(FORTUNE Magazine) – CAN SONY MAKE DEALS as well as it makes tape players? That question is taking on urgency in Hollywood -- not to mention at Sony headquarters in Tokyo -- nearly two years after the company paid some $5 billion for Columbia Pictures Entertainment, rekindling worries about the Japanese picking off American jewels one by one. The deal brought Japan's most famous consumer electronics company together with the biggest-grossing U.S. moviemaker. The all-star international cast of When Sony Met Columbia . . . has grown to include not only Sony's venerable chairman, Akio Morita, but also golden boy producers Peter Guber and Jon Peters (Batman, Rain Man) -- and Hollywood hotshots like Bruce Willis, Macaulay Culkin, Arnold Schwarzenegger, and Barbra Streisand. Today the common wisdom in Hollywood -- using the word ''wisdom'' loosely -- is that Sony got itself into a deal that cannot possibly pay off. Sony USA vice chairman Michael ''Mickey'' Schulhof argues -- persuasively -- that it will. The 640 billion yen (more or less) question is: When? The short answer is no time soon. Pursuing the synergy strategy that has swept the entertainment world, Sony bought Columbia not so much for the profits it would generate directly but rather to boost sales of Sony's home electronics hardware. But Columbia's greatest contribution to Sony sales so far takes place at the company store in Burbank, where Columbia mugs and baseball caps sit next to Sony TVs and compact disks. Columbia's overriding concern at the moment is the health of its money-hungry movie business, which eats up $150 million more cash each year than it produces. In the longer view, Sony's strategy looks better. Says Virginia Kouyoumdjian, a consumer electronics consultant in Tokyo: ''Sony is putting in place very cleverly the pieces that look like the key to entertainment in the next century.'' That assumes, of course, that the electronic cowboys from Tokyo don't get disgusted with Tinseltown and ride off into the sunrise prematurely -- something they are unlikely to do. Back when Sony bought Columbia, then 49% owned by Coca-Cola, Hollywood's gossip meisters savaged the deal. Those naive fellows from Tokyo paid way too much for way too little, they snickered; Japan should stick to VCRs. A particular puzzlement was the management team that Sony brought in to look after its new trophy: Longtime partners Guber and Peters had never run a major studio and in fact were under contract to rival Warner Brothers (owned by the parent of FORTUNE's publisher). To buy them out of that contract cost Sony at least another $500 million. Says Peter Dekom, a prominent entertainment lawyer: ''Sony screwed itself by saying, 'I must have them.' The minute you do that to yourself in a negotiation, you're dead.'' Even more perplexing to Sony watchers is the way Columbia has been run since the Japanese took over. In an era when much of Hollywood is at least pretending to tighten its Gucci belt, Columbia has been expanding faster than Terminator 2 sells tickets. Last year Sony sank roughly $500 million into Columbia. It will ship another $500 million to Hollywood in 1991, bringing its total investment close to $6.5 billion. Owing in part to expansion of the studio, annual overhead for expenses like salaries and talent contracts at Columbia has risen nearly 50%, to more than $300 million. Whatever happened to the Japan that can say no? SONY EARNED just $828 million on sales of $25.6 billion for the fiscal year that ended in March 1991; at that rate it cannot afford to send too many more $500 million checks to America. As a result, over the next year Sony plans to tap both U.S. and Japanese equity markets for a total of perhaps $2 billion in fresh capital. The company would sell some $800 million worth of new shares in Sony Music Entertainment of Japan and raise the remainder in the U.S. by issuing preferred or common stock, or both, in Sony Software Corp., its entertainment group. Events of the past year added to the sense that Sony acted rashly. First came the abrupt, unexpected departure last September of Walter Yetnikoff, the brilliant but increasingly uncontrollable music mogul who worked behind the scenes to help Sony put together the Columbia deal. Three months earlier Yetnikoff had signed a new three-year, $25 million contract to run Sony Music Entertainment. Then, in May, who should suddenly fade out of the picture but Peters, Hollywood's own Horatio Alger hero, best known to most Americans as Barbra Streisand's former lover and hairdresser. Since taking over as Columbia's co- chairman, Peters had been generating more headlines about his reported free-spending shenanigans -- using a corporate jet to fly flowers to a girlfriend, for example -- than about his management expertise. Columbia announced that