Metro-Goldwyn-Mayer is free at last, agreeing Monday to pay $225 million to Warner Bros. to terminate a restrictive homevideo distribution deal 3-1/2 years early.
A thorn in the Lion’s side since it was negotiated in 1990 by Giancarlo Parretti during his short-lived ownership of the studio, MGM had been required to distribute all its video product worldwide through Warner Bros. for a 10%-15% fee.
Now, early termination of the deal on Jan. 31, 2000, will give MGM full control over its 5,100-title film library, something MGM execs believe will be crucial to the Lion as DVD distribution and Internet video sales emerge as new and lucrative businesses.
MGM is paying a high price for its freedom, however, as the $225 million is more than it would have had to pay if Warners kept distributing its video product until the agreement’s original expiration date in May 2003. MGM is operating under tight cash constraints already — it has not turned a profit since Kirk Kerkorian retook control of the studio in July 1996 — and it indicated Monday it may do another equity offering to pay for the fee.
That means 90% MGM shareholder Kerkorian will have to put up most of the money, just a few months after he pumped $630 million in to improve the Lion’s liquidity.
Few doubt the deal is worth it, however. Aside from giving the Lion full control over its library, it may also prompt MGM to increase its production slate by doing more co-financings.
The Warners distrib agreement required MGM to get prior approval from Warner Bros. before selling off video rights to any of its productions, That limited MGM’s ability to enter into co-productions, MGM chief financial officer Dan Taylor said.
“We may take advantage of more opportunities as they present themselves,” Taylor said, noting MGM was now “looking at a potential increase” in the size of its production budget. MGM releases 10-12 pics a year.
Longer term, by removing shackles from MGM, the deal makes the Lion much more attractive to outside buyers, and that is sure to be an important issue for Kerkorian.
The homevideo distrib agreement was a major issue during the auction of MGM by French government agency CDR in 1996, ensuring such bidders as Polygram did not offer as high a price as they would have if the agreement hadn’t been so all-encompassing.
That is because Warner Bros. took the view that any “affiliates” of MGM — including buyers of the company or companies that MGM bought itself — were covered by the distrib agreement. Warners had argued, for instance, that it should handle Orion Pictures video product after MGM acquired Orion in 1997 (a view MGM always rejected).
Monday’s deal will even make MGM’s life easier with its lenders, an important consideration given the company’s reliance on its bank line to cover continuing operating losses. Taylor said Warners ranked above the banks in repayment terms, another vestige from the distrib agreement’s original terms, and this security would now be removed.
Fees until Jan. 31
Warners got its pound of flesh, however. MGM has paid half the $225 million already and must pay the other $112.5 million (plus interest) to Warner Bros. by Sept. 1, although the deal’s expiration is not effective until next January. MGM will continue to pay WB video distribution fees, as per the agreement, until that date.
In addition, MGM has agreed to early expiration of its video distribution on the Turner Entertainment library — pre-1986 MGM titles and pre-1948 Warner Bros. titles — which had been due to expire in June next year.
MGM will save about $50 million a year from early expiration of the Warners deal, estimates JP Morgan analyst Matt Harrigan, offset by $20 million it was getting in revenue on the Turner deal. Harrigan noted that in solely economic terms, Warner Bros. is getting the better end of the deal.
Indeed, people close to Warners said the payment included a “freedom premium” from MGM for the cost of getting out of the arrangement, as well as an estimate of the fees due WB between now and 2003.
‘Good deal’ for WB
“It’s a very good deal for us and a necessary deal for them. We’re happy. We’re clearly being paid more than we would have (earned) in fees,” said Warner Bros. co-chairman Bob Daly.
“It was important for them to make such a deal. Today’s economic model for a studio demands this,” Daly added.
The $225 million payment is a “fair amount of capital for them, but I think it’s something that was perceived as being necessary,” Harrigan said, by enabling MGM to be a “true studio” and not reliant for video distribution on another major. Still, MGM stock fell 68¢ to $11.06, as investors reacted to the expected equity offering.
Taylor did not dispute the estimates of how much MGM would save, but said the upside could be higher because MGM would handle its video distribution better than Warner Bros.
“We will have much more focus,” he said, noting that since the deal was signed, Warner Home Video had started handling HBO and Turner product (Warner Bros.’ parent Time Warner acquired Turner Broadcasting in 1996).
One of the main strategic objectives of Kerkorian’s management team since he reacquired the Lion was to amass a major film library. But the Warners video deal restricted MGM from getting full advantage out of its big library, Taylor noted.
Now, MGM can exploit the DVD market, which is “exploding much faster than we had anticipated.” And he noted that the Internet allowed MGM to sell its titles in a way that was not previously available — for instance, by putting its entire library on the World Wide Web for sale.
Doing more co-productions will enable MGM to lay off risk, a policy now being followed by most other major studios. Taylor said MGM is “still evaluating the mix between debt and equity” for MGM going forward, taking into account a possible increase in its production budget.
Terminating the deal removes one of the last vestiges of Parretti’s disastrous ownership of the Lion. He signed the deal to help finance his acquisition of the studio, as Warner Bros. advanced $125 million against its future fees.
Parretti’s shaky finances prompted Warners to get a senior collateral position on MGM’s assets, which persists today even though Warners had recovered the $125 million by 1992.