THE BIG PICTURE - WikiLeaks



It is a pleasure to sit down with Rob Wiesenthal, Group Executive, head of corporate development & M&A, Sony corporation; EVP & CFO, Sony Corporation of America. Our focus will be on Sony’s entertainment related businesses which include film, TV, music and video games.

THE BIG PICTURE

• How will the Film industry’s transition to a digital world impact your studio’s revenue growth and profit margins? Will your studio’s profit margins be able to expand with a declining DVD market?

The greatest pressure on studio margins has been driven by a decline in DVD sell-through. That has been driven not only by a transition to digital, but by a transition to newer physical rental models (subscription/Netflix and kiosk/Red box). In fact, a transition to digital can be beneficial to the extent that it is a transition to higher-margin models (e.g., EST).

But there are numerous opportunities to expand margins going forward as the landscape continues to evolve. Securing and executing on the production of strong film franchises and TV shows and continuing to grow profits in our networks is critical to margin expansion, regardless of a transition to digital. Continuing to tightly manage costs will also remain important. Within digital, there are opportunities to support and emphasize higher-margin models (e.g., EST) and explore new windows (e.g., day-and-date VOD). And opportunities remain to expand Blu-ray as a higher value, higher-margin model within physical.

a. How is the rest of Sony positioned to capitalize on these changes?

• Where do the greatest opportunities lie within your existing portfolio of assets? What technologies or business models are you most bullish on within the digital transition?

SONY PICTURES

THEATRICAL

• 3-D: It seems like the ratio of 3D box office as a percentage of total box per film is slipping for recent releases—do you agree?

While we have seen a drop in the 3D box office ratio from releases from earlier in the year, this remains a fluid issue and there are several factors to consider.

Several of the recent summer releases had a lower 3D:2D box office ratio; however, we found this trend to be associated more with family films. 3D releases in the fourth quarter 2009 (Cloudy with a Chance of Meatballs and Avatar) and first half of 2010 grossed between 50% - 81% from 3D; titles such as Toy Story 3, Shrek Forever After, Despicable Me, and Cats and Dogs have seen their 3D:2D ratio range from 41% to 54%. As 3D ticket prices are higher, it is more expensive for a typical family of four to attend a showing in 3D.

Conversely, other niche genres that exploit 3D have seen a higher ratio of 3D box office. Late summer releases such as Step Up 3D, Piranha 3D, and our Resident Evil: Afterlife yielded an average 3D box office ratio of greater than 80%, demonstrating their higher reliance on 3D dollars. We are keeping a close eye on these figures and expect the 4th quarter’s 3D releases to perform well.

Moreover, the inconsistent 3D performance data this year can be partially attributed to the increasingly crowded 3D release calendar. Today, there are approximately 5,700 3D screens in the US, which, when coupled with an average of 1-2 new releases per month, makes it more difficult for 3D films to secure and retain 3D screens.

In the US, DCIP and other digital cinema installation groups have aggressively begun their rollouts. As more and more screens become available, competition for space will become less of an issue and films will have the ability to run longer in 3D and likely maximize their 3D grossing potential.

What are your current thoughts on 3D as a growth driver for your theatrical business? Is its appeal waning in the eyes of the consumer or is it more a function of a lull in compelling 3D product?

3D will remain a significant driver of our business for the foreseeable future for our animated and action/adventure genre features. In examining the competitive release slate for the next calendar year, there are 30 films scheduled for release in 3D in 2011, and already another 25 estimated for 2012 alone.

Sony Pictures just released Resident Evil: Afterlife which opened #1 this last weekend with approximately $26.7mm in total box office, nearly 84% or $22.3 mm of which is from 3D. In the upcoming calendar year, Sony Pictures will be releasing five films in 3D – Green Hornet, Priest, The Smurfs, Arthur Christmas and The Invention of Hugo Cabret in the US. Additionally, Sony Pictures will also be releasing The Adventures of Tintin in 3D in certain international markets later this year.

