Dreamworks Animation’s Nightmarish Day

Filed Under (Company Research) by Ockham Research Staff on 24-05-2010

The stage was set for a monster box-office tally as the final installment of the “Shrek” franchise was released last weekend.  Shrek Forever After, the fourth installment would be the largest launch of an animated film showing at around 9,500 screens, a record number of which were 3D and IMAX showings which command premium pricing.  This was supposed to be a huge day for Dreamworks Animation (DWA), and estimates for the opening weekend ranged from $80 to $120 million.  Instead the movie disappointed greatly bringing in only $71.3 million, $50 million less than the last Shrek movie.  DWA is trading more than 10% lower in late day trading on the weaker than expected attendance estimates.

It appears Dreamworks beloved cash-cow “Shrek” has finally run its course, and subpar reviews did not help matters either.  To be fair, this was the fourth best opening weekend for an animated movie of all time (three of the top four are Shrek movies), and the mass appeal of Shrek may help it achieve longevity at the box office.  Dreamworks last major release How to Train Your Dragon was a disappointment on the opening weekend in March but later box office results rescued the film.  Furthermore, Shrek was number one ranked at the box-office this weekend with the second place film brought in only about a third of Shrek’s haul.  Shrek should continue to be the top kid-friendly film as there are no 3D or animated films set to be released until Toy Story 3 on June 18.

The best case scenario would be for Shrek to achieve the same staying power as How to Train Your Dragon, which grossed only $43 million in opening weekend yet finished with $210 million in box-office receipts.  Many analysts expect the Shrek film to make 3x its opening weekend performance, but anywhere close to the nearly 5x for “Dragon” would be a boon for Dreamworks.  3D theatres accounted for 61% of domestic opening weekend sales and with four full weeks without another 3D release Dreamworks may be able to recoup much of the estimated $300 million spent on making and marketing the film.  The film will likely still be profitable as international sales were not included in the total and were actually fairly strong bringing in $26 million.  Interestingly, particular strength came from Russia where Shrek brought in $20 million and topped “Avatar” for the country’s box-office record.

At Ockham, we are reiterating our Fairly Valued or natural stance on DWA, but after today’s sell-off it trades at the low end of its historical price-to-cash earnings and price-to-sales ranges.  The opening weekend results are disappointing, but it was clearly the top draw for movie-goers.  We expect to see Shrek at or near the top of the box office for the next few weeks, and think that the market may have panicked a little prematurely much in the same way it did with “Dragon”.  Remember, the stock sold off more than 8% in response to that disappointing opening weekend.

IMAX’s Valuation is in Fantasy Land

Filed Under (Company Research) by Ockham Research Staff on 11-03-2010

Imax Corp. (IMAX), which operates giant screened movie theatres as well as licenses the technologies to third parties, reported an outstanding fiscal fourth quarter 2009 on Thursday morning.  The company benefited from the blockbuster success of Avatar, which is arguably one of the most visually appealing movies ever made.  The high screen quality as well as the ability to show 3D films was a key reason for Imax’s surging revenue in the quarter.  To date, Avatar on its own has been responsible for $218 million in box office revenue at IMAX theatres.  In the recent quarter, sales rose 98% to $54.2 million and easily topped analysts’ estimates of $45.3 million.  Earnings came in at $.20 per share easily topping the analysts’ view of 6 cents due to the greatly increased traffic due to feature films like Avatar.

In addition to Avatar, IMAX appears to have another huge blockbuster on its hands as just last week Alice in Wonderland shattered previous IMAX opening weekend sales totals.   Globally, IMAX sold $15.2 mln in tickets with nearly 80% of that from US theatre locations.  The success of the movie’s opening weekend sent IMAX shares more than 18% higher in three trading days coming into the earnings report.  Furthermore, the company said that box office sales to date this year have been $187 mln, blowing away the results from a year ago at this point of only $14 mln.  It is clear that IMAX is really hitting its stride and growth should continue through the next few months with new installments in the successful movie franchises of Iron Man, Shrek, and the Twilight series.

The stock is riding high on its awesome recent performance and currently sits at its highest point since late in the year 2000.  However, some analysts warn that IMAX may face increased headwinds in second half of this year.  There is expected to be a lull in potential IMAX blockbusters, and other theatres are quickly starting to adopt 3D capabilities while not charging the premium IMAX ticket price.  More theatres offering 3D movies would surely cut down IMAX’s market share.  Furthermore, movie studios may start to clamp down on IMAX as they make a better cut from sales at regular theatres.

