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Monday, December 28, 1998

An Investment Opinion
by Alex Schay

That's Entertainment

It has been said that media conglomerates are capitalism's answer to the circus. They operate on the premise that if the high-wire act fails to impress the audience, perhaps the juggler will, or maybe even the dancing bear. In practice, some of the acts invariably leave the audience a little listless, and even the reliable crowd pleasers eventually slip for lack of the ringmaster's wholehearted attention.

A more succinct, albeit prurient, lesson is provided by Warren Buffet who said, "If you have a harem of 40 women, you never get to know any of them very well." The point seems to be -- the 1960s aside -- that if corporations are involved in too many different lines of business, investors should be somewhat leery.

How does an investor go about unlocking the value of cable TV channels, sports teams, movie studios, TV producers, book publishers, radio stations, newspapers, magazines and theme parks -- all at the same time! One factor that must be considered is that these seemingly disparate business branches are all outgrowths from the same tree: the oak that is the production and distribution of content. Vertical integration and cross-marketing are the order of the day, with the largest media companies gaining significant economies of scale. The recession resistant strain of the cable network business is associated with the subscription fees that the cable operators pay to programmers (about 50% of revenues) and are independent of the ratings or economic environment.

Some of the mega-media concerns are anchored with cable cash flows, with Viacom (NYSE: VIA) taking in roughly 40% of its cash flow from cable networks and Time Warner (NYSE: TWX) garnering about the same percentage of cash flow from its cable systems. Disney (NYSE: DIS), on the other hand, has its "creative content" segment to point to as its base, with a little over 40% of its operating revenue coming from its film business, television programming production, home video, and consumer products groups. Historically, the "wild card" for all the mega-media companies has been the relative success of the movie offerings over the course of the year. And that's where we'll turn with this column today.

With all that vacation, the summer months and the December holiday season are crucial times for the movie studios. Here is a run-down of some of the biggies and their public owners: Disney (NYSE: DIS) owns Touchstone, Miramax, and Walt Disney Studios; Viacom (NYSE: VIA) owns Paramount; Seagram (NYSE: VO) owns Universal; Time Warner (NYSE: TWX) owns New Line and Warner Brothers; Columbia Pictures is owned by Sony (NYSE: SNE); and Twentieth Century Fox is owned by Fox Entertainment (NYSE: FOX) -- that is News Corp. (NYSE: NWS). Here are the numbers for the box office gross over the Christmas weekend:

(Revenues and Total in millions)
Movie Revs Screens Wks Out Avg/Screen Total
1. Patch Adams $25.3 2712 1 $9,329 $25.3
2. Stepmom $19.4 2358 1 $8,227 $19.4
3. You've Got Mail $19.1 2756 2 $6,930 $48.6
4. Prince of Egypt $15.3 3218 2 $4,755 $40.2
5. The Faculty $11.8 2365 1 $4,989 $11.8
6. Mighty Joe Young $10.9 2502 1 $4,357 $10.9
7. A Bug's Life $10.1 2456 6 $4,112 $114.6
8. Star Trek $7.5 2677 3 $2,802 $47.9
9. Enemy $5.2 1505 6 $3,455 $87.4
10. Jack Frost $4.0 2142 3 $1,867 $22.6

The gross for the top 12 films came in at $133.9 million, which beat last year's numbers by 3.4%. As far as the studios that benefited, Disney was at the top of the field with $38 million, followed by Universal's $25.3 million, Warner Brother's $23.1 million, Sony's $19.4 million, and Paramount's $7.5 million. None of the public companies that own these studios made appreciable movements in trading today. The primary reason is that only about three out of every ten motion pictures are actually successful on their own -- that is, without substantial downstream revenue participation. The numbers get baked into the securities very quickly.

The points of distribution for the movie "product" have grown enormously over the last five years, coming not only from multiplex build and overseas distribution, but from home video, pay-per view, premium channels and cable network growth as well. When even an unsuccessful film can sell 100,000 copies for rental -- at around $60 per copy wholesale -- this can have some dramatic impact on the financial equation (real hits can sell 500,000 - 700,0000 copies).

The natural result of increasing distribution alternatives is a crowded marketplace, with film lifecycles getting more and more abbreviated. Typically, a film these days has about two or three weeks to prove itself in the theater market before it heads for pay-per-view, home rental, or foreign shores -- primarily because marketing and exhibition costs become too onerous. Film costs have been rising along with the increased distribution opportunities at a compound rate of about 10% over the last five years, primarily due to increasing marketing costs in getting the word out across all the disparate channels, as well as some inelastic supply issues (the top talent and the duplicate-what-has-worked syndrome).

Many studios are looking to retrench a little bit in 1999 by getting partners to finance more flicks and by simply making fewer movies. Disney has reported that it is looking to cut back to about 15 movies in 1999, compared with the current rate of 20-25.

Another interesting issue in terms of movie distribution that investors might want to look at in 1999 is the DVD effect. Most observers feel that with DVD sales booming, price points will come down quickly in 1999 -- with $200 players being the magic number. This move, in tandem with DVD disks eventually falling into the CD price range a few years out, will not be that great for rental companies that need to duplicate inventory, but will be a boon for media companies that need to re-issue titles (like the companies with substantial music libraries in the LP to CD days). Time Warner and Disney will be two beneficiaries of this trend. Enjoy the last days of 1998, and see you at the movies.

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