As the theatrical footprint evolves and more 3D screens become available, we believe 3D will continue to be a major driver of our business and audiences will continue to pay a premium price for a premium experience. However recent examples prove that the quality of the film is still key, and 3D alone cannot carry a marginal film.

a. How large is the 3D conversion opportunity for Sony’s library product?

• From a Home Entertainment perspective, the growing install base of 3D in the home plus the expected decreases in costs for quality 2D to 3D conversions will lead to additional 3D opportunities for Sony library product

• Following the conversion of a title, there are then a variety of opportunities available for 3D exploitation – from a Blu-ray 3D release to broadcast/digital avenues, and even a potential 3D theatrical re-release

• Specific to Blu-ray 3D, familiar catalog favorites in 3D will be a compelling option for consumers that have just purchased their Home 3D setup

b. What are you expectations for 3D consumption in the home?

• In the near-term the greatest volume of 3D content in the home will via cable and satellite television

o Upcoming Sony, Discovery, IMAX channel launch

o ESPN 3D

o DirecTV offering dedicated 3D channels to broadcast NASCAR, baseball games, and 2010 World Cup reruns

• However, heading into the holiday season, we anticipate that studios will pick-up the pace on 3D Blu-ray releases due to the large number of 3D theatrical releases

o By the end of 2010, it is expected that there will be approximately 10-15 Blu-ray 3D titles in the market at retail – by the end of 2012, it is expected that a total of 80-100 titles will have been released on 3D BD

o For Sony Pictures, by the end of 2010, we will have 5 releases on 3D Blu-ray (Cloudy with a Chance of Meatballs, Open Season, Monster House, Resident Evil: Afterlife, and 3D World Cup Highlights)

• Longer-term, feature films on 3D through Blu-ray will be critical to driving mass adoption (as the it will take some time for the current broadcast infrastructure to reach a point where it can provide the same 3D picture quality as BD)

o Already, 3D movies have proven popular in theaters for a mass audience

o 3D is a natural evolution for Blu-ray format and enables delivery to the home via a familiar, mass platform

o Per Futuresource, 50% of US homes will have a 3D Blu-ray platform by mid-2014 and 46% will have 3D enabled TVs

• Assuming 3D BD releases pace as described above, we expect that 3D BD will represent ~20% all Blu-ray sell-through transactions by year-end 2012

• What portion of your pipeline in 2011 and 2012 will consist of either an “event” or franchise film? Ultimately where would you like to see this mix settle out?

Number of releases varies from year to year, but SPE's guideline for its multi-label approach remains around 20-22 per year (excluding Sony Classics). In 2011 and 2012, we expect to release 3-5 “event” or franchise films per year.

• What upcoming films are you most excited about

We are excited about all of our upcoming films. Most notably:

• EASY A – An ensemble cast including Emma Stone, Amanda Bynes, Stanley Tucci, Thomas Haden Church, Lisa Kudrow and Penn Badgley brings this updated take on The Scarlet Letter to theaters.

• THE SOCIAL NETWORK – The powerhouse team of writer Aaron Sorkin and director David Fincher bring the story about the founding of Facebook. We expect the film to be critically-acclaimed and a strong performer worldwide.

• HOW DO YOU KNOW – A relationship comedy from writer/director James L. Brooks, starring Reese Witherspoon, Paul Rudd, Owen Wilson and Jack Nicholson.

• THE GREEN HORNET – The popular TV series and comic book has been adapted to the big screen by Seth Rogen who is also starring. The film will be released in 3D and IMAX.

• THE GIRL WITH THE DRAGON TATTOO – The English-language adaptation of the award winning crime novel by Stieg Larssons will star Daniel Craig and Rooney Mara. The title is the first book of a trilogy.

• THE SMURFS – Sony Pictures Animation will follow up their 2009 hit Cloudy With a Chance of Meatballs. The live action/CGI-animated 3D feature will be the first major theatrical version of the popular TV series.

• JUST GO WITH IT – Adam Sandler and Jennifer Aniston star in this romantic comedy about an L.A. plastic surgeon posing as a married man to avoid commitment to the young, beautiful women he is dating.

