French Film Buff

PolyGram Chief Executive Alain Levy is a contrarian.

Despite skepticism on Wall Street and in Hollywood about the short-term prospects of the multibillion-dollar company he runs and the current health of the company’s core businesses, music and movies, the unflappable Frenchman prefers to take the long view.

“There’s hysteria about the state of the music business . . . and the town here publicly committing suicide about the film business is awful,” Levy said in his brusque, no-nonsense manner in a recent interview at PolyGram’s Beverly Hills offices.

Levy has brought PolyGram, currently the largest music company in the world, to a precipice in the volatile movie business. The company is prepared to raise its investment in Hollywood to more than a billion dollars in the next 18 to 24 months to compete with the major studios. The move could either thrust PolyGram into the top ranks of entertainment companies or leave it in the cold with substantial losses.

Interestingly, the 50-year-old, London-based PolyGram president is bullish about an industry in which many executives are having anxiety attacks over soaring production and marketing costs and an overcrowded marketplace.

It’s also a business that proved disastrous for PolyGram in the early 1980s when the European music company first plunged into Hollywood and promptly lost $140 million.

“I think the studios are doing a great job of saying how lousy the business is,” said Levy, who has been responsible for pushing the company’s reentry into the movie business since becoming chief executive in 1991.

“I’ve never seen anybody in an activity saying so many bad things about the activity they themselves are in,” said Levy, who comes to Los Angeles about every six weeks. He contends there’s “too much focus on the cost side and not enough on the revenue side for anyone to say it’s a bad business.”

Although he acknowledges costs are spiraling to an “absurd” level, Levy believes they’ll be offset by increasing growth in foreign markets, the explosion of pay-for-view, satellite and other channels throughout Europe and Asia, and the emergence of digital videodiscs in the United States.

“Long-term, we think it’s one of the most exciting businesses to be in, provided you know what you’re doing,” said Levy, confident that PolyGram will continue to see double-digit growth on the revenue side of its movie operation through the end of the century.

Filmed entertainment, which accounts for 16% of PolyGram’s total annual sales of about $5.5 billion, will rise to 20% to 25% by 2000, Levy hopes.

*

“We’re more optimistic about the movie market than we are about the music market,” said Levy, noting that the film business in 1996 generated worldwide revenues of about $38 billion and is growing at about 9% a year globally, compared with 4% to 7% for the music business.

Levy recognizes that the film business is high-risk and “very dangerous,” one in which “people can make enormous mistakes.”

But, he argues, “it’s the only business I know where you build an asset.” Unlike building a factory, “which in 10 years would probably be worth zero, movies are the exact opposite--they’ll be worth more than they were when you first put your money in,” said Levy, citing the recent sales of such giants as Universal, Turner, Paramount and MGM as evidence that huge premiums are placed on entertainment assets today.

Levy’s patience in building PolyGram--75% owned by Dutch giant Philips Electronics--into an asset with worldwide value is reflected in the measured, low-cost approach the company has taken since revisiting the movie business in 1992.

PolyGram Filmed Entertainment, headed by Michael Kuhn, has adopted a cautious strategy that has thus far kept it from what Levy calls “ego spending,” a notorious habit that has put many start-ups out of business and often gets studios into financial hot water.

Levy’s tentative approach to building a studio from the ground up has yet to put the company into the Hollywood big leagues, where it sorely wants to be considered a major media player alongside Time Warner, Disney and Viacom.

His caution on the music side cost PolyGram a chance to own a chunk of Interscope Records, the hot Westwood-based label that Time Warner dumped in 1995 following a controversy over rap lyrics. Sources at his own company think Levy erred by dropping out of the bidding after MCA coughed up $200 million for a half-interest in the label.

Interscope went on to dominate sales during the lucrative Christmas season and last week logged 10 of the nation’s top 100 albums--the same amount as the entire PolyGram Music Group. But Levy says he has no regrets about his decision to pass on the Interscope deal, which he characterized as “very risky.”

*

Over the last decade, PolyGram has invested more than $1 billion to acquire a handful of prominent U.S. labels, including A&M;, Mercury, Island, Motown and half of Def Jam. Although some competitors say Levy undermined the creative edge at A&M; and Island, analysts say his vision helped transform PolyGram from a quiet classical music company into a major competitor in the pop world.

Levy, credited with helping propel PolyGram into one of the decade’s fastest-growing entertainment conglomerates, now is intent on turning the company’s film assets into gold.

As it did in music, the company is spending hundreds of millions to make it happen. To date, PolyGram has sunk $800 million on the movie side to acquire a collection of production boutiques and finance production. Levy says PolyGram is prepared to invest an additional $350 million in working capital into the company over the next two years.

