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Starz Bulks Up

8/31/2007 8:00 PM Eastern

Movie-centric pay TV channel Starz feels the time is right to ratchet up its presence in the premium space by adding brand-defining original scripted series.

While Time Warner-owned HBO and Viacom’s Showtime have built their popularity largely on original shows such as The Sopranos and Weeds, respectively, Starz has relied primarily on major theatrical films such as the Lord of the Rings trilogy and Pirates of the Caribbean.

The movie-based mix has worked to the extent that it has attracted a reported 16.1 million Starz subscribers, as compared to Showtime’s 15 million subscribers. And Starz’s primetime lineup of Hollywood movie premieres regularly draws higher ratings than Showtime, Cinemax and every other premium service other than HBO, network officials said.

Now, one year after parent Liberty Media rebranded an expanded Starz Entertainment unit as Starz LLC, the premium service is poised to take more ownership control of its content via original programming. In January, the channel will introduce two original comedy series, followed with the summer 2008 debut of an hour-long drama.

From producing and distributing content from its Starz Media division — which includes home-video arm Starz Home Entertainment; DVD and television production company Starz Productions; and several animation studio/production companies — to the distribution of such content through the Starz Entertainment division, which includes the Starz and Encore premium channels and multiplexes, as well as the Vongo Internet-based pay-per-view movie service, Starz executives say the company is ready to compete on the same originals playing field as its premium brethren.

ALL ABOUT HOLLYWOOD

“We’ve always been about bringing the best of Hollywood — classic films, independent films, and foreign films — that’s really the basis of Starz and the Starz Networks,” newly promoted Starz executive vice president of programming Stephan Shelanski said. “Now, we’re introducing originals, because we think that it’s good idea to expand our portfolio of programming and have original content that we can control ourselves to offer our viewers. If they like our movies, we think they’ll like our originals, too.”

One of the reasons Shelanski is bullish about the network’s originals is that its new shows reflect the company’s core Hollywood theme.

The network’s first foray into the genre, a half-hour series dubbed Head Case, stars comedian Alexandra Wentworth as a judgmental therapist to Hollywood’s celebrity elite. The series is based on a 10-episode, semi-scripted, short-form series that aired on Starz this past April and that drew celebrities such as Jason Priestley, Andy Dick, Rick Fox, Alanis Morissette, Ralph Macchio and Tom Sizemore to the therapist’s couch.

The second series, Hollywood Residential, is another semi-scripted series that stars Adam Paul as an underachieving actor who lands a job on a struggling home-improvement cable network “fixing” the homes of Hollywood celebrities. Paula Abdul, Jamie Kennedy, Cheryl Hines, Tom Arnold, John Cho, Chris Kattan, Carmen Electra and Beverly D’Angelo are among the stars whose houses the show’s star seeks to improve, Shelanski said.

Shelanski said Starz wanted to tackle comedy — a genre it sees as underserved in the cable environment — first. “Also, the semi-scripted, improvisational nature of these suits the premium-channel platform well … we want to bring programming our audiences are not going to see on broadcast or basic cable.”

The network will delve into drama as well, with its not-yet-named, one-hour series debuting next summer of 2008, but Shelanski would not reveal details.

With its new originals, the network hopes to create another destination night outside of its Saturday night movie premieres, although Starz president and chief operating officer Bill Myers said it’s unclear as to which night it will launch its new comedies.

SOURCE: Starz LLC
Top channels: Starz, Encore, 16 movie channels in all.
Total revenue: $1.029 billion (combined last four quarters).
Starz launch: Feb. 1, 1994 (first movie: Scent of a Woman).
Starz On Demand launch: Sept. 19, 2001 (Cleveland, Ohio; Adelphia Communications).
Starz HD launch: Dec. 2, 2003.
Key movie suppliers: Walt Disney Pictures, Sony Pictures Entertainment, Overture Films, Sony Revolution Studios, Miramax Films, Touchstone Pictures, Hollywood Pictures, Pixar, TriStar, Screen Gems, Sony Classics and Warren Miller Films for multi-year, exclusive first-run output.
Top 2007 movies (by box office): Pirates of the Caribbean: Dead Man’s Chest, $423 million; Cars, $244 million; The Da Vinci Code, $217 million.

10% SOLUTION

Over the next five years, Myers said, original programming could represent as much as 10% of Starz’s primetime lineup.

“All of this on the original side makes incredible sense today, not just for what it does for the consumer, but it adds real value to our cable operators because its putting a product that we think can help them drive their business,” Myers said. “At the end of the day, video is still an important component in the cable world and we want to continue to improve that business through original programming.”

With three originals in one year, Starz’s commitment to scripted series is almost as aggressive as that of HBO or Showtime. But Shelanski says Starz is not looking to compete with those two networks — yet. “We’re not fooling ourselves and saying we’re going to be competitive coming right out of the gate,” he added. “We’re going to take it very slowly and ramp up gradually year to year.”