• MIB 3 – The third installment of the blockbuster franchise Men In Black will bring original stars Will Smith and Tommy Lee Jones to the big screen in 3D. 

• Can you give us a sense of expectations in your current fiscal year (March, 2011)?

As we approach the mid-point of fiscal year 2011, we’re very pleased with how the film slate has performed. Our summer opened to fantastic results from THE KARATE KID which has earned over $300 million in worldwide box office on a modest budget. Our string of hits continued with Adam Sandler’s GROWN UPS, Angelina Jolie in SALT, Julia Roberts in EAT PRAY LOVE and Will Ferrell in THE OTHER GUYS. The fourth installment of the Action/Horror franchise RESIDENT EVIL recently opened at number one. Rounding out the rest of the year, we’re expecting strong performances from David Fincher’s THE SOCIAL NETWORK, THE TOURIST starring Angelina Jolie, the Seth Rogen adapted THE GREEN HORNET, the Adam Sandler/Jennifer Aniston romantic comedy JUST GO WITH IT and the Jim Brooks directed HOW DO YOU KNOW.

• What do you expect steady-state margins to be long-term for your Film segment?

Despite the obvious challenges in the home entertainment market, we’ve taken significant steps to build new revenue streams and contain costs. As a result we hope going forward that margins will be consistent with what we’ve delivered historically from the motion picture segment. We also acknowledge that in a hit-driven business, earnings in any given year are subject to volatility as tent-poles like Spider-man provide a spike in receipts.

• On the cost side, how does Sony compare to the industry in terms of marketing budgets for your films and talent costs? Are there future cost saving opportunities from a fixed cost perspective or will margin improvement be more driven by variable cost savings or a shift to higher contribution margin products (i.e. digital products)?

Regarding marketing costs, Sony compares favorably to the industry in terms of marketing budgets for our films. The average marketing budget for "like films" is fairly similar across studios. Sony is usually at or slightly below this average. This is in-line with our goal of carefully managing marketing expenses while ensuring we have sufficient share-of-voice to open our pictures well.

Regarding talent costs, we have made great headway in getting talent to adapt to the new economic challenges in the business. What that means is essentially we expect talent to wait until we’ve made money before they participate in profits. Our efforts have been largely successful as even the top global stars have compromised on their historical deal quotes.

[Fixed Costs] In the last two years we’ve made the difficult decision to take significant overhead costs out of our business that will continue to benefit operating performance going forward. In addition we will carefully manage our cost structure to restrain growth in that area.

[Variable Costs] On individual films we continue to seek out cost efficiencies including state-sponsored production incentives, shifting marketing dollars online or into social media and deferring talent compensation until we’ve cleared certain profit thresholds. Blu-ray still provides a high margin distribution channel in physical media as we seek to grow new revenue streams in digital media.

• How would you characterize the state of the film financing business today? How long do your current film financing agreements run and what percentage of your films are co-financed?

The film financing business today is challenging, however various opportunities exist which we’ll continue to explore. Our overall slate co-financing deal runs for another 1 ½ years. In a given year, roughly 50 – 75% of our slate is co-financed.

• Spider-man has obviously been a huge franchise for you. You are now in the process of essentially rebooting the series – care to share with us any early thoughts on how successful the next one will be?

We are extremely enthusiastic about the prospects of the fourth Spider-man film with a talented young filmmaker, Marc Webb, taking the helm and a new face for Peter Parker in Andrew Garfield. Andrew will also appear in our upcoming release The Social Network.

• How do you think about the value of film libraries in the current environment? Are there any meaningful library opportunities now that MGM appears headed for a recap and new lease on life?

The value of film libraries has clearly declined with the corresponding erosion in the home entertainment market. However, there remains significant value in existing film libraries with the growth of Blu-ray and emergence of digital revenue streams. In addition, new devices will provide an influx of demand for quality content. The recent sale of the Miramax library provides evidence that buyers are still attracted to film libraries and see value in the reliable cash flow they can generate.    

