what they say, is gone,” says a competitor, who argues that the paired studios’ weak performance was obscured until recently, when they adopted conservative accounting standards similar to those used by industry leaders Disney, Warners and Paramount.

(Flexible accounting, a Hollywood bugaboo rooted in the wide range of practices permitted by the Financial Accounting Standards Board rules, became a front-burner issue recently when Lorimar and Warner Communications issued a prospectus and proxy statement showing that 93% of Lorimar’s $250.7 million in shareholders’ equity would be wiped out if the company were placed on Warners’ more conservative system, which writes off films quickly.)

“What (this) says is that Lorimar probably rarely if ever made money, despite the fact that a few years ago it was not only reporting sizable earnings but was in some quarters perceived to be a stable growing company,” one securities analyst, who declines to be identified, wrote in a letter of complaint to the accounting board.)

Columbia Pictures Entertainment says its accounting is now as conservative as that of Disney and others in key respects. Company President Victor Kaufman has said Columbia is financially sound and should begin generating substantial cash flow in 1991, after sustaining negative cash flow of up to $200 million this year.

Behind the dark talk, however, lies sure knowledge that a severe shakeout--and perhaps the first permanent collapse of a major studio since RKO shut down in 1953--would mean rich rewards for the survivors.

Despite the huge influx of video and cable cash, the movie business earned lackluster overall profits in the 1980s, largely because costs went up at least as quickly as sales. While revenue doubled to about $7 billion from 1979, operating profit climbed only about 15%, and may peak at about $800 million this year, according to Wertheim Schroder entertainment analyst David Londoner. That 11.4% profit margin is far less than the 16% margins reported by broadcasters, or the 19% posted by newspaper publishers, according to statistics compiled annually by Veronis Suhler & Associates.

Precisely because the profit margins are relatively thin, however, a modest 10% reduction in the industry’s approximately $3 billion in production cost could result in a profit surge of $300 million, or more than 40%, even if foreign markets don’t keep growing or new technology doesn’t pique a new appetite for movies.

Acutely aware of such figures, a new generation of bottom-line-oriented managers at the majors fought bitterly for cost reduction in contract battles with the Teamsters and the Writers Guild of America. For the industry as a whole, however, a brief contraction in the number of pictures might produce the same effect, if audiences remain constant: less spending, dramatically more profit.

Londoner says such a surge is possible, though by no means certain. Encouraged by big-company fundamentals, however, he currently has Warners, Paramount and Disney on his “buy” list. “That’s the biggest number of these stocks I’ve ever recommended at once,” he says.

On its flip side, a movie contraction could be grim news for theater owners, who have been furiously building new screens--pushing indoor screens up 50% to about 21,000 in the 1980s--and now seem doomed to split a stubbornly constant number of about 1 billion admissions annually, and a declining number of films.

“This whole industry is stagnant. . . . There’s going to be a shakeout,” says Sumner Redstone, a longtime exhibitor who last year branched heavily into cable systems and TV programming with his $3.4 billion purchase of an 83% stake in Viacom International.

In the typical eight-screen multiplex, according to movie distributors, the seventh and eighth screen did well in recent years by churning films from the independents. As those disappear, however, there will be little choice but to hold over major studio pictures that have already weakened--letting the big studios milk the last dollars from a film, but reducing choices and sharply cutting profits for the theater owner who had previously boasted something fresh every week.

Disney, convinced that just such new movie economics are already tilting in favor of the studios, last month notified theater owners that it planned to maximize its receipts by soliciting bids on every picture rather than bargaining primarily with established customers. “There are more and more theaters, and less and less films to put in them. If we can get 3% or 4% more (from exhibitors) on $700 million (in annual box-office revenue), that’s a lot of money,” explains one Disney executive.

In a signal development, a U.S. grand jury recently entered an antitrust indictment against Fox, charging that the studio had reverted to the once-common practice of block-booking--that is, exerting its muscle over theater owners by insisting that they take weak pictures like “Big Trouble in Little China” in order to get strong ones like “Aliens.” Fox denied the charge and is defending itself in court.

Perhaps more ominously, Redstone predicts that studios like Warners, Universal, Columbia, and Paramount--having purchased their own theater screens in substantial numbers--will be tempted to cash in on their “vertical integration” by channeling potential hits to their own theaters, as they did before the so-called “Paramount consent decrees” broke up studio-theater marriages in the late 1940s.

“Some companies that have both production and theaters are getting pictures not on the merits” of position in an individual market, says Redstone. “The only assumption you can make is they’re getting product because of their strength and power.”

At the other end of the movie pipeline, Hollywood talent has become obsessed with stability--perhaps feeding a vicious circle that makes the strong even stronger.

“I find actors and directors asking what are my instincts about the (production) company being there next week,” says Arnold Rifkin, co-founder of Triad Artists Agency. “When clients start asking the same questions we’re already asking internally, it makes us even more concerned about the instability factor.”

Executives at Paramount, Disney and Warner Bros.--widely perceived to be Hollywood’s most stable movie operations--claim that such concerns are driving the best talent into their hands, making it doubly difficult for laggard firms to catch up and pushing the industry toward the six- or seven-company configuration Wall Street would so love to see.

“Talent is saying to the agent, there are only a few places I want to go. So only what these studios turn down goes some place else, which tends to perpetuate the cycle,” maintains Richard Frank, president of Walt Disney Studios.

