What An Analyst Sees In DreamWorks…And What They Missed

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DreamWorks Animation is a public company. Its stocks are sold on the New York Stock Exchange (NYSE) and have been since it was spun off from the original DreamWorks LLC in 2004. Since then, it has existed as an independent entity producing its own films in partnership with a distributor (formerly Paramount, now FOX). As a public company, it is subject to how various ‘analysts‘ think the company is doing. Today I’m going to look at one so that we can all see what Wall Street sees in Dreamworks, and also what they miss.

For the analysis, we’re going to use a recent one by Buffett Junior on Seeking Alpha, a website devoted to analysing stocks in all sorts of ways. It’s a fairly straightforward article with no big surprises but that doesn’t mean its all-inclusive.

What The Article Got Right

DreamWorks Success

During the last fifteen years, DreamWorks has created some of the best and most memorable CG animated films of all time.

You can’t argue with that. The studio certainly has created a string of successful CG films that are bettered only by Pixar. Disney as we all know, struggled to get their CG act together before ultimately buying the Emeryville studio to fix the problem. Other studios have also found success, but on a much more modest scale. DreamWorks specialises in big-budget blockbusters, and has so far done well by US standards.

Its Release Schedule

More recently, the company announced that it will now do three films per year from 2013-2016. I believe that this larger annual release schedule is likely to create more stable financial results for the company.

Despite the increasingly crowded marketplace, DreamWorks does need to get as many films out as quickly as possible for simple reason that as an independent company, it is dependent on its library of works. Tying into this was its recent purchase of Classic Media, which will further enable it to extract revenue without the expense of creating something new.

The Focus On Sequels

Investors might notice that a good portion of the future release schedule is comprised of sequels. The company’s long-term goal is to release at least one sequel film every year. With an entrenched fan base, sequels are inherently less risky and provide the opportunity to generate additional profits through increased home video sales, merchandising, and licensing.

You can’t argue with that logic, its right on the money but we’ll discuss it more further down.

Non-Film Activites

In recent years, DreamWorks has commenced a number of initiatives aimed at further capitalizing on its franchise film properties, such as Shrek, Madagascar, Kung Fu Panda and others. These business initiatives seek to diversify the company’s revenue streams by exploiting the film properties in other areas of family entertainment…

Slowly but surely, the studio has moved from its traditional base in feature films. the article discusses live-shows, TV shows and the various theme parks the company has either announced or already has in the works. There’s not a lot to say except that the move ensures that as the feature film division starts to play a smaller role in the revenues, it will help insulate the studio from the fluctuations of the film market.

The Managment

Under Mr. Katzenberg’s leadership, DreamWorks became the first studio to produce all of its feature films in 3D and in 2010 became the first company to release three CG feature films in 3D in a single year. It would be difficult to name anyone better suited for this job than Mr. Katzenberg.

My admiration for Jeffrey Katzenberg has been noted before and to say he is the best person suited to the job is a fair assessment of his value to the studio. His experience with Disney during its 90s renaissance has proven very valuable to DreamWorks, especially so since the company was spun off from its parent.

Risks

Because of the company’s limited release schedule, a box-office flop could significantly impair annual earnings and cash flows. It is extremely difficult to forecast a movie’s performance before its release, especially for non-sequel movies.

Animated films typically take longer and are more expensive to produce than live-action films, which increases the uncertainties inherent in their production and distribution. The typical DreamWorks animated film takes three to four years to produce after the initial development stage, as opposed to an average live-action film, which can be produced in less than one year. Additionally, the average budget for a DreamWorks film is $150 million, which is much higher than even that of a big-budget live action film.

A more near-term risk that investors should consider has to do with the company’s most recent theatrical release Rise of the Guardians, which so far has been a huge disappointment. The film cost about $145 million to make, and it has generated $260 million in global box office ticket sales since its debut in late November, well below that of a typical DreamWorks Animation movie. Before DreamWorks can make a profit on the movie, its distributor needs to recoup all its expenses plus pocket 8% for itself. That is the hurdle a DreamWorks movie has to clear before it even reports any revenue. Since the entire undertaking shared by the studio producing the movie and the distributor is approximately $300 million, DreamWorks will most likely be forced to record a large write-down next quarter. In other words, the company will report lower earnings than investors expect and the share price will most likely suffer because of it.