It is clear that IMAX has performed admirably in the past quarter and should continue to see sales growth into the next few quarters, but as far as valuation is concerned, we would not recommend buying at this price level.  The success at the box office for Avatar has been widely publicized and it may prove to be a ground breaking film that encourages the use of 3D even more often.  However, when looking at the company’s historical price-to-sales metric versus the year just ended (heavily influenced by Avatar) it is clear that the market has priced in much of this growth.  Over the last ten years IMAX has traded for 1.3x to 3.7x sales per share.  In the year just ended the metric has ballooned to 5.9x sales per share.  In terms of price-to-cash earnings per share, the stock has just narrowly returned to profitability in the last year, and while the prospect for earnings growth looks almost certain, the forward looking P/E ratio is not a bargain at over 26x.

Based on our valuation, we would recommend investors not get caught up in the hype over IMAX’s recent performance, and we are maintaining our Overvalued rating.  The company is finally starting to improve fundamentally and strengthen their historically shaky balance sheet, but the market has already awarded the stock with a 277% gain in the last twelve months.

Coinstar and Time Warner Strike a Deal on DVD Rentals

Filed Under (Company Research) by Ockham Research Staff on 17-02-2010

With yesterday’s announcement of new terms with Time Warner’s (TWX) Warner Brothers studio, Coinstar (CSTR) has removed one major uncertainty in their business model.  Coinstar’s Redbox division, which operates self-service DVD rental kiosks, has been locked in legal battles with movie studios regarding terms for the availability of their films.  The problems arose from Coinstar buying large quantities of DVDs on the day of release at wholesale prices and offering them for rental for $1 per day.

This situation was unacceptable to the studios as this threatened a key source of revenue: initial sales of popular movies.  This is especially critical to studios as DVD sales have already been in decline for some time.  So, the studios refused to sell at wholesale to Coinstar, and forced Redbox to invent a “workaround”.  Essentially, they would send employees to buy as  many copies of new releases as possible from big-box retailers.  Even though this was less cost effective, there were few alternatives to filling the company’s 22,000 kiosks.  However, a recent limit on quantities by retailers sent Coinstar back to the drawing board, and was a major cause of concern for investors.

Coinstar’s new deal with Time Warner has a 28-day window in which Redbox will have to wait after a new release.  Furthermore, Redbox has agreed to destroy the DVDs after their popularity slows rather than sell the used DVDs at a huge discount.  In exchange, Redbox will get sufficient supplies for each film at wholesale prices.  This is a very similar deal to the one that Time Warner made with Netflix (NFLX) recently, although Netflix has the added ability to offer streaming rentals on some titles.  Both sides are heralding this as a win-win and this may provide a roadmap to settle the ongoing disputes with other studios.

As for our valuation on these companies, we have CSTR as Undervalued and TWX as Overvalued.  We consider this as a more significant deal on CSTR’s end because Redbox, their fastest growing and most promising business line, had become very strained by the legal battles with studios.  This breakthrough has caused at least one analyst to upgrade the stock, and in general the analyst community is bullish on CSTR.  For example, the analyst at Merriman Curhan Ford said that the stock may be worth $59 to $77 in a note penned following this deal.

At Ockham, we have a positive outlook on Coinstar shares also, and based on the market’s historical valuation we think it could reach the high $40’s.  For example, in the past the market has been willing to pay between 7.9x and 13.9x cash earnings, while the current price-to-cash earnings is only 5.3x.  Similarly, price-to-sales is currently only .72x, which is well below the historically normal range of 1.15x to 2.07x.  It is clear that recent legal standoffs have held the stock down and made it fall out of favor with the market, but now there is a light at the end of the tunnel.  We expect the other studios to follow Warner Bros. lead and soon Redbox can put the capital it was using on legal fees towards growth.  The market is ripe for this solution, as it presents an alternative to disappearing bricks-and-mortar stores and it requires no monthly fee like rent by mail options.  Competitors such as Blockbuster-licensed kiosks owned by NCR Corp. (NCR), but Coinstar’s Redbox has the lead on them and will look to expand on that.

Disney: Marvel Deal a Hero or a Villain?

Filed Under (Company Research, Newsletter) by Ockham Research Staff on 01-09-2009

In a blockbuster deal, Disney (DIS) announced that they will acquire Marvel Entertainment (MVL) for cash and stock equal to about $50 per share.  Marvel began as a simple comic book company in the 1930’s, and is now a $4 billion dollar business with some of the most well known characters in the world.  Through the years, Marvel has developed its characters into brands in and of themselves, and they have more than 5,000 characters in their stable.  Recently, most of Marvel’s revenue has come in the form of licensing out their characters for films and video games, toys and television shows.

