You Still Have a Chance to Buy Marvel

Shares of Marvel Entertainment (NYSE: MVL  ) have poked into the black for the year this week, but for my money, this could be just the beginning of a new round of gains for the stock.

Marvel soared more than 6% after reporting earnings that blew away earlier estimates. Revenue rose 75% to $197 million, while per-share income fell by a penny to $0.57. Both results easily topped the Street's targets.

Meanwhile, Marvel's newest film, X-Men Origins: Wolverine, made in cooperation with News Corp.'s (Nasdaq: NWS  ) 20th Century Fox, slashed competitors in its opening weekend. Hugh Jackman's first solo outing as the often-angry, always-indestructible mutant took in $85 million at the domestic box office and another $73.1 million outside the U.S., Box Office Mojo reports.

Like peers Walt Disney (NYSE: DIS  ) , Time Warner (NYSE: TWX  ) , and DreamWorks Animation (Nasdaq: DWA  ) , Marvel's characters -- old and new -- are drawing patrons to theaters.

As if that mattered ...
If only the Street cared. Analysts have downgraded Marvel's stock three times since the beginning of the year. Caris & Company has done it twice, for example.

Wedbush Morgan, on the other hand, can't make up its mind. On Feb. 17, shortly before Marvel issued an outstanding fourth-quarter report, analysts there upgraded the stock to "buy." This morning, they dropped their rating back to "hold."

To be fair, Wedbush has done well with its pick. Calling a buy at $25.10 -- Marvel's closing price on Feb. 17 -- looks brilliant now. But why the downgrade, Wedbush? Why not buy again?

Perhaps because there's still a broad misunderstanding about how well-positioned the Marvel Studios business is, when it really ought to be obvious:

Components of Adj. Cash From Operations

Last 12 Months*

2008*

2007*

2006*

Reported net income

$198,964

$205,535

$139,823

$58,704

Depreciation and amortization

$1,457

$1,559

$5,970

$14,322

Amortization of film inventory

$206,390

$135,339

$0

$0

Amortization of financing costs

$4,980

$4,981

$4,980

$4,980

Deferred revenue

$9,600

($16,509)

($28,956)

$140,087

Film production costs

($37,770)

($53,135)

($251,045)

($15,055)

Net borrowings from film facility

($273,583)

($74,209)

$255,926

$7,400

Capital expenditures

($3,052)

($2,384)

($2,659)

($16,286)

Adj. Operating Cash Flow

$106,986

$201,177

$124,039

$194,152

Sources: Press releases, SEC filings.
*Numbers in thousands.

Two things should jump at you in reading this table:

  1. Marvel generates a ton of cash.
  2. So much cash, in fact, that it cut its net film debt by more than $270 million.

Impressed? You don't know the half of it. Turns out Marvel actually repaid more than $330 million in gross film borrowings. Today, the company owes its cinema creditors just $61.9 million, down from $204.8 million at the end of December.

An adamantium-clad deal
Something else to realize -- yes, this is the important part -- is that Marvel was generating these numbers under less generous distribution terms, and before it signed Samuel L. Jackson, who made a key cameo appearance in last year's blockbuster, Iron Man, to a nine-picture deal.

Jackson's arrangement is sweet, but Marvel's distribution deal with Viacom's (NYSE: VIA  ) Paramount Studios is sweeter. The partnership calls for Paramount to handle distribution worldwide -- previously, Marvel had been required to presell foreign territories through regional partners -- and to cut its producer fee by two points, from 10% to 8%. In exchange, Marvel will fund the first third of production of future films, beginning with Iron Man 2, through its bountiful free cash flow.

That's admittedly a riskier deal than before, but I'm not worried. Marvel operates the fourth-largest licensing business in the world, according to License Global magazine, and boasts a history of careful capital management:

Metric

Last 12 Months

2008

2007

2006

Earnings before interest and tax

$353.90

$348.64

$273.03

$110.16

NOPAT (37.5% tax rate)

$221.19

$217.9

$170.64

$68.85

Avg. Invested Capital

$520.36

$540.16

$387.86

$345.75

ROC*

42.5%

40.3%

44.0%

19.9%

*Return on capital.

For context, consider that not even Google (Nasdaq: GOOG  ) manages those sorts of returns. In fact, on this basis, the search king is less than half as good as Marvel.

So let analysts say what they want. Let them scream about how it's time to take profits, about how this rally is ridiculous, and how only a (small-f) fool would buy now.

They're wrong. A fool wouldn't buy Marvel now, but a Fool would.

Face front, True Believer! More Marvel-ous Foolishness awaits:

Disney, DreamWorks, and Marvel are Stock Advisor selections. Disney is also an Inside Value pick. Google is a Rule Breakers recommendation. Try any of these Foolish services free for 30 days.

Fool contributor Tim Beyers is also an analyst for Motley Fool Rule Breakers. He had stock and options positions in Marvel and Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. Its disclosure policy is the best there is at what it does.


Read/Post Comments (7) | Recommend This Article (29)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 06, 2009, at 6:50 PM, TMFBreakerTAllan wrote:

    Tim

    Doesn't Marvel have to pay back the film facility from the box office receipts - Marvel's share goes to the film facility before they get their hands on it, doesn't it? Not that the amount of cash isn't impressive, but I think that the success of IM and Hulk at the box office is the reason that got paid down so quickly.

    Somebody correct me if I am wrong.

    T. Allan

  • Report this Comment On May 06, 2009, at 7:11 PM, tom2727 wrote:

    Very interesting "big F" Foolish argument. Like many Foolish arguments I've seen over the years you neglect to mention how much the stock costs relative to all those stellar absolute numbers. Not once do you mention its current market cap or PE.