Myers also said he’s not expecting to compete with Showtime and HBO for Emmy honors in the drama or comedy categories in the near future.

“We have a broader view than HBO or Showtime,” he said. “We’re trying to put together a package that’s really compelling to the consumer, and in our minds, it’s the combination of originals and movies.”

So why now?

“I’d be lying if I said we weren’t envious of some of the success that they’ve [HBO and Showtime] had,” Shelanski admitted. “But we’re doing [originals] for our own reasons. One of which is that we’re a different company now that can fully take advantage of scripted programming.”

Miller Tabak media analyst David Joyce, who doesn’t cover Liberty or its companies, but does cover HBO parent Time Warner, said Starz’s diversification effort, made possible by the acquisition of production studio IDT Entertainment, makes sense. That’s because serving strictly movies hasn’t resulted in “really astounding” subscriber growth.

“Viewers like to have a mix of original-series programming, as well as movies, on the pay networks,” Joyce said.

Thanks to IDT and other Liberty acquisitions folded into Starz LLC, the channels don’t need to be completely spoon-fed by movie studio product.

A little over a year ago, the then-Starz Entertainment Group brand was defined by acquired movies from Hollywood studios such as The Walt Disney Co. and Sony Pictures.

SOURCE: Nielsen Galaxy Explorer live household coverage ratings, Jan 1-June 29, 2008, provided by Starz LLC
HBO 28.7 million
Encore 28.2 million
Starz 15.8 million
Showtime 14.3 million
Cinemax 11.9 million

With the exception of a few movie-oriented documentaries and original movies — and 30-second animated movie parodies featuring bunnies re-enacting Pulp Fiction or Alien — Starz, Encore and its multiplexed channels aired movies 24 hours a day.

Movies do draw viewers: Despite not having a staple original series, Starz has been able to consistently finish among the top 10 premium and ad-supported networks in the monthly primetime ratings race.

According to Nielsen Media Research, Starz last month averaged a 1.0 primetime rating, doubling Showtime’s 0.5 rating and performing better than several basic services airing first-run original series, such as Sci Fi Channel, ESPN and Spike TV.

But three years ago, Starz looked like it was headed into a financial black hole.

Expensive deals to get movies from Disney and Sony’s Columbia Pictures studio were causing costs to soar by hundreds of millions of dollars per year — programming costs for what was then Starz Encore Group rose $225 million in 2004 (to about $700 million) and were expected to rise another $125 million in 2005, Variety reported at the time.

And in 2003, key affiliate Comcast won a settlement in a lawsuit that enabled it to pay Starz Encore far less in license fees for the movie services. Comcast objected to carriage-deal terms it inherited in its purchase of AT&T Broadband systems, specifically the systems AT&T had acquired from Tele-Communications Inc. TCI (run, as was Liberty, by John Malone) had agreed to pay Starz a fixed license fee regardless of how many TCI subscribers bought Starz.

Starz lost cable subscribers in 2003, and Malone said publicly he was willing to consider transactions that would bolster the service’s long-term viability. Variety in March 2004 said “insiders” predicted “an auction may be inevitable because of the pay web’s untenable cost structure.” HBO and Showtime were considered logical buyers.

Starz’s emphasis on Hollywood movies instead of more manageable original series wasn’t looking so stellar.

But Starz weathered that crisis under CEO Robert Clasen (a former Comcast cable chief), and now points to “steady and solid” subscriber growth over the period since then.

SOURCE: Nielsen Galaxy Explorer live household coverage ratings, Jan 1-June 29, 2008, provided by Starz LLC.
HBO 1.9
Starz 1.1
Cinemax 0.8
Encore 0.6
Showtime 0.6

BY THE NUMBERS

Liberty reported during its latest fiscal quarter that Starz increased its subscriber base by 7% versus the same quarter a year ago, to 16.1 million, while sister premium service Encore (showing older movies) is up 6%, to 28.4 million.

In 2006, the network generated $1.3 billion in affiliate revenue, up from $1 billion in 2005, according to SNL Kagan.

In other key balance-sheet points, operating cash flow was up to $186 million in 2006 from $171 million the prior year, with programming expenses up 5%, to $703 million last year from $668 million in 2005, according to Liberty.

“Our cash flow continues to improve and by the end of the year, we expect that we will meet our cash-flow targets,” Myers said. “As we add subscribers, it’s telling us that cable operators and satellite providers like the product and it fits well into their product offerings.”

Liberty disclosed that Starz distribution deals with two affiliates have expired, and that those affiliates are paying at “revised rates,” while Starz negotiates new agreements. Because of that, and because big operators Time Warner and Comcast are paying less to distribute Starz services to former Adelphia systems they have acquired, Starz absorbed a $24 million hit to its revenue.

