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Fear factor

H'wood frets that prime cuts are omens of new era of austerity

As the old saying goes, when friends lose their job, it is a recession. When you lose your job, it is a Depression.

Either way, the sense of gloom in Hollywood is higher than usual, fueled by a number of factors. The big question: Is the fear greater than the reality?

Certainly, there are ominous clues:

  • Disney reduced its film slate and laid off some 650 employees, leading to speculation that other studios may follow.

  • Studios are scaling back producer deals. Sony is getting tougher on terms for producers and even Tom Cruise at Paramount will be subjected to a more frugal production deal.

  • Homevideo sales are slowing faster than expected, without a viable new distribution platform to replace them.

  • New leaders at the Writers Guild of America and the Screen Actors Guild are more militant, renewing predictions of a crippling strike when the guilds’ contracts expire in November 2007 and June 2008, respectively.

Hollywood runs on anxiety: Successful people fear that their success will be taken away; out-of-work folks fear that they will never be hired again. But even in this nervous atmosphere, the sense of dread is unusually high.

Mixed with the worry is an uneasiness that these cuts are not based on Hollywood realities but on boardroom mandates. Projecting income for the first quarter of 2008 is hard for any manufacturer, but next-to-impossible for anyone dealing with audience whims.

Yet the studio-owning corporations seem unwilling to recognize that the quarter-by-quarter formula can be more short-sighted than the big-picture approach.

There’s plenty to back up the pessimism. Just last week came another indicator. A Kagan Research report showed that on average, studios last year recouped only 84% of production and domestic marketing costs from domestic theatrical rentals and homevid sales.

But optimists see signs of prosperity. Boxoffice so far in 2006 is at $5.47 billion, up 5% over last year; new delivery systems indicate a hunger for even more product; new money is flooding the town (one studio topper says he has multiple hedge funds competing to partner on pics).

In addition, saber-rattling over a strike is a long-standing tradition that rarely leads to work stoppage.

And, despite cutbacks in producer deals, new talent is still landing lucrative paydays. Witness the twin deals that J.J. Abrams recently landed at Warner Bros. and Paramount.

Paramount and Universal are creating their own international distribution divisions following the dismantling of their partnership in United Intl. Pictures. Fox is launching a new specialty division, Fox Atomic.

So it depends if you want to see the glass as half-empty or half-full.

“Our business goes in cycles,” says producer Lorenzo di Bonaventura, former head of production at Warner Bros. “You had the same worries when the VHS market was maturing. Everyone talks negatively about DVD sales. Yet no one says they’re declining, they’re just not increasing as in the past.”

Clearly, the business is changing. While the Internet offers potential, no film or TV supplier is making a fortune off of it yet. Downloading sites such as Movielink have been slow to take hold, and studios still haven’t signed deals with Apple’s iTunes.

As for the new generation of high-def DVD players — well, are you excited about buying one?

Corporate CEOs like Disney’s Bob Iger and Time Warner’s Richard Parsons, in speeches and at conferences, haven’t exactly been bullish on the film biz as an area for expansion. But then, those two are not innately movie guys.

Time Warner’s second-quarter earnings last week were robust — but more mixed on the studio side. At Warner Bros. Entertainment and New Line, operating income was up by 10%, but revenues dropped by 10%.

Following layoffs at WB and Paramount-DreamWorks, the Disney cutbacks raised fears that significant slicing and dicing will go on at other studios, particularly in homevideo, although none has announced their intention to do so.

Says veteran entertainment attorney Eric Weissmann: “We are in a strange time where the studios are retrenching, but the same number of movies are being made and seen.”

Corporate parents are increasingly exercising more control and scrutiny over the film business, as studios try to shore up their bottom lines to please shareholders.

One Hollywood exec even calls all the rounds of studio cost-cutting a kind of conglom “snow job” on Wall Street — an way to bump up the parent company’s stock short term.

The slowdown also shows up in the numbers: Job growth in the motion picture business will continue this year, but at a rate of about 1.5% — more modest than in years past, according to the Economic Development Corp. of Los Angeles County.

“Every so often, studios go through periods where they say, ‘We need to improve profitability. Let’s cut back,’ ” says Jack Kyser, the group’s chief economist. “You have an industry in a great state of flux,” he adds. “The Disney layoffs sent shudders throughout the business because it brings a new uncertainty.”

