Paramount eyes going it alone

(Fortune) -- Is Sumner Redstone simply looking for leverage in his negotiations with CBS's Showtime? It sure looked that way Monday when Redstone's Viacom announced that its movie studio Paramount Pictures is in talks with Metro-Goldwyn-Mayer and Lionsgate to create a new premium pay-tv cable channel - potentially making it a direct competitor to its current cable distributor and former corporate sibling over at CBS.

But behind the scenes, a grim new reality has descended upon the cable movie channel business: movies are no longer the big draw. In Showtime's case, it's the original programming, like "Dexter", "The Tudors", and "Weeds" that have brought Showtime into prominence in the past few years. Showtime's premium cable channels, in fact, are among CBS's more attractive assets.

Over the last few years, as HBO (TWX, Fortune 500) has struggled to replace former hits such as "The Sopranos" and "Sex and the City", Showtime has boosted its competitive position, posting increases in affiliate fees and subscribers. JP Morgan analyst, John Blackledge, estimates Showtime added some 1.3 million subscribers in 2007, sparked by the popularity of the network's original programming.

And as Showtime continues to invest in its unique programming, observers suspect that it's looking to pay less for rights to show Paramount, MGM, and Lionsgate movies. Says James Goss, an analyst with Barrington Research in Chicago: "CBS wants to draw the line in terms of how much they'll pay for the film slate at Showtime - especially since having a high-cost film slate isn't something the subscriber-base is indicating it wants."

Under its expiring contracts with the three movie studios, Showtime paid some $300 million a year for the rights to their films. But over the past few years those films have been drawing progressively fewer viewers. "In the past six or seven years, movies on Showtime have seen as much as an 80 percent decline in viewers," says David Joyce, an analyst with Miller Tabak & Co. in New York.

Doug Creutz, a media analyst with Cowen and Company in San Francisco, foreshadowed the hardball negotiating that would inevitably result from Showtime's new muscle. "Given the changing relative importance of original programming versus movie content for Showtime, we expect that the network will have additional leverage in renegotiating its film rights deals with studios such as Paramount (VIA), MGM and Lions Gate," Creutz told investors in a February missive. "Changes such as a la carte film rights purchases, as opposed to full film slate deals, could result in significant cost improvements for Showtime."

If the three movie studios deliver on their threat to walk away from Showtime in favor of setting up their own pay-tv channel, Showtime will suffer a near-term hit. The studios could suffer too, as a premium channel could cannibalize DVD sales or (legal) downloads of the movies.

But in one sense, it could be a good thing for CBS (CBS, Fortune 500). CEO Les Moonves may be preparing a salvo of his own with a bid to play in the movie studio realm. "CBS can now use that $300 million a year to buy or produce other film content," says Joyce. CBS's effort can only work though, if management can "maintain fiscal discipline on production budget and marketing spending given a desire to drive earnings growth," notes Cowen and Company's Creutz.

The melee between Redstone and Moonves will be closely-watched. Viacom has said its service won't be operational for another 18 months. Since cable provider Comcast (CMCSA) has a partial stake in MGM (MGM, Fortune 500), observers say the new premium network should at least have access to the cable company's 24 million homes to start from. Even so, in the ever-changing film business, Redstone's gambit will show whether consumers prefer to spend their hard-earned dollars on pure-play movie channels or pay-TV outlets that rely heavily on original content.