The buyer of Polygram Filmed Entertainment will need to inject $400 million into the film studio in 1999, and at least another $120 million in 2000, to maintain PFE’s current business plan, according to people who have looked at the company’s books.
Bidders analyzing PFE in preparation for making final offers next week said they were lowering their valuation of the company after concluding it has extremely high overhead with heavy cash needs.
Of course, it is in the interest of bidders to talk down the price at this time, just a week before the bidding deadline of Sept. 18. But many Wall Streeters with knowledge of Polygram, including some who are not involved in bids, have long argued that it was worth far less than the $1 billion seller Seagram Co. is hoping to get for it.
Several bidders said that after studying PFE’s accounts in due diligence, they are surprised by the amount of money spent by Polygram to build PFE over the past few years. PFE’s 15 production deals were singled out by a couple of bidders as being unusually high in their cost.
PFE is being sold as a result of Seagram’s agreement to buy music giant Polygram Holdings, which invested a total of $1.2 billion to develop PFE over the past several years.
U.K. music giant EMI, apparently seen by Seagram’s advisor Goldman Sachs as the best chance for a high price, is said to be valuing PFE at $450 million to $500 million.
Potential bidders, which also include MGM, Canal Plus, Carlton Communications, Lakeshore Entertainment and Artisan Entertainment, were particularly struck by the heavy cash commitment necessary to maintain PFE’s existing business plan, which calls for 16 pics to be released next year.
PFE management told bidders the company would need a cash injection of $376 million next year to cover its estimated cash flow loss and another $118 million in cash in 2000, sources said.
People close to some bidding groups believe that the estimates may be optimistic. After analyzing PFE’s financial data in due diligence, several bidders say the real cost of completing and releasing pics will likely be higher than estimated and the cash injection will therefore need to be bigger.
PFE has lavish budgets for future film production. It estimates that its development, production and acquisition will hit $1 billion in 2000, rising to $1.3 billion in 2002.
To its defense
Defenders of PFE argued its costs were lower than other studios. “PFE’s average negative cost is about half or two-thirds that of its major competitors,” said one commentator.
But due diligence has only lowered the valuation of the company for most bidders, sources said. Bidders argue that PFE’s 1,500-title film library is also worth less than PFE’s valuation.
Polygram sources contended the financial needs are consistent with those of a major film company with a worldwide distribution network.
“If you want to finance a full production slate of 16 movies, then that’s what it costs,” said a senior exec with knowledge of the company’s operations.
PFE supporters said that what many observers have failed to understand is that its revenues were artificially depressed by its heavy investments in worldwide distribution, including the launch of domestic operation Polygram Films last year.
“PFE laid out its (expenditure forecasts) to its shareholders in 1991 and management has never once exceeded those forecasts,” said the source. “The whole core of the PFE presentation is that the hard work is done. PFE now has direct distribution in 85% of the world. The losses have been investment.”
One source said that several bidders were concerned about the quality of PFE’s future slate, noting that the company put extremely optimistic projections on forthcoming pics.
PFE told bidders that it expected “Return to Paradise” to gross $40 million in the U.S. Pic opened with $3.7 million on Aug. 14 and has grossed 7.6 million to date.
And PFE is predicting that its $80 million Robin Williams starrer “What Dreams May Come,” which opens on Oct. 2, will gross $100 million.
One commentator pointed out that PFE was, to a certain extent, the victim of the seasonal nature of the film biz. If the company was being sold when one of its hits, such as “Four Weddings,” “Bean” or “Dead Man Walking” was performing at the box office, the perception would be different.
“It’s not PFE’s fault that it’s being sold just before it turns profitable,” the source said.
Due diligence information shows that PFE’s ratio of total receipts to total costs on film releases ranged from 0.87 in 1993 to a high of 1.42 in 1994 (when “Four Weddings” was released), back to 1.05 in 1995, 0.96 in 1996 and 1.08 last year.
PFE, the source said, expects revenues to top $1.4 billion next year. “You ought to be able to make a profit if you can keep your overhead costs down to between 10 and 12% of total revenues” this person said.
PFE’s overhead currently is running at an annual rate of about $170 million. PFE told bidders in briefing books that it expects to cut that figure by about $22 million next year, but several bidders said that, even so, the overhead would still be too high.
However, bidders who compare Polygram’s overhead to that of other minimajors such as New Line or Miramax forget that those companies only distribute directly in the U.S., and not internationally, therefore lowering their overhead costs.
Seagram and PFE declined to comment on the process.