Archive for category: Dreamworks

This article originally appeared on SNL Kagan on April 6, 2010.
The two most recent 3-D releases have not lived up expectations set by Avatar and Alice in Wonderland. Theater owners probably don’t care but should studio owners?
The North American box office continues to chug along, up over 10.9% according to BoxOfficeMojo.com. Most of the press reports discussing box office attribute the gains to the growing slate of 3-D films. No doubt consumer interest in 3-D and especially their willingness to pay premium ticket prices for the 3-D experience is very good news for theater owners. However, for studios the news has been a little more mixed recently.
The massive, history-making success of Avatar, followed by the much stronger than expected performance of Alice in Wonderland was greeted by conventional wisdom that everything in 3-D worked for studios as well theaters. Produce in 3-D from the start or covert to 3-D in post production and studios had a sure thing with more tickets sold at premium prices.
I have always been a bit skeptical of 3-D phenomenon so the rapid convergence of conventional wisdom caught me off guard. It also cost me money as my skepticism kept me out of the theater stocks. What always concerned me was that as 3-D films become commonplace, consumers would not be willing to pay the premium ticket price. Either they would pass on the film altogether or just see the 2-D version.
I also kept reminding myself that opening a film and sustaining its box office was about marketing and the quality of the film. Eventually, the consumer interest in 3-D because of the novelty would wear off.
I think the recent performance and critical response to How To Train Your Dragon and Clash of the Titans suggests that for the studios 3-D can be a positive but is no guarantee. Given the added production costs, rumored at $25-50 million, and what often will be incremental advertising to promote 3-D awareness, just producing a movie in 3-D is no guarantee of success. It is still about opening the film with effective marketing and sustaining the box film because the movie is good.
How To Train Your Dragon opened to a disappointing $43.7 million two weekends ago. The film showed decent but not great legs with a 33.7% drop in its second weekend. Given the fantastic reviews – 98% at Rotten Tomatoes – and the strength of the Dreamworks Animation brand, the opening significantly underperformed expectations.
What happened will always remain a guess but there a few possibilities. There has been some speculation that dragons play poorly in the US based on past dragon-themed films like Eragon. The TV ads, billboards, and trailers looked good to me but maybe they missed the mark with the target family audience. 3-D screen availability was squeezed by Alice in Wonderland the first weekend and Clash of the Titans the second weekend although analysts seemed satisfied with the screen count relative to their box office estimates. Could it be that ticket buyers just did not want to pay up for another 3-D film? Maybe they decided spending $40-60 bucks for tickets for a family of four was too much? Maybe they decided the other Dreamworks films in 2-D were good enough so why pay for 3-D? Maybe they decided that after Avatar and Alice they just did not need to see another 3-D film?
Clash of the Titans is a different story. Warners did a great job of marketing. They made the decision to convert to 3-D after the film was complete and went all in on the marketing budget emphasizing the 3-D angle. The film got panned by critics. Many critics even suggested that 3-D made the film worse! The opening weekend of $64 million including Thursday night shows met expectations but the Friday to Saturday decline was steep, often a sign that a film will not have legs. 3-D clearly helped Titans but if film suffers a huge second weekend drop profits may be elusive on a film rumored to have cost $125 million with a marketing budget that must have been at last another $50 million. More importantly for the future of 3-D, does the fact the film got panned mean that ticket buyers will be more skeptical of future 3-D action films?
The bottom line is that the last couple of weekends suggest that the future of 3-D profits for studios may not be as simple as it seemed. With the coming surge in 3-D releases, consumers may become more discriminate in what they pay up for or pay to see at all. Constraints due to lack 3-D equipped theaters will quickly dissipate. A year from now will early industry and consumer fascination with 3-D prove to have been overhyped? I think so. I just hope my view still is not costing me money?
Disclosure: The Entermedia Funds are long Time Warner and Dreamworks Animation. Steve Birenberg is co-manager of the Entermedia Funds, co-owner of the Funds’ investment management company, and has personal monies invested in the Funds.