The success of Marvel’s characters is no surprise to cinephiles as franchises for Spider-Man, Iron Man, and X-Men have been among the highest grossing blockbusters of the past few years.  Since 2002, movies based on Marvel characters have grossed more than $4.8 billion at the box-office.  Of course, there have been even greater revenues from DVD sales, video games, etc.  Consumers love these action packed movies, and there is a seemingly limitless appetite for sequels as the latest installments of Spider-Man and X-Men have been the strongest performers yet.

For Disney, this deal provides some very lucrative brands that they can leverage and gain a stronger foothold particularly among young males.  Disney had recently seen strength among its programing targeted particularly to young female audiences with the likes of Hannah Montana and High-School Musical.  Disney is also dealing with industry-wide slumps in DVD sales, and they believe that the strong character associations and branding allow Marvel’s movies to outperform the industry.

The deal appears to be a good match placing a small studio with lots of characters with a major media conglomerate that can really pump out content and expand the audience to a more worldwide audience.  However, the question as always, did they over pay?  Disney has offered a premium of about 29% over the previous closing price for Marvel and some analysts are worried that it is too rich.  S&P has warned that they may downgrade Disney saying,

“We are concerned that Disney’s potential issuance of debt, its plan to buy back the stock portion within one year, the high purchase price, and the potential for continuing EBITDA declines in Disney’s businesses if the recession is prolonged will lead to debt leverage remaining above our threshold for an extended period.”

Furthermore, Lazard Capital Markets lowered its ratings on both Disney and Marvel to Hold from Buy, and stated that the $50 purchase price was higher than their $46 target price for Marvel.  Disney said that they expect earnings will fall in the short term, primarily due to the dilution of 59 million in new shares.  Furthermore, we do not expect a Marvel character based blockbuster to be released until 2011 when both “Thor” and “The First Avenger: Captain America” are expected.  In the mean time, those two films will be costly to produce and further dampen earnings prior to their premier.

At Ockham, we are not as concerned over the price that Disney paid because the acquisition has such huge potential over the long term.  Of course, the deal will be dilutive to current shareholders, but if your time horizon is long earnings should be back by 2012.  Furthermore, we were more bullish than Lazard on Marvel, as we were anticipating the price over the next year would rise to $50 and accordingly had an Undervalued rating on MVL.  Of course, post announcement it is likely almost all of the appreciation potential has been exhausted.  We also see Disney as Undervalued, but to a lesser extent.  Even though some analysts may be downgrading Disney because of the increased debt load and dilutive effects of the deal, we continue to believe Disney is a good buy for the long term investor. 

Dreamworks Story Book Quarter

Filed Under (Market Commentary) by Ockham Research Staff on 28-04-2009

Dreamworks Animation SKG (DWA) reported earnings that outpaced analysts estimates despite not having a major domestic in theatre release during the first quarter.  Well technically, “Monsters Vs. Aliens” was released in the last week of the quarter, but very little of that was reflected in this quarter.  The studio’s strategy of focusing on family friendly movies appears to have paid off in the last quarter as DVD sales of “Madagascar: Escape 2 Africa” were very strong, as was the film’s international release.  Of the company’s $263 million in revenue for the quarter, $148 million was contributed from the second installment of the wildly successful Madagascar franchise. 

Analysts were expected the company to bring in $212 million in revenue and earnings of 45 cents per share.  Both totals beat the street’s view with revenue of $263 million (68% growth) and earnings of 71 cents per share.  As if the earnings and revenue growth was not impressive enough, the company also improved on gross margins up to 40.6% from 38.6%.

Year to date the stock was down about 25%, but it is getting a nice bounce in after hours trading since reporting the impressive results from the first quarter.  We initiated out Undervalued stance on DWA back in early March.  The shares are rallying nearly 15% in AH, but there could still be legs as Dreamworks seems to have kept the momentum going with a strong start from “Monsters Vs Aliens”.  The studios first 3D movie brought in more than $58 million in its opening weekend, and reports are that the movie has grossed about $320 million already in the young quarter.  Dreamworks seems to have found a perfect niche in the film industry with animated movies that the kids love and its entertainment parents can afford, and branching out to 3D and IMAX (IMAX) is keeping their product fresh.

“Recession proof, that people are looking for cheaper alternative to entertainment and the resurgence of 3d. “monsters versus ailions” the DREAMWORKS picture took $58.2 million in the opening.” Fox Business Network 4/1/2009