While open to different opportunities to grow our library, we prefer to focus on building and growing our film library internally rather than through acquisition.

HOME ENTERTAINMENT

• Can you update us on progress to drive 3D consumption into the home this year? What more should we expect heading into the holiday season and 2011?

• See above for broader industry-level view

• We are the first studio to release a 3D BD title at retail (Cloudy with a Chance of Meatballs)

• By the end of 2010, Sony Pictures will have 5 3D Blu-ray releases in the market – the most aggressive 3D BD release slate in the industry for 2010

• Beyond standard retail shelf presence, we are actively bundling our 3D BD releases with our Electronics business to drive hardware and software penetration opportunities

• In early 2011, Sony, Discovery, and IMAX will launch the first 24x7 3D channel

• Can you update us on recent home video trends (units, wholesale pricing) and discuss your expectations for the holiday season?

According to the DEG, the US home entertainment business reached $8.8 billion for the first six months of the year. This represented a -3.3% decline in performance from the prior year when aggregating for all forms of DVD, Blu-ray and digital distribution (sell through and rental including VOD). Domestically YTD (Jan – June), the sell through market (DVD and Blu-ray combined) is down –9% in units and –8% in value. Average retail price has increased +1%, reflecting overall stability in pricing in the market as well as continued Blu-ray adoption by consumers. The traditional rental market is down -4.9% to $2.95 billion for the same period according to Rentrak Home Video Essentials with video-on-demand up 19.1% to $865 million.

This holiday season, we expect stronger performance than last year driven by lower priced Blu-ray hardware & software and overall stronger consumer confidence. For our business particularly, we expect substantial dividends from entering the fourth quarter with at least 30% more box office than we had in Q4 2009.

• VOD day and date – can you give us any details on day-and-date release performance and the impact on sell through?

We have been satisfied with the performance of our day-and-date titles; both in terms of VOD lift achieved and the impact on our retail business. SPHE selects films that are considered “rental” titles, i.e. having limited sell through appeal, for day-and-date release, mitigating sell through cannibalization risk to our overall slate.

a. How meaningful is your VOD business today as a % of revenue and EBITDA?

While we consider VOD to be a significant growth area as consumers transition from packaged media to electronic delivery, current VOD revenues comprise less than 5% of total revenue on a typical studio release.

• Blu-ray: When you compare where Blu-ray is in its lifecycle relative to where DVDs were at the same time, Blu-ray has fallen behind in terms of discs being purchased. Has the performance of Blu-ray met your expectations in terms of revenue for new releases as well as catalog?

While both DVD and Blu-ray are optical media discs, their lifecycles should not be considered analogs. DVD was a revolutionary technology that was accompanied by a revolutionary business model shift (collapse of the sell through window, shift to mass merchant distribution, large drop in consumer price) and benefited from strong growth in consumer discretionary spending, fueled by the credit bubble.

Blu-ray is an evolutionary technology, primarily providing incremental improvements in sound and picture quality over DVD. Since its launch, Blu-ray has encountered a format war and strong economic headwinds, as the consumer has shifted from a “premium” mindset to one of frugality. Against this backdrop and considering that hardware penetration as not hit mass market adoption yet (forecasted to be 23.5% by year end), Blu-ray is meeting our expectations in terms of New Release, and to a lesser extent, Catalog.

With regard to the latter, consumers have not gone out to replace their DVD libraries, but rather have focused on collecting franchise action and family titles that typically have the strongest sell through appeal overall. Until recently, the studios were partially to blame for this, as Blu-ray catalog pricing did not take into account the inherent differences in Blu-Ray appeal (“HD-worthiness”) for different titles/genres, instead opting for a “one size fits all” skimming strategy from the DVD playbook. If the recession has illustrated anything, it is that you have to get the price/value equation right for the consumer.

Source: Screen Digest

a. Do you think the model has permanently shifted away from ownership and towards rental?

