Marvel: Still a Screaming Buy

Earlier this week, Marvel Entertainment (NYSE: MVL  ) balanced an outstanding earnings report with news many found disappointing: The budding superhero studio may not get a film to the silver screen in 2009.

Executives blamed the delay on the writers' strike. That's possible. Even though a side deal during the middle of the strike brought its writers back to work sooner than most, Marvel is unique in that there's no storehouse of scripts at HQ. Only recently had studio bigwigs hired writers for future films based on unused characters Ant-Man and Captain America.

However, it could also be that Marvel's greenhorn status as a producer meant that executives weren't prepared beyond this year's release of Iron Man and The Incredible Hulk. If true, I can hardly blame my fellow investors for worrying.

But they absolutely shouldn't be selling. Nothing has changed since November; Marvel is still valued as though its movie studio is worth nothing.

Not one penny.

Gentlemen, start your calculators
Do the math with me. I promise it'll be more fun than watching that C-SPAN special you recorded yesterday.

Let's begin with operating income:

Operating Income

2007*

2006*

2005*

2004*

2003*

2002*

Licensing

$196.1

$77.6

$143.4

$152.7

$83.2

$47.6

Publishing

$53.5

$44.1

$36.4

$37.3

$25.5

$19.6

Toys

$54.7

$21.1

$15.5

$58.1

$77.9

$30.6

Overhead

($22.4)

($22.7)

($24.1)

($23.7)

($19.4)

($17.3)

TOTAL

$281.9

$120.1

$171.2

$224.4

$167.2

$80.5

Sources: Marvel press releases, SEC filings.
* Numbers in millions.

That's truly massive growth, Fool. More than 28% annually over five years.

Yet each of these businesses has a long history. Publishing goes back to the 1930s. Toys had been created in-house until a 2006 outsourcing deal. But licensing revenue truly defines Marvel's non-Hollywood operations.

Licensing is code-speak for cash earned from the use of any of Marvel's 5,000 characters to produce sales. Deals are everywhere. Crocs (Nasdaq: CROX  ) puts the Hulk on its shoes. General Mills (NYSE: GIS  ) sells Spider-Man fruit snacks. And of course, Sony (NYSE: SNE  ) makes films starring the web slinger.

Best of all, Marvel is the world's sixth-most-valuable licensing brand (PDF file), worth $4.8 billion in retail sales annually.

Would you say all that is worth the $26 a share for which Marvel trades today? I would. (Warning! More math coming!)

Here's how. Let's keep things simple and use Marvel's six-year average operating income of $174.2 million. Taxing that at 40% leaves $104.5 million. When divided by Marvel's 78 million shares, that figure equals $1.34 per share in net income. Multiplying that by a P/E ratio of 20 provides a share price of $26.80.

Yes, I realize that Marvel's peers in diversified entertainment trade for less. Time Warner (NYSE: TWX  ) nets just 14 times earnings, for example. Viacom (NYSE: VIA-B  ) commands 16 times earnings. Yet neither Time Warner nor Viacom is growing by 28% a year. Marvel is, and I don't see that changing soon. If I'm right, the Marvel you know today -- the one that has yet to earn a dime from self-produced films -- will keep on growing by at least 20%. Assuming its P/E ratio falls between 14 and 20, Marvel could be worth between $47 and $67 a share by the end of 2012, resulting in 12% to 20% annualized returns.

Hulk, meet Shrek. Shrek, Hulk.
But again, that's without any contribution from self-produced films such as Iron Man. If 'ol Shellhead and his in-house peers do well, further returns will follow.

Remember: Marvel only said that it would see delays in 2009. Management hasn't backed away from its long-term production schedule, which calls for 10 self-produced films in five years. If that schedule holds, Marvel could see as much as $1.1 billion in operating income from these films over 7 years.

What would that be worth by 2012? During Marvel's earnings conference call, studio chief David Maisel likened his operation to DreamWorks (NYSE: DWA  ) , in that it has similar distribution deals for its films.

DreamWorks is worth $2.4 billion in market value as I write. I wouldn't assume that the home of one big green giant (the Hulk) could be worth as much as that of Hollywood's other green meanie (Shrek) after 8-10 films. But $1 billion seems possible, which would come to $13 per share.

Once more with the calculator, shall we? Adding $13 to our base range equals ... (key punching sounds) ... $60 to $80 a share in five years. Wowza.

Hulk smash puny market!
As a contributor to the Rule Breakers team, I often seek to invest in trends, rather than cheap valuations. But the math for Marvel is just too compelling. How else do you explain a stock valued as if its blossoming production company were worth absolutely nothing?

But even if Marvel Studios isn't worth all that much -- say, less than half the current value of its closest peer -- it could still propel the shares of its parent company to $80 each, producing 24% returns a year over the next five. There's only one away to describe a stock like that.

A screaming buy. Still.


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