Lions Gate: On the prowl for a buyer?
The movie studio that brought you 'Crash' is the hottest in Hollywood. Now buyout rumors are swirling. Can it survive on its own? Does it want to?
(Fortune Magazine) -- The movie is bad, and everyone in the screening room knows it. But Jon Feltheimer, CEO of Lions Gate Entertainment, isn't fazed. "Just because it sucks doesn't mean we can't make a few bucks with it," he says.
He turns to Peter Block, head of acquisitions: "What kind of deal are they offering? With that kind of opportunistic thinking, Feltheimer and vice chairman Michael Burns have built nine-year-old Lions Gate (Charts) into the Southwest Airlines (Charts) of the movie industry: a disciplined, no-frills, profitable independent studio.
Last year the 18 films the company released grossed $344 million at the nation's box office, and 15 of them made a profit, a phenomenal success rate in Hollywood. The slasher "Saw II" (tag line: "Oh yes, there will be blood") cost $6 million to make but grossed $87 million.
Actor-director Tyler Perry's comedy "Diary of a Mad Black Woman" cost $5.5 million to make and brought in $50 million. The ensemble drama "Crash," which Lions Gate acquired for $3.3 million, generated $54 million and, as you may have heard, beat out odds-on favorite "Brokeback Mountain" to win the Academy Award for best picture last March.
The all-business Feltheimer and the decidedly more Hollywood Burns "are quite simply the best in the business," says Sherry Lansing, former longtime head of Paramount Pictures. "They aren't afraid to take a chance, nor are they afraid to bring fiscal discipline to a business that, well, doesn't tend to do business that well."
Lions Gate keeps its bets small, producing or acquiring inexpensive niche pictures. It markets them cheaply but aggressively and relies on one of the industry's largest film and TV libraries to provide enough cash to ride out the ups and downs. It's a smart plan, and Feltheimer and Burns have executed it well.
Their biggest problem now could be too much success. Lions Gate moves fast and inexpensively. It makes and markets most of its movies for under $20 million, compared with the $100 million industry average. Lions Gate will usually acquire only finished art films, for example, because of the higher risk of execution. And even then it won't shell out much more than a couple million.
"What we're really good at is figuring out how to position ourselves to make money most of the time, and if we lose money, not lose a lot," Burns says. Lions Gate has been protected from box-office disappointments by the revenue generated from its film library, which pulls in more than $200 million each year - enough to cover the company's annual overhead.
But as DVD sales flatten and the number of new libraries left to purchase dries up, the question arises: How can Lions Gate keep its cash flow, its lifeline, from drying up too? More important, how can it continue to grow?
One way is to start making bigger movies with bigger potential upside - call it the Miramax model. Another way is to start growing by acquiring other lines of business, such as TV syndication.
Both have a fundamental risk: They start to make Lions Gate into something it has never wanted to be - big. The studio has shown some signs of diverging from its original business plan, like building its own production studios in New Mexico and going ahead with a $35 million movie with martial-arts action star Jet Li.
Feltheimer and Burns insist they aren't breaking from the "small is beautiful" model that has worked so well for them. They point out that Lions Gate will risk less than $10 million on the Jet Li picture (they've presold the foreign rights and brought in partners) and that real estate partners and the state of New Mexico are paying most of their studio construction costs.
"We have $200 million in the bank," says Feltheimer. "The possibilities are endless." All that leaves Wall Street generally bullish on the company but split on whether it's fully valued or not. The stock is down 25% from last year, when it hit its all-time high of $11.63. The most optimistic analysts now have $13 to $15 price targets.
It's been a rumor for years that Paramount has twice considered buying Lions Gate but balked at the pricetag. And after corporate raider Carl Icahn revealed he'd amassed a 4% stake in the studio in May, sale rumors started all over again. While Icahn won't comment, he's probably mainly interested in the value locked up in the company's 5,500-title library, by far its most valuable asset.
Viacom (Charts) sold DreamWorks' 59-title library to a group led by Soros Strategic Partners for $900 million earlier this year. And in late 2004, Sony (Charts) and a group of partners paid $4.8 billion for MGM's 4,000-title library.
Using the same valuation method, Lions Gate's library would be worth about $960 million - more than the company's market cap at the moment. "[Icahn] simply wants to make money," says David Miller, an analyst with Sander Morris Harris. "This is the last remaining public film library. He recognizes the scarcity value of these assets."
Feltheimer says no deals are imminent but adds, "We've had a number of conversations with Icahn, and our sense is that they believe our company is undervalued. They put a lot of value on the library, and we agree."
For all this talk of assets and valuation, though, there are and always have been some aspects of the movie business that can't be reduced to items on a balance sheet.
Like charm, or the halo effect that comes from being considered hot. Take Burns' wedding bash a few weeks ago at Hollywood's famed Chateau Marmont hotel. That was reserved for 400 friends: Jackson Browne on the microphone. Kevin Spacey on a couch. Sushi from Matsuhisa. Champagne everywhere.
One A-list movie star said, "Look around. Everyone here wants to work for them. Everyone here wants to be their best friend. How often do you hear that about independent studios who pay crap?"
This is an excerpt from a story in the July 24 issue of Fortune. To read the complete version, click here.