Theatrical grosses rule again as 3D rises and DVD falters

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How fitting that when “Alice in Wonderland” is the top draw so far at the box office this year, Hollywood itself is starting to feel as if it’s fallen down a rabbit hole.

The industry is waking up to a topsy-turvy world where everything it’s gotten used to for decades has again changed — perhaps forever.

Studio libraries have lost their value, and making movies is now about how much you can make theatrically rather than banking on the kind of coin that can be collected for years down the road. In short, the homevideo paradigm that has driven Hollywood’s thinking for the last five to 10 years has been upended. The biz has shifted back to the traditional box office-based model, now enhanced by the rise of 3D.

It’s a harsh new reality that’s become especially apparent over the last six months as a frenzy of bidding — or the lack thereof — for MGM and Miramax Films, a potential acquisition of Overture Films and hostile takeover of Lionsgate exposed the current state and financial future of the film biz.

Until three years ago, libraries were thought to have a pretty stable value,” says an analyst who has assisted investors in evaluating the price of studio libraries. “But people are starting to question the value of libraries because the numbers are showing there’s not the demand from the public that there used to be.”

A 4,000-film library like MGM’s consistently pumped out close to $600 million each year for the company. That figure has since plummeted to $400 million, but once overhead costs are factored in, the number is actually $250 million.

Specialty label Miramax’s 700 films had been generating around $100 million a year for Disney. In five years, that’s expected to drop to $25 million, unless new pics are added to the mix.

That’s largely because titles have lost 20% of their value over the last two years. An older film that sold $1 million worth of DVDs in each year from 2003 to 2007 earned $800,000 in 2008. Last year, that fell to $640,000.

That decline is what’s led to lowball offers from companies like Time Warner, which offered $1.5 billion for MGM. The Lion was seeking at least $2 billion.

The Mouse House was looking for bids of at least $700 million to offload Miramax, but instead it received an offer of $600 million in cash and payouts over several years, from Bob and Harvey Weinstein, backed by supermarket mogul Ron Burkle, while Alec Gores’ investment venture the Gores Group and Tom Gores’ Platinum Equity offered $550 million in cash as their joint bid.

A third bidder, Pangea Media Group, run by David Bergstein, is said to have bid between $650 million and $700 million. But individuals close to the process questioned the viability of that prospective deal, given that the financier is embroiled in an involuntary bankruptcy proceeding involving the assets of Thinkfilm, Franchise, Capitol and other companies he controls, and that he faces more than two dozen creditors, including the guilds, who are seeking back payment of residuals and salaries.

Several interested bidders, including Summit Entertainment, Lionsgate Entertainment, Amir Malin and Ken Schapiro’s investment fund Qualia Capital, and Daniel Snyder, owner of RedZone Capital and the Washington Redskins football team, walked away from the auction after they balked at Disney’s starting bid of $600 million. They were considering bids of around $450 million.

Given the more high-profile films it has in its library, not to mention the James Bond franchise and “The Hobbit,” MGM’s pics are attractive to investors because the films can be rebooted or launched as new franchises. Potential buyers have said they want to keep MGM afloat as a studio, but they’d still have to start paying off the Lion’s $3.7 billion debt, with interest payments due in mid-May.

In the meantime, New York investment portfolios like Qualia Capital and Access Industries, as well as Relativity Media, have offered up $500 million in equity to enable MGM to continue producing films and use B.O. earnings to make payments, while upping the value in the company with potential hits (it has remakes of “Red Dawn,” “Poltergeist” and “RoboCop” in the works). News Corp has similarly offered up $250 million.

Miramax, however, is in an entirely different position.

The Weinsteins already have the rights to produce sequels based on mainstream pics “Scream,” “Scanners,” “Hellraiser” and “Halloween,” but films like “sex, lies and videotape,” “Shakespeare in Love,” “The Diving Bell and the Butterfly,” “Gangs of New York,” “Cold Mountain,” “The Queen,” “The Cider House Rules,” “Amelie,” “Pulp Fiction” and “No Country for Old Men” don’t easily lend themselves to remakes or sequels.

Because those films are prestigious and won acclaim, the titles proved perennial performers on homevideo every year, consistently selling about the same amount of units, even though the market for arty fare was small and the pics weren’t good fits for some TV channels.

Once the homevideo market started taking a hit in 2008, however, “that type of product fell off a cliff,” the analyst says.

The specialized stuff is really great during awards season, but I just don’t know who wants to watch ‘The Crying Game’ right now,” he adds. “Nobody’s interested in (owning) challenging 15-year-old material.”