The two lapsed affiliates are Cablevision and DirecTV, and the prospects for getting a new DirecTV deal are expected to be enhanced by Liberty’s pending acquisition of the DirecTV control stake from News Corp. and subsequent placement of Starz and DirecTV in a tracking stock. DirecTV, in fact, is the only distributor thus far to say it will carry three pending Starz high-definition services, amid its rush to get to 150 national HD services. The Starz services will be in the initial wave of new DirecTV HD services, in September.

Starz has high hopes for the September launch of three high-definition channels — Starz Edge, Starz Comedy and Starz Kids & Family — figuring cable affiliates will add them as they continue to ramp up HD offerings in competition with DirecTV and other competitors.

Comcast’s settlement with Starz gave the cable operator access to Starz library titles for on-demand distribution and a pair of movie services, RetroPlex and IndiePlex, for digital cable.

Starz’s strong, movie-oriented lineup makes Starz a valuable piece of Comcast’s programming roster, said Matt Bond, the operator’s executive vice president of content acquisition.

“Starz provides value to us as a premium service,” Bond said. “People like movies, and Starz has a significant quantity of recent Hollywood hits.”

Starz has also tossed its hat into the online-movie-downloads ring, via a service called Vongo. While Myers would not reveal subscriber or usage numbers for Vongo, he said it allows Starz to serve its audience on any movie-viewing platform it seeks.

Myers also cited the popularity of on-demand services from Starz and Encore. Both services have viewer-retention averages of around one hour, compared with 10 to 30 minutes for most on-demand services. (Starz On Demand does have a big missing piece when it comes to cable distribution: Time Warner Cable doesn’t offer the service, except in inherited Adelphia systems and some contiguous “classic” Time Warner operations. Starz said it’s hopeful Time Warner Cable will add it elsewhere. Cablevision Systems also doesn’t offer it; Comcast offers both Starz on Demand and Encore on Demand.)

“Consumer habits are changing and the way [consumers] want to enjoy their entertainment is different today than it was as early as three to four years ago,” Myers said. “So we continue to add what we think is compelling services on top of our existing base.”

Yet with all of its financial and distribution success, Shelanski said something was still missing from Starz’ portfolio.

“A year ago, before we had the greater Starz company we have now, we were strictly a pay television service offering movies,” he said. “We were not part of a bigger entertainment corporation where we could exploit different revenue streams. So for us, we were at a very strong disadvantage versus other networks.”

Indeed, as Starz generated strong ratings and affiliate growth through movies, HBO and Showtime built up a lot of buzz and ancillary revenue from the development of original programming. HBO in particular has been able to parlay the on-air success of original series such as The Sopranos and Sex and the City into profitable syndication and DVD deals.

It wasn’t until Starz’s acquisition of IDT Entertainment a year ago that the company would be able to position itself to control its own programming destiny by having the assets to produce and distribute its own content. Now under the Starz Media division, IDT’s animated and live-action studios — Mainframe Entertainment, Manga Entertainment, Anchor Bay Entertainment, DPS Studios and DPS Film Roman — will produce movie and television content for Starz, according to Myers.

Then, in November, Starz created movie studio Overture Films, which is charged with developing eight to 12 full-length movies a year for the company, according to Shelanski.

“We like the idea of creating assets that we can own and control,” he said — although the first two comedy series, as well as its drama series, will be developed by outside production companies. “If we spend the money to produce an original, we can exploit it on DVD and we can have our Starz International team sell it internationally.”

Diversifying its movie lineup with originals also makes good business sense given the uncertain future of the premium movie business, according to Shelanski.

THREAT TO THEATRICALS

While movies will always draw viewers in its premium window, the value of premium movies is threatened by the growth of other movie-distribution platforms, such as Web downloads.

The Internet online movie download-to-own and rental business is expected to grow from 9.5 million in 2006 to nearly 60 million in 2010, according to a recent report from research firm Research and Markets.

“With the prevalence of movies in so many other platforms and so many different media, it’s hard for us to build a brand when it’s just movies,” Shelanski said. “We’re not abandoning movies — movies will still be 99% of what we do — but to throw in things like originals is just another reason to continue to subscribe to Starz.”

The premium-movie category will remain vibrant even with the growth of other movie-distribution platforms, predicted Bruce Leichtman, president and principal analyst for Leichtman Research Group. That’s because at the end of the day, he said, viewers will always prefer to watch blockbuster films on their big-screen televisions.

“To whatever degree downloading will have an impact, it will be on the rental PPV window,” Leichtman said. “The people who tend to pay to download movies are the same people who subscribe to the premium services, so I don’t see any substantial impact on the [premium] business.”

September