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This analysis of Digital Domain Media Group was provided to TradingIPOs subscribers in advance of its IPO. On November 18 the company announced that its initial public offering of 5 million shares was priced at $8.50 per share.

Digital Domain Media Group (DDMG) plans on offering 6.325 million shares at a range of $10-$12. Roth Capital and Morgan Joseph are leading the deal. Post-IPO, DDMG will have 47 million shares outstanding for a market cap of $517 million on a pricing of $11. IPO proceeds will be used for working capital (i.e., to fund losses). PBC will own 40% of DDMG post-IPO.

From the prospectus: 'We are an award-winning digital production company.'

The company provides CGI and digital visual effects for motion pictures and advertising. The company has received 3 Academy Awards and 4 awards for Scientific and Technical Achievement in motion pictures. DDMG has done CGI and/or effects work on 80 major motion pictures including Apollo 13, Titanic, and The Curious Case of Benjamin Button.

Sector - Increasing consumer demand led by an increase in 3D content as well as the trend towards more cost effecting on screen effects via computer generated effects. Total visual effects market was $1.4 billion in 2010 for feature films and $214 million for advertising. Both segments enjoyed double digit growth in 2010, although fairly low ad comps with 2009.

Note that DDMG plans to use IPO monies to begin producing their own large scale live-action films. I'm never a proponent of investing in start-up motion picture production companies. The risk reward is rarely favorable to outside investors. DDMG's first co-production (with Oddlot Entertainment) is for a film to be titled 'Ender's Game'. DDMG will be a primary investor in the film and will lead the digital production.

In addition to live action, DDMG plans on getting into animated film production.

Note that DDMG has no experience leading production on films pre-IPO.

Also DDMG is apparently getting into the for-profit education sector. Aligned with Florida State University, they are launching the Digital Domain Institute offering a fully accredited four-year BFA degree. Classes commence in the spring of 2012.

Ambitious branching out by DDMG. Unfortunately for IPO investors, DDMG has been funneling all traditional effects revenues into the projects above leaving a very ugly earnings statement in their wake.

13 active feature film project work as of 11/1/11. Revenues for these projects should be $100+ million.

Financials

$1.50 per share in case, assuming an $11 pricing.

2011 - Really shaky 3rd quarter. Bad enough that the company noted outright in the prospectus it was a light quarter. Full year revenues should be in the $105 million range. Gross margins here are ultra-slim. Much too slim for a company that has been around for nearly 20 years. Even back in 2008(before embarking on new lines of business), gross margins were weak. Gross margins should be in the 15%-20% range. Losses staggering as 1) gross margins eat most of the revenues and 2) DDMG has been spending heavily on their primary production and education plans. Losses should be in the $1.50+ range. I cannot own a company burning through this much cash. Period, end of story.

2012 - Losses should continue to be staggering. DDMG will need a major hit with their first film to make this IPO look even average in range.

This is a successful visual effects company that is un-investable due to ugly earnings statements. By all accounts DDMG is quite good at what they do: visual effects for the motion picture industry and advertising. Lot of risk here as DDMG embarks on feature film primary production responsibilities (with the implied financial risks) as well as a for-profit educational center. DDMG couldn't put money on the bottom line for years before embarking on these plans. Now? Losses of $1.50+ per share. Not interested.

Source: Digital Domain Media Group IPO: Beware Of Ugly Earnings Statements