A big fear is that new technology will bring upheaval, a structural shift that will leave many in the dust.

But as experience shows, the predictions of imminent change can be off the mark.

A decade ago, the sentiment was the polar opposite, with buzzing over the pending digital future creating optimism that Hollywood would benefit from an insatiable demand for content. Variety declared it the “upsizing of Hollywood,” as studios were in an expansive mode.

DreamWorks was designing a new backlot, WB was launching animation and special effects units; the Walt Disney Co. was staffing up a giant new Internet venture, Universal was so bullish it enlisted star architect Rem Koolhaas to redesign its lot. All those plans have been shut down, or simply never materialized.

By contrast, in the eyes of Wall Street, studios now are seen as bloated entities. U is looking to sell off portions of its lot while other studios are closing or selling off non-core divisions. Paramount recently shuttered an historic scoring stage.

A case can be made that, as painful as layoffs can be, media conglomerates are simply waking up to studio excess, whether in the size of film budgets, star salaries or in overall overhead.

“It seems like people are tightening their belts, but it is not too unwarranted,” says producer Bill Mechanic, the former chairman and CEO of 20th Century Fox Filmed Entertainment. “There has been unchecked growth for a time. Every business goes through it.”

In fact, when it comes to expenses, studios are getting hammered by rising advertising and marketing costs, made all the more ironic as marketing chiefs now head Universal Pictures and Walt Disney Pictures.

So far, no other studio than has announced a major reduction in their film slates. Outside of Disney’s plans to release just a dozen or so pictures per year, as of now the number of movies other studios are releasing is looking pretty much unchanged into 2007. Not that they haven’t studied the possibility: For months, Warner Bros. has looked at the possibility of cutting back by as much as eight pics, from the 20 to 23 it makes each year. No decision has been made, and if there is any reduction, it wouldn’t come until 2008 or 2009.

Some marketing chiefs even grouse that they wish fewer movies were in the pipeline, given the heavy demands and expensive cost of promotion. Fewer pics would allow them more time to sell and grow each release. Distributors, however, want a continuous flow of product to fill slates. The volume not only allows distributors to get the best theaters, but helps build libraries.

“I would be hard-pressed to think that other studios would make only 10 movies per year. They need the content,” says Tom Sherak, the former chairman of 20th Century Fox Domestic Film Group and now partner in Revolution Studios, which is itself scaling back as a deal with Sony expires.

Jim Tauber, president of Sidney Kimmel Entertainment, said that it seems that studios are showing few signs of reducing the slates in their specialty units, giving a continued boost to pictures budgeted at $25 million or less. “Those are businesses that are performing well for the studios with strong risk-reward ratios.”

What has helped prop up studio film slates has been a wave of hedge funds and private equity investment in the business, allowing studios to finance pics at stratospheric budgets.

Deals could slow after the high-profile misfires like “Poseidon” and “Lady in the Water,” but interest among investors continues, allowing studios to further shield themselves from risk.

“There is one particular studio where they have attempted to get equity investments greater than 50% of their budget,” says Amir Malin, the former CEO of Artisan Entertainment who is running the investment fund Qualia Capital. “This is something that we have seen in the past four or five months.”

“The more sophisticated equity and hedge funds have developed a great learning curve, and they are much more conservative about film financing,” he says. “There is so much capital out there, and there are hedge funds out there that have not entered that are enamored of the industry.”

Undoubtedly, the equity investments have helped studios justify their projects to the corporate parent.

That oversight is what worries many studio vets.

“We may not fit in with the corporate strategy, but we are making money, and that is what is saving us,” says one studio executive.

As austerity becomes the norm, executives will be forced to rationalize more unconventional projects, or lavish producer deals. The latter may look like a waste of money on Wall Street, but for studios they can mean a steady flow ideas into the system.

“While the short-term results of cost cutting almost always looks good as margins improve in the quarters immediately thereafter, the negative long term impacts are often well hidden and devastating,” says Brian Mulligan, a former top exec at Universal Seagram and Fox who now runs entertainment and investment advisory firm Brooknol Advisors.

“Of course, entertainment enterprises require ongoing management of costs, but recurring and constant re-rationalization of the business can do more harm to a company than allowing profligate spending.

He adds: “As the old management maxim goes, ‘You can’t save your way to prosperity.’ ”

—Diane Garrett, Jill Goldsmith, Pamela McClintock and Gabriel Snyder contributed to this report.

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