- DreamWorks is recovering from several flops and is caught in a cyclical industry slump.
- The company has all the tools it needs to recover from recent problems, though nothing is certain.
- DWA's difficulties and slumping stock price present an opportunity for aggressive investors.
DreamWorks Animation SKG, Inc. (NASDAQ:DWA) has fallen on hard times. Its earnings call for the second quarter on July 29, 2014, led by CEO/Chairman Jeffrey Katzenberg, seemed like it was straight out of one of its animated feature films, perhaps "Shrek Forever After" (2010). In that film, friendly ogre Shrek finds himself in an alternate universe where he is a hunted animal and his entire existence threatens to be erased.
No, it wasn't quite that bad. Really. But it was bad.
Let's run down some of the lowlights from the call and the earnings report:
- There was a net loss of $15 million (.18) vs. expected (.02);
- Revenues were $122.3 million, missing expectations of $137.9M;
- Library revenue was down 25% from the previous quarter;
- Additional costs have been incurred due to switching the release dates of future films;
- 2014 has been the worst summer in history for Hollywood in terms of theater attendance;
- An SEC investigation was initiated during the quarter over a write-down of film inventory for film disaster "Turbo" (another SEC investigation is pending, discussed below).
These and other issues have sent the shares of DreamWorks crashing from a high of $36.01 on December 30, 2013 to a low of $19.20 on July 30, 2014. This is a negative return during that span of 46.7%. There has been a total technical breakdown of the chart, with the share price crashing down through the 200-day moving average and, after a re-test, falling further to its lows, from which it has barely recovered.
For a contrarian investor, we now have them right where we want them. The only question is timing and how much risk to take on.
Background of DreamWorks
Since DreamWorks appears to be at a point of crisis, this is a good time to review the history of the company. DreamWorks SKG was founded in 1994 by Steven Spielberg, Jeffrey Katzenberg and David Geffen (the initials of their last names comprise the "SKG"). They are all entertainment experts, tops in their fields. They sought to capitalize on the rising interest in animated feature films reflected in the "Disney Renaissance" that began with the release of "The Little Mermaid" in 1989.
DreamWorks Animation's first animated feature film was "Antz" in 1998, a modest success, and it grew from there. The studio became a powerhouse with the huge success of "Shrek" in 2001, which launched a series of sequels that currently ranks as 10th on the list of all-time highest grossing franchises and film series (the Harry Potter series is No. 1). Subsequent DreamWorks franchises also have done extremely well, including the "Madagascar" series (21st all-time).
Jeffrey Katzenberg was the Chairman of Walt Disney's motion picture division when he resigned and co-founded DreamWorks in 1994 due to succession issues at Disney (he was passed over). While at Disney, he was credited with starting the Disney Renaissance and shepherding through its biggest successes, including "Beauty and the Beast," "Aladdin" and "The Lion King." Katzenberg also initiated the distribution deal with Pixar Animation that ultimately led to its merger with Disney. He has been in charge of DreamWorks without interruption since its founding, and just recently received the National Medal of Arts at the White House.
DreamWorks Animation had a phenomenal run from the first "Shrek" film through "Madagascar 3: Europe's Most Wanted," released on June 8, 2012. All of the companies franchises were doing well at that time, but they were getting long in the tooth. It was time to try to start some new franchises or, as Chance from "Being There" might say, plant a new garden.
The first attempt, "Rise of the Guardians," released in November 2012, did poorly. Holiday crowds were not interested in a dark tale about Christmas despite the presence of stars like Hugh Jackman and Chris Pine in the voice cast. The flop forced the studio to take an $87 million writedown. "The Croods" then came out on March 22, 2013 and turned things around. It was a critical and commercial success (leading to a new franchise). Well, one flop is okay perhaps.
But the follow-up to "The Croods," "Turbo," released four months later, was another disaster. It forced a writedown of $13.5 million. Hopes were high for the next film, "Mr. Peabody & Sherman," a reboot of an obscure 1960s television children's cartoon, but it also floundered. This forced an additional $57 million writedown in the first quarter of 2014.
