Poly plans perk

Low-balled Seagram could merge PFE with MGM

Faced with an embarrassing $700 million write-down even if it accepts the highest offer received so far for Polygram Filmed Entertainment, Seagram Co. may be forced to consider more inventive ways for disposal of the film studio, Wall Streeters say.

Among the ideas being proposed to Seagram is merging PFE into another company like Metro-Goldwyn-Mayer in exchange for a equity stake in the combined enterprise. That way Seagram would have a chance of getting some value for its investment if the combined company prospered.

No discussions have occurred on such a proposal, an MGM spokesman said Sunday, and it is not known whether Kirk Kerkorian, MGM’s majority shareholder, is holding any talks on the idea separately.

Innumerable obstacles

But people close to the situation say the notion faces innumerable obstacles, including the differing valuations of MGM and PFE and the fact that both companies are currently losing money.

Still, one person close to the situation said Friday that “there are a lot of ideas floating around about how to help rationalize this process for Universal. There is a reasonable structure that says Universal and MGM collaborate.”

Execs from Seagram Co.’s Universal Studios could not be reached for comment Sunday. The obstacles blocking such a deal are not insurmountable, some observers argue. And Seagram does not have many alternative options.

“They had an open house on (PFE),” said an observer of the bidding process, “and (almost) nobody showed up for the party.” If Seagram accepts the highest bid received — Artisan/Canal Plus’ offer of $400 million for PFE (plus $300 million of debt) — it would have to take a write-down on Polygram Holdings’ books, soon to be consolidated into Seagram, of up to $700 million. That is because by the time the PFE sale would close, Seagram would have had to put another $150 million into PFE, raising the total investment in the company to almost $1.4 billion, say people with knowledge of PFE’s balance sheet.

The other two bidders, MGM and Carlton Communications, made offers only for the library, sources said, at prices that would involve an even bigger write-down.

CEO favors sale

The Canadian beverage and entertainment giant has reviewed keeping PFE itself and absorbing its production and distribution assets into its Universal Studios unit — an idea, sources say, that finds favor with senior U execs. But Seagram CEO Edgar Bronfman Jr. is believed to be keen to off-load PFE.

Taking an equity stake in a combined MGM-PFE would not raise cash to help pay for the Polygram Holdings acquisition, which was one of the advantages of selling PFE. But Bronfman may decide it is better to wait and potentially get more out of an equity stake in a combined PFE-MGM in the future.

On the face of it, a merger of MGM and PFE would seem to be a combination of unequals. Even at MGM’s current depressed stock price of around $15, it has an enterprise value (including debt) of $2.2 billion while Seagram could at best argue PFE was worth its total investment of $1.4 billion, and Kerkorian would likely argue PFE was worth only $700 million.

This could be overcome, some observers say, by valuing the two companies on an equity basis. MGM’s equity is worth only about $1 billion right now, whereas Seagram could argue PFE’s equity is worth about the same.

Devouring cash

The other big problem with such a combination is that both MGM and PFE are voraciously devouring cash right now, rather than making money. Kerkorian recently had to agree to underwrite a $500 million stock offering to improve the Lion’s liquidity, although MGM hopes its cash flow will improve as licensing rights on its library revert back to it during the next few years.

PFE’s cash needs, based on its existing business plan, are even bigger than MGM’s. In the second half of this year alone, it needs $150 million to stay afloat, say people close to the situation. Next year the company needs $400 million, and at least another $120 million will be necessary in 2000.

But those cash requirements were based on PFE’s existing business plan, which could be dramatically slashed. Combining the overhead of the two companies could lead to some cost-savings.

One attraction for MGM is PFE’s international distribution network, which covers 85% of the international market in terms of revenues. Although it currently forms part of international distribution alliance United International Pictures, MGM sources say that the Lion could theoretically extract itself from UIP at a year’s notice.

Library growth

By merging with PFE, MGM would also substantially increase its film library — to around 5,500 titles — and give its 1999 release slate a significant boost.

Seagram may be better off replacing Goldman Sachs, its adviser on the deal, and extending the bidding deadline. Some potential bidders, such as Lakeshore Entertainment, did not submit a bid because it had insufficient time after due diligence to formulate its offer. Most of the bidders complained that Goldman was dictatorial in its handling of the auction and did not allow them enough time, or give them enough information, to make their best offer.

As a source close to one of the bidding groups said Friday, “We remain very aggressive and interested in completing this deal.”

MGM spurns suitors

Meanwhile, MGM confirmed Friday that it “was no longer currently in the discussions with unidentified companies regarding possible business combinations,” a reference to a disclosure it made in early August regarding discussions with News Corp. and Walt Disney Co.

The studio issued this statement while announcing that the offering of new stock would be made to shareholders on its books as of Oct. 5.

The “discussions” with Disney and News are believed to have been prompted by MGM’s former shareholder, Seven Network of Australia, which wanted to sell its stake. Last month, Kerkorian bought out Seven at its original investment price of $24 per share, indicating that he believes the Lion is still worth that.

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