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UPDATE 4-Lions Gate seeks MGM deal, gets Icahn's support

* Lions Gate proposes merger with MGM

* Icahn throws his support behind possible deal

* Still pressing ahead with lawsuit against Lions Gate

* Lions Gate shares slip 1 percent (Adds analyst comment, challenges facing Hollywood)

By Paul Thomasch

NEW YORK, Oct 12 (Reuters) - Lions Gate Entertainment Corp LGF.N has proposed merging with Metro-Goldwyn-Mayer in a deal that would combine two studios that have thrilled audiences with hits including "Mad Men" and "James Bond," but also face a full cast of challenges.

The proposal immediately won support from corporate raider Carl Icahn, an investor in Lions Gate and MGM, who in a statement on Tuesday said such a deal would “enhance value for all constituencies.”

Lions Gate, in a filing with regulators, disclosed that it has approached MGM with a proposal, saying the combined company would be owned by its shareholders and MGM’s creditors.

Key to any deal would be the support of Icahn. Lions Gate’s largest shareholder, Icahn also holds half a billion dollars of MGM’s debt. In the past, he has been critical of any ideas about combining the studios -- having once compared a merger to a cash-strapped couple who decide to buy an “overpriced” mansion. (For a Breakingviews column: [ID:nN12168167])

Lately, Icahn has changed his tune.

“We believe this proposal as submitted is far better for MGM holders than the current proposal to combine MGM with Spyglass,” Icahn said in a statement.

Lions Gate, the studio behind TV and film hits such as "Mad Men" and "Precious," has been hurt by the decline in DVD sales, video piracy and a slowdown in consumer spending that has plagued much of the industry. It also lacks the scale of the major Hollywood studios, like Walt Disney Co DIS.N or Viacom Inc VIAb.N.

What is more, Lions Gate management has been trying to fend off Icahn, who has made a tender offer for all outstanding shares and has promised a proxy fight.

For its part, MGM, home to a valuable library with the James Bond and Pink Panther franchises, is suffering from the same troubles as much of the movie industry, but also is saddled with roughly $4 billion of debt.

MGM recently proposed a prepackaged bankruptcy plan under which production company Spyglass Entertainment would contribute certain assets in return for a roughly 5 percent stake in the reorganized MGM. [ID:nN07181114]

The bankruptcy plan calls for Spyglass Entertainment founders Gary Barber and Roger Birnbaum to take over the management of the studio once it emerges from Chapter 11.

A source familiar with MGM said lawyers and bankers involved in the bankruptcy process would meet on Tuesday to discuss the Lions Gate plan, adding that it was unclear whether the proposal was superior to the Spyglass deal.

Icahn’s comments came on the same day he was to square off in court against Lions Gate, which he is suing over another deal to sell some of its debt to an investment fund controlled by director and shareholder Mark Rachesky [ID:nN26203709].

He said the proposal would not have an impact on his lawsuit.

"We intend to continue to pursue our lawsuits regarding Lions Gate's recent dilutive transaction with Mark Rachesky," said Icahn, who has been stepping up his dealmaking in entertainment. He holds about a third of the senior debt of video chain Blockbuster Inc BLOKA.PK.

The proposal to combine Lions Gate and MGM was first reported by the Los Angeles Times, which said terms called for MGM lenders to control 55 percent of the merged company. That compares to the 95 percent they would own under the deal with Spyglass.

“At this point, is it too late in the process to turn things around?” asked Lindsay Berz, who analyzes distressed companies for Chapdelaine Credit Partners in New York. “Instead of owning 95 percent of a company with tremendous value, they have to compare that to a plan of 55 percent of a merged company with Lions Gate, and where’s the value? People have to step back and evaluate that.”

Lions Gate shares were down about 8 cents at $7.40 in New York Stock Exchange trading. (Additional reporting by Tom Hals in Wilmington, Delaware, Sue Zeidler in Los Angeles, Sayantani Ghosh and Sakthi Prasad in Bangalore; Editing by Maureen Bavdek)

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