To level set, at the market’s peak in 2007, sell through only represented 31% of total HE transactions. For the 1H10, the sell through split was 21%. As we have discussed, there was a sea change in consumer behavior that fundamentally changed purchasing mentality from one of “trading up” to “trading down” during this period. With the availability more convenient rental options in Redbox, Netflix and emerging digital models, the consumer has certainly established new patterns of consumption, albeit at the margin, given the overall 10% shift in transactions (of course, not at the margin for the studios).

So, to the question of whether or not this change in consumption is permanent, one should consider if the change in the consumer’s mindset will be – i.e. will our new cultural values of thrift linger on post-recovery, as they did after the Depression? We certainly may regain some ground; however, considering that the 2007 levels were attained at the height consumer credit excess, it is highly unlikely we will ever see these levels again. As a studio, we believe we are in for a prolonged recovery and we have adapted to the new consumer reality. That said, our experience has been that the strongest titles (2012, Karate Kid, Avatar) are still converting at levels comparable to peak historical performance. We are also optimistic that mass-market adoption of Blu-ray, and the introduction of 3D Blu-ray will spur consumer appetite to own our product. Despite this, we are still very much focused on reengaging the consumer by creating more compelling products, rationalizing our retail pricing and leveraging emerging platforms such as Ultraviolet to enhance the appeal of sell through.

Source: Screen Digest, SPHE

• You have been a partner with Starz for the pay TV window. How do you view Starz as a long term partner and its viability in a changing landscape?

We view Starz as a good long term partner. They remain a committed buyer for studio motion picture product, even as they strengthen their original programming slate. Their subscriber base is strong and they have demonstrated a willingness to find subscriber growth in new platforms, for example Starz Play on NetFlix. We also believe that the market for current window subscription television, in which Starz is well positioned, will remain viable and strong.

a. If Netflix offers you enough money for your films after your deal expires (2015), would you offer your streaming rights for your films on an exclusive basis?

Price is obviously very important but the length of the deal, the media and exclusivity licensed or held back, the product commitment, the stability of the buyer and other factors, are also important.   We would certainly consider an exclusive deal with Netflix if the overall terms were compelling.

• With all the new players and technologies impacting the Film industry – can we discuss your thoughts on each, what their impact is to Sony’s financials today and expected future impact as well as whether you consider them a friend or foe?

a. Netflix

b. Redbox

c. Apple with Apple TV and iPads – first for just your Film and Music businesses and then separately for Sony overall

d. Amazon

We consider all of them our distribution partners. SPHE’s philosophy has been to follow the consumer, so these companies represent great opportunities to find new transactions in the market. With the infrastructure increasingly in place for digital, we're excited at the prospect for growth and we feel each of them, as well as our current retail partners, will be able to play in the market. While at an individual view level, we economically prefer transactional rental to subscription, we think both have a role in the market if maximizing our overall product value to the variety of customer segments that exist. With regard to Redbox, we are very satisfied with the performance of our deal and we have elected not to move to a 28-day window. Similar to Disney and Paramount, we have not observed any significant cannibalization from Redbox and, in light of that, adopting a windowing strategy would entail taking a substantial reduction in revenue without an offset.

• What experimentation have you done thus far with an early “premium” VOD window? Is a 30-day window on the horizon or is this too radical a concept for your exhibitor partners? What gives you confidence this window will be incremental and not damage your traditional VOD business or exhibitor relationships?

As you are aware, we have tested an early window concept with Hancock and Cloudy with a Chance of Meatballs on Sony’s BIVL service. As far as our relationships with our exhibition and HE distribution partners, they are all aware that the status quo is not acceptable in this dynamic market. However, we view an early window product as a niche offering to an under-served consumer segment, as opposed to a mass product to replace current views and, as such, we expect impact on our partners to be slight. The challenge in this environment is to get the price/value (i.e. timing) of the product right to achieve meaningful uptake.

TELEVISION

• Discuss Sony Television Studio’s performance in the upcoming TV season covering both broadcast and cable networks.

