Viacom's Paramount Pictures announced Sunday that it has agreed to buy DreamWorks SKG, the independent film and TV studio founded 11 years ago by Steven Spielberg, Jeffrey Katzenberg and David Geffen, in a deal worth $1.6 billion in cash and debt.

In order to limit its cash outlay, though, Paramount, while retaining distribution fees, plans immediately to sell the existing DreamWorks library of 59 films to other investors.

Under the agreement, Paramount is acquiring all of DreamWorks' projects currently in development; DreamWorks' television division and its properties; and exclusive rights to future DreamWorks Animation TV characters in TV shows. Although the publicly traded DreamWorks Animation is not part of the deal, Paramount will take the worldwide distribution rights to its movies, currently held by the original DreamWorks, beginning in 2006 and continuing for seven years.

Paramount will also sign new three-year employment contracts with Geffen, as chairman of DreamWorks, and Spielberg as a producer-director.

It is expected that by 2007, DreamWorks will contribute 4-6 live action movies annually to Paramount's output of 14-16 releases per year.

For 2006, Paramount's slate should be buttressed by DreamWorks Ani's "Over the Hedge;" the musical "Dreamgirls," a DreamWorks/Paramount co-production; and Clint Eastwood's "Flags of Our Fathers," a DreamWorks/Warner Bros. Pictures' co-production.

The deal, hammered out quickly over the course of the past week, saw Paramount snatch the prized asset away from NBC Universal, which had been conducting on-again, off-again discussions with Geffen during the past nine months. Although Universal executives had hoped to reach an agreement, NBC Uni owner General Electric was moving too slowly for Geffen's taste.

Speaking in a conference call, Paramount's new chairman Brad Grey, who was instrumental in pushing forward the deal, called the acquisition "a transforming event for the studio. ... It means we've got great filmmakers attracting exciting talent and material." And Tom Freston, co-president and co-chief operating officer of Viacom, predicted that the transaction would "dramatically accelerate the turnaround at Paramount, which is one of my top priorities."

Although DreamWorks was launched with great fanfare 11 years ago, it has had to gradually scale back its ambitions to be a full-scale entertainment company -- selling off its music and electronic games divisions over the years and spinning off DreamWorks Animation as a public company last year.

Ultimately, its limited output of 6-10 films per year could not support its free-standing distribution apparatus, Geffen explained, saying, "We had hoped to be able to make enough films to be able to rationalize the cost of being our own distributor. Sadly, we were never able to make enough films to make that economically sound. So with this deal we are combining our marketing and distribution people with Paramount, and together we will be able to distribute our films at a much, much lower cost per film. So it's a win-win for both of us in this area."

Geffen said that most of DreamWorks' 500 employees will be retained as the company becomes a new label under the Paramount banner. But Rick Sands, who joined DreamWorks as president and chief operating officer in April, will be leaving the company, he said, adding that when Sands came on board he was interested in working with an independent company.

The deal puts an enterprise value of $1.6 billion on the DreamWorks assets. Viacom chief financial offer Michael Dolan said in the call that $775 million of that price tag covers equity, with the rest being for net debt and various obligations.

Freston said he expects a big chunk of the total price to be offset by the sale of the existing DreamWorks live-action film library to a third-party financial buyer in a deal likely to be finalized over the next couple of weeks.

He projected a price tag of $850 million-$1 billion, which Dolan said along with other factors would lower Viacom's net price for DreamWorks to $500 million-$650 million.

In October, the Viacom board had refused to allow Paramount executives to open negotiations with DreamWorks, since it didn't want to shoulder the costs of a large acquisition. But it approved the newly structured deal, since, Freston argued, Viacom could get all the desired strategic benefits while significantly lowering its cost. The transaction also will ensure Viacom sees financial benefits from Paramount again as the overall firm is set to deliver double-digit revenue and operating cash flow growth, Dolan said.

Strategically, the deal boosts Paramount's leverage with retailers and exhibitors and gives Viacom a TV sales group, Grey said. In the proposed split of the current Viacom, the future CBS Corp. rather than the new Viacom is getting the conglomerate's existing TV sales force. The split is set to become fully effective at the beginning of the new year.

Freston and Grey were tight-lipped Sunday about the likely buyer of the DreamWorks live-action library. Freston said they were in "advanced conversation" with "one or more parties," but he wouldn't specify them beyond speaking of "financial partners." Those words usually point to private equity groups or rich individuals. One industry observer suggested that private equity groups, such as Providence Equity Partners, were indeed likely partners, as they have been aggressively investing in the entertainment industry.

Viacom officials said they haven't set fees and other details of the planned distribution deal between Paramount and the financial buyer, even though a deal is expected to be announced by year's end.

Geffen declined to specify the new DreamWorks label's production budget, saying only that it will be the same amount as the independent studio had through a credit line and that it will be "plenty of money to make movies."

Asked about the status of Microsoft co-founder and Charter Communications controlling shareholder Paul Allen's investment in DreamWorks, Geffen said the DreamWorks Animation initial public offering paid off Allen's $600 million investment, with the Paramount deal making Allen a profit.

Geffen lauded Paramount on Sunday for taking just a week to assemble its current offer that led to signed contracts on Friday, as he, Spielberg, Freston and Grey all sat down together. He added that nine months of talks with NBC Universal parent General Electric never produced a final deal even though he tried "very hard." GE had originally put an offer on the table, only to revise its terms downward in September.

Spielberg, who began his career at Universal, noted mixed feelings in a statement, saying, "Due to my very long history and my loyalty to Universal, I was saddened that after long negotiations and many compromises, we were unable to come to terms with Universal's parent company, GE. Nevertheless, I am truly looking forward to working with Tom Freston, Brad Grey and (Paramount president) Gail Berman, as this is an exciting opportunity for each of us to embark on a new adventure together."

With Paramount and Universal breaking up UIP, their joint international distribution company, and setting up separate international operations, the added films DreamWorks will supply were considered by both studios key to ramping up their foreign operations, and Universal executives were disappointed by the unexpected development.

In 2003, DreamWorks extended its home video distribution agreement with Universal Studios Home Entertainment through 2010, but Geffen said that home video rights will revert to Paramount within a year or less.

Neither side in the new Paramount/DreamWorks partnership suggested that Spielberg, who has always cherished his creative freedom, has agreed to direct any set number of film for the new DreamWorks label. Geffen said, "Steven hasn't found his next picture yet, but since we began DreamWorks, other than the sequel to 'Jurassic Park,' he's never made a movie for anyone other than DreamWorks." (Spielberg has made movies for other studios where DreamWorks came in as a co-producer.)

However, Spielberg isn't expected to relocate to Paramount from his offices on the Universal lot, originally built for his Amblin Prods. According to sources, Spielberg has already signed a lease agreement on the facilities, and Geffen noted, "I don't think Steven will ever leave his offices on the Universal lot."

In Monday trading, Viacom was up 36 cents at $34.78

Gregg Kilday reported from Los Angeles; George Szalai reported from New York. Anne Thompson in Los Angeles also contributed to this report.