Is DreamWorks a Dream Come True, or are Disney and Lions Gate Better?

Source: DreamWorks. 

After news broke on Jun. 16 that "How to Train Your Dragon 2" reported lackluster box office results during its first weekend in theaters, shares of DreamWorks Animation SKG (NASDAQ: DWA  ) plummeted 11% to close at $24.35 before rising nearly 2% the next day. In light of these developments, some investors might be tempted to throw the entertainment company off stage in favor of The Walt Disney Company (NYSE: DIS  ) or Lions Gate Entertainment (NYSE: LGF  ) , but is it possible that now might be the time to go all-in instead?

Knowing the difference between mediocre and disaster!
For the weekend, "How to Train Your Dragon 2" brought in $49 million. Although this sounds like a nice chunk of change, the fact that it fell 25% short of the $65 million analysts expected should be cause for concern. Because of the relatively poor release, the film will need a strong international opening in order to justify the $145 million required to make the movie.

Source: DreamWorks.

Despite its lackluster performance, the movie did perform better in its opening weekend than its predecessor, "How to Train Your Dragon." In its first weekend, the film raked in $43 million and went on to report box office sales of $494.9 million. Between its box office, home entertainment, and ancillary results, the film contributed $174.2 million for DreamWorks, second only to the $244.5 million recorded by "Shrek Forever After" in 2010.

Is this a chance to buy DreamWorks on the cheap?
Given that the performance of "How to Train Your Dragon 2" wasn't terrible when compared to its prequel, is it possible Mr. Market is overreacting to the news, and DreamWorks makes for a strong long-term play from these levels? To find out, it's important to look back and see how the business has performed in recent years.

Between 2011 and 2013, DreamWorks saw its revenue stay virtually flat, rising from $706 million to $706.9 million. According to its most recent annual report, this modest uptick in revenue came from a 43% jump in revenue in its Television Series and Specials segment, which rose from $74 million to $105.9 million, and its Consumer Products segment, which rose 56% from $43.1 million to $67.3 million. This was, however, offset by a 9% decline in its Feature Films segment, which fell from $551.4 million to $500.2 million.

Source: DreamWorks. 

From a profitability perspective, DreamWorks' performance was even worse. During the past three years, the studio saw its operating income fall 31% from $109.9 million to $76.3 million. The main driver behind this deterioration in profitability was its selling, general, and administrative expenses, which shot up from 15.9% of sales to 27.2% as higher executive compensation, incentive programs, and costs relating to recent acquisitions negatively affected the company's bottom line.

During this same three-year period, rival Lions Gate saw its revenue soar 66% from $1.6 billion to $2.6 billion. Pretty much all of this increase in revenue came from the company's Twilight Saga and The Hunger Games films. From a profitability standpoint, the studio did even better, with operating income skyrocketing 676% from $33.5 million to $259.9 million as higher revenue was complimented by a reduction in the business's cost of goods sold from 57.2% of sales to 52.1%.

Source: Lions Gate.

Probably the most interesting player in the market, however, was Disney. During this three-year period, the company saw revenue from its Studio Entertainment segment drop 6% from $6.35 billion to $5.98 billion. The drop in sales was due to a 28% drop in Home Entertainment revenue from $2.44 billion to $1.75 billion as its movie unit sales fell precipitously. This was, however, partially offset by an 8% improvement in both Theatrical Distribution and Theatrical and SVOD sales.

Source: Disney.

Even though this performance looks poor, the segment's operating income actually rose 7% from $618 million to $661 million. This rise in profitability for Disney's segment can be attributed to an 8% falloff in operating expenses as well as to a 9% decline in the segment's selling, general, and administrative expenses. Even after adding back unallocated expenses (assuming a pro rata distribution), the segment's operating income managed to grow 4% from $496.6 million to $514.5 million.

Foolish takeaway
Based on the data provided, Mr. Market was anything but happy with the performance metrics posted by "How to Train Your Dragon 2." When you combine these disappointing results with the fact that DreamWorks hasn't necessarily been the poster child for success in recent years, it's understandable for investors to worry. While it's possible that the future could very well be brighter for the business moving forward, a better play might be to consider a stake in Disney or Lions Gate instead.

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  • Report this Comment On June 22, 2014, at 2:36 PM, IrvThal wrote:

    You're kidding, right? A few years ago, you could barely GIVE away LGF, and now you're recommending it on the strength of a single franchise? This is how DWA got into trouble in the first place -- building its reputation on one single franchise instead of putting that success in its proper context and moving forward with the best strategy possible. Apart from "Hunger Games," LGF has nothing. It can't do anything with "Twilight" -- that brand has been completely tapped out. "Hunger Games" has a couple of more films left, then IT'S done.

    Disney is obviously the gold standard here, and for sure they got lucky with "Maleficent," but "Guardians of the Galaxy" and the upcoming Marvel films outside of "The Avengers" are hardly slam dunks. Will the Marvel strategy allow for greater mining of the properties, or will Marvel be limited to an "Avengers"-related film every couple of years? Meanwhile, "Star Wars" is hardly the slam-dunk everyone assumes it to be. As Lucasfilm and Fox found out with the prequels, all the hype in the world won't matter if the films aren't excellent, and the track record Abrams has of screwing up franchises is pretty significant. He nearly killed "Mission Impossible," he couldn't build a successful franchise with "Super 8" (not even one sequel!), and he almost ruined "Star Trek" completely. Given that "Star Wars" is also shaping up to be an exorbitantly expensive film, possibly THE most expensive ever made, the fact that it will have to gross $2 billion to break even is pretty daunting.

    I think Katzenberg and Co. have figured out that they've been doing it wrong. An animated film cannot cost $175 million. Every animated film can't gross $500 million. They're going to have to go after singles and doubles and start loading the bases, EXACTLY the way Katzenberg did at Disney live action back in the mid to late 1980s with "Big Business," "Shoot to Kill," "Outrageous Fortune," etc. That strategy worked because it was cheap with high rewards. The $175-million-per-film strategy can't work. BUT ... DWA has been branching out into less-expensive TV, which also offers it great opportunity for international sales. It has been stepping up its licensing initiatives. It just needs to reign in costs (especially its outsized salaries) and move more confidently in the direction of creative growth with carefully controlled costs. I think there's a LOT of upside for DWA, certainly more than LGF.

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