Reading the tea leaves

None of this should come completely as a surprise. Signs of change for the film business have cropped up increasingly in recent years:

Disney chief Bob Iger has been lamenting for years — as early as 2005 — that studios need to experiment with shrinking distribution windows and release DVDs earlier than usual to protect the bottom line of the studios. The homevideo business saw DVD sales and rentals peak in 2006, earning $24 billion.

MGM almost roared for the last time in 2004 when it had trouble using its library as the primary selling point to lure new investors to stay afloat. While it was able to find some new Lion-keepers at the last minute, when it was eventually bought by Sony and a consortium of investors for $5 billion (far more than the $1.5 billion currently being offered), executives like Iger were taking notes.

What’s coming out of the studio pipelines also has changed, with more greenlit films based on established toy, videogame and comicbook brands or reboots of films that already proved themselves at the B.O. The thinking is that the titles will generate as much coin as possible right out of the gate at the megaplex and then, it’s hoped, prove attractive to audiences across all distribution platforms later on, thanks to their name recognition.

If there has been one major driving force shaping how Hollywood operates these days, it’s the recession.

Fewer DVDs are moving off store shelves than ever, with penny-pinching consumers opting for cheaper alternatives such as renting movies from companies like Netflix and Redbox. Blu-ray continues to grow, but it is far from taking the place of DVD.

The result is less coin in studio coffers over the long term, a shift that has forced studio chiefs to seek out as much upfront revenue as possible.

And that’s added fuel to Iger’s battle cry again to reinvent distribution windows. The Mouse House chief stirred exhibs’ ire in February when he said Disney would release the DVD for “Alice in Wonderland” 13 weeks after the film’s bow rather than the usual 17-week window, in order to debut the title before summer when DVD sales are generally sluggish.

We think that’s not only a good thing for the company and for the filmmakers, but it’s a good thing for the business, because it is in the best interest of the exhibitors that the movie industry stay healthy,” Iger told CNBC in February. “The strategy is to make sure that the business is as healthy as possible. We’re dealing with conditions that have changed, whether it’s on the piracy front or on the competitive front or on the economic front. And so the only reason the strategy really has changed is to contend with conditions that a dynamic marketplace is providing us. That’s it. It’s not about revolutionizing the business. It’s about making sure that the business of movies is healthy.”

That’s one major reason why so many studios are embracing 3D.

When Disney’s “Alice” rolled out, an estimated 65% of its $217 million worldwide bow came from 3D screenings. The format boosted the gross of “Alice,” and “Avatar” before it, by as much as one-third, studios say.

Consumer demand for more 3D fare has allowed exhibitors to increase ticket prices by as much as 50% in some markets, enabling studios to earn more.

In fact, 3D has proved so lucrative that DreamWorks Animation’s Jeffrey Katzenberg has said it’s helping offset the drop in DVD sales and created a new revenue stream for studios.

Katzenberg has also championed 3D as a technology that will generate renewed interest in libraries, given that traditional films can be converted and play on the new 3D TVs that are hitting the market, and won’t require the use of cumbersome 3D glasses five years from now.

Other avenues

Foreign TV sales, with pricing that has remained steady over the years, is also considered a bright spot for library titles, which can earn as much as $500,000 for high-profile star-driven films and $50,000 per pic for more obscure fare. But buying a library won’t necessarily result in new international film sales, because many of the TV contacts involving MGM and Miramax’s more appealing pics have already been brokered through 2020 and beyond.

That leaves few options for wringing out more coin from catalogs. One is the hope that moviegoers adopt digital platforms for home viewing.

Studios are working overtime to broker as many deals as possible with companies that can digitally sell or rent their releases, including Netflix, Apple’s iTunes, Amazon’s Video on Demand, CinemaNow, Sony’s PlayStation Network, Vudu, Hulu and YouTube. The digital streaming push should get a significant boost now that movie rental services are also embedded within major videogame consoles like Nintendo’s Wii, Microsoft’s Xbox 360, Sony’s PlayStation 3, Blu-ray players, TiVos and other set-top boxes, as well as new HD TV sets. IPhones and iPads could be next.

Studios have also paired up with a consortium of cable companies to launch a $30 million marketing campaign to promote the Movies on Demand VOD service found on set-top boxes. The effort, dubbed “The Video Store Just Moved In,” aims to educate digital cable customers on the ease of renting a movie via their TV remote controls.

Still, says one analyst, “Digital isn’t a big line item at this point for studios. If it doubled every year it still wouldn’t be a big number in five years.”

The future depends on how executives forecast the future of homevideo.

On the rosy end of things there are people who think that what’s happened to DVD is recession-driven and it will see a bounceback,” says another analyst. “On the pessimistic side, you see people assuming that the 20%-plus declines are just going to continue.”

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