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Is MGM Cutting Sony from the Script?

By Ronald Grover As a Hollywood studio, MGM has had more lives than its fabled Leo the Lion trademark. Created in a merger of studios in 1924, Metro-Goldwyn-Mayer (MGM) was Hollywood's No. 1 moviemaker for decades, offering up such classics as The Wizard of Oz and Gone With the Wind. It fell into decline in the 1960s, and in the last 30 years had a string of owners, including billionaire Kirk Kerkorian, the mysterious Italian moneyman Giancarlo Parretti, and eventually Kerkorian again.

Until recently, much of Hollywood had given the lion up for dead. In September, 2004, a group of private-equity investors, assembled by Sony (SNE), bought the studio for $5 billion in cash and stock (see BW Online, 9/15/05, "MGM Puts a Content Crown on Sony"). The script seemed simple enough: Sony would assume responsibility for making films for MGM's well-known James Bond and Pink Panther series and milk MGM's impressive library. MGM would no longer function as a studio.

BEING JILTED? MGM has, in fact, closed down much of its distribution operation so that Sony can market and distribute MGM's flicks on DVD and in the theaters. And it has begun co-producing films like the Philip Seymour Hoffman movie Capote and the comedy Yours, Mine & Ours, to be released on Nov. 23.

Now the plot twist. With the Oct. 24 appointment of longtime media executive Harry E. Sloan as its chairman and CEO, MGM is declaring that it's ready to start acting like a studio again. Sloan, who left Hollywood in 1990 to start Swedish TV company SBS Broadcasting, established his credentials as an empire builder on Oct. 19 when he sold SBS for $2.1 billion. In interviews right after his hiring, Sloan said the studio and its investors intend to make films -- with or without Sony -- and create its own cable TV channels.

Where does that leave Sony? That's the question that some folks inside Sony are starting to ask themselves, my sources say. After pumping in $300 million, Sony owns 20% of the new MGM. And it gets the rights to distribute MGM's films for at least another year, in addition to running the foreign cable channels that MGM brought into the deal. Sony also has a seat on the new MGM board. But that's a far cry from running the place.

DIGITAL EXPLOSION. Controlling interest actually belongs to the four private-equity firms that put up the bulk of the $1.6 billion in cash, with Providence Equity Partners owning 29%; Texas Pacific Group, 21%; DLJ Merchant Banking Partners, 7%; and Quadrangle Group, 3%. Sony gets distribution rights to movies MGM will produce and has the rights to co-finance films with MGM. (Sony and MGM are jointly producing the next James Bond, Pink Panther and Rocky installments).

Sources close to both Sony and the MGM investors play down persistent Hollywood rumors of tension between the two sides. But you have to wonder at what point Sony starts to get its back up. Sloan has made no secret of his intent to jump-start production of films and TV shows, and has foreshadowed that MGM will do some production for its own account and others in partnership with Sony, which would likely continue to distribute all of the films.

Moreover, given the growing appetite for digital distribution of films, the new MGM intends to use that content to feed the legions of homes overseas and in the U.S. that will be getting hundreds of TV channels. "There will be maybe 400 million digital homes in the next decade, and we're going to make the content for those homes," Sloan tells BusinessWeek.

ABLE TO EXIT. Sloan isn't saying much more than that. But others with knowledge of the new MGM sketch out a script that has MGM going its own way, and they say it will raise money from third parties and hire its own directors and producers. MGM is likely to find foreign money or other investors to bankroll its films, much as former Miramax Co-Chairmen Harvey and Bob Weinstein just did to launch their new film company.

And Sloan, with his history in creating foreign TV outlets, is likely going to start cable and satellite TV stations around the world, adding to the dozen or so channels that currently beam MGM films and TV shows. Whether MGM would own the stations outright or allow Sony to own some is still an issue, according to those with knowledge of the two companies. Sony has the right to manage some of the stations for MGM, and it distributes MGM's TV shows in foreign markets. But their agreement is less certain for the newer channels.

Sony, MGM, and the investor group aren't commenting. But sometime in 2006, according to a source with knowledge of the deal, MGM has the right to end its distribution arrangement with Sony under certain conditions. That would enable MGM to search for a new partner. That may not be likely, given the fact that the two companies will be intertwined with so many projects by that time, but it's possible.

SLASHING COSTS. And if MGM puts together enough money and projects, it could go shopping. For now, Sony and MGM seem to be working well together on their various joint ventures, say sources.

It's clear that its investors see MGM as more than a $5 billion asset. For one, it could be a sequel to the Warner Bros. Music story. In March, 2004, Providence was among a group of private-equity investors that helped buy Warner Music (WMG) from Time Warner (TWX) for $2.6 billion (see BW, 12/8/03, "Will Bronfman Have the Last Laugh?"). The private-equity firms did what they do best: They forced management to improve the bottom line by cutting costs. By the time Warner Music went public 14 months later, the private-equity firms had been paid more than the $1.1 billion they had put into the company through a series of special dividends and one-time payments -- and they still owned more than 80% of Warner Bros. Music.

Can the private-equity folks do the same thing at MGM? Even before the ink was dry on its sale agreement, the managers retained by the investors had started to whack away at MGM's overhead. More than 1,000 of the studio's 1,400 employees were pink-slipped, as the distribution operations were moved over to Sony. With far fewer expenses, MGM has been able to about double the $250 million a year in cash flow that the library was producing before the merger. And as more foreign markets open up, it intends to expand sales of the DVDs from its library of 4,000 movies and more than 10,000 episodes of TV shows.

A STAR AGAIN? MGM is still losing money. In its most recent quarter, it dropped $86 million, based on calculations that come from Sony's most recent earnings report, in which it was required to report its share of losses. But that's fairly irrelevant. Private-equity firms usually have a time horizon of three to five years to turn around a company, make a huge killing, and sell it off. And by hiring Sloan, who's also investing in the new MGM, this appears to be exactly what the money behind MGM seems intent on doing.

With its 20% stake, Sony will get its share of the upside if MGM does come roaring back. Or Sony, under pressure to restructure due to weak electronics sales, could be pressed to buy out the partners to keep the company -- and its very valuable library of older films -- from going to another studio. For a studio that has been to the brink and back more times than a punch-drunk action star, MGM still appears to be out there swinging.

Grover is BusinessWeek's Los Angeles bureau chief

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