Peters was leaving to start his own production company, which will turn out films, music, and television for Columbia Pictures | Entertainment. Sony and Columbia say the departure was voluntary; a 45-day gag agreement prohibiting all sides from talking added to speculation that it was not. Contends a Hollywood studio chief: ''Sony is already admitting half its mistake.'' Just when Sony thought the bad news had abated, along came Hudson Hawk, a $50 million turkey starring Willis that opened Memorial Day weekend to scathing reviews and pitiful domestic box office. HUDSON HAWK SEEN AS DEAD DUCK, headlined the Wall Street Journal. The movie, which will lose about $35 million, didn't hurt reported earnings. The wonders of purchase accounting enabled Sony to write it off as part of the cost of acquiring Columbia. But Sony's image suffered once again. If Sony executives have second thoughts about going Hollywood, however, they are well hidden. Says Frank Biondi Jr., CEO of Viacom International, a communications and entertainment conglomerate: ''Mickey's running the darn thing, and he looks quite at ease. He's not a guy walking around looking stressed.'' A meeting with Schulhof confirms this. Executives at Columbia Pictures likewise insist they have felt absolutely no interference from Japan -- a claim that seems backed up by their continued unabashed spending on pricey talent deals and a 15-year, multi-hundred-million- dollar renovation of their new headquarters and production facilities in Culver City. Guber's dream is to transform Columbia into a major multimedia enterprise by the end of the decade, a place where people can come to ''play in many palettes'' from film to laser disks to high-definition TV. Says he: ''We're still in the process of tooling this company. There is still more to be done. So there are going to be more things happening -- not less.'' For Columbia, Sony is the perfect parent. It provides the two essentials of survival in Hollywood: time and money. Says Jonathan Dolgen, the widely respected former president of Fox Inc. who recently took over as head of Columbia's motion picture group: ''Sony wants you to do well, vs. to do well this quarter.'' All very reassuring to Columbia's management, but will such an approach help that massive investment pay off? Actor Warren Beatty, whose latest movie, Bugsy, is to be released by Columbia's TriStar Pictures in December, says, ''The big question is: Is that intangible product so valuable that it doesn't matter what Sony paid for it? I think that's their gamble.'' Add up the numbers and the odds don't look so good. Last year, on an operating basis, Columbia Pictures Entertainment -- comprising motion picture production (Columbia, TriStar), television production, and Loews Theatres -- earned more than $200 million, a surprisingly high figure inflated somewhat by those miracles of purchase accounting. Cash flow is a different story. In the weird world of entertainment bookkeeping, studios can count movie production costs as an asset -- ''film inventory'' on the balance sheet -- rather than as an expense. This asset is written down over time to match expected revenues as they come in. That means a movie studio could be reporting big profits yet have no cash -- which happens to be the case with Columbia. EVEN ASSUMING that Guber lives up to his $2.75-million-plus salary and turns Columbia into the futuristic studio he dreams of, the company's near-term profits won't likely amount to much relative to Sony's purchase price. The most a studio has ever earned on an operating basis in one year is about $365 million (Warner Brothers in 1990, not counting charges associated with the Time Inc.-Warner Communications merger). That's according to David Londoner, an entertainment analyst at Wertheim Schroder. On Sony's $6.5 billion investment, $365 million would represent only a 5.6% return. It's also 83% more than Columbia made last year. Says an investment banker who was involved in the Columbia negotiations: ''I can't tell you that economically this deal will be a barnburner. It's not.'' So why did Sony do it? Armchair strategists point out that Sony could have invested its $6.5 billion in much higher yielding assets: The median company in FORTUNE's Service 500 returned 15% annually to investors over the past decade. But the critics forget that Sony did not buy Columbia for its earnings. Says a knowledgeable Hollywood executive: ''There is one reason Sony did this deal, and one reason only. The man's name is Akio Morita.'' According to those who know him, Sony's co-founder, now 70, had long felt it was Sony's manifest destiny to enter the entertainment business -- partly to be a pioneer, but more important, to gain access to software that would entice consumers to buy Sony hardware, such as 8-mm