One Thing Could Save DreamWorks Animation


Dreamworks CEO Jeffrey Katzenberg at the International Consumer Electronics Show in Las Vegas, January 2014. Photo: Associated Press

For film and animation companies like DreamWorks Animation (NASDAQ: DWA  ) , it can be tricky to continually pump out blockbuster hits quarter after quarter. One or two major misfires in a row can really ruin a company's quarterly earnings. Such was the case with DreamWorks in the first quarter of 2014, when it posted a $43 million loss.

This is especially tough news for investors to bear in light of competitors Disney (NYSE: DIS  ) and Time Warner (NYSE: TWX  )  releasing the megahit movies Frozen and The Lego Movie, respectively. These huge profit drivers have been highlights of those companies' earnings and continue to reward their investors. Now DreamWorks will need a strategy to save itself, but that might just be around the corner.   

DreamWorks' earnings take a beating
Mr. Peabody & Sherman was the latest in a list of recent releases over the last few quarters that have led to writedowns on DreamWorks' financial statements, and one that ultimately drove the company's negative earnings as it posted a loss of $43 million. This is starting to look like a trend. Mr. Peabody and Sherman caused a $57 million writedown, Turbo, the snail movie, caused a $13.5 million writedown last year, and the company took a $87 million writedown on Rise of the Guardians. DreamWorks has had some profitable films over the last year, but overall the company is still reporting losses.

LEGO Movie drives profits of over $190 million. Photo: Forbes

By contrast, The LEGO Movie, with its theme song of "everything is awesome", helped Time Warner show off great first-quarter earnings in early May. The movie grossed $252.7 million for Time Warner at a cost of only $60 million. Along with other successful movies in 2013 from Warner Bros., Time Warner's CEO promised that with a "slate of movies for the rest of the year... Warner Bros. is positioned to have another excellent year in 2014." The company announced that Warner Bros. is already working on another Lego movie for release in 2017.

Of course, it's needless to say that Disney's Frozen was the highest-grossing animated movie ever and put DreamWorks' recent releases to shame. With these industry results, DreamWorks seems to have fallen behind its competitors.

It wasn't always this way, and Dreamworks CEO Katzenberg is promising to get back to the system that has produced more hits in the past. He told Time journalists that "Movies in the best of times are an uncertain business. We went 16 for 16 hits here. To assume that you will always do that — and now we've had a few that didn't — is foolish." Note that is "foolish" with a little "f". For Foolish (big F) investors, betting on a DreamWorks come back might make this recently beat-up stock very attractive at its current low valuation. One reason to bet on this comeback: the company's investment in China. 

This could save DreamWorks: The Chinese media industry
DreamWorks is making a big bet on its growth in China, and if it goes well, this could be a major boost for the struggling company. The vast Chinese film and media industry continues to explode. PricewaterhouseCoopers projects a value for the industry of $6.49 billion in 2017, more than double its $3.26 billion value in 2012.

 
Source: ChinaFilmBiz.com

Enter Oriental DreamWorks, a "Chinese content company." Dreamworks has made a huge investment in China by partnering with Shanghai Media Group and three other local entertainment investment companies in a joint venture that includes production studios and attractions in Shanghai, a venture in which DreamWorks Animation holds a 45% stake. The new company will not only focus on animated TV production, it will also make live-action films, live-action TV, and mobile and Internet content. DreamWorks CEO Katzenberg is optimistic about this market and said that "China in three or four years will be the No. 1 movie market in the world... I just look at it as a place of opportunity."

Oriental DreamWorks already has multiple projects in the works which are keeping it busy. An exciting current project is Kung Fu Panda 3, the third of the Kung Fu Panda series which has been very successful for the company. If this film release in late 2015 goes well, it could be the start of a very lucrative partnership for the Chinese venture.

Additionally, the company is opening DreamCenter in 2017, a integrated production center for both film and live theaters as well as animation studios. Dreamworks isn't stopping there, the company is also playing in the theme-park industry in China. Oriental Dreamworks is building near Shanghai, China, preparing a $3.1 billion indoor park that is set to open in 2018.

It'll be a battle with Disney for Chinese attention
Just as it is in the U.S., Disney will be a tough company to compete with in China. Smart and already well-diversified operations helped Disney report another terrific quarter this month. The company posted revenue up 10% over the same period of last year. With these revenue increases and what should be well-performing movies in the pipeline coming later this year, Disney is preparing itself to have a record-beating year in 2014, even above its incredibly profitable 2013.

Disney is also producing media content specifically for Chinese audiences. Through a partnership with Shanghai Media Group (one of the same companies that has partnered with DreamWorks), Disney is preparing to release Chinese-specific content to the masses soon. Even more interesting is that Disney will be creating a brand presence in China much earlier than DreamWorks will, with its own theme park opening in 2015.


Mickey Mouse prepares to welcome Chinese visitors. Photo: Disney

Disney is about to increase its bet on China with its Disney Resort in Shanghai, China coming next year. Disneyland Hong Kong has been a highlight of the company's earnings since its opening in 2005. Mainland China will be a very different environment than Hong Kong, and the park there should see even higher visitation rates. Disney Resort Shanghai, the first resort on China's mainland, is under development and set to open in 2015. This theme park should prove to be a major profit driver for Disney, and will help to create more brand presence for its overall Chinese operations.

Foolish investment conclusion: Looking for future value
Katzenberg, chief executive of DreamWorks Animation, is a veteran in the industry. In fact, he was the chairman of Disney between 1984 and 1994. "We've come very far along, but in terms of being a broadly diversified family branded entertainment company, I still think we're in our junior years." he said. A broad entry into China might be just what the company needs to become very profitable.

Competing with Disney in China will be just as tough as it is in the U.S. However, with box-office revenue expected to double that of the U.S. by 2025, there will be enough demand to go around and this will keep both companies busy. Because DreamWorks has had a few mis-calculations over the last year, its stock has been beaten up. For investors who are confident in DreamWorks' long-term strategy, this might mean that now is a very good entry point.

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