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There's Gold in MGM's Oldies

By Ronald Grover The Hollywood rumor mills were working overtime this week, fanned by an article in The Los Angeles Times that fabled studio MGM is for sale. Of course, MGM, controlled by Kirk Kerkorian, has more or less been for sale ever since the octogenarian billionaire paid $1.3 billion in 1996 to reacquire from French bank Credit Lyonnais the studio he has owned -- and sold -- two other times in the past 15 years.

This time around, the rumored bidding price of $7 billion seems truly remarkable. Especially when you consider the studio, despite a smattering of hits in the past year, is still considered Hollywood's weakest sister.

You see, Kerkorian and MGM Chairman Alex Yemenidjian, Kerkorian's one-time financial adviser who operated the MGM Casino in Las Vegas for the billionaire before heading to Hollywood, have discovered what gets media moguls to come to the bargaining table. It's called a library. And in MGM's case, this collection of mostly older movies has all the blue-sky wonder of an Internet stock in the pre-bust days.

BOND AND BANZAI. How high could the price for MGM's movie archive go? Hard to say, and Kerkorian and Yemenidjian aren't talking -- at least to the media. But whatever the price is today, you can bet it will be higher tomorrow. And with more than 4,100 titles -- including the popular James Bond and Pink Panther series -- MGM may just have what the vast majority of dot-comers could never quite pull off: a high-flying asset that actually produces not only revenues but earnings as well.

At $7 billion, the 4,100 MGM titles -- minus the $1.5 billion price tag Wall Street analysts put on MGM's cable-channel holdings -- would be worth a very steep $1.3 million apiece. Granted, the library has its share of dogs, like The Adventures of Buckaroo Banzai. But the beauty of owning a Hollywood studio is you get to average out the good and the bad. For every film like Mr. Accident, there's a Silence of the Lambs that can be sold over and over again to cable channels, Polish TV stations, and the red-hot DVD market.

This year, the films in MGM's library will generate operating earnings of $180 million, UBS Warburg analyst Christopher Dixon figured in a recent research report. That's more than half the $326.2 million in operating earnings that Dixon projects for MGM.

BIG SCORE. The value of libraries has been taking off faster than has Harry Potter on his quidditch broomstick. In 1985, when Ted Turner bought the TV rights to 3,235 of MGM's films, including Gone with the Wind and The Wizard of Oz, he paid a then-unthinkable $1.1 billion, or about $336,000 a title. Even adjusting for inflation, that would value each of those titles at $553,000, less than half of what MGM figures it can get for each of its films.

Why the big boost? Back when Turner was plunking down all those dollars for Scarlett, Dorothy, and Toto, there were only so many places to put those films. Turner figured his big score would be getting them on his cable channels. Today, you can add home video, DVD, and, coming soon, video on demand -- streaming over the Internet and Lord knows what else -- to delivery options.

Just take DVDs. Last year, according to the studio-backed DVD Entertainment Group, American consumers spent $6 billion to buy or rent DVDs of Hollywood films, 2.4 times more than they spent in 2000. And next year, consulting firm Adams Media Research projects, folks will spend $9 billion on DVDs, surpassing the $8.4 billion or so films will rake in at the box office. Indeed, most folks in Hollywood today figure that movie theaters are little more than promotional vehicles, creating buzz that helps studios really clean up with sales of DVDs and home videos.

DEAL MACHINE. MGM clearly had this figured out back in 1999, just before Yemenidjian made the jump from Kerkorian's casino to his studio. With Yemenidjian calling the shots from behind the scenes, the studio struck a deal to pay $225 million to buy back the video and DVD rights to 4,780 titles that had been sold to Warner Bros. in 1990 when prior management was desperate for cash.

Yemenidjian then went into overdrive, cutting deals left and right to generate cash from those newly reacquired films. A week later, MGM signed its first deal to show the films with a British pay-per-view company. Ten days later, it signed a Japanese satellite operation.

However, the real gold mine is DVD sales. Last year, MGM generated $264.2 million in revenues from selling DVDs of more than 300 of its titles, including such oldies as When Harry Met Sally and the Rocky series. That's a 67% hike from a year earlier, and closing in on the $395 million generated from home video sales.

In mid-December, the company told Wall Street that it expected to post four times the earnings it had projected earlier in the year, citing the "better-than-expected performance for the company's film library." It is expected to announce earnings in mid-February.

CHANGING SEATS. The problem for MGM is that, apart from pressing DVDs, it doesn't have the number of outlets it needs to really cash in on those titles. True, it controls more than a dozen cable channels, mostly overseas. It also owns a 20% stake in Rainbow Media, for which it paid $820 million in early 2001. That helps get its library of older films on cable channels like Bravo and American Movie Classics. But it has nowhere near the number of outlets of a company such as AOL Time Warner, which owns HBO, TNT, TBS, and Turner Classic Movies, as well as the WB TV network.

Still, that's only part of the reason Kerkorian and Yemenidjian are anxious to sell their library to a larger media company. With the kind of cash flow that MGM's library produces in the DVD market, the two dealmakers see a major opportunity to trade up -- and get a better seat at a bigger table.

For starters, Kerkorian wants a tax-free transaction, which would allow him to take stock in place of cash and a stake in whatever major media company might bid on MGM. As for Yemenidjian, the trusted lieutenant is likely to want a management role of some sort in the company that eventually buys the MGM assets. MGM was contacted but would not comment about takeover rumors.

MONEY MINT. So does that make a deal for MGM a sure thing? The $7 billion price tag carries with it a multiple of higher than 25, meaning that it would take 25 years at current cash-flow levels to make back the money someone would spend. Not too many shareholders would be willing to wait that long for a big-ticket purchase to pay dividends. Indeed, when Turner paid what was then a multiple of nearly 11 for his MGM library, it was considered so high that he had to do the deal with high-interest junk bonds.

What Turner clearly knew was that cable TV, hungry for vintage movies to fill its lineup, would eventually make the multiple he paid seem like a bargain. Today, the channels Turner started, which Time Warner bought in 1996, are the backbone of AOL Time Warner's cable unit and fairly mint money, with revenues of about $7 billion annually and nearly $2 billion in operating earnings.

MGM figures the onrush of new technologies will make a pile of money just as quickly for whoever buys its library -- Hollywood's largest. Not bad for the weak sister. Grover is Los Angeles bureau chief for BusinessWeek. Follow his weekly Power Lunch column, only on BusinessWeek Online

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