These three failures left the studio in a hole: not only did it lose money on the films, but anticipated future revenue streams from sequels to those films now were not going to happen. With things starting to look grim, the studio released "How to Train Your Dragon 2," a sequel to a 2010 hit, on June 13, 2014. It has done good business so far and is considered a success. However, as explained on the conference call, it is still in an "un-recouped position," meaning virtually no money has flowed to the studio's bottom line yet.
All of this left the studio with a net loss of $15.4 million for the second quarter, sharply lower than a $22.3M profit in the same period last year, on revenues of $122.3M, -42.7%. The revenue also missed analyst expectations of $137.9M. The quarterly loss, at 18 cents a share, was far below the consensus forecast for a 2 cent loss.
It is difficult to imagine a more excruciating conference call to conduct than the one Katzenberg handled with aplomb on July 29th. There was no good news to report, he couldn't discuss some of the latest bad news (the new SEC investigation, which joins one already in progress by the SEC about several film companies' operations in China, including DWA), and the summer of 2014 has been "the worst summer in the history of the industry."
So, the question naturally arises: does this present an opportunity? Perhaps it does, if you are a contrarian willing to take on the risk.
Regardless of any personal opinions folks may have about him and his outspoken political advocacy, Katzenberg is one of the legends of the film business and understands it better than perhaps anyone else. You can't let your politics intrude on your investing or you invite disaster. So, why is DreamWorks having problems?
Well, some of their recent choices of films have been unsuccessful. That is just part of the business, and every studio goes through periods like that. DreamWorks' release schedule from here is loaded with sequels (see chart below) which tend to do well and in a predictable fashion relative to the performance of the previous film. The most bankable word in Hollywood is "sequel."
As Katzenberg noted, the movie business is cyclical, and the entire industry is stuck in one of those down cycles. The film business is both seasonal and cyclical. The peak seasons are the holiday season beginning in November and the summer season beginning around Memorial Day. There also are over-riding multi-year cycles that affect the seasonal cycles.
According to Katzenberg during the conference call, the down cycle that Hollywood is experiencing this year should reverse and over the next couple of years - "in particular, 2016" - will present "maybe unprecedented opportunity in the movie business." He stated emphatically that the current industry slump is not a secular trend in the film business that will never reverse. Either you believe Katzenberg or you don't, and that is a vital decision to make before buying (or shorting) the stock. All previous cyclical downturns have reversed to the upside.
Another factor to consider about DreamWorks' recent results is the huge earnings to come from the already released "How to Train Your Dragon 2." It has accumulated $424M gross box office internationally as of this writing, with more to come. That revenue will be booked in coming quarters. It won't happen right away: according to company President Ann Daly during the call, those revenues will "stretch into 2015 and beyond." However, the success of the film is unquestioned. Domestic box office is down about 20% from the first film, true, but revenues are up abroad. Domestic revenues are less and less important to the industry as the overseas markets grow. Katzenberg said it is too early to say how well the film really did, but the studio should know "in the next 2 to 4 weeks." The film already is a success internationally and it hasn't even opened yet in China, Italy and Spain. The profits from this hit film should appear on schedule in coming quarters and presumably at least help to cover the write-downs on the previous flops.
All sorts of other promising films are in the pipeline (release dates always are tentative and subject to change at any time). Another "Madagascar" sequel, "Penguins of Madagascar," is due out on November 26, 2014, in time for the Thanksgiving crowds. Katzenberg said that a recent 20-minute preview at Comic Con was well-received. A Steve Martin/Rihanna film, "Home," swapped places with the penguins film and now will be released on March 27, 2015 - Katzenberg wanted a "softer" seasonal opening slot for the new potential franchise. Rihanna is preparing a soundtrack for that film which should help to raise its profile.
After that, there will be a "Kung Fu Panda" sequel at the end of 2015 and another "Dragon" sequel in mid-2016. Looking way out to 2018, there will be the first sequel to the "Shrek" spinoff "Puss In Boots," which was a surprise hit a few years ago. In fact, there are sequels to successful DreamWorks franchises scheduled for every year through 2018.
