The Value of Marvel's Next Act

On Friday, we covered Marvel Entertainment's (NYSE: MVL  ) $525 million in financing for the films it plans to produce as an independent studio. Today, I want to rap about how the move could aid profits and affect the valuation of the shares. Ready to get started?

A full slate
Let's begin at the top. Marvel, a Motley Fool Stock Advisor pick, has several films in production with studio partners, including Ghost Rider and Spider-Man 3 with Sony (NYSE: SNE  ) and Fantastic Four 2 with News Corp.'s (NYSE: NWS  ) 20th Century Fox. Projects in development include The Punisher 2 with Lions Gate (NYSE: LGF  ) and X-spinoffs Magneto and Wolverine, to appear in pictures made by Fox.

Naturally, there's more to Marvel's licensing business than films. Consumer products, merchandising, and publication rights also add to the kitty. And it's a huge business: Licensing accounted for $188.6 million in sales over the trailing 12 months, equal to 51% of total company revenue during that period. Expect the new Marvel to continue to embrace this model as a way to enhance revenue generated from its Marvel Studios arm.

But what about the risks?
Glad you asked. On Friday, I wrote that Marvel's greatest risk comes from producing unprofitable films. Let's refer to history to measure the size of that risk.

Since Marvel's financing is limited to PG-13 rated films, we need only to know how well Marvel's teenybopper slate has performed. A check of the data at Box Office Mojo provides a broad range for the nine PG-13 flicks starring the comic book king's characters -- from $24.4 million domestically and $56.5 million worldwide for Elektra and $403.7 million domestically and $821.7 million worldwide for Spider-Man.

On average, Marvel films pull $199.7 million domestically and $395.7 million worldwide. Those are strong numbers, which Marvel used in developing future projections that may be found in this presentation (link downloads a PDF file).

It's a lengthy read, so be prepared. That said, most of what you need to know can be boiled down into this chart -- available on slide 22 -- which estimates the relative profit of Marvel-made films based on box-office revenue:

Domestic box office

Projected film profit

Operating income contribution

$100

($16)

($1)

$150

$42

$62

$200

$92

$117

$250

$140

$170

$300

$187

$222

Source: Marvel Entertainment; numbers in millions

Don't worry about the "domestic box office" moniker. It's simply nomenclature Marvel included in its presentation to simplify the presentation of estimates. All of its projections are, in fact, comprehensive and account for, among other things, global distribution plus DVD and TV rights.

What matters is that Marvel could greatly boost operating income with a hit. Meanwhile, the 5% producer fee it earns on all revenue generated from films it creates will further juice operating profit in good times, and protect against losses in bad.

Should you like Marvel when it's angry?
Now comes the tricky part: transforming all this mumbo-jumbo into projected earnings. For its part, Marvel says that it's fair to base future estimates on an average $200 million take at the domestic box office, with $130 million as the assumed production budget. I'm not so sure that's reasonable, since history shows that the only films to reach that revenue watermark feature a mutant or a web-slinging wall crawler.

Nevertheless, executives may be right. I accounted for that uncertainty by producing three separate scenario projections of operating income flowing from its independent releases. Bear in mind that these estimates are based on Marvel's own math and the assumption that Marvel Studios will release two new films per year during the period I'm evaluating, beginning with Iron Man in May of 2008:

$150 million avg. domestic box office

Film

Released

Oper. income 2008

Oper. income 2009

Oper. income 2010

1

2008

$14

$33

$9

2

2008

$10

$37

$10

3

2009

$14

$33

4

2009

$10

$37

5

2010

$14

6

2010

$10

TOTALS

$24

$94

$113

Sources: Marvel Entertainment, TMF estimates; numbers in millions

$200 million avg. domestic box office

Film

Released

Oper. income 2008

Oper. income 2009

Oper. income 2010

1

2008

$27

$63

$18

2

2008

$19

$70

$19

3

2009

$27

$63

4

2009

$19

$70

5

2010

$27

6

2010

$19

TOTALS

$46

$179

$216

Source: Marvel Entertainment; numbers in millions

$250 million avg. domestic box office

Film

Released

Oper. income 2008

Oper. income 2009

Oper. income 2010

1

2008

$39

$91

$26

2

2008

$27

$102

$27

3

2009

$39

$91

4

2009

$27

$102

5

2010

$39

6

2010

$27

TOTALS

$66

$259

$312

Sources: Marvel Entertainment, TMF estimates; numbers in millions

Next, I decided to add my 2010 operating income estimates to an average of the operating income for the publishing and licensing segments over the past four years:

2010 operating income

Low-end estimate

Median estimate

High-end estimate

Publishing

$30

$30

$30

Licensing

$126

$126

$126

Corporate

($21)

($21)

($21)

Studio

$113

$216

$312

TOTALS

$248

$351

$447

Sources: SEC filings, TMF estimates; numbers in millions

Why am I discarding toys? Marvel Vice Chairman Peter Cuneo admitted in an interview that Marvel's toy business revenue will be ancillary in the future, a benefit of the firm's relationship with Hasbro (NYSE: HAS  ) .

Worth the price of admission?
Forming a valuation on estimates of future operating income can be very dicey. But since it's all we have here, I'll take a stab. I'm assuming a normalized 36% tax rate and no interest or increases in Marvel's share count, since excess free cash flow should sweep clean the balance sheet between now and 2010.

Metric in 2010

Low-end estimate

Median estimate

High-end estimate

Net income

$159

$225

$286

Diluted shares

86.7

86.7

86.7

EPS

$1.83

$2.59

$3.30

Source: TMF estimates; numbers in millions expect per-share amounts

Finally, we need to know what multiple to apply. Since Marvel's future is dependent on the movie business, it seems only fair to lump it in with DreamWorks Animation (NYSE: DWA  ) , Pixar parent Disney (NYSE: DIS  ) , General Electric's Universal, and other producers. Applying a studio industry average P/E of 24.9 to my per-share estimates values Marvel at between $46 and $82 a stub by the end of 2010. That's a compound return of at least 22% annually using Friday's close of $20.71.

Frankly, that surprises me. I'm not at all sure Marvel's estimates are reasonable. But if they are, the shares are outrageously cheap right now. My advice to more conservative Fools is to keep a close eye on the 2007 box office. We'll know a lot more after Johnny Blaze rides in February. For the rest of you ... Excelsior!

Marvel, Hasbro, Dreamworks, and Disney are Motley Fool Stock Advisor selections. Ask for us an all-access pass and you'll get a backstage look at all of the stocks that are helping David and Tom Gardner beat the S&P 500 by more than 39% as of this writing. It's free for 30 days. All you have to lose is the prospect of a richer portfolio.

Fool contributor Tim Beyers owns more than 2,000 comics but no shares in any of the companies mentioned in this story at the time of publication. Get the skinny on all of the stocks in his portfolio by checking Tim's Fool profile. The Motley Fool's disclosure policy is invincible.


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