Some part of me believes that the market, and Joe Investor in general, still thinks Marvel (MVL) is just a comic book company that has a few movies to its name. Don't misunderstand me – the stock is up fivefold or so since 2001 when it was just a comic book company. Since then, however, the company has burst through its outer garments like Bruce Banner on a bad day. It's become a completely different beast that nobody seem to know how to value.
When Marvel began its makeover early in the decade, the company generated revenue from its comic books, toys, and license fees Hollywood studios paid to make some of those comics into films – the biggest being the Spider-Man series. I liked this model because the movie business is insanely risky and it guaranteed Marvel would generate revenue without taking any risk.
Movie deals and licensing fees
Four years ago, Marvel made a pact with Merrill Lynch (now absorbed by Bank of America (BAC)) and Paramount Studios (a subsidiary of Viacom (VIA)), in which Merrill would provide $525 million of non-recourse financing for Marvel to make its own films from a slate of ten characters. Marvel would pick up the first 5% of gross as a producer's fee, then Paramount would recoup distribution costs and its fees, and then Marvel would keep the rest. Shady Hollywood accounting aside, this was a fantastic deal for Marvel. However, the real genius behind the deal was that the only collateral Marvel had to put up was the rights to those same characters.
At first, Wall Street and even some of Geekdom (of which I am a proud member) questioned both the entertainment and financial value of the characters: Ant-Man, Black Panther, Captain America, Cloak & Dagger, Doctor Strange, Hawkeye, Iron Man, Nick Fury, Power Pack, Shang-Chi, The Avengers, and The Incredible Hulk.
At the time, I said it didn't matter who the characters were. First, Marvel had already proven it could deliver in the genre, based on the success of X-Men. Second, I knew one of the people involved, Kevin Feige, having worked with him on a television show. Kevin had the smarts to understand what audiences wanted in a Marvel film, and how to make it mainstream. Third, if Marvel couldn't deliver on a creative level, it was unlikely that anyone else could, so if Marvel defaulted on the loan, Merrill would be holding the rights to ten characters that were probably worth less than $525 million.
In essence, Marvel really had nothing to lose and everything to gain.
I was not concerned at all, though. The three creatively weakest films prior to this deal, The Punisher, Daredevil, and Elektra – produced by other studios -- grossed $289 million in global box office on combined budgets of $138 million. Even if you double P&A costs, all three films end up extremely profitable when you factor in ancillary markets such as DVD, pay TV, etc.
And these results were for the three worst films! Marvel would subsequently have complete creative control over the rest of its slate. Since then, it's delivered the phenomenally successful Iron Man and even a remake of The Incredible Hulk. Only Marvel could get away with remaking a film that had just been made five years previously, and still generate $263 million in worldwide box office.
That is indicative of yet another reason why Marvel's plan would work: there is a built-in audience that will see whatever it produces. Some of it includes us folks from Geekdom, others are just regular folks like my poor wife, who hates superhero movies but loved X-Men.
Marvel films aren't just for geeks because they are rooted in universal human stories. As long as Marvel sticks to that core concept, hires the right creative people to execute the films, and doesn't veer into nine-figure excess budgets too often, they will do just fine.
Add to this the fact that Marvel continues to generate enormous numbers in licensing ($292 million in 2008), their publishing unit ($125 million) continues to ride the wave of the comic book – graphic novel rage that has been going on for several years, and it continues its move into animated television productions; Marvel will remain a solid company financially.
The future looks bright as more and more films are set for release. Marvel has also embraced its status as a true independent company by starting an in-house writer's studio. There, a handful of writers will concoct just about anything Marvel wants them to, albeit at terms I would describe as unnecessarily onerous. The one thing Marvel can afford to be is generous, even to the lowest levels of talent. It would buck the trend of Hollywood's antagonism towards talent, which has resulted in labor actions from the WGA and SAG.
If Marvel wanted to, it could (and should) set the standard for a reworking of the studio system of the 50's. Hire dozens of in-house creative talent, pay them handsomely, give them a small piece of the ownership pie - in short, make them partners. Marvel would have talent falling over themselves to work with them. Granted, it has that now given the tight labor market, but the deals are unnecessarily one-sided and the company is squandering an opportunity to re-shape Hollywood to universal benefit.
But that's a minor point and an admitted pet peeve. Ahem…moving on….
Investors should read the most recent 10-K to make certain they understand how the Merrill Lynch facility works. In short, Marvel is well within the requirements for drawing down those funds, meeting all covenants, and even repurchased the mezzanine portion of the debt. With a weighted average cost of senior debt of 5.78% last year, and films that continue to tear up all markets, Marvel has excellent positioning.
The things that could upset the apple cart include a spike in interest rates without the company having caps in place (they do on some of the debt currently), a change in the creative personnel that manages the company (I don't see that happening), or some kind of wholesale rejection of comic books (interest is only increasing).
I had a teacher in high school tell me to use all of my intellectual capability when assessing a problem, but like Pixar before it, I just don't think there's a way to properly value a company whose revenue streams are as unpredictable as Marvel's. The films and television that they own have library value. And while there are various methods of approximating that value, the truth is that there's no real way to peg it. What I do know is that Marvel characters have endured for decades, which suggests the library value is rather large. Marvel's "Identifiable Assets", as listed in its 10-K, is about $937MM. But even that is subjective and only reflects present value. It doesn't include what it'll see from its products and library going forward.
What I believe is that the company has a long way to go, will generate tons of cash flow, has cheap money with which to manufacture its product, and is extremely well-managed. For my money, today's price is lower than what it should be and what would reflect its true value – but it would take a super-genius to tell you what that price, in fact, should be.
Full Disclosure: Long MVL; no other positions