Upcoming DWA Releases
|Film||Scheduled Release Date|
|Penguins of Madagascar||November 26, 2014|
|Home||March 27, 2014|
|B.O.O.: Bureau of Opportunity Operations||June 5, 2014|
|Kung Fu Panda 3||December 23, 2015|
|Boss Baby||March 18, 2016|
|How to Train Your Dragon 3||June 17, 2016|
|Trolls||November 4, 2016|
|Captain Underpants||January 13, 2017|
|Mumbai Musical||March 10, 2017|
|The Croods 2||November 3, 2017|
|Larrikins||February 16, 2018|
|Madagascar 4||May 18, 2018|
|Puss in Boots 2: Nine Lives & 40 Thieves||November 2, 2018|
DreamWorks is creating other new revenue streams as well. It began DreamWorksTV on YouTube only a month ago, and it is building theme parks in Europe and Asia. It recently purchased back rights to its feature films released before 2013, and it has a promising joint venture in China, Oriental DreamWorks. The company also recently acquired rights to classic character Felix the Cat and intends to "expand the Felix brand into the fashion and lifestyle space."
The diamond in the rough is China. The Chinese market has become so important to Hollywood that DreamWorks' upcoming "Kung Fu Panda 3" will be released there - witness how "Transformers: Age of Extinction" pulled in more box office in China than in the United States during its first five days of release. DreamWorks is ahead of the curve in China, building a massive DreamCenter theme park in Shanghai (Disney also is building its first theme park on mainland China in Shanghai; the Mouse Factory is rarely caught asleep these days). The Chinese love DreamWorks - the beauty of the original "Kung Fu Panda" film even led to internal complaints that foreigners could do animation about Chinese history better than the Chinese themselves could, causing a lot of soul-searching there.
DreamWorks also is licensing parks in Moscow, St. Petersburg and Yekaterinburg. It is partnering on a park in downtown London, England. The sun will never set on the DreamWorks Empire once all the pieces are in place.
DreamWorks thus is growing roots around the world. Animation knows no borders. It is only a matter of time before the investments it is making now in television, theme parks, the Chinese joint venture, Felix the Cat and other projects mature and the recent flops are forgotten - assuming the studio survives. And there is no indication beyond the numbers themselves that it won't. Make your own decision on those. Katzenberg said during the conference call that the studio has adequate credit to draw down as necessary.
Timing is everything in investing and trading, as it is in life. Are there risks - huge risks - to owning DWA? You betcha! DWA is under SEC investigation with no details available, it is disappointing analysts financially, and the chart is a complete sloppy mess.
So, anything is possible. The movie business is crazy volatile, "flying high in April, shot down in May." That's life. The company has been near bankruptcy before, apparently as recently as 2005 due to another flop and some poor DVD projections. It likely will be near bankruptcy again, that is not uncommon in the industry (Disney has had difficulties several times during its existence). SEC investigation always are serious business, and we don't know a thing about this most recent one.
This is a play for confident investors who believe in the studio and are willing to take on prudent risk for possible solid gains down the road. Or, perhaps just for a quick trade if that is your style. I can well imagine some crying "He must be crazy to suggest that stock!" Well, if you think that, this one isn't for you, it is a value play that may take time to play out.
On a short-term technical basis, the DWA shares have a large gap to fill to 22 but of course could go lower instead. For traders, with the stock trading at $19.93, a prudent short-term buy with a stop around the recent low of $19.20 presents a low-risk entry point. Indicators such as RSI at 21.8 suggest an oversold condition. On a longer-term basis for a position play, an entry point on future dips - of course depending upon overall stock performance and with prudent stops in place - before the hype begins for "Penguins of Madagascar" later this year could pay large dividends.
DreamWorks Animation is a high-risk play that offers nice potential returns for the contrarian investor willing to wait for its current investments and projects to play out.