Films in cable crunch

Pay TV executives want to change terms of deal

Armed with his new stake in DirecTV, John Malone will no doubt change the landscape of the cable and satellite biz. But the ripple effect extends into some unexpected places — including the sale of theatrical films to Malone’s Starz pay TV network and its HBO and Showtime competitors.

With plans to become a bigger player in films, Malone had hired Chris McGurk, former vice chairman and chief operating officer of MGM, to buy or produce up to 12 movies a year, all of which will end up on Starz.

Showtime also is emphasizing original programming, not just movies but series.

In both cases, Starz and Showtime will be less dependent on Hollywood, which is in danger of losing a longtime cash cow: theatrical movie sales to pay cable.

Some of the major studios’ deals at HBO, Showtime and Starz expire in 2008 and ’09, and the three networks are seriously weighing whether they want to renew.

If they decide to tear up their current theatrical contracts, which ensure a multimillion-dollar payday for each movie, Hollywood would be forced to rethink some of its economics.

The pay cablers’ money makes the difference between profit and loss for many theatricals. And, just as crucially, any potential loss of pay TV money would affect studios’ decisions on what future films get made.

The 2008-09 expiration dates may seem a long way off, but as studios develop movie scripts years in advance, they automatically build in the anticipated pay TV revenues. But some of those far-off projects could be scrapped if there’s any prospect the pay TV dollars will go away or be drastically reduced.

“You’re effectively planning to greenlight movies based on deals that are expiring,” says a studio exec.

Especially at risk are low to midrange films. A loss of a few million bucks could mean these films won’t get made.

“If you have a big hit, a movie makes money everywhere, but if you have average box office on a movie, your profit is going to be in the pay deal,” says one studio chief.

For years, virtually every studio release was included in lucrative long-term output deals with HBO, Showtime and Starz.

It’s not likely these outputs will just disappear. Whatever happens, pay networks will still have an insatiable demand for movies — they’re just tiring of the nature of the deals: Take one movie, take ’em all.

The industry expects Starz to renegotiate its Disney deal in some form when it expires in 2009 because, unlike HBO and Showtime, Starz hasn’t produced a lot of original series.

HBO’s deal with Fox also ends in 2009, and network execs have said movies will remain a vital part of HBO’s service to subscribers. HBO may produce plenty of original series, movies and sports events, but movies make up 70% of its overall schedule.

In fact, each of the three pay nets has more than a dozen multiplex channels, and each also programs a robust on-demand service.

“What’s happening today is that pay TV networks are changing their priorities,” says a studio exec. “They want a certain amount of movies, they just don’t want too many.”

Some cable execs say the value of movies is declining for two reasons: The networks are using more original programming, and subscribers can see the pictures in a variety of formats, from DVDs to streaming video online, months before the films arrive on pay TV.

Output deals vary, but the networks pay an average of $7 million a picture. The fee can go much higher, based on a box office formula. Starz could end up paying $20 million for “Pirates of the Caribbean: Dead Man’s Chest,” for example. Even a low-budget film with a tidy gross, like “The 40-Year-Old Virgin,” could harvest well over $10 million from HBO.

In December, CBS Corp. chief financial officer Fred Reynolds revealed that Showtime funnels more than $300 million a year to its three main suppliers: Paramount, MGM and Lionsgate.

These output deals, which expire in 2008, run up against the fact that CBS is planning its own feature production unit — and all of the CBS titles would end up on Showtime.

Naturally, CBS’ plans have created nervousness among studio execs. “We’re in a situation where if it’s true that pay TV networks are going to cut their payments,” says the exec, “it’s absolutely going to have an effect on the number of movies that can be released theatrically in the U.S.”

If Showtime doesn’t renew its deals, studios like MGM and Lionsgate will be hard hit, as will the Weinstein Co. (which has not engineered an output deal since it opened for business in 2005).

Weinstein Co., Lakeshore Entertainment and Sidney Kimmel Entertainment are the most notable indie producers whose current titles go to Showtime as part of the network’s MGM output.

In less jeopardy are HBO’s deal with Fox and Starz’s pact with Disney, each of which expire in 2009. But these renewals won’t be slam-dunks: HBO and Starz are sure to insist on big discounts.

HBO and Starz also have made it clear that they have no plans to sign any more output deals.

HBO, Showtime and Starz are adamant that, over the next few years, the studios will begin harvesting real money from streaming movies on the Internet and downloading them to iPods, cell phones and portable media players.

“This has a lot to do with changing windows,” says a producer who is involved in some of the deals. “In a world that includes other pre-pay windows like downloads and iPods, why are the cable networks paying what they’re paying for these movies?”

The pay networks say the dollars flowing from these fresh revenue streams will more than make up for any diminution in the amount of money the studios pocket from pay TV license fees.

“Showtime’s appetite for movies has diminished because its priorities have shifted somewhat in favor of original series like ‘Weeds,’ ” says Randy Manis, senior VP of acquisitions and business affairs for ThinkFilm, which doesn’t have an output deal with Showtime but recently sold it the Edward Norton movie “Down in the Valley.”

Showtime and Starz want to own their movies, not just rent them in the pay window.

Reynolds and his boss at CBS Corp., Leslie Moonves, are convinced that some of the money they pay to Paramount and others might be better spent on producing five or six movies a year, which CBS Corp. then would own in perpetuity. However, Viacom chairman Sumner Redstone likely would step in if Moonves’ strategy threatened to put a severe dent in Paramount’s bottom line.

“A lot of financing” for Moonves’ low-budgeted movies would come from banks, Reyolds says, adding that CBS would end up shouldering “very little risk.”