Film Industry Reeling Under Profit Plunge

At Universal Pictures, the party’s over. The studio has decreed that it will no longer pay for the elaborate premiere parties that are a staple of the Hollywood social scene.

Universal’s surprise move is emblematic of an industrywide slump, as plunging profits and feeble ticket sales have sent the dream factory into what some see as its deepest downturn in 20 years.

In an industry long considered recession-proof, profits will tumble 20% this year on top of a 15% fall in 1990, analyst David J. Londoner has projected. Wall Street’s lagging enthusiasm for Hollywood is vividly clear: Entertainment stocks were down an average of 22% from their 52-week highs as of Aug. 1, according to investment analysts Donaldson, Lufkin & Jenrette.

After a decade in which production costs almost tripled, austerity is practically demanded now. Universal’s 1992 schedule contains only one film budgeted at more than $30 million, a Ron Howard-Tom Cruise project called “Far and Away.” Walt Disney Studios has slashed its film costs by 35% to 40%. And Sony Pictures Entertainment cut overhead by $25 million this year.

In related moves, Paramount Pictures has jettisoned the high-priced producers behind the successful “Naked Gun” movies. Warner Bros. will shoot “Batman 2” on its back lot, after traveling to England for the original. Twentieth Century Fox has targeted runaway marketing costs for cutbacks. Current spending is “sheer lunacy,” Fox Inc. Chairman Barry Diller says.

“If costs had remained flat, the downturn wouldn’t be bothersome,” Diller said of the film industry. “But costs have been wildly exceeding the temperature of the market. Unless that is reversed or balanced in some way, it will have obvious, disastrous repercussions.”

Especially hard hit by the downturn are the independent production companies, which ironically, have been responsible for some of Hollywood’s great successes recently.

A spate of bank mergers and bad loans have created a credit crunch that threatens the survival of some companies. Independents, which secure their own financing and distribution, are in a mad scramble for production money--and many of them are coming up empty-handed.

Hollywood’s slump has also taken its toll on companies that provide services to the industry. At least one firm has instructed employees to entertain clients at lunch instead of dinner to save money. Other executives have been told to fly coach--something that once would have been unthinkable.

“It is perhaps a sea change in the financing environment for Hollywood,” said Harold Vogel, a Merrill Lynch entertainment analyst. “The competition for big stars and the spending patterns were really rooted in the low-interest capital that was available from the mid-1980s to about 1990. Now . . . you’ve got people looking at big budgets and wondering how they’re going to finance all this.”

The final, crushing blow to Hollywood self-confidence came this summer, as big-budget movies such as “Hudson Hawk” and, to a lesser extent, “V.I. Warshawski” nose-dived.

As worried film executives search for ways to revitalize their industry, even the idea of what constitutes a good movie is being redefined. Everything old is new again. Comedies, Westerns, thrillers and other genres with the broadest appeal are increasingly in vogue. Studio chiefs are also more attuned to the tastes of the international marketplace.

“People understand a Western,” said Martin Davis, chairman of Paramount Communications. “It’s us versus them. The moviegoer wants to identify with what’s on the screen. They want the dream. And that’s what we’re selling. We lose sight of that now and then.”

Film profits are difficult to measure, Hollywood’s accounting methods are notoriously indecipherable and only half of the major companies are publicly held. But analysts and others agree that profit margins have significantly narrowed. Londoner, of Wertheim Schroder & Co. in New York, estimates that all of the major studios combined made about $1.2 billion in 1989. This year, he expects pretax profits to drop to about $800 million.

In an essay titled “Was Chicken Little Right?” prominent entertainment attorney Peter Dekom warns that movie business earnings are eroding at a dangerously quick pace.

“Each and every one of us knows that this simply cannot go on,” Dekom writes.

“Things are bad,” said one motion picture studio chief when asked to respond to Dekom’s gloomy appraisal. “It’s not disastrous yet. But there’s a lot of fear out there.”

That fear started last summer, when a string of expensive and highly touted movies such as “Dick Tracy” and “Days of Thunder” failed to fill the expected seats. A subsequent cost-cutting memo from Disney Chairman Jeffrey Katzenberg brought the discussion of Hollywood’s problems into the open. But concerns have since intensified.

As production costs rose 185% over the last decade, according to the Motion Picture Assn. of America, attendance stalled or dropped slightly. The shortfall was offset by ticket-price increases. But executives say further hikes are impractical, because of the recession and the widespread belief that prices already are too high.

In the past, too, Hollywood’s profits were bolstered by technological breakthroughs, such as cable television and video. But the next big thing--the expansion of pay-per-view programming or new foreign markets--is probably five to 10 years away, film executives say.

“There have always been (economic) hurdles,” said Universal Chairman Tom Pollock. “But the hurdles have risen now. They’ve all gone up a foot or two.”

Some analysts consider this Hollywood’s worst slump since the late 1960s and early ‘70s, when high costs and low returns forced studio consolidations and massive real estate sales while putting 50% to 70% of the industry out of work. One studio boss at the time went so far as to suggest that Los Angeles underwrite the movie business.