PolyGram’s four production companies--London-based Working Title, Propaganda Films, Island Films and Interscope Communications--report to Kuhn and develop and produce their own slates of movies. The company has earned a reputation for quality, modestly budgeted independent hits such as “Fargo,” “Dead Man Walking,” “Four Weddings and a Funeral” and “The Usual Suspects,” which have been marketed and released through its U.S. specialty film distributor, Gramercy Pictures.

But even the hits--including a few high-cost titles such as “Sleepers” and “Jumanji,” released domestically through the majors--haven’t generated enough to offset the losses of its flops and growing investment in the film business.

Since entering the film business five years ago, PolyGram has lost about $100 million, an amount Levy characterizes as “peanuts” considering the nearly $900 million in revenue it logged last year.

“You want to compare that to the R&D; in the pharmaceutical industry or Philips or anywhere else?” said Levy, who can be as combative as he is candid when challenged. The loss, he likes to remind, doesn’t reflect the rising asset value that films such as “Four Weddings” have added to PolyGram’s library.

The company is starting a major U.S. distribution operation this fall and is ramping up the number and size of its releases. Budgets of at least four films a year will be upped to $50 million to $75 million. The company’s first major release will probably be “The Game,” a $70-million drama directed by David Fincher and starring Michael Douglas and Sean Penn.

Levy estimates the annual overhead of the in-house distribution unit to be $20 million to $25 million--a minor expense compared with the increased marketing dollars PolyGram will now shoulder, which can be upward of $20 million a film. PolyGram had let the major studios bear those costs on its big films by selling off domestic rights.

PolyGram will go from distributing about 12 titles a year to 16 in the next couple of years, with an annual target of 20. About six will be “major releases,” meaning they’ll open on 1,500 to 1,800 screens. It will continue to put its smaller releases out through Gramercy.

The company also announced plans to make a big push in the network, syndication and cable arena with the formation of a new domestic TV production division. Although PolyGram owns the ITC library, which it bought for $156 million in 1995, it has yet to be a significant player in the U.S. market. ITC--which produces “The Big Easy” for USA Network and is developing a CBS pilot based on “Fargo”--will be folded into newly dubbed PolyGram TV.

Levy acknowledges the increased risks PolyGram is taking in film and TV, but he believes the company has a competitive advantage because of a strong cash flow from the music side and a worldwide distribution network already in place. PolyGram directly distributes its movies in key overseas territories, including Britain, France, Benelux, Spain, Germany, Australia and New Zealand.

Having their own distribution allows studios to retain the upside on their product and keep valuable ancillary rights, such as video and cable, which are otherwise sold off to pay for production.

But they also keep the downside--if a slate goes badly a company can lose hundreds of millions of dollars. This is one reason the history of Hollywood is littered with companies that tried and failed to make it into the big leagues--most recently Savoy Pictures, which was dismantled last year.

What PolyGram still lacks is the mass of a studio, which is why it is still actively pursuing a major film library after failed bids to buy MGM and Samuel Goldwyn Co. last year. Its library, with close to 500 film titles and 11,000 hours of TV programming, generates between $20 million and $25 million in annual cash flow; major studio catalogs throw off $75 million to $100 million to offset costs and losses.

The ability to package library titles with new movies gives a company huge leverage when distributing its product to growing worldwide distribution outlets, including satellite and interactive television. Levy says PolyGram continues to look at all acquisition opportunities and has the blessing of Philips to write a check at the right price.

*

In the meantime, he says, PolyGram may form another film label to feed more product into its distribution system and build more library.

Some industry analysts say they are befuddled by PolyGram’s movie strategy.

“There’s a very divided view on Wall Street of their film strategy,” said one. “Half the Street is very concerned they’re going to make a major acquisition and half the Street is concerned they won’t.”

Investors also have been concerned that in a bull market PolyGram’s total earnings have been flat for the last two years and its stock is off a third from what it was in 1995. The downbeat news is presumably what led to months of rumors that Philips was considering selling part or all its entertainment assets. However, Philips’ new chief executive, Cor Boonstra, recently said there are no plans to abandon PolyGram.

Levy says PolyGram “has always been considered a core activity” of Philips, and he’s “never heard anything to the contrary.” He disputes rumors that there are serious tensions with its largest shareholder and says he’s had no arguments with Boonstra about the company’s results.

In music, PolyGram has controlled about 13% of the $12-billion U.S. market throughout the 1990s. Last year, however, the corporation went through a dry spell and currently ranks last of the six major record conglomerates in sales of current albums in the U.S., where retailers have been plagued by flat sales and severe financial problems.

Internationally, however, PolyGram is a powerhouse. The company’s distribution and relationships with strong indigenous talent in many countries have made it the largest music company in the world.

One reason business was off in the U.S., Levy says, was because the corporation overestimated the sales potential of follow-up albums by established pop acts. PolyGram also suffered turmoil in its executive ranks.