I’ve written catuious commentary since Monsters vs. Aliens opened to $59 million in North America, in line with analyst estimates. The second weekend saw a drop of 45%, which is on the high side. The film is tracking close to Ice Age 2 over the past week but is $10 million behind overall. Ice Age 2 did $195 million so a figure around $180 million for MvA seems like a plausible estimate. This is a decent figure but is not enough to drive DWA shares higher.
Where the shortfall may be higher is in international box office. Opening weekends around the globe are well behind Kung Fu Panda and Madagascar 2, andin the few markets such as Russia, where the film has been open for at least two weekends, the grosses look signficantly behind KFP and Mad 2. KFP did $416 million outside of North America. Madgascar 2 did $414 million abroad. It looks to me like MvA will fall far short of these two films, potentially leaivng the global gross at less than $500 million. For DWA shares, that is a disappointing figure.
DWA was downgraded earlier this week by Rich Greenfield of Pali Research on concerns about the international numbers. Rich also asked a good question: will the dominance of the 3-D version of the film hurt DVD sales since 3-D is not available in the home? This is a critical question as DVD sales, even at recent lower tie ratios (ratio of DVD sales to box office), are the driver of EPS.
I think DWA shares are without a catalyst for the next six months with risk to the downside if MvA box office continues to lag Wall Street expectations. Downside risk exists to mid-teens if earnings fall to current low end estimates. In the very near-term, expect more cautious comments from analysts on the international box office numbers.

Despite my hopes that Dreamworks Animation (DWA) had a good set up going into last night’s earnings reports, the stock is going to trade down sharply this morning. Adjusted for a one-time tax benefit, EPS missed estimates due to higher costs associated with new ventures to diversify revenue (TV, virtual worlds, Broadway) and an adjustment to reflect lower ultimate profitability for Kung Fu Panda related mostly to initial estimates for higher DVD sales. I think these trends will be very troubling for investors as they undercut near-term earnings potential with few signs yet that long-term earnings power is going to be enhanced.
CEO Jeffrey Katzenberg correctly noted on the call that not all the news is bad. Kung Fu Panda’s DVD sales exceeded early December guidance by more than 10%. Madagascar 2 DVD sales since the February 6th release date are running strongly. In addition, Coraline, a 3-D animated film from another studio recently released is performing well.
The hope for the stock now is that Monsters vs. Aliens has good buzz leading into its March 27th opening followed by an opening weekend of $60 million and decent legs. I think those things are possible but it is an all or nothing bet that I am not inclined to make. More importantly, the message form the 4Q and 2008 results is that the profit model for even huge box office successes now faces much lower margins.
As a result, I sold all Northlake long positions in DWA despite the additional weakness. In the near-term, I could see the shares slipping as low as 10 times 2009 estimates, which will fall from $1.56 to under $1.50. There is asset value support, especially in a takeover, and the 2010 outlook has several positive catalysts, so this should be a worst case scenario.

Dreamworks is in the news. First, Dreamworks SKG, the privately held, live action movie studio that is home to Steven Spielberg, is changing plans and will use Disney (DIS) as a distribution partner as opposed to Universal Pictures (owned by GE). Second, Dreamworks Animation (DWA), the publicly held animation company, was the subject of a lengthy positive article in the New York Times.
To clear up any confusion, SKG and DWA are completely independent with the exception of overlapping shareholders (Spielberg, David Geffen, and Jeffrey Katzenberg). The news stories about SKG have absolutely no impact on DWA.
The SKG news does matter to DIS, however. I think it could be a modest positive. DIS has sharply reduced its own productions to its core family franchise, both animated and live action. The SKG deal gives DIS another 5-6 adult films per year to distribute and brings the prestige of having Spielberg as a partner. Reports indicate DIS may invest up to $400 million in SKG which should be recouped profitably through the distribution fee (8-10% of box office). Usually these deals give the distributor payment off the top, directly from gross box office receipts, generally producing a modest but consistent profit stream. DIS is strong financially despite its cyclical and secular challenges so the company is in a position to invest while other studios (NWSA/FOX, Warners/TWX, Paramount/VIA, Sony, Universal/NBC) have parent companies who need to preserve cash. On last week’s conference call, CEO Bob Iger indicated DIS would its financial strength to invest and build the company for the long-term. SKG is not a huge deal but I think it is a good example of what Iger was referring to.
As for the article about DWA, I think it provides a balanced view that leans positive and supports my thesis that DWA is uniquely positioned among major media companies as insulated from the some, but not all, of the cyclical pressures currently buffeting the industry.
DWA reports on 2/24. Estimates have dropped sharply due to weak DVD sales at Christmas but I think the lagging performance of the stock reflects this fact. Slowing sales of tickets for Shrek The Musical on Broadway have also contributed to the lagging share performance. I think the earnings report and call will clear the stage for a rally into the March 27th release of Monsters vs. Aliens. Insider buzz on the film is good and the stock has rallied into movie releases in the past. I think DWA is a good long side trade in the current market environment.