At Paramount, chairman Frank Mancuso talks of a growing “economy of trust” that occasionally lets his studio pay less than a competitor might bid for the same script or star. “At the big agencies, the last thing they want to hear from an important client is, ‘How could you have put me at (a failed studio)?’ They can’t place their important talent where there may be instability and they would have to answer for it.”

Weaker competitors bridle at the so-called “super-major” theory, arguing that the natural volatility of movie management eventually catches up with the strongest players. “Certainly there have been great management teams, with Frank Price at Columbia, say, or Michael Eisner and Jeffrey Katzenberg at Disney. But they tend to last for two- or three-year periods,” says one MGM executive.

At least some evidence suggests that the winner’s circle has narrowed, however. MGM/UA, in a constant state of flux, has been near the bottom of the box-office rankings since the company was formed with MGM’s acquisition of United Artists in 1981. Columbia, similarly plagued by frequent management changes, hasn’t placed higher than third at the box office in more than a decade, and Tri-Star has been a persistent laggard despite its success with the “Rambo” films.

Meanwhile, Warner Bros. has been a consistently strong performer despite a lack of blockbusters; Disney has blossomed under a longtime management team lured from Paramount, and Paramount, which held its nonpareil producer relationships intact when top managers left for Disney and Fox in 1984, has had a spectacular seven $100 million-plus hits in the last two years.

Fox has apparently begun to stabilize its management, and both Columbia and Universal have been struggling to boost performance through production pacts with the likes of Michael Douglas and Ron Howard. Yet the classic system under which weak players regularly toppled the strong by overpaying for top stars may be giving way to a new order that rewards constancy above all.

“If Coca-Cola is going to change management at Columbia five times, our directors simply aren’t going to give them the baby,” warns a powerful agent.

Typically, new players--big money plus ego attracted by glamour--have kept the movie business from simply reverting to what one studio chief calls “a natural oligopoly.”

Fresh buyers could unsettle Hollywood again, bringing fresh capital to the weak, and touching off another dizzying round of production spending. As recently as last week, $4.5 billion (sales) media conglomerate Time Inc. said it was interested in buying a studio.

But powerful forces have combined to make that more difficult.

To begin with, moviedom’s cost of entry has gone up, largely because the studios, which customarily operated without much long-term debt, followed much of corporate America in borrowing heavily through the 1980s.

Rupert Murdoch entered the business only three years ago by purchasing Fox for $575 million, plus a debt load that pushed the price somewhat over $1 billion. But a buyer today might be forced to pay $6 billion for MCA, including $1.1 billion in debt, or some $3 billion for Columbia, including the $1 billion debt it ran up through acquisitions and movie losses during Coke’s stewardship.

“The owners have already sucked the leverage out,” says one securities analyst.

Because of price inflation, individual, ego-driven “entrepreneurs” like Marvin Davis, Kirk Kerkorian, John Kluge (who owns voting control of seventh-place Orion), and even Murdoch appear to be less likely buyers for the studios than mega-conglomerates even bigger than $7.6 billion-a-year (revenue) Coca-Cola.

Key investment bankers contend that the next round of buyers are almost certain to be foreign, partly because Japanese and other companies are now playing with cheap dollars, and partly because corporations like Sony and Nippon Steel are looking toward the entertainment business to solve their own corporate problems.

Sony, with $12 billion in annual sales, recently spent $2 billion to acquire CBS Records, and has publicly said it might buy a movie company in order to more quickly match new “hardware”--say, a new generation of laser disc players that can play both music and movies--with “software,” i.e, records and films. A favorite Hollywood dictum of the moment quotes Sony Chairman Akio Morita as saying “the whole world would be Beta” instead of VHS, if Sony had owned a studio when it introduced its pioneering Betamax VCRs.

And Nippon Steel, the world’s largest steel company, is already in a joint venture with MCA to build a Universal studio tour in Japan--part of the steel giant’s plan to put 10% of its $18 billion annual revenue in “leisure” activities by the mid-1990s. To meet that goal through a Hollywood play, the Japanese concern might have to buy a company almost as large as MCA, which has about $2.6 billion annual revenue.

But sober minds in the financial community say that Kirk Kerkorian’s recent failure to get his reported $1 billion-plus asking price for MGM/UA may signal that the potential buyers aren’t ready to throw cash at Hollywood any time soon.

“The funny money just isn’t there,” says one investment banker who recently tested the foreign market for studio buyers.

If not, the movie industry may simply get a bit smaller, and more profitable for the survivors. “I wouldn’t say it’s going to be a better world,” says DEG’s Greenwald. “But it’s certainly going to be more efficient.”

MEDIA INDUSTRY PROFITS Industry Segment: Cable TV 1987 Revenues: $5,945.8 mil 1987 Profits*: $1,064.1 mil Profit as a percentage of Revenues: 17.9% Industry Segment: Movie, TV Production/Distribution 1987 Revenues: $10,581.6 mil 1987 Profits*: $1,001.4 mil Profit as a of Revenues: 9.5% Industry Segment: Radio & TV Broadcasting 1987 Revenues: $15,551.5 mil 1987 Profits*: $2,481.9 mil Profit as a of Revenues: 16.0% Industry Segment: Newspaper Publishing 1987 Revenues: $15,843.6 mil 1987 Profits*: $3,064.2 mil Profit as a percent of revenues: 19.3% Industry Segment: Recorded Music 1987 Revenues: $3,807.9 mil 1987 Profits*: $457.0 mil Profit as a percent of revenues: 12.0% * Pre-tax operating income SOURCE: Veronis, Suhler & Associates