In a 1978 report, entertainment analyst Londoner wrote that the film industry was nearly brought down by three problems nearly identical to those that exist today: big budgets, an oversupply of product and an overreliance on outside markets for revenue.

Thanks to diversification into video, theme parks, publishing, music, cable and other areas, theatrical returns have become less important in a studio’s overall revenue picture. Still, studios cannot afford continually to write off the massive losses that some films incur.

Studio chiefs were thrown by the surprisingly poor response to several mass-market movies this summer, including “Life Stinks,” “Dutch” and “Mobsters.” Some executives fear that cash-poor audiences are waiting for those films to appear on video. That would be bad news for studios, since they receive 50% of the revenues from ticket sales but less than 30% from video rentals.

Meanwhile, four companies have received as much attention for their economic problems as their films this year. MGM-Pathe Communications Co. and Orion Pictures Corp. teetered on the verge of bankruptcy for months. And Warner Bros. and 20th Century Fox are handicapped by the staggering debt loads of their parent companies, Time Warner Inc. and News Corp., respectively.

Analysts say Hollywood’s biggest challenge is determining how to enforce reasonable budgets without alienating audiences accustomed to big-name stars and even bigger special effects. Traditionally, studios have a hard time rejecting projects that appear to have “hit” written on them.

“Trying to be sensible and stay sensible in this business is a chore,” said Warner Bros. Chairman Robert Daly. “It may sound easy, but to do it is a lot of work.”

Agents and producers are loath to publicly discuss their problems, since Hollywood runs on the illusion of success. But stories of studios dropping projects altogether or slashing budgets on movies with major stars are commonplace. To shore up shaky morale, Disney’s Katzenberg has given what are widely described as “pep talks” around Hollywood, telling agents and others that the industry is capable of surviving the belt-tightening.

Said Fox chief Diller: “This business is undergoing a transformation that will, when this resolves, be looked at as being radical.”

Brad Marks, a Century City-based executive recruiter who specializes in entertainment jobs, has started a transitional counseling division for the hordes of laid-off entertainment executives seeking his help. The service now accounts for 10% to 15% of his overall workload.

It’s not clear who will rescue Hollywood financially.

The Japanese were Hollywood’s primary source of outside financing for many years. Japanese firms pumped more than $13 billion into Hollywood through Matsushita Electric Industrial Co.’s purchase of MCA Inc., Sony Corp.’s acquisition of Columbia Pictures Entertainment and other deals. But with the worldwide economic slowdown, they are experiencing their own economic problems.

Wall Street had also backed away, though there are indications it will become more active again in raising cash after the recent, successful $2.76-billion rights offering for Time Warner.

The effect of Hollywood’s financial troubles is most severe on the independent production companies that operate outside the studio system. A string of independents born in the freewheeling 1980s--including Vestron, DeLaurentiis Entertainment Group and Weintraub Entertainment--have already collapsed under their own debt.

Credit Lyonnais Bank Nederland was the primary supporter of the independents. But it has pulled back because of controversy over more than $1 billion in loans to Italian financier Giancarlo Parretti for the purchase last year of MGM. Credit Lyonnais has since taken control of the financially troubled company.

“The attention on Credit Lyonnais’ difficulties has sent shock waves through the banks and other financial institutions,” said Christopher Murray, a lawyer who specializes in entertainment industry financing. “If they are getting burned this badly, a lot of people feel it must be an inherently risky business.”

Gary Matus, a senior vice president at lending giant Bank of America, said the credit crunch is as bad or worse than any ever seen in the history of the film business.

“There is clearly a withdrawal from risky ventures,” Matus said. “And the independents are pretty risky, because they bet on box office and other markets to pay back enormous investments.”

Ironically, the capital crunch comes as the role of independent companies in the marketplace is growing.

The three highest-grossing summer movies--”Terminator 2,” “Robin Hood” and “City Slickers”--are from independents: Carolco Pictures Inc., Morgan Creek Productions and Castle Rock Entertainment, respectively.

“For truly independent companies this is a very, very difficult time,” said Alan Horn, Castle Rock’s managing partner. “We feel like we’re steering through these rocky waters, and we see the wreckage of all these other companies all around us.”

Hollywood’s profits are tumbling . . . (Combined profits of major Hollywood studios) 1989: $1.2 billion 1990: $1 billion 1991: $800 million (projected) Source: David J. Londoner, Wertheim Schroder & Co.

. . . as box-office take slips . . . (U.S. box-office revenue (through Aug. 20 each year) 1989: $3.26 billion 1990: $3.20 billion 1991: $3.11 billion Source: A.D. Murphy, Variety

. . . helping pull entertainment stocks back to earth. (Percentage decline of selected . entertainment stocks from yearly highs (as of Aug. 1)) Wlat Disney Co.: 11.4% King World: 21.4% New Line Cinema: 25.9% Paramount: 16.1% Time Warner: 31.4% Source: Donaldson, Lufkin & Jenrette