Sony and MGM: Figuring Out a $5 Billion Deal

Weekly Corporate Growth Report, Jul 5, 2004 by Dolbeck, Andrew

Sony Pictures Entertainment, a unit of Sony Corporation, has been in negotiations to acquire Metro-Goldwyn-Mayer Inc. There was speculation that a completed deal might be announced at MGM's recent shareholder meeting, but a definitive deal agreement has not yet been reached. MGM, with its film production studios and extensive film library would clearly benefit Sony, but financing arrangements appear to be holding up the acquisition. Delaying too long may mean Sony will have to deal with competing bids from rival buyers.

A merger between Sony and MGM would create a combined home video business that would, if it had existed in 2003, have generated $3.69 billion in sales and represented 16.5 percent of the total home video market in that year, according to Video Store Magazine Market Research. Sony owns Columbia TriStar Home Entertainment, which currently holds the number three home video marketshare position.

But what Sony really stands to gain is MGM's impressive film library. The library contains about 4,000 films, including the James Bond franchise, the Pink Panther series, "Midnight Cowboy," "Rocky," "Rain Man," and other famous films. Less than 30 percent of MGM's library is currently released on DVD. Even so, the company's catalog generates over $400 million annually in royalties.

The deal would put a major film library in the hands of a company with sufficient capital to manage it for the long-term, according to Dennis McAlpine of McAlpine Associates. McAlpine predicts that a successful deal with Sony would mean a more stretched out release policy for the MGM library to avoid saturating the market with classic films.

The deal could also prove beneficial to Sony as a maker of entertainment hardware. Sony profited 20 years ago when it bought into the music industry prior to the release of its Sony Walkman portable CD player. Buying up MGM would position the company to capitalize on future technological developments in the audio-visual arena.

It's clear that Sony could profit from the acquisition, and negotiations have been amicable, so why hasn't a deal been reached? Sony is having difficulty financing its prospective $5 billion bid for MGM. Sony is negotiating with its financial partners, Texas Pacific Group, Providence Capital Inc., and DLJ Merchant Banking, on the details of a complicated deal.

The holdup in sealing the deal actually has less to do with financing than with when and how Sony can buy out its partners. Sony would like it partners to buy the lion's share first, thus keeping the acquisition off Sony's balance sheet so its debt rating isn't impacted. Then, over time, Sony would buy out its partners, acquiring MGM completely. Sony's partners, understandably, would like some detail about how and when they would exit the deal and Sony is having some difficulty spelling out exactly how the arrangement would work. Allen & Co., Blackstone Group, and Credit Suisse First Boston have been brought in to help structure the deal.

MGM delayed its annual shareholder meeting from May 12 to late June in hopes of announcing a completed deal. Instead, MGM Chief Executive Alex Yemenidjian commented on the Sony negotiations, saying, "As it turned out, we have more strategic alternatives available to us than we realized, and we need more time to properly explore all our alternatives."

"Alternatives" could mean other suitors, but Yemenidjian did not specify any details. Sony once had exclusive negotiating rights for MGM but that time has past, allowing other companies to compete for the film studio. Time Warner, which expressed interest in MGM last year, could be a potential rival. Warner Brothers, a unit of Time Warner, has distributed MGM films on video for years. Warner Brothers also owns MGM's pre-1986 film library, which includes classic movies such as "Gone With the Wind" and "The Wizard of Oz."

Time Warner Chief Executive Richard Parsons has stated that he considers $5 billion too high a price for MGM. Robert Wright, the CEO of NBC Universal agrees, stating that his company is interested in MGM but that $5 billion "sounds pretty pricey."

Since the other major known potential bidders, NBC Universal and Time Warner, both feel the deal price is high, it is possible that Yemenidjian's statement is a face saving gesture for MGM. NBC has also recently acquired a movie studio from Vivendi Universal SA, making it less likely to make a high bid to acquire another one.

MGM has not set any deadline for additional bids. The negotiations with Sony have been friendly so far, but drawing out the process may not be in MGM's best interest. The longer the negotiations go, the more likely Sony or one of its partners may choose to walk away from the deal. If the deal does turn sour, Yemenidjian may have to produce some real strategic alternatives.

Soucres: The Deal, Los Angeles Times, Video Store Magazine, Wall Street Journal

By Andrew Dolbeck

Editor