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Hollywood Vs. The Digital Horde

Hollywood is the Holy City of imagined threats — everything from asteroids to zombies, with rogue regimes, interstellar thugs and 50-foot women in between.

One threat Tinseltown is downplaying is the rise of online outlets for film, television and video content. David Zaslav, president and CEO of Discovery Communications, told concerned analysts in a Q1 conference call last month that, despite the emergence of online video, consumers are watching more TV than ever before.

"This really is a great time to be in the content business because we've created essentially a new window," Zaslav said on the conference call. "We worked very hard to figure out what works for us.

Discovery Communications (DISCA) (based a safe distance from Hollywood, in Silver Spring, Md.) produces travel, adventure, food, home and nature shows, among others. Some 85 million subscribers follow its Discovery, Science, Military and other channels through providers including Time Warner Cable (TWX) and Comcast (CMCSK).

The fear has been that film and television were headed for the same loss of audience suffered by the newspaper and music businesses. Millions of consumers now read news online and access music digitally, rather than buying CDs. Movie and TV watching, many argued, were also set to shift to the Web in a way that would bust older revenue models.

In some instances, the theory has proved true. The rise of Netflix (NFLX) and Redbox (run by CoinstarCSTR) have cut into industry DVD sales and toppled retail phenomenon Blockbuster. Media executives continue to fight a rear-guard action against pirated video content. But Zaslav sees the prospects for content providers like Discovery through a different lens.

Discovery has responded to the online trend by packaging its content for viewing on Netflix, Hulu and Amazon (AMZN), among others. Discovery is "platform agnostic," he said, willing to license its vast library across multiple venues with advertising support, in the U.S. and offshore.

"When you combine the larger addressable audience across our international platforms with more robust programming, the result has been substantial viewership gains," he said.

Moreover, the expansion of its TV shows to online platforms has not reduced viewership on its traditional channels.

The company is one of 22 publicly traded stocks in the Leisure-Movie & Related industry group. The group, ranked No. 30 Friday among 197 groups, includes Cinemark (CNK) and Regal Entertainment (RGC), the movie theater chains, as well as companies that make technology for digital distribution, such as RealD (RLD) and Avid Technology (AVID). Movie and TV show production companies such as Lions Gate (LGF) and DreamWorks (DWA) are in the industry group as well.

Complexity Shields Profit There are several reasons why the emergence of digital content hasn't cannibalized visual industry revenue the way it did the music trades.

One is that video is not as easily shared as music. The file size of a TV show or movie is enormous compared with a song. That makes it more challenging to pirate and redistribute.

Another is that video entertainment executives learned from mistakes made by the music industry, which initially ignored the digital transition.

"TV and video from Day 1 has been different," said Bruce Goerlich, chief research officer at Rentrak (RENT), a media research and data analysis firm. "That so much revenue was sucked out of the music business kept people afraid.

What we've seen now, he said, are companies willing to experiment with content and create new platforms.

One example is Hulu, the popular online TV channel created by Disney (DIS), News Corp.'s (NWS) Fox Entertainment Group and Comcast's NBC Universal Media.

Hulu streams a wide range of TV shows and movies, available for free viewing with advertising support or with membership fees for premium content.

Hulu is still a work in progress, and acts as a workshop used by the studios to understand what shows viewers prefer to watch, when and where.

Cable TV providers have also experimented with various online platforms, though success on this front has been limited.

"Nobody is really sure of anything at this point," said Goerlich. "The focus is still on how to monetize this content. The changes being made are incremental, with an underlying anxiety about being careful.

Tinkering With The Recipe The video content providers are also trying to figure out how much to charge Netflix, Redbox and others for distribution rights, in a way that benefits both sides, and when to make shows available.

Owners of theater chains have kept close tabs on the rise of online movies or on-demand films offered by cable networks. For the most part, film producers continue to give the major movie theater chains AMC Entertainment, Cinemark and Regal Entertainment their way.

The chains receive exclusive first-run windows for new movies, drawing consumers into theaters before they can see the films from the comfort of their own couch. For the past seven years, theater owners have had exclusive distribution of movies for an average of about four months and one week, before the productions are released to DVD or video on demand.

"Theater owners have not had to worry about that window being reduced," said Michael Arrington, analyst with IHS Screen Digest.

Allowing theaters exclusive rights hasn't been a burden to Hollywood studios either.

"Hollywood is doing pretty well, from the beginning of the supply chain to end," said Arrington. "Their business is not under assault like it was with music.

Big Screens Still In Demand Consumers enjoy an expanding multitude of video entertainment options, but the old-fashioned movie-going business model continues to reap profits.

But they aren't easy pickings. Revenue and profit growth usually hinge on big-budget movies that may or may not reach blockbuster status. Some years they come through, and some years they don't.

In 2011, movie theater ticket sales in the U.S. and Canada fell 4% to $10.2 billion. But for the 12-month period ended March 31 ticket sales rose 6% to $10.7 billion. That's due to a strong first quarter, when ticket sales rose 23% from a year ago, according to the National Association of Theatre Owners.

Globally, theater box office receipts hit a record $32.6 billion in 2011, up 3% from the prior year.

Bill Livek, CEO of Rentrak, said the movie industry is in a good position with international markets opening more theaters.

"The movie studios are producing great content with an eye on big markets outside the U.S.," said Livek. "New theaters are opening up fast in China.

Imax (IMAX), the Canada-based developer of advanced digital filming and screening technology, has opened 92 theaters in China, with contracts for 225 in total. That's up from 70 theaters a year ago.

China is also being more aggressive in protecting movie copyrights, pushing down sales of pirated movie content, said Livek.

China's interest in expanding its movie business is evident by the recent acquisition of AMC Entertainment. Kansas City, Mo.-based AMC, which operates 346 multiplex theaters with 5,034 screens, was was acquired by China's Dalian Wanda Group for $2.6 billion.

Digital Hits Tipping Point Theater owners have steadily added more cinemas able to show movies in digital format. The rise of digital cinema theaters has been a work in process for about 20 years, though it's finally hit a tipping point. The amount of digital cinema screens in 2011 reached 63,825 or 51.5% worldwide, according to research firm IHS (IHS).

Digital cinemas have many advantages for theater owners. The cost of digital distribution is lower than it is with film. And with digital cinema, theater owners can quickly alternate pre-movie advertising platforms.

Cinemas are experimenting with broadcasting live events, such as sports or concerts. Digital cinema is also the primary venue for 3-D movies, which have a higher ticket price.

The shift to digital has been fueled in part by the innovative technologies from companies like RealD, the leading developer and licensor of 3-D projection systems. More than 20,200 screens at motion picture theaters worldwide use RealD technology. That's up 35% from the prior year.

Jon Feltheimer, CEO of Lions Gate Entertainment, spoke confidently in a May 31 conference call about his company's ability to produce more shows and expand content across multiple platforms.

"Having the 'Hunger Games' and 'Twilight' franchises," he said, "coupled with a prolific library, strong and profitable TV business and a record backlog of $1 billion gives us highly visible cash flow and earnings for the next several years."