All of these can be evenly applied to any animation studio, although they are again more pronounced because DreamWorks is independent with no corporate parent to pick up the difference if they make a loss. There’s not much to add to these, but other risks are discussed below.

The rest of the article deals with the financials and valuation, neither of which is of interest to me and is unlikely to be of interest to you either, so we’ll ignore them.

What the Article Missed

The article provides a very comprehensive overview of the DreamWorks Animation organisation. The items above are totally worthy of inclusion, but they are not in and of themselves the entire story when it comes to a studio like DreamWorks. Here’s what it missed.

DreamWorks (Relative) Success

Yes, the article does include this, but it does only look at CG films and in although it notes that the studio’s films make up almost half of the top 20 highest grossing CG animated films, it’s not quite as simple as that. Why? Well quite simply, the entire list is made up of films from DreamWorks and, uh, Pixar. In other words the only other CG studio in existence for much of the time.

OK, so the revenues look good, but it’s like being in 1939 and saying Fleischer Brothers is a successful animated feature studio when there’s really only Disney to compare it to, and the market hasn’t fully developed.

The Animated film market is a bit more complicated than that, especially when you realise that DreamWorks began with traditional 2D animation and has faced competition from the same ever since.

The Focus On Sequels

Again, the article makes light of the sequels and notes that they are safer than original material. However, DreamWorks has been known for being extremely sequel-happy. (Remember Jeffrey Katzenberg’s comments about there being five Kung Fu Panda films after the original’s success?)

What the article doesn’t look at is how restricting that outlook can be. Yes, sequels are a financial safe bet but that argument flies out the window when you look at Pixar. They somehow manage to get a good story out [almost] every time and to be fair, their case of sequelitis has more than likely been acquired from Burbank than from within.

Original films do carry more risks, and this is something that animators and those unfamiliar with the way stock markets work can find tough to understand. Yes, it would be great if DreamWorks released original films constantly (and got great revenues for it), but when the odd dud does get through, that regrettably puts a squeeze on the studio’s ability to borrow money (and thus operate); an ability that is sadly regulated by the stock market and its skittish ways.

Alas DreamWorks needs sequels, at least for the foreseeable future as it funds its expansion plans. Until then, we can expect to see regularly recurring franchises. Let’s just hope they don’t reach Ice Age levels of ridiculousness.

The Non-Film Activities

The article doesn’t dwell too long on these anyway, but it completely neglects to mention two things, namely the studio’s digital strategy and its gradual shift to a technological focus.

Firstly, DWA has proven to be a bit of a pioneer in the digital media market. Although it remains a very traditional Hollywood studio in its home video dealings (there’s still plenty of money in DVDs), it was the first major studio to give Netflix the early rights to films. In other words, from 2014, their films will be available on Netflix before they are broadcast on television networks. Although it’s a fairly minor detail, it is indicative of the seismic shift that the media market is currently undergoing.

Secondly is the studios not-so-advertised shift to technological development. Besides the Ptch app the studio has developed, on the enterprise side, its tools and systems have become models for others to follow. That is something that many analysts seem to gloss over despite the fact that it his rapidly becoming a critical factor in the companies operations.

‘Piracy’

Piracy and shifting consumer preferences could severely weaken DVD sales, a major source of profits for all movie studios for the last decade.

Although that’s a common argument, there are many, many more factors at play when it comes to DVD sales. Illegitimate downloading is only one factor. DreamWorks appears to be already addressing the issue with the aforementioned Netflix deal, but you can be sure that the studio is well aware of what will happen as DVD sales slide. It’s a risk, but not as substantial a one as it normally made out to be.

Revenue Sources

The company currently derives substantially all of its revenue from a single source, the production of animated family entertainment, and the lack of a diversified business could adversely affect the company.

Such a statement appears to imply that the animation market is a non-diversified one. It’s the classic “animation is a genre” outlook. There is plenty of diversity within animation itself and the studio has done quite well to diversify itself within it. The article even discusses its move into other industries like theme parks and so on.

