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TheStreet Open House

Once Great, Kerkorian's MGM Is a Bottomless Money Pit

It's been a while since we last stopped by for one of our ever-popular International Coffee moments with octogenarian bloodsucker Kirk Kerkorian of Metro-Goldwyn-Mayer (MGM) fame.

And with the passage of a year, a lot has happened on the K2 front: More dreadful movies, more operating losses, more rights offerings and the "resignation" of company head Frank Mancuso -- all larded up with more front-office B.S. about MGM being (as ever) in the advanced stages of turnaround mode.

So pour yourself a cup o' joe and let's get down to some serious quality time concerning the ongoing effort of Mister K. -- a.k.a. the Vampire of Vegas -- to stave off disaster at MGM studios.

Sad to say, but the outlook ain't great. Since taking over the studio in 1996, K2 has presided over one of the most glorious records of artistic failure in the history of Hollywood, bringing to market an almost unending stream of theater-emptying drivel. Topics have ranged from Canadian gay guys to lovable comics to troubled young people to monsters that come out of test tubes and sewers.

This avalanche of garbage helps explain why the company closed its books in 1998 on $157 million in net losses for the year, widening 23% from the year before. And 1999 is shaping up as even worse, with a tsunami-size $306 million in losses rolling in for the January-to-March quarter, vs. only about $18 million in red ink for the comparable earlier quarter in 1998. Even if you back out some $225 million in onetime contract termination charges for scrapping fiascos in the making, you're still left with $81 million in quarterly losses -- a nearly fivefold increase in a year.

What lies ahead? Judge for yourself. Coming to a theater near you any day will be, for example, Mister Accident. This is the heartwarming tale of (and I'm not making this up) "the janitor of a free-range chicken farm who meets the woman of his dreams and joins her in trying to thwart the tobacco industry's nefarious plans to addict new customers through nicotine-injected eggs." (To which I can only think: Oh, my God!)

Or how about Flawless -- about a "tough, conservative security guard who suffers a stroke and is assigned a rehabilitative program that includes singing lessons with the drag queen next door." (You don't have to say it, believe me, I know.)

It just goes on and on like that -- a story of love and redemption in the world of a ticket scalper; a blind man sees again; a crazy girl gets normal and thereby wrecks her brother's life; a priest faces a tough choice. Aside from the company's upcoming latest installment in the James Bond series, it's a lineup that has now become all too familiar from MGM: pure and worthless crapola.

Bad movies -- and I mean really bad movies -- have been erupting from MGM for so many years now that no self-respecting agent wants his clients to have anything to do with the place. As a result, the studio never sees the good scripts, never gets offered the bankable stars and has thus been left to loiter on the fringes of Hollywood as every decent deal in town simply passes it by.

Back in 1997, when K2 tried to dump a stub end of his holdings in MGM on the public via an IPO, the deal's promoters talked the offering up as a great chance to get in on the last "pure play" movie studio available in Hollywood. They could as easily have pitched it as a swell ground-floor chance to get in on the financial equivalent of lung cancer. The truth of the matter is, no one in his right mind wants to get into the business. They all want to get their money out of it as fast as they can.

Steve Ross of Warner Communications didn't buy Time because he wanted to spend his life hanging around Gerald Levin. Michael Eisner didn't have the Walt Disney Company (DIS) buy Capital Cities/ABC because he figured that even Peter Jennings would be more fun than Jeffrey Katzenberg.

All these deals and many more like them were done for the singular reason that the movie business stinks -- no matter how tricky or twisted you make the accounting. You simply can't make any money in a business in which every bankable star in the game now backs his own personal 18-wheel tractor trailer up to the studio's front gate and demands the right to haul off all the profits before agreeing to sign anything.

Movies are made for one reason -- and one only: ego and glamour and the desperate hunger of fat middle-aged men to see what Michelle Pfeiffer looks like with no clothes on -- a pretty expensive obsession when you don't have a theme park (or a TV network, or a publishing business or some other such side deal) with which you can refry the beans of your hits and into which you can dump the costs of your duds.

John Kluge found this out the hard way when he bought Orion Pictures back in the 1980s and wound up having to sell out at a loss of roughly a quarter billion dollars a few years later. And you would have thought that K2 would have learned the lesson himself long ago as well -- especially when you consider that he'd bought, then sold, MGM twice already before his latest go-round. But it seems some people never learn -- the best evidence of which is that when Kluge finally decided to cut his losses and bail out, back in 1997, who did he wind up selling to but Kerkorian himself!

Lately, we've been hearing all the familiar front-office rumblings about a turnaround being in the works. There's been the departure of the company's chief executive, Frank Mancuso, and his replacement with a Kerkorian underling from K2's Las Vegas casino operations, Alex Yemenidjian. And Yemenidjian, in turn, has begun making the rounds of the media, telling folks that the bad news is all out and that the company will actually be increasing its film production schedule to maybe 20 films a year in the period ahead.