The studio is producing more primetime network shows than it has in a decade.  We have 25 series on the air across broadcast and cable networks this season, including 8 new shows (Happy Endings ABC, Mad Love CBS, Mr. Sunshine ABC, Plain Jane CW, The Big C Showtime, Franklin & Bash TNT,  and Nate Berkus on local stations).    Our slate includes two returning broadcast network series, "Rules of Engagement" and "Community," as well as reality shows on three different broadcast networks  ("Shark Tank" for ABC, "Plain Jane" for the CW and "Sing Off" for NBC). We have just renewed "The Dr. Oz Show" for 2 more years,  with more double runs than any other talk show.  95% of the show's initial run will be in the highly-desirable news lead-in time period, in many cases replacing  "The Oprah Winfrey Show" beginning in 2011.  Together with Harpo Productions, we have just launched on Monday, another show for first-run syndication called "The Nate Berkus Show."  We have slightly more measured but still high expectations for it.  Dr. Oz just won the Daytime Emmy for best host and Breaking Bad just won two Primetime Emmy awards for best drama actor and best supporting drama actor.  We're very optimistic and proud of our slate of programs.   "Wheel of Fortune" and "Jeopardy!" continue to be the #1 and 2 game shows in syndication and our soaps continue to perform well in daytime.  We also produce acclaimed MOWs, such as "Georgia O'Keefe," which was nominated for several Emmys.

• TV syndication appears to be healthy again – what is the long term outlook for this business?

We believe the long term outlook for this business is positive and that growth will come from a rebound in the ad market and an expansion of retransmission consent fees for the networks' owned and operated stations.    Sony pictures television is well positioned for the future. We have several comedies and dramas hitting off-net syndication in the future as well as, Dr. Oz and Nate Berkus in first-run syndication.

ADDITIONAL QUESTIONS

1. Will Netflix create a new window for film studios in light of the $1bn Epix is commanding?

The NetFlix-Epix deal does not, as we understand it, represent a new windowing pattern for feature films.  NetFlix is another buyer for subscription television rights to motion pictures in the current pay window.  The NetFlix-Epix deal does, however, confirm that NetFlix is a viable new entrant into the subscription pay television market, willing and able to pay program license fees commensurate with cable/satellite based services. This is a positive development for the industry.

2. Will HBO/Showtime/Starz be forced to pay more for films as a result of NetFlix' generosity?

NetFlix is a buyer for essentially the same rights and windows as HBO/Showtime/Starz and has shown its willingness to offer pricing competitive with these cable/satellite-based subscription pay networks.  As a result the pay TV networks will need to become more aggressive with the license fees they pay studios and in the associated rights they are licensing. 

3. How disruptive will Netflix be to home video and other current windows such as TV syndication?

• For impact on home video, see answer to the question above “With all the new players and technologies impacting the Film industry – can we discuss your thoughts on each, what their impact is to Sony’s financials today and expected future impact as well as whether you consider them a friend or foe?”

• For impact on pay TV and TV syndication windows: NetFlix is creating competition for premium, subscription networks but is not fundamentally changing the motion picture windowing model.  Subscription pay precedes the network/syndication windows. The network and syndication markets are differentiated from subscription pay both in timing but also in being available on an ad-supported basis to the widest possible audience.  We believe demand for content in this window will remain strong.

SONY MUSIC

• What is your outlook for music market trends for the rest of 2010 and 2011 in the US, Japan and other major territories (for both you and the market)?

• Discuss your strategy for broader revenue streams from 360 degree deals with artists.

• What is Sony’s A&R strategy for the next few years and how does this compare to your A&R spending as a percent of revenue over the past 5 years?

• What do you expect steady state margins for your recorded music and publishing businesses to be?

• Can you discuss your renegotiated agreements with both the Michael Jackson estate and Simon Cowell?

VIDEO GAMES

• Any comments on the current industry trends and expectations for the holidays?

• Can you talk about where you are in terms of profitability with manufacturing the PS3 console?

• Expectations for PS3 sales for 2011 and how that compares to the Xbox and Wii in terms of share of the market?

• Do you view the online casual gaming space as a direct competitor?

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