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There's no doubting that Berkshire Hathaway (NYSE: BRK-B ) chairman Warren Buffett struck a brilliant deal when he bid $5 billion for a big chunk of Goldman Sachs (NYSE: GS ) . But he should also be buying Marvel (NYSE: MVL ) .
The gold in Goldman Sachs
Let's review the Goldman deal first. It's brilliant because:
- Berkshire receives a 10% annual yield on its preferred stake.
- Accompanying warrants give Buffett the right to buy $5 billion worth of stock at $115 per share.
So we know that (a) Buffett is already generating double-digit returns by way of dividends and (b) he's got a shot at massive capital gains in the common.
How massive? Let's say Goldman maintains the P/E ratio of 8 that it has today. Let's also say that per-share earnings fail to meet analyst estimates but instead grow at 3%, equal to the historic rate of inflation. That leaves us with a $147 stock, and 8% average annual returns.
Got that? Eight percent in capital gains, 10% in dividends; Berkshire could reap 18% annualized returns over the next three years and three months, proving once again that Buffett beats the pants off of Bernanke.
What you might not realize is that Marvel could deliver even better returns.
There's no business like show business
Earlier this week, the comic-book king struck a deal with Viacom's (NYSE: VIA ) Paramount Studios to distribute its next five films, including the sequel to megahit Iron Man, here and around the globe.
Paramount also paid Marvel $60 million for profits related to Iron Man, leading executives to raise 2008 guidance for film revenue to $125 million to $140 million, up from $65 million to $80 million. Paramount was under no obligation to make the payment, a Marvel spokesperson told me yesterday.
Sweet as that is, it's the fine print that's sweeter still -- two points, in particular. First, Paramount has agreed to cut its distribution fee from 10% of receipts to 8%, The Wall Street Journal reports. Second, Marvel will cover one-third of film production costs outside of its $525 million film facility, which will cover the remaining two-thirds.
So, while Marvel increases its risk by committing more capital to films, it's positioned to reap higher profits from any success -- both here and abroad.
A super-powered business model
Time to connect the dots and show how this deal could lead to higher returns for shareholders. But, before I do, let's review the basics once more. Marvel makes money three ways:
- Licensing. Marvel, like Disney (NYSE: DIS ) , is one of the world's largest licensors. Every time its characters are used to promote or create a product, it gets paid. Think of the Spidey shoes Crocs (Nasdaq: CROX ) had planned.
- Publishing. This is the core comic-book and graphic-novel business. Marvel says its share of the market exceeds 50%.
- Films. Marvel produces its own, but also has licensing deals with Sony's (NYSE: SNE ) Columbia Pictures, for the Spider-Man series, and News Corp.'s 20th Century Fox, for the X-Men and Fantastic Four families of characters.
We know that most of Marvel's future growth will come from licensing and film production. What we need is an estimate of 2011 operating profit.
Let's start with the core business. Through June, licensing and publishing had produced $290 million in operating profit. That should expand to $405 million by 2011, assuming growth matches the 10% sector average.
For film profit, I think we should stick with $216 million, which is equal to what Marvel has long projected would be its third-year take for its first six films. Better terms from Paramount increase the chances that this is a conservative estimate.
And finally, the math ...
So, that's $621 million, which, after subtracting corporate expenses and taxing the remainder by 40%, becomes $358.2 million in net income and $4.53 in per-share earnings. Marvel has traded for between 12 and 43 times earnings since 2005. Multiplying $4.53 by 15 -- equal to the historic average P/E for all stocks -- creates a $68 stock, and 24% average annual returns.
Marvel beats Goldman. Maybe.
Or maybe not. There are unknowns in Marvel's model; we've only seen two of its self-produced films. Meanwhile, thanks to a double-digit dividend and the bond-like nature of preferred stock, Buffett's stake in Goldman comes with a regular schedule of fat payments.
Marvel, not so much. But its cheap valuation and history of efficient capital deployment suggest that I’m being very well compensated for my risks as a shareholder. No investor, not even Buffett, could ask for more.
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