This will be the first in a new series of columns I will write titled “Why You Should Own…”
The first stock is Dreamworks Animation (DWA) . DWA is currently trading at $21, a new 52-week low. The 52-week high was $32.73 on Sept. 2. The market cap is $1.9 billion. At the end of 2008, DWA should have about $350 million in cash and less than $100 million in debt. DWA pays no dividend.
The consensus estimate for 2008 is $1.82. For 2009, the estimate is $1.67. At $21, the P-E on 2008 is 11.5. For 2009, the P-E is 12.6. The lower 2009 estimate is because there are minimal revenues from Shrek, DWA’s most profitable franchise.

Why You Should Own DWA for the Short Term
DWA has very positive earnings momentum that should hold through at least the first half of ’09. The fourth-quarter 2008 estimate has risen over the last 90 days. The momentum is being driven by success earlier this year from Kung Fu Panda. Panda grossed $215 million domestically and $416 million abroad, making it DWA’s most successful film besides the Shrek series. Even with a $130 million production budget and another $100 million plus for marketing, the film is profitable before DVDs. The DVD just went on sale and immediately went to No. 1 on the charts.
DWA will also benefit in the near term from the successful release of Madagascar: Escape 2 Africa on Nov. 7. The film is on track to match Kung Fu Panda and exceed the original Madagascar. While the timing of revenue and expense recognition means that Madgascar 2 will not contribute greatly to EPS in the near term, the success is a great confidence boost for meeting or even beating 2009 estimates, something that very few companies can now offer.
DWA has two other near-term catalysts. First, on Dec. 10. the company will be holding its first- ever analyst meeting. DWA has lots of good things to say about the near term and long term, so the timing is good.
Second, Shrek the Musical debuts on Broadway in December. On its own, the musical will not be a big profit-driver, assuming it is successful. But if it is a success, it further diversifies DWA’s revenue stream and builds a greater base of long-term earnings power.
Finally, and maybe most importantly for the near term, DWA is a major media stock that has zero advertising exposure. There is minimal cyclical or secular challenge to DWA’s business model unlike almost every other media stock.

Why You Should Own DWA for the Long-Term
2009 has been a critical year for DWA. The massive worldwide success of Kung Fu Panda and the successful sequel to Madagascar has dramatically boosted the company’s long-term earnings power and the consistency of its financial results. Along with Shrek, DWA now has three franchises that can spin sequels. Each new film in each franchise boosts profits from the library via the films, merchandising and TV rights. Three franchises make it easier for DWA to release two films per year, one sequel and one original. It also takes the pressure off every original to be a resounding success. Wall Street rewards consistent long-term earnings growth. DWA exits 2008 in its best shape ever.
What Could Go Wrong
DWA trades at a premium to other media stocks, which now generally have single-digit multiples on 2009 estimates. The shares have also held up very well compared to other major media stocks that are down 50%-90%. DWA is subject to disappointing box office for any of its films. In the near-term, weak holiday sales for the Kung Fu Panda DVD or poor international box office for Madagascar 2 (it has only opened in Russia so far) are a risk. In 2009, DWA will be releasing two original films. Originals are not as profitable as sequels and present greater odds for a disappointment. DWA is also planning on a boost from 3-D for its films in 2009 and beyond. So far, the rollout of 3-D theaters has severely lagged expectations.
My Position
DWA was purchased in early November at just under $27. I have not added to positions since that time.
The Bottom Line
DWA has positive earnings momentum, minimal estimate risk, the potential for upside earnings surprises, a debt-free balance sheet and identifiable catalysts. These all support near-term performance while the long-term outlook has greatly improved, thanks to the broader portfolio of hit movies and franchises that now exist in the company’s library.