Resist The Urge To Fish For Gains At DreamWorks Animation

Aug. 1.14 | About: Dreamworks Animation (DWA)


DreamWorks Animation has reported weak financial results in FY2014, including an operating loss.

Management has indicated that the Securities and Exchange Commission is investigating its accounting of a film write-down.

The company's performance has led to a current year sell off.

Shares of DreamWorks Animation (NASDAQ:DWA) have been feeling the heat in 2014, down roughly 19%, thanks to a financial performance that has been below expectations, highlighted by a double-digit drop in total revenues. The main culprit has been a generally underwhelming showing at the domestic box office, which has left its last two pictures, How To Train Your Dragon 2 and Peabody & Mr. Sherman, still trying to recoup their costs and turn a profit. To add fuel to the fire, DreamWorks Animation recently disclosed that the Securities & Exchange Commission is investigating the company's accounting of its December 2013 writedown of assets related to its Turbo picture. However, if opportunity is born in times of struggle, could it be time to buy in, or would investors be better off with more diversified players, like Lions Gate Entertainment (NYSE:LGF) or Walt Disney (NYSE:DIS)?

What's the value?

DreamWorks Animation is a niche player in the movie business, producing roughly two to three feature films per year, compared to the ten to fifteen films released by the major studios. The company has found success by churning out sequels to its popular franchises, including How To Train Your Dragon and Madagascar, an undoubtedly more cost-effective approach than trying to build a new franchise from scratch every time. The net result for DreamWorks Animation has been a fairly consistent history of operating profitability over the past five years.

Unfortunately, releasing two to three pictures per year isn't likely to create significant top-line growth, especially if one or more of them don't get moviegoers into the seats. In DreamWorks Animation's latest fiscal year, it released two major pictures, one of which did well (The Croods, $187 million in domestic box office receipts) and one of which didn't fare as well (Turbo, $83 million in domestic box office receipts). Not surprisingly, the company's feature film segment reported a 14.2% revenue decline during the period, hurt by an unfavorable comparison to the prior year when the Madagascar 3 picture was a runaway hit with more than $200 million at the domestic box office.

On the upside, management has been trying to spark growth for DreamWorks Animation by investing outside of the feature film business, which currently constitutes more than 70% of total revenues. Along those lines, the company acquired Classic Media, owner of a portfolio of trademarks including Casper and Lassie, for more than $150 million in 2012, which was followed by the 2013 acquisition of Awesomeness TV, a leading producer of online media programming. While the transactions added debt to DreamWorks Animation's balance sheet, they should ideally lead to more consistent revenue and profit streams, making the company less reliant on blockbuster results at the box office.

Looking into the crystal ball

The question for investors is whether DreamWorks Animation's recent moves will lead to future profit growth, thereby providing a solid foundation for a higher market valuation. Based on its performance to-date in FY2014, the answer would seem to be "not in the near term", evidenced by a 22.6% decline in revenues and an operating loss, not to mention weak cash flow generation. As such, investors should probably avoid the story in favor of competitors that are showing better profit growth profiles, like Lions Gate Entertainment and Walt Disney.

Much like Dreamworks Animation, Lions Gate Entertainment relies heavily on its motion pictures segment, which accounted for roughly 83% of total revenues in its latest fiscal year. However, the company has been successful at building a growing and profitable television production business, with more than 30 shows on 20 different networks, a segment that generated a solid 18.1% increase in revenues during the period, helping to offset a down year for its film business. More importantly, Lions Gate Entertainment's increasingly diversified business mix is providing cost efficiencies in the media distribution area, which enabled it to report a 12.5% gain in adjusted operating income, despite a decline in total revenues.

Similarly, Walt Disney continues to post profit growth in FY2014, up 30.4%, thanks to across-the-board revenue growth, including a 28.1% increase for its film segment. During the period, the company benefited from a strong performance for its film slate, led by its animated picture Frozen, which generated more than $400 million at the domestic box office and another $800 million at the international box office. The biggest beneficiary, though, is likely to be the company's shareholders as the film segment's success flows to Walt Disney's other businesses, notably its consumer products division, where the company expects higher future sales and profit from consumers looking to extend their relationship with the brand.

The bottom line

DreamWorks Animation is certainly cheaper than it was at the start of the year, after its double-digit price decline. That being said, the negative price action seems warranted, given the company's lack of profitability in FY2014, as well as the overhang of a potential SEC investigation. As such, investors should probably wait for DreamWorks Animation to return to profitability prior to betting on the story.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.