videocassette recorders, videogame players, and, down the road, high-definition television sets. Says Schulhof: ''In the late 1970s we began to recognize the need to take Sony beyond hardware. Through our experience with Betamax, we discovered that the compelling motivation for the purchase of hardware is software.'' Sony's Betamax, introduced in 1975, got high marks for technology but couldn't record for as long as the VHS format, created by JVC. Consumers went for VHS, especially after Hollywood studios started releasing movies in the VHS format. That spelled the beginning of Sony's obsession with software. To this day the company is convinced that had it owned a studio, Betamax would have been a greater success than it was. Industry experts aren't so sure: Sony's music software has apparently done little to help sales of Sony's new digital audiotape players, which have caught on only with equipment buffs. Furthermore, Columbia movies attract about 15% to 20% of domestic box office receipts, and most experts say that's not enough control of the software to drive hardware sales. Writer and economist Benjamin Stein dismisses the whole synergy theory: ''It's like saying that people who own a restaurant must also own a huge ranch. Studios are not that profitable. So why take the gamble?'' Adds Chuck Goto, a consumer electronics analyst with S.G. Warburg in Tokyo: ''If there's any synergy, it has to be gravy. And it's going to be a good many years before Columbia pays off on its own.'' Sony's critics tend to forget one other thing: Even if synergy doesn't live up to its stratospheric expectations, in Columbia Sony has acquired a major asset, largely at extremely low interest rates from 0.3% to 1.4%, thanks to its friendly Japanese bankers. Says lawyer Dekom: ''Over the long term, Sony's asset will appreciate and eat up their mistakes. The key is to hang on long enough to capitalize on that appreciation.'' The more cash Sony pours into Columbia up front, the longer it will take to justify the investment. Assuming the studio were to earn $200 million a year consistently -- a respectable performance -- just paying for Guber and Peters would take nearly four years. In addition to buying the pair out of their Warner contract, Sony paid $200 million for their production company, Guber- Peters Entertainment. Total cost of the management team: some $700 million. NEARLY TWO YEARS after the deal was done, synergy is moving into the spotlight at Columbia. The newest star is Sony hardware. The studio is a perfect showcase for high-definition technology, embodied in Sony products. Sony believes this electronic imaging system is the wave of the future, not just for television but also for moviemaking, computer-aided design and manufacturing, and a host of other applications. To sell Hollywood on the wonders of high-resolution imaging, Sony has set up a production center at Columbia. Producers, directors, and special-effects supervisors from any studio in town are free to come and experiment. Director Francis Ford Coppola used the place to shoot seven hours of screen tests for his forthcoming Columbia film Dracula. Says Guber: ''Originally this was going to be located in a separate Burbank facility. I said, 'That's insane. You need to put it in a place where people can see it -- where Steven Spielberg will walk by -- so it demystifies it for those who have to use it.' How do you do that?'' He lowers his voice to a stage whisper. ''You put it in the middle of your lot.'' In many ways Guber is ideally cast for the part of Columbia's boss. A lawyer by training, he has spent virtually his entire career producing movies. Happily for Sony, he has long been fascinated by the technology of the business. He says, ''I was always a technological kind of character. I was a ham radio operator. I've always been into that. But I never had an arena to explore it.'' He was not hired solely for his ability to pick pictures, as is commonly assumed, although that was certainly a big selling point. Guber recalls, ''When I sat with Morita, I said, 'If you are picking me to do movies, forget it. I ain't coming.' I wanted the opportunity and the challenge of putting the components of the company together.'' In this role Guber shines. Says CBS Entertainment President Jeff Sagansky: ''Peter is one of the few executives in our business with vision. I wouldn't bet against him.'' Guber has spent much of his first two years in what he calls ''putting Humpty-Dumpty back together again'': assembling a new management team (some might call it a battalion), relocating the company's scattered executives from Manhattan and Burbank to Culver City, and signing such top-tier talent as Robert DeNiro, Dustin Hoffman, James Brooks, and Penny Marshall to multimillion-dollar deals. ''We want to be in charge of