One presumed sign of the improving outlook, according to Yemenidjian, is that the company will be writing off as much as $225 million in second-quarter losses for the period ending June 30, and with the decks thus presumably cleared, the new and improved MGM will, according to a recent press release, at last be able to "focus on maximizing the opportunities ahead."

To which one can only respond: Airsick bag, please! By producing more movies in the future, the company will have more losses to write off! In fact, a look at the company's current balance sheet shows that, for all practical purposes, MGM has a limitless supply of writeoffs in the pipeline already.

In movie accounting, the gimmick is to capitalize your costs, not expense them, with the result that the outlays for box-office calamities like Species II turn up, for a time at least, on the balance sheet as assets, making you look rich when in fact you could be stone-cold broke. Fess-up time comes when the accountants can't stomach the charade anymore and make the company write off the "assets" as amortized charges against earnings.

As of March 31, the latest period for full data, MGM's balance sheet showed roughly $2 billion of film assets, of which nearly $350 million are for movies that haven't even been completed yet. That $2 billion accounts for more than 100% of all the balance-sheet equity the company's got. And you can be sure a whole lot of it is totally worthless -- as the company's latest announced plans to write off close to $150 million of it attest.

Though Wall Street seems willing to give K2 the benefit of the doubt as to what will happen next, evidence grows by the day that the company is, in fact, slowly but steadily running out of money -- and at some point it's going to be impossible to stave off the day of reckoning by gimmicky rights offerings to squeeze more cash out of existing shareholders.

At MGM's current price of about $18 per share, Wall Street is valuing the company at just a bit over $2.7 billion, with K2's own 90% stake worth about $2.4 billion of the total. But the company also has balance-sheet debt of $1.5 billion, which means that anyone wanting to buy the business would actually have to pay $4.2 billion.

The question is, for what?

One smart fellow of my acquaintance says he figures the film production side of the business is basically losing $40 million per year on each of the roughly dozen films it cranks out yearly, meaning a total film production cash drain of $500 million annually.

But since the company as a whole is reporting a yearly cash-flow drain of only $450 million, he assumes that the rest of the business -- which basically amounts to licensing and syndication fees from its film library, and nothing else -- is bringing in $50 million a year in cash. (If film losses are less, then, naturally, cash flow from the library will be greater. Since the company doesn't break out the details, there's no way to know for sure.)

With media companies like Disney, Viacom (VIA) and Time Warner (TWX) now selling for 13 to 15 times year-ahead cash flow, one might thus say that the film library, if sold alone, would fetch no more than $1.5 billion in today's market -- and that assumes a generous $100 million in cash flow.

On top of that, there's not much else to value since the company has no real estate to speak of (it was sold years ago) or even a production studio. True, there's licensing rights for anyone wanting to make some new James Bond movies in the future. (MGM owns the rights to the franchise.) But my source says he figures the rights would probably go for $200 million to $300 million.

And, finally, there are the rights to the MGM logo, which surely must be worth something. A chap of my acquaintance offered to pay $50 million for those rights a while back, which is all he figured they were worth, and the company turned him down. So let's be generous and say that $200 million would be more in the zone.

And frankly, that's about it -- all you'll be getting for your $4.2 billion: a $1.5 billion film library and maybe $500 million worth of odds and ends -- which is to say, $2 billion max -- out of which you'll have to pay off that $1.5 billion of debt, leaving you with only $500 million, or about $3.30 per share.

In fact, of course, you wouldn't wind up with even that much. Reason: The company currently has maybe a dozen new projects in various stages of development, complete with plenty of contracts that obviously can't be torn up without incurring all sorts of termination and related costs. Bottom line? Shutting down production to conserve cash could easily wind up eating through most, if not all, the remaining stockholder equity, making the shares -- which are currently selling for $18 -- worth maybe nothing at all.

These are not numbers calculated to swell with pride the bony bosom of Wall Street's nastiest raider (if you don't count Carl Icahn or Ron "the Finagle King" Perelman), for they show plainly enough that on strict valuation principles, MGM's $18-per-share price is probably $18 too high.

And that, in turn, is certainly hard cheese for K2 since he has so far shelled out, according to a number of Wall Street analysts who follow the matter, the rough equivalent of $15 per share to step into this bottomless dung heap.

So add it all up and nothing much has fundamentally changed to make us alter our view, pronounced here nearly a year ago, that MGM is a mess that Kirk Kerkorian is in up to his neck and he's sinking fast. A year from now? Well, if he's still got his head above water, we'll drop by for another visit. Until then, thanks for the quality time.

You can reach me by e-mail at cbyron1@home.com .

Christopher Byron's column appears in the New York Observer, and he also writes a Wall Street and investing column for Playboy. He is the former assistant managing editor for Forbes, the Wall Street correspondent for Time and the Bottom Line columnist for New York. Byron holds no positions in any of the stocks discussed in his column. While he cannot provide investment advice or recommendations, he welcomes your feedback at commentarymail@thestreet.com.

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