Why SoftBank Wants to Make Movies With DreamWorks Animation

Japanese telecom giant SoftBank (SFTBF -4.43%) wants to make Hollywood movies. Recent reports state the company is interested in acquiring DreamWorks Animation (DWA), the studio behind Shrek, Madagascar, and How to Train Your Dragon. The proposed acquisition could complement SoftBank's $250 million investment in Legendary Pictures, which recently financed Godzilla and 300: Rise of an Empire.

Source: Wikimedia Commons.

SoftBank has been growing quickly over the past few years. The company acquired an 80% stake in Sprint last year, owns mobile game maker GungHo Online Entertainment, and holds partnerships with Japanese subsidiaries of E*Trade, Ustream.tv, EF Education First, and Morningstar. However, SoftBank's talks with DreamWorks and investment in Legendary Pictures hint at big plans to build a media empire, just as Sony (SONY 0.37%) did with the acquisitions of CBS Records and Columbia Pictures in the late 1980s.

Can SoftBank really evolve from a telecom company into a media conglomerate? Let's break down the facts and figures to see for ourselves.

Why SoftBank wants to make movies
Between fiscal 2009 and 2012, SoftBank's annual revenue rose 16% while its net income soared 285%. This was attributed to the growing adoption of smartphones since the iPhone's debut in 2007 and the subsequent rise of mobile gaming.

Between 2012 and 2013, revenue more than doubled to $64.8 billion and net income rose 41% to $5.1 billion, thanks to the inclusion of Sprint's earnings. If SoftBank acquires DreamWorks Animation, it would add $700 to $750 million more to its top line, based on the studio's annual revenue over the past three years. Last year, 71% of DreamWorks' top line came from its feature films, 15% came from TV specials, and almost 10% came from consumer products. 

The talks with DreamWorks Animation, as reported by The Hollywood Reporter, would value the animation studio at about $3.4 billion -- which would represent a 67% acquisition premium based on a stock price of $24. Although filmmaking can be a risky business, SoftBank is probably interested in expanding marketable DreamWorks characters such as Shrek to GungHo's mobile games or cross promotions for its e-commerce and telecom businesses.

Madagascar 3. Source: DreamWorks.

Why DreamWorks Animation should sell itself
DreamWorks Animation -- which should not be confused with DreamWorks Studios, the live-action arm from which it split in 2004 -- has not impressed investors for a long time.

The stock has fallen 33% since the beginning of 2014, due to poor earnings, a regulatory investigation into a writedown related to its snail-racing film Turbo, and weak promises that the Chinese release of How to Train Your Dragon 2 and the upcoming release of Penguins of Madagascar would get the studio back on track.

The problem with DreamWorks Animation's business model is that it completely relies on jumping from one film to the next, in hopes that the next movie won't bomb. It also only releases about two films per year.

Source: Box Office Mojo, Rotten Tomatoes.