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Sony/MGM: Catalog Lure Keeps Dealmaking Going

7 Jun, 2004 By: Erik Gruenwedel

As Sony Corp. extended its exclusive negotiations to formulate a $5 billion deal for film studio Metro-Goldwyn-Mayer, financial and industry experts say such a consummation wouldn't alter the home video landscape dramatically, so much as it would create a business pact challenging to most CFOs.

A merger between the two would see a combined home video business (with Sony's Columbia TriStar Home Entertainment) that, in 2003, would have generated $3.69 billion for 16.5 percent of the total home video marketplace, according to Video Store Magazine Market Research, keeping CTHE in its same No. 3 marketshare position behind Buena Vista Home Entertainment's 19.6 percent in 2003.

“I don't think it is going to have a major impact on home video, but it will certainly put a major library in the hands of somebody who has enough money to manage it for the long-term rather than the short-term profit,” said analyst Dennis McAlpine with McAlpine Associates, New York. “I don't think it is going to change pricing.”

Citing “strategic alternatives,” MGM last month delayed its annual shareholders meeting to June 29, saying it required additional time so company officials could “evaluate such alternatives.”

A spokesperson from MGM said the company didn't have any comment on the matter; a Sony spokesperson was not immediately available for comment.

With less than 30 percent of its 4,000-plus-title library released on DVD, according to MGM, the studio's catalog, including TV programming, generates in excess of $400 million annually in royalties, according to a source familiar with the negotiations.

“It's not just the movies from the '30s, '40s and '50s, it's the whole Orion [Pictures] library from the '70s [that MGM acquired in '97],” said Tom Adams with Carmel, Calif.-based Adams Media Research. “There are other libraries out there with more titles but not as high quality. So it's definitely volume and quality when it comes to MGM.”

Regardless of the depth and quality of its library, the ongoing proliferation in DVD of yesterday's theatrical gems and clunkers isn't unique to MGM.

“I think we are in a phase in the industry where there is a lot of dumping of old titles,” said McAlpine. “That phase won't last too long because of market saturation.”

He said a deal would probably mean a more stretched out release policy for the MGM library.

Blu-ray Group
As a manufacturer and provider of entertainment hardware and software, Sony's acquisition of MGM fare would allow it to replicate business foresight that saw the Tokyo giant 20 years ago delve deeply into the music industry prior to the launch of the Walkman portable CD device.

Sony is a major proponent of the Blu-ray Disc format, a next-generation, high-definition video platform. Home video unit CTHE said it would bow home video in Blu-ray by 2005.

“After they lost Betamax [to VHS], they felt they had to control software to guarantee acceptance of their hardware,” McAlpine said.

Financial Chess
Principle barriers to completing the deal revolve around Sony and its group of private equity firms' structuring of the $5 billion offer, according to sources close to the deal.

Debt structure for Sony and establishing an exit strategy that would allow the equity firms to get their money back aren't easy to draft, according to experts familiar with mergers and acquisitions.

“If Sony bought them, it would establish a Sony/MGM subsidiary, of which it would own 60 percent and 40 percent by the private equity firms,” said Shelly Singhal, managing director and EVP of SBI-USA, a Newport Beach, Calif.-based advisory firm specializing in growth companies.

Singhal said a typical strategy would include borrowing a majority of the acquisition amount to minimize Sony's equity contribution and then contracting some type of equity offering of the subsidiary to repay that debt.

MGM's cash flow would be used in part to pay the interest on the debt, Singhal said.

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