I don’t think it’s a fair assessment to proclaim DreamWorks content model as a risk. Would it be nice to see some more mature content from the studio? You bet, but the US is regrettably far behind the likes of Japan where animation is almost as much of an adult’s movie-watching experience as a child’s. Until that fact changes, DWA will have to stick with aiming content at younger consumers for the time being.

Conclusion

Apologies for the super long post. If you hung in until now, you’ll know that sometimes a studio’s health is dependent on a wide variety of factors that analysts can sometimes skip because they aren’t as important to the bottom line as they initially appear. Secondly, you’ll have garnered an idea about how a studio can get the cold shoulder from stock markets when an artistically great film does below “expectations”.

What would you add to the above? Is there something that DreamWorks could be doing in your mind to grow its business but isn’t? Let us know in the comments!

Puss In Boots is No. 1. So Why is DW Stock Down?

First of all, no need to worry, this isn’t going to be a lecture on economics. I hate those too. What it will though, is discuss how a studio’s stock can move relative to its releases. It’s not something that animators need to be too aware of as it doesn’t have a direct effect on their work, but it can affect how the studio operates on a higher level or indeed how decisions made in light of it can filter down to the lower ranks.

Firstly though, what does a stock’s price represent? If you said how much a company is worth, then congratulations! You’re correct! However, how do you determine how much a company is ‘worth’? Do you simply add up how many buildings it owns or how much cash it has on hand? No. It’s a bit more complex than that.

The price of stock is a complex thing that takes into account how much the company owns, but also how well (or poorly) its expected to perform in the future. If a company is expected to perform well, its stock price is high or is rising. If a stock price drops, it’s an indication that the company is either expected to do worse than it was or it’s simply failing to live up to its potential. Either way, the stock price is always correcting itself as investors either bid or sell at a price they feel is the right value.

In the case of DreeamWorks, the share price is just about half of what it was a year ago. Does this mean the company is only half as good now than it was then? No, of course it doesn’t. It simply means that the outlook for the studio is a bit hazier.

A studio’s stock price is a mixture of the company’s assets, it’s revenue steams (DVDs, etc.), it potential release slate (ever wonder why studios like to announce new projects years in advance?) and its current release slate. DW’s recent slide is the result of the current release slate in the form of Puss in Boots.

Y’see, there are analysts, hundreds if not thousands of them, whose job it is to analyse a company in the finest detail. They pour over company reports, sector reports, market reports, weather data (yes, those winter storms on the East coast can have a real impact), consumer spending, you name it. Their goal is to try and predict how well a company will perform based on the data available to them. They’re the ones who compile it all and sell it to other firms or investors who will make their decisions based on the data within.

Naturally, they paid close attention to the opening weekend of Puss in Boots, and unfortunately for DreamWorks, it came up short. From the LA Times:

With a production budget of about $130 million, “Puss in Boots” generated $34.1 million at the box office over the weekend. Although it was No. 1 movie, ticket sales were well below the $40 million to $45 million that most Wall Street analysts had forecast.

The resulting compendium that Wall Street ‘forecast’ is that with a lower box office, the DVD sales will be lower as will any and all merchandise, TV rights and potential sequels. As a group of pessimists, analysts are about as big as they come.

“But so what?” I hear you say. “Stock prices only have a bearing on investors, not on the studio itself”. This is true, but, a company’s ability to borrow is heavily dependent on their future prospects, and since investors have signalled that they’re not good, DreamWorks will now have to pay more for financing.

All of this goes to the bottom line of a film, where belts might get tightened. This is where the actions of this week will be felt by the rank and file. If upper management decide to scale back budgets, then there will be very real changes made on the ground level. People may be let go, or (more likely) schedules will be shortened and films brought forward to boost takings.

What does all of this teach us? Well, it should say not to pay much attention to analysts. They’ve got it wrong before (UP, anyone?) and they’re likely to get it wrong again. They also tend to focus on the very short term. It’s rapidly becoming the case that the box office opening is unconnected to a film’s subsequent performance in the DVD market and beyond.

DreamWorks (and every other studio) is in the middle of some choppy seas at the moment, and its simply dealing with them as best it can. Having the stock price go down is not the end of the world, not even close. Besides, any real investor is looking at the long term view, and in that regards DW is doing pretty fine considering its still independent.