Marvel Plays Daredevil

For months, Marvel Entertainment's (NYSE: MVL  ) investors have been seeking the knockout punch that would level the villains dragging down the share price. Second-quarter earnings came short of that goal, but it was still a notable victory for the struggling hero.

Though down year over year, sales of $84.4 million and per-share earnings of $0.19 easily beat Street estimates. That's understandable. Last year, Marvel benefited from over $6 million more in contributions from the Spider-Man movie franchise it has built with Sony (NYSE: SNE  ) .

And there are other signs of improvement. Consider the toy business. Marvel earned 8.5% more from toys in Q2 2006, despite a transition away from its royalty arrangement with ToyBiz. That's good news for those who cheered a distribution deal with Hasbro (NYSE: HAS  ) .

Future projects also remain on track. Marvel Studios has three movies planned for 2007 under existing licensing agreements: Ghost Rider (February), Spider-Man 3 (May), Fantastic Four 2 (June). Ghost Rider could go horribly wrong if the demonically possessed Johnny Blaze, played by Nicholas Cage, is too much of a caricature. The new FF, however, plans to focus on a classic storyline from the comics, in which the team learns that aliens do exist and that not all of them are friendly. Color me interested.

I mean in the movie, not the shares. Not yet, at least. My problem with Marvel remains that there isn't much organic improvement in the business. If anything, the quality of the balance sheet is deteriorating.

Blame buybacks. Over the past six months, Marvel has spent roughly $287.3 million to repurchase 15.6 million shares, or an average price of $18.41 a stub. Obviously, the buybacks gave earnings a massive boost. But liquidity has suffered in the process: Marvel has assumed $96.7 million of floating-rate debt that costs 6.65% at today's rates. Meanwhile, the comic book king is left with $11 million in the bank, down 90% from its balance a year ago.

To be fair, this could be a very shrewd move if management is correct in assuming that returns from its stock will exceed 7% annually for the foreseeable future. Plus, Marvel expects to generate $120 million in cash from operations this year, which should help replenish cash and pay down debt.

Nevertheless, Marvel is now a studio, which puts it in a much more capital-intensive business. Accepting additional liquidity risk at the same time that capital needs are rising strikes me as, at a minimum, bizarre and perhaps even dangerous. After all, even superheros need an escape plan.

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Fool contributorTim Beyersdidn't own shares in any of the companies mentioned in this story at the time of publication. You can find out which stocks he owns by checking Tim's Foolprofile. The Motley Fool has an ironcladdisclosure policy.

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