When to sell a stock that has performed well is one of the hardest problems in investing for me. On June 18, I published an article on DreamWorks Animation SKG, Inc. (DWA) and the stock has run up since. This company is one that could fall into a buy and hold forever category. A compounder that might turn out to be a multi-bagger over many years. However, I write articles on a regular basis for Seeking Alpha. I review many companies on a daily basis, and to be frank I think there are better opportunities. The company is still very interesting but on a value basis I think it's better to go somewhere else and revisit DreamWorks when it's cheaper.
What were some of the original reasons to recommend DWA?
First I'll review some of the original reasons that I recommended DreamWorks and see if they are still valid:
The pay TV ecosystem is developing fast with battles raging between Amazon (AMZN), Netflix (NFLX) and Google (GOOG) owned YouTube. What shape digital distribution is going to take remains to be seen. One thing is for sure: An improved distribution platform for digital high quality content, like DreamWorks Animation produces, is a positive development for the company.
DreamWorks has recently entered into a licensing agreement with Netflix for 1,200 animated television episodes over the next five years. This adds a more stable revenue stream, which is something the company was lacking. This licensing agreement actually materializing is an improvement over the possibility of this materializing so the market is right to account for that improvement.
DreamWorks is in solid financial shape. The company has $76 million in cash and $165 million of outstanding long-term debt.
The company now holds $156 million in cash and $300 million in long-term debt. The ratio is pretty much the same. This doesn't change too much in my evaluation of the company.
DreamWorks Co-founder and CEO Jeffrey Katzenberg is held in high regard. Katzenberg ran Disney's animated film studio before leaving to form DreamWorks. He doesn't hold as many of the shares as I would like though but has done a great job at DreamWorks as far as production value goes.
This didn't change.
Insiders are buying. Ever since reading Peter Lynch classic: One Up On Wall Street, I always check what insiders are doing. They have been buying over the last year, and it's not just the CEO grabbing some shares but a wide range of key insiders participate. As a group they increased their holdings in DreamWorks by 22.38% TTM.
There has been a change in insider perspective as lately they have been net sellers. Especially in October and November a few different insiders sold shares. It's not a great practice to read too much into insiders selling into strength but it's surely not a positive signal.
The company has an excellent track record of producing blockbuster movies and consequently a strong library of franchises, the company has released a total of twenty-six feature films, including the franchises of Shrek, Madagascar, Kung Fu Panda, and How to Train Your Dragon. As of June 2013, its feature films have made $11 billion worldwide, with its $430 million average gross surpassing all other studios besides Pixar ($595 million). Three of DreamWorks Animation's films-Shrek 2, Shrek the Third, and Shrek Forever After-are among the 50 highest-grossing films of all time, and sixteen of the films are among the 50 highest-grossing animated films
This is still true and I believe their strong library and ability to create strong franchises will drive profits in the future. As I mentioned in the introduction I don't think they will generate enough profits to justify the current stock price. To see if that is true I ran the current numbers through a discounted cash flow calculation.
Discounted Cash Flow Calculation
The fundamental reasons to like the stock; great franchises, solid management, solid financial shape and hit potential are all still present in some form or shape but the actual cash flow vs. stock price is another matter.
The library of strong franchises is something of a competitive advantage as incumbents do not enter the market with it and it helps box office potential when the company launches future sequels. I'm accounting for this by modeling future cash flow growth a few years further into the future.
Because of the interesting prospects of the business I'm factoring in terrific growth, above the market's average over this period. But even when I make the calculation with very strong numbers I don't come closer than a net present value of $27 per share.
In theory a stock is always a long or short. In practice that only really holds true when managing sheer unlimited capital. Both in the long and short category I think there are better candidates to place your bets on than DreamWorks right now.