I'll assume that like me, you don't jump to read 14 pages of potential pablum by some random stranger you happen on through the internet, so I'll distill the key points of my DWA write up. DreamWorks Animation (NASDAQ:DWA) is a well-run company that is trading below what shareholders would receive in an orderly run-off. The company is focused on the most profitable segment of the movie industry and its content can be further monetized due to the brands created by the movie characters in ways that ordinary films cannot. The company operates in an oligopolistic industry with high barriers to entry and owner-operator management.
| ||Dec-05 ||Oct-11 |
|Film Library ||10 ||23 |
|Blockbuster Franchises* ||2 ||4 |
|Borrowings ||194 ||0 |
|TTM Net Income ||104 ||168 |
|FD Shares Outstanding || 104,062 || 84,565 |
|Share Price ||$25 ||$19 |
|Market Cap ||$2,601,550 ||$1,606,735 |
|*Shrek, Madagascar, Kung Fu Panda, How to Train Your Dragon |
1. Value –
I estimate that in an orderly run-off, the business is worth more than $18/share, or the current market price. The current book value is $15/share. Every $100m the 8 films carried as inventory on the balance sheet generates in profits over the next 2-3 years is worth $1.18/share (figure ~$200m or $2.36/share). Were DreamWorks to sell the library and related intellectual property at the same revenue multiple (2.2x) as the Miramax library sale, it would generate another $321m or $3.75/share fully taxed. I believe these numbers are conservative based on historical performance of DreamWorks movies and prior content sales. In a run-off, DreamWorks shareholders would receive at least $5-$7/share in excess of $15 of book value for a vague value of $20-$22/share, or 10%-25% higher than the current price (see my full write up
for discussion and why the vague value is vaguely more valuable than I posit here). This implies that future movies released will destroy value, although quite the opposite is much more likely. As a going concern, it trades at 10x earnings, but figuring out future earnings is impossible. If it trades below run-off value, you don't really have to take a punt on guessing what earnings will be over the next 5-10 years. If it resembles the past, shareholders should do fine.
2. Profitable Growth Runway
– As the combined tailwinds of a growing global middle class and higher per capita revenue due to 3D take effect, revenue per film will increase, even if reception is average. Both require very little action on behalf of the company. The company has increased film output from 4 films every 2 years to 5 films, which should further capitalize on this trend. The 3D film production process adds $10-$15m in costs to each film and a rising global middle class is free. The animated film industry is oligopolistic, communicating in plain sight release dates to avoid competition over audiences. A focus on declining DVD sales neglects the increasing mediums for distribution requiring desirable content like that produced by DreamWorks. So even if the company releases the qualitatively similar movies as it has done in the past, it will actually achieve greater quantitative results.
3. Incremental Reduction in Cost of Failure
– The company has never been stronger with a film catalogue that has the depth of 4 franchises – Shrek, Madagascar, Kung Fu Panda, and How To Train Your Dragon – that can be monetized through various licensing agreements from live entertainment to TV shows and toys. This creates a cash stream that requires little-to-no incremental investment and is independent of the film business. The business is debt free, which reduces fixed costs and removes any pressure from the company to enter lousy deals to meet payments. Both of these factors are abstract, but make the company very robust, a necessity in an industry with uncertain film-by-film success. This strength has allowed the company to increase its rate of film production. Every successful film released that creates a new franchise lowers the company’s reliance on creating successful films in the future to drive profits.
– The full name of the company is DreamWorks Animation SKG. The SKG stands for Spielberg, Katzenberg, and Geffen. All have a meaningful stake in the company. Katzenberg takes all his compensation in stock options. Katzenberg has a long-term track record of success in the animated film industry reaching back over 20 years. He has made mistakes like anyone else, but has been able to create numerous profitable films over his career and at DreamWorks that outweigh the failures. Most of the uncertainty surrounding the company - success of films, distribution agreements, future of DVD - should be tempered by the presence of a qualified management team and incentivized owners among other factors. The SKG trio could have retired long ago if they were just in it for the money. Disclosure:
I am long DWA