Why Sony Is Now A Bit Player At MGM

Private equity backers have taken control of the studio Howard Stringer coveted

In the high-stakes world of private equity dealmaking, sometimes you have to be careful what you wish for. Just ask Howard Stringer. In the summer of 2004, the head of Sony (SNE ) of America badly wanted to beat Time Warner (TWX ) and win control of the faded Metro-Goldwyn-Mayer studio and its library of 4,000 films. He won the day by persuading four private equity groups, led by Texas Pacific Group and Providence Equity Partners, to chip in nearly two-thirds of the cash for a $4.9 billion deal. Six months later, Stringer was rewarded by being named the first non-Japanese to head Sony's entire parent corporation.

But in the 19 months since the deal closed, Sony has been pushed to MGM's sidelines--so much so that when MGM signed actor Tom Cruise to help run its United Artists unit, Stringer learned about it only hours before the Nov. 2 announcement. Sony's private equity partners have killed the Japanese company's lucrative deals to distribute MGM's films on video and TV. And MGM has reworked its deal with Sony to get more money from the James Bond franchise. Sony is releasing Casino Royale, with British actor Daniel Craig as 007, on Nov. 17, but will likely split revenues from the planned 2008 film with MGM and lose Bond altogether after that. "It was one of the most serious misalignments of a studio and investors out there," says media investment banker Stephen Prough of Salem Partners.

Almost from the beginning, Sony and its investors were on different wavelengths. A Sony-promoted deal to sell half of the rights to the UA name to former Fox (NWS ) studio chief Bill Mechanic for $250 million was killed earlier this year by incoming MGM CEO Harry E. Sloan, a Providence-appointed board member.

MOVING THE CLASSICS

But it was Sony's poor performance selling MGM's library of old films, including West Side Story and Rocky, that most upset the investors. Sony wasn't getting anywhere near the estimated cash flow it had projected from the library, say insiders. The DVD market had softened, and Sony's own studio wasn't making many hit movies, which are usually packaged with older titles to help sell them. "We realized that distributing the old films wasn't one of our strengths," says Sony Pictures Chairman and CEO Michael Lynton. The investors, who had inserted provisions in their deal if Sony couldn't hit its targets, yanked Sony's contract with three years to go, shifting its business to Fox in return for a $625 million up-front payment.

With its 20% stake, Sony still has two MGM board seats, but Sloan is the one running the show now. The highly regarded Hollywood executive made a killing selling his startup SBS Broadcasting to private equity investors and has convinced MGM owners he can make their property more valuable as a stand-alone company. To do that, he has restarted MGM's theatrical and TV distribution arms, taking both back from Sony. Sloan intends to tap other private investors to make films, including movies created by Cruise. And he's intent on making more money from the Bond franchise.

Sony executives figure they won big by signing MGM to put its films on its next generation Blu-ray high-definition DVD instead of the rival HD DVD. MGM might decide to bolt, however, especially if Sloan can fix it up and sell it to someone else. Sony could outbid that company. But as Stringer recently told an industry panel about losing MGM's DVD business to Fox: "We screwed up."

By Ronald Grover

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