our own destiny,'' Guber says. While that is not a bad strategy, his challenge -- his imperative -- is to implement it at a rational price. Since taking over he has spent close to $2 billion to ramp up the company's movie production and marketing operations. Guber justifies the spending by insisting the studio needed a jump start, but how much of a jump start Columbia needed is arguable. The previous management team put in place ! distribution deals with Castle Rock and Carolco that gave Columbia its biggest hits so far in 1991: City Slickers and Terminator 2. Columbia is betting especially big on Hook, a $60 million Steven Spielberg extravaganza produced by TriStar Pictures, starring Robin Williams as an aging Peter Pan, Dustin Hoffman as Captain Hook, and Julia Roberts as Tinker Bell. It's due out in December. Because of an equity participation deal that gives the stars a huge percentage of the studio's portion of box office receipts, the movie has to bring in a walloping $120 million just to break even. TriStar boss Mike Medavoy professes unconcern. Says he: ''Ask any studio if they wouldn't change places with us. And if they say otherwise, you tell 'em I said they're lying.'' AT A RECENT MEETING with a couple of dozen top Columbia executives, Guber preached the wonders of Sony's new Mini Disc, a portable, shockproof compact disk player, similar to the Walkman, that the company will introduce late next year for around $500. ''Just holding this machine, you realize you are holding something revolutionary,'' he said. ''It's exciting. It's sensual.'' This is what Sony dreamed of when it bought the studio: bringing together the entertainment side of the house with the electronic side to create a one-stop- shopping entertainment and information company. To that end, in February Sony announced the creation of Sony Electronic Publishing, which makes up Sony Software Corp. along with Columbia -- rebaptized as Sony Pictures Entertainment in August -- and Sony Music Entertainment. The electronic publishing division will develop programs for a wide range of Sony products, including interactive multimedia games and videogames. To create the software, the company plans to draw extensively on the talent and resources at Columbia and Sony Music. For example, next year Sony will introduce Play Station, a home videogame player that accepts interactive compact disks rather than the traditional videogame cartridges made by Nintendo. Unlike today's videogames, which are purely computer generated, the next generation of games will combine music, film, graphics, and special effects so that videoholics can become part of a movie by watching real footage, listening to the soundtrack, and interacting with the characters. Of course, to program such a game one needs film and music . . . Do you begin to get the picture? Sony sees videogame software as an important part of its business. Says Olaf ) Olafsson, 28, a smooth talker from Iceland, who runs Sony's electronic publishing business: ''Primitive cartridge-based games brought in $4 billion to $5 billion in the U.S. last year. The videogame business won't get any smaller. It will get more sophisticated. With film and music, the games will be much more interesting.'' Since movie-related software is to be a major part of Sony's videogame business, Olafsson and his designing men and women plan to spend plenty of time on the Columbia lot -- and they won't just be watching. Says he: ''By owning a studio, we can get involved right from the beginning, during the writing of the movie. We can get footage as it's being filmed. We can say, 'Can you film the backstage in a certain way, because we need it for a videogame?' '' Olafsson has already been to the set of Hook several times to decide what backgrounds to use in a Hook videogame, which parts of the soundtrack to include, and how best to time the game's release. SONY DISMISSES the abundant criticism of its Columbia deal as typical American short-termism. Entertainment, it believes, is a sound business to be in. The industry has reinvented itself twice in the past 20 years, with pay television and home video, and the patent office isn't closing. Whether the next revolution is holography or high definition, the hero won't be the hardware. So how much is owning a studio worth? In Sony's grand vision, that question will not be answerable for many years. But the Japanese don't mind waiting. Says a powerful entertainment executive close to the company: ''Sony is the most Westernized company in Japan, but they go home at night and put on a kimono. People forget that.'' Accountants might not see profits in today's numbers, but, Sony believes, build the software and they will come. That may be typical Japanese ultra-long-termism -- but experience shows it would be foolish to laugh.