Hollywood Expected to Fare Well in a Downturn

USA Networks Inc. Chairman Barry Diller is telling his executives not to lose sleep over the jittery stock market and the threat of a worldwide recession brought on by a reverberating financial crisis in Asia, Russia and Latin America. After all, Diller said recently at a meeting of his top executives, USA’s television, concert ticketing and Internet businesses are virtually recession-proof because consumers take refuge in entertainment during tough times.

Indeed, history shows that families continue to watch TV, rent videos, go to the movies and buy CDs when the economy falters. In a deep and prolonged recession, box office sales might taper as videos gain popularity; consumers might scale back their music and television purchases, buying one CD at a time rather than three and cutting back on their pay-per-view and premium channel purchases. Advertisers certainly pull back, with some of them choosing cheaper mediums such as radio and cable over broadcast and print.

But Hollywood feels less pain than other industries because it peddles inexpensive serums for escape rather than big-ticket discretionary items such as luxury vacations, cars, homes and washing machines whose purchases are often put on hold during contractions.

While Hollywood is more dependent on international markets than ever before, the diversification of most large media concerns will cushion the impact of the international crisis. That is why entertainment stocks have generally held up during the recent gyrations on Wall Street.

One notable exception is the Walt Disney Co., whose reliance on international markets, retail sales and recession-sensitive theme parks makes the company more vulnerable than others.

The resiliency of entertainment is good for Southern California, whose economy is tied to the health of Hollywood. In the 1970s, the regional economy relied more heavily on aerospace business, which is more susceptible to world economic downturns.

But during the last downturn, in the early ‘90s, an insatiable appetite both here and abroad for movies and television shows fueled employment and greatly reduced the damage to the region.

“Hollywood and international trade kept Southern California from sinking deeper into recession,” said Jack Kyser, chief economist at the Los Angeles Economic Development Corp.

To be sure, many experts insist that the U.S. economy so far is on solid footing and that the recent turmoil in the stock market is an isolated reaction to downturns abroad. But the fear is that the international financial crisis could undermine U.S. companies that derive revenue abroad, infecting the economy at home as earnings shrink and costs and jobs are slashed.

“Entertainment is the most bullet-proof industry in a recession, second only to Wonder Bread,” said Christopher Dixon, an analyst at PaineWebber Inc. “The hottest industry during the Depression was motion pictures. People escape into the fantasy of films.”

He added that many of the entertainment stocks hit hardest on Wall Street were trading too high and now are more reasonably priced. Diller even told his employees that times like these create bargains for acquisition-hunters like USA, which during the last three years has snapped up cable channels, Internet services and a broadcast station group.

International markets have become increasingly important outlets for Hollywood, with movie studios alone deriving nearly half of their box office receipts abroad. “The growth of international markets is great, but if you live by the sword you have to die by the sword,” said Harold Vogel of SG Cowen Securities, who calls himself the most bearish entertainment analyst on Wall Street.

Entertainment companies with vast international operations have already felt a pinch. Disney’s growth slowed for the first time in the quarter ending in June as reduced demand for its videos and merchandise in Asia contributed to a 2% decline in profits.

After reducing Disney’s earnings estimates in June, several analysts cut year-end projections for the company, prompting Disney to warn investors of a downturn in fourth-quarter profits and a disappointing year-end. Disney’s stock has fallen by 22% this year, while rivals Time Warner, Viacom and News Corp. are up 40%, 53% and 14%, respectively, for the year.

Disney says its stock simply has cooled off from a hot streak sustained through the ‘90s that its rivals did not enjoy. And analysts say Disney is in a category all its own in entertainment because of its broader dependence on retail sales as well as foreign travel to theme parks here. Analysts also worry about a simultaneous ratings decline at Disney’s ABC and the rising cost of sports rights, which could cut into ESPN’s huge profit margins.

Jessica Reif Cohen, an analyst at Merrill Lynch, said the increased diversification of media giants during the last decade better insulates them from business fluctuations. Time Warner’s booming cable television business, beefed up by the 1996 purchase of Turner Broadcasting System, has helped counteract doldrums in the worldwide music business and could help cushion its publishing group from a recessionary advertising slump.

Some parts of the entertainment industry would withstand a recession better than others. Publishers, television and radio stations could see advertising spending contract, with some analysts and money managers particularly worried about companies that have paid top dollar to expand, betting on continued good times.

Such a contraction could have a trickle-down effect, squeezing spending on programming just as financial strains at the networks are already reducing the number of scripts being developed and big star deals. Still, most stations are tied into long-term contracts for syndicated programming.

Cable concerns generally fare better than broadcasters because they do not rely solely on advertising, but charge subscription fees.

The industry, however, could face a hard sell for new technologies that add charges to customers’ bills and that are key to future growth, such as digital TV and modems that allow high-speed Internet connections.

For the moment, the market downturn has packed the hardest wallop to high-flying Internet stocks and those of broadcasters such as Chancellor Media Corp. and Sinclair Broadcasting whose rapid expansion has saddled them with heavy debt that could haunt them in a recession.

For instance, many experts say that Chancellor needs brisker growth than the historic 8% a year in radio to make some of its expensive purchases pay off.

While the entertainment industry in Los Angeles would be mostly shielded from a downturn, the Asian crisis has nonetheless sent a chill through the industry. For the first half of 1998, jobs in entertainment in Los Angeles grew by only 3%, compared with previous yearly gains of 5% or more since 1992.

Job growth throttled back because of the strong dollar, which in addition to reducing purchasing power abroad has caused production crews to migrate out of Los Angeles to cheaper locations such as Canada and Australia.

The Asian crisis also wiped out a source of financing for small independent producers. “A lot of projects never got off the ground because Asian distribution contracts were key to their financing,” Kyser said.

Currency devaluations have hurt large media companies in countries such as Taiwan, Thailand, Singapore and Indonesia. “In Taiwan, I’m stretching out payment terms for long-term clients,” said Michael Grindon, president of Columbia Tristar International Television, which operates TV channels and produces and sells programming abroad for Sony Pictures Entertainment. “In Japan, I might postpone adding people, but I’m not going to shut down the offices or cut back. We’ll hunker down and tough it out because the underpinning of the economy is sound.”

In a reflection of how all entertainment companies are managing their risks by diversifying, Grindon says he will make up for lost business in Asia by pursuing such developing markets as South Africa more aggressively.

While Sony said it will sit on the sidelines rather than push ahead with a new channel in Russia, Viacom’s MTV Networks said it is proceeding with plans to launch a channel there later this month. “We’re rethinking how to launch--having a big celebration and a VIP party may not really be appropriate given the mood there,” said MTV Networks Chairman Tom Freston.

Because MTV is licensing its programming rather than financing the start up of a new channel as it usually does internationally, Freston said MTV has little economic downside in Russia.

Overall, however, Freston said the international businesses of MTV Networks, which includes Nickelodeon, TV Land, VH-1 and MTV, are all showing year-to-year growth, even in Asia.

In the music business, the lack of hits worldwide packs an additional punch during troubled times, when consumers generally refrain from purchasing the three older CDs on their list to save up for a CD on the top 10 list.

What is more, in developing markets, recessions have stymied the sale of CD players, which are just beginning to catch on, said Rudi Gassner, chief executive of BMG Entertainment International.

Gassner said BMG’s sales in developing Asian countries have recently dropped by up to 50%. “Everybody better dress up warmly because it’s going to be get pretty chilly out there.”