*

Before the year closed, Island President Johnny Barbis was given the boot and Def Jam’s distribution deal was shifted from Island to Mercury. A barrage of fiscal restrictions were also imposed on Motown chief Andre Harrell, whom Levy criticized for signing too many acts and spending too much money on self-promotion--particularly the full-page color ads Harrell ran in trade magazines touting his 1995 arrival at the label.

Motown’s market share has shrunk considerably since PolyGram purchased the label four years ago for a whopping $300 million. Levy said he is not pleased with Harrell’s lack of progress in trying to rejuvenate Motown, but denied speculation that Harrell’s brief reign is about to end.

“It should not happen this year,” Levy said. “Andre has a string of albums coming out and if those albums perform, there is no reason to get rid of an executive who is extremely talented. If there is a total failure with the new acts he signed, however, then, yeah, I have a duty to my shareholders and to myself to ask whether the guy is right for the job. But then again, that would apply to any manager running any of our labels. It’s got nothing to do with Andre; it’s got to do with my duty not to throw money away.”

While Kuhn runs the movie side, Levy keeps a close watch over its activities from PolyGram’s headquarters in London and base in New York, where he spends half the year. Two weeks ago, Levy and Kuhn met with Wall Street analysts to articulate PolyGram’s strategy in the movie business.

“I want analysts to realize the asset we’ve created. . . . We’ve been too vague about where we were going,” Levy said.

Some were impressed with the presentation.

“There was initially a lot of skepticism about them going into the film business,” said David Londoner, an analyst with Schroder Wertheim & Co. “But that clearly isn’t the case now. The losses have really not been huge. They’re building a credible organization and have done a pretty good job producing a classy bunch of modestly budgeted films.”

Harold Vogel of Cowen & Co. says PolyGram’s chances of becoming a major player in the movie business are better than some because “it entered slowly enough to have its eyes open,” and “it has the capability of absorbing significant losses relative to the cash flow and earnings power it derives from the music business.”

Levy bristles at the mere suggestion that PolyGram may be susceptible to some of the same pitfalls others have encountered trying to break into the Hollywood top ranks.

“Maybe the biggest handicap we have is history, because it’s been littered with so much irresponsible behavior that people assume we’re going to behave the same way,” Levy said. “I would call on the jury to look at the last five years and see how many people predicted our gloom and doom within a year or two--and it didn’t happen.”

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

A Profile of PolyGram

The world’s largest music company, PolyGram is jumping more deeply into the risky movie business this year in a quest to become a major Hollywood player

Music assets

* A&M; Records (includes Polydor Records)

* Island Entertainment (includes Island Records)

* London Records

* Mercury Records (includes Mercury Nashville)

* Def Jam

* Motown Records

* PolyGram Classics & Jazz (includes London/Decca, Deutsche Grammophon, Philips Classics, Verve)

***

Film operations brought in 16% of 1996 sales and are expected to increase.

Music: 84%

Film: 16%

***

PolyGram Filmed Entertainment

* Movie production

Interscope

Island Pictures

Working Title

Propaganda

* Movie distribution

Gramercy Pictures

PolyGram International

* Creative partnerships

Jodie Foster’s Egg Pictures

Tim Robbins’ Havoc Inc.

* Other

PolyGram TV (includes ITC)

PolyGram Video

PolyGram Merchandising

***

Net sales, in billions

1996: $5.69

Income from operations, in billions

1996: $0.65

Stock Price quarterly:

Thursday’s close: %50.25

Source: Polygram

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Alain M. Levy

PolyGram president and chief executive. Born in 1946 in Metz, France.

*

Education: A graduate of the Ecole des Mines in France, he later earned a master’s at the Wharton School of Business.

*

Career: In 1972, he joined CBS International and moved up through the ranks to managing director of CBS Disques in France. He joined PolyGram as head of its French music operation in 1984, took over direct management of the companys U.S. operations in 1990 and a year later was named head of the whole group

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

PolyGram’s Music Group

Over the past decade, PolyGram has invested more than $1 billion to acquire a handful of prominent labels, transforming the quiet classical music company into a major competitor in the pop world. PolyGram is the No. 1 record company in the world and has controlled about 13% of the $12-billion U.S. market throughout the 1990s. The corporation, however, currently ranks last out of the six major record conglomerates in sales of current albums in the U.S.

Mercury Records is booming with hits by 311 and Foxy Brown, thanks to deals struck with Capricorn and Def Jam. Island has hits by U2 and Dru Hill following a lengthy sales drought. Sales at A&M; have been sluggish due to moderate showings from such acts as Sting and Bryan Adams--although Sheryl Crow’s latest album is picking up.

The labels and artists

* Island: U2, Dru Hill, Cranberries

* A&M;: Sheryl Crow, Barry White, Bryan Adams

* Mercury: Shania Twain, 311, Tony Toni Tone

* Def Jam: Foxy Brown, Redman, LL Cool J

* Motown: Boyz II Men, 702

Source: Polygram