Showbiz bulls to trample bears?

Guest column

Wall Street and Hollywood have each historically considered the other a fundamentally different culture. Having worked in both, I don’t share that view. Each has a comfort with risk not found in more traditional businesses.

Perhaps more tellingly, each has a marked tendency to overreact to short-term events while underestimating or even ignoring the significance of long-term trends. Note the recent alarums about second-week drop-offs, escalating ad spends, sagging tentpoles and presumably anemic film profits. Not to mention steady drumbeats claiming, wrongly in my view, that electronic “piracy” by consumers will destroy a little $12 billion business called DVD.

These concerns have arisen in the teeth of an amazing — and mostly unmentioned — degree of growth in underlying consumer demand for all types of entertainment. Struck by this strange confluence of negative rhetoric and positive reality, I set out to corral as much data as I could that supported the notion that, mirabile dictu, entertainment has been of late — and is likely to remain — a growth business.

Before I unleash a torrent of numbers on you, a few caveats are in order: this is frankly the “bull” case. It is one I think both valid and under-appreciated. But, unlike Fox News, what follows does not purport to be “fair and balanced.”

During the past three years — while nearly all other industries have struggled with a lingering recession, Sept. 11 and its aftermath, war in several locales and a bout of SARS –the entertainment industry has experienced robust growth in consumer demand for nearly all its products. By focusing on the demand side of the equation, I am by design looking primarily at the top line — revenue.

I am fully aware of a countervailing growth on the cost side, with resulting pressures on the bottom line. But other businesses, trying to squeeze higher profits from flat-to-declining sales, wish they could have some of enter-tainment’s high-class problems. Am I ignoring a few misguided mergers, growing debt levels, heightened competition or other ills to which at least some showbiz flesh is subject? No. I just happen to think excessive attention is being paid to the problems, while the good news remains strangely muted.

So let’s for a moment return to those heady days of soaring stock prices for the major media congloms — about three years ago — when steady growth for these companies was a near-universal prediction. Back in June of 2000, the combined market capitalizations of AOL Time Warner, Disney, News Corp., Viacom and Vivendi Universal aggregated precisely $600 billion. (Sony has been omitted only because of its heavy non-media component.)

Now, in 2003, Wall Street has marked the value of these five behemoths down to $254 billion. This 58% haircut in price approaches fire sale levels and would normally be occasioned by a comparable collapse in earnings à la the Internet or high-tech industries.

Quite the contrary. Back in 2000, our Media Big Five reported total EBITDA (a much-abused but still useful measurement of cash flow) of $22.9 billion. For the most recent twelve months ended March 31, 2003, total EBITDA had risen 14% over that 2000 figure to $26.1 billion.

How was it possible that these five companies had, in toto, managed quite respectable earnings gains? Only Disney shows a decline, with the blame for its 35% EBITDA fall-off mostly accruing to a sharp drop in profits at the Alphabet Network. The real reason for this unexpected earnings increase: strong growth in worldwide consumer demand for nearly every form of entertainment, at a level that producers of more mundane products could barely imagine.

Veronis, Suhler Stevenson’s annual survey of the media landscape calculates U.S. consumer per capita spending on all categories of entertainment. Comparing last year’s numbers to the level back in 2000, we see two-year growth in such spending of 19% at the box office, 22% for home video, 15% for basic cable and satellite subscriptions, and 18% for premium cable/satellite offerings. Only the woebegone music sector showed a decline, and it a surprisingly mild 6% drop.

That same study also calculated the time the average consumer spent at various leisure activities. Here, to get a little broader perspective, I compared the per capita hours spent in 1996 to those of 2002. While viewing of network affiliates declined at a modest 1% annual rate, hours spent eyeballing cable and satellite programming rose at a 7% per annum clip. And pre-recorded video? Thanks to DVD, its claim on consumers’ time grew at a torrid 15% compound annual rate over those six years.

Looking at the dollars actually received by U.S. movie companies, every sector of the feature film side of the business, both domestic and international, has yielded sharply higher revenues since 2000. Using published MPA data as a base, and adjusting for DreamWorks and the U.S. indies, I pegged total worldwide film revenues at $32.5 billion in ’02, up from $26.2 billion in ’00 — a two-year gain of 24%. Both the domestic and the overseas totals grew at roughly that impressive rate.

The star here was of course home video, where a tripling in DVD volume powered the overall home vid biz to a 35% jump — and that includes VHS, which dropped some 32%. (Did I hear someone say “cannibalization”?) But the basic fact is that Hollywood has learned how to make and market big-grossing films far more consistently. The industry released two $100 million-plus grossers in 1980; nine in 1990; and 26 in 2002. Inflation alone explains only a small part of these compelling stats.

So people are spending more money on movie ducats, on DVDs, on monthly cable bills — and they’re spending more of their limited leisure time viewing these media. And the advertisers who support much of Hollywood’s production are behaving like the proverbial drunken sailor. What is the Wall Street analyst to make of these undeniably positive trends? My modest suggestion is to realize that it may have been momentary madness that made Wall Street price these companies at 26 times EBITDA.

But doesn’t pricing them at a multiple of less than 10 realized EBITDA for the leading companies in a growing business seem excessively negative? And what do these trends portend for the managements of these companies? That they will not be forgiven by those analysts — or by their own corporate overseers — if they do not, at long last, bring a reasonable portion of this swelling tide of revenue down to the bottom line.