Investing; Taking Big Risks Out of Small Films

By ERIC DASH
Published: February 29, 2004

WITH a total of four nominations at the Academy Awards tonight, for ''The Girl With a Pearl Earring'' and ''The Cooler,'' Lions Gate Entertainment has captured the attention of Hollywood.

But Lions Gate, an independent studio based in Vancouver, British Columbia, has also caught the eye of Wall Street. Its shares have soared 251 percent over the last year and now trade at $6.50, a new high, on the American Stock Exchange. Some analysts suggest that the shares could be worth much more.

While its movies have garnered considerable critical acclaim, they have generally not been smash hits at the box office. The studio has not posted an annual profit since 2001. But the company expects better commercial success later this year, when it releases separate movies starring Robert DeNiro and Nicole Kidman, as well as ''The Punisher,'' an action film based on the Marvel comic book character.

The studio also produces television shows and has assembled a large film library, diversifying its revenue so it does not need a blockbuster to be profitable, said Jon Feltheimer, the chief executive.

''We have no desire to be No.1 when we release a picture,'' he said. ''Our overriding concern on each picture is to make money -- and certainly not lose money.'' By keeping costs low and having a more predictable revenue stream, he said, ''I do not have to pray for a film to succeed.''

Still, the company has set some ambitious financial targets. Although it lost $30 million in the third quarter, Mr. Feltheimer said that it would soon turn a profit. In the next fiscal year, which begins in April, he said that Lions Gate would generate more than $80 million in free cash flow and would begin to pay down $150 million in debt.

Lowell J. Singer, an analyst at SG Cowen Securities, said that the company's goals should be attainable. ''Execution is a very prominent driver here,'' he said, though ''it's certainly not in the bag.''

Though small by Hollywood standards, Lions Gate has grown substantially since its initial stock offering in 1999. It received considerable notice when Halle Berry won the 2001 Oscar for best actress for her performance in the Lions Gate film ''Monster's Ball.''

Most of the company's operations are in Los Angeles, but its official base is in Vancouver, where it also owns a sound stage. The company's stock trades on both the American and Toronto exchanges; Peter Wilkes, a spokesman for Lions Gate, said that the company had attracted several prominent investors, including Paul Allen, the co-founder of Microsoft; James L. Dimon, the chairman of Bank One; and Mark Cuban, an Internet billionaire who owns the Dallas Mavericks basketball team.

Lions Gate has snapped up several smaller companies -- most recently, Artisan Entertainment, based in New York -- to create Hollywood's largest independent studio, part of a strategy of consolidation that Mr. Feltheimer said he developed four years ago with Michael Burns, the studio's vice chairman.

The company's stock has surged 59 percent since mid-December, when it acquired Artisan, which owned a big film library and had distributed films including ''The Blair Witch Project'' and ''Buena Vista Social Club.''

''Artisan was the big kahuna out there,'' Mr. Singer said.

Today, Lions Gate's biggest and steadiest revenue stream comes from its film library, Mr. Feltheimer said. Lions Gate's expanded collection of more than 8,000 titles -- including fitness videos, children's programs, classic films like ''It's a Wonderful Life'' and action hits like ''Terminator 2: Judgment Day'' -- should prove popular with cable television channels and retail customers at chains like Best Buy and Wal-Mart, Mr. Feltheimer said.

He projected that the library would generate more than $200 million in distribution revenue in the next fiscal year, up from $46 million this year, which does not reflect the contribution of the big Artisan film library. Mr. Feltheimer also said that the film library would supply content for CinemaNow -- a fledgling video-on-demand business that the studio controls. Among other shareholders in CinemaNow are Microsoft; UPC Global, a European cable company; and the Blockbuster unit of Viacom.

The film library gives the company some stability, but Mr. Feltheimer says Lions Gate's most crucial growth component is ''the success of our feature films and television products.'' He acknowledged that its production arm made the studio a riskier investment but said that it also allowed the company to offer investors potentially more attractive returns.

Dennis McAlpine, an analyst at McAlpine Associates, an investment research firm based in Scarsdale, N.Y., warned that while Lions Gate has diversified, independent movie production is inherently risky. ''It's a tough business,'' he said. ''You have got to get movies that make money.''

Mr. Feltheimer said that Lions Gate had been unprofitable because of the expense of buying and digesting other companies and, recently, the cost of marketing its Oscar-nominated films, but that it had kept production costs down. All but one of the last 29 films it has released have been profitable, he said.

THE company finds creative ways to sign the stars for its movies, he said, often negotiating smaller salaries in exchange for a more flexible and shorter production schedule, the opportunity to work with a particular director or part of the film's potential profit. It also tries to keep marketing budgets in check. ''The Girl With a Pearl Earring'' initially opened in just eight theaters, he said, and moved only gradually into 400 nationwide. By contrast, ''Lord of the Rings: The Return of the King'' opened in 28 countries in its first five days, incurring enormous marketing costs while racking up big sales at the box office.

So far, Lions Gate has been careful to rein in its appetite, Mr. McAlpine said.

''As long as they keep the formula of doing relatively low-cost films and not overspending on marketing and distribution, then they should survive and do pretty well,'' he said.

Still, the risks are substantial. Investing in Lions Gate, Mr. McAlpine added, ''is one step better than investing in films directly -- becoming an angel for an independent film, which I certainly don't recommend.''