    Now I haven't looked at Marvel myself. No idea if it's a good buy. But I have one simple question for you. You're saying it's a buy today's $32.95/share right? But would it be a good buy at $50? $100? $200? $500? Clearly there's some point where this stock would become grossly overvalued, yes? Yet all of your "buy this stock because" arguments are just as true at $500 as they are at $33.

    Are you saying Marvel would still be a good buy at 10 times it's current market cap? If not, why? Revenue still rose at 75%. It's ROC is the same. It's still paying down debt. It's still working those deals. All the reasons you cite in your article still apply. There's nothing in your article that indicates what you think the correct value for Marvel is. This is a problem I've had with Motley Fool from day 1.

    I don't know, but I'm guessing the reason Wedbush Morgan downgraded to "hold" is VALUATION. A concept you've probably never heard of, judging by this article. Apparently you'd have them maintain a "strong buy" rating all the way up to $500/share. I mean if the ROC is 42.5%, the stock just couldn't possibly be overvalued right?

  • Report this Comment On May 06, 2009, at 10:53 PM, TMFMileHigh wrote:

    Evening guys,

    I think tom2727 has dared me to write a follow-up article about the value of Marvel's business. I accept the challenge gladly. Look for a new commentary on Monday.

    And so it's clear: Yes, I have written about Marvel's valuation. Many, many times. Here's one:

    http://www.fool.com/investing/general/2008/02/21/marvel-stil...

    On Wedbush: I think they're smarter than to use valuation as an excuse to downgrade a massive-growth business trading for less than 13 times earnings. More likely: the stock is teetering towards the firm's 12-month price target.

    BreakerTAllan, the cash flow question is a good one. The facility doesn't pay out cash to Marvel till after at least 3 films are made. But for accounting purposes, Marvel records the effects of film receipts moving into and out of the facility.

    That's why you see my "adjusted cash from operations" figure in each of these articles -- it's a reflection of cash collected after fully accounting for the ebbs and flows of movie-related borrowing and repayments.

    Now, as for what juiced cash flow, we can look at two things:

    1. Box office receipts, yes, but even more important were highly lucrative DVD sales, of which Marvel saw a huge portion. DVD sales are what made IH, an otherwise mediocre film at the box office, a commercial success.

    2. Don't underestimate the impact of licensing -- it's a lucrative business. Most of Marvel's licensing contracts re-up in Q1, kicking off cash payments.

    For example, in February, Marvel re-upped its toy licensing agreement with Hasbro, which immediately kicked off a $50 million upfront payment, recognized in the Q1 results described above.

    So ... no, Marvel's prodigious cash flow is about a lot more than just IM and IH.

    Otherwise, I wouldn't have put more than 20% of our portfolio's assets into this one stock.

    Hope this helps and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On May 07, 2009, at 1:08 AM, TMFBreakerTAllan wrote:

    Tim, thanks for the detail you provided as to the accounting for the cash and explanation of cash from operations. I am a big fan of Marvel's business model and have been a shareholder for years. Right now, MVL has a high percentage of my portfolio as well.

    As for the licensing, Marvel, has have proven itself year after year as being a company that can bring in money for selling stuff that was made and paid for years ago. No disagreement from me that this is a real strength with the company.

    To say Marvel paid down the debt with its cash is true. But they had to pay down the debt with the cash. Not that it isn't impressive, but would you place more value on Marvel if they were able to self-finance films and could control what happens with the revenue from the self-produced films? Or would the risk of loss of that cash be a factor to lower a valuation in comparison to the non-recourse lending facility?

    Thanks again for the response and I look forward to your take on the valuation.

    T. Allan

  • Report this Comment On May 08, 2009, at 9:54 AM, TMFMileHigh wrote:

    'Morning T. Allan,

    >>Would you place more value on Marvel if they were able to self-finance films and could control what happens with the revenue from the self-produced films? Or would the risk of loss of that cash be a factor to lower a valuation in comparison to the non-recourse lending facility?

    I *love* the arrangement that Marvel has now because it appropriately balances risk versus reward. Conversely, were Marvel to self-finance all films via cash flow, it would be the equivalent of an all-in bet for the company. Not good stewardship, in my view.

    The trouble with Marvel is that it's a very long-term play. If the Street Set finds the story hard to understand as a result, it's because they can't see past the tips of their noses.

    FWIW and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On May 08, 2009, at 11:04 AM, TMFBreakerTAllan wrote:

    Tim

    Thanks for the opinion. The film facility does balance risk well. I don't think the story is hard to understand for the Wall Street Set; I just think this is one of the stories or investments that will require a longterm outlook as you said. So far, Marvel has had success by becoming a very focused studio.

    T. Allan

  • Report this Comment On May 18, 2009, at 4:43 PM, tom2727 wrote:

    Wow, you actually answered me. How about that. I checked out your earlier write-up, and sure enough it has a pretty decent opinion of Marvel's valuation with numbers to back it up. Truly a rare bird for TMF.

    But I think that kind of analysis should be part of any article which includes a recommendation to buy or sell a stock. Presumably your headline would have been "You Missed Your Chance to Buy Marvel" if it was trading around $60 at the time. And your headline would have been "SELL!!!!" if it was over $100 (based the estimates from your earlier article).

    This article was like having a real estate agent walk me through a house showing off its good points; granite counters, great views, walk in closet, etc. And then asking me if I want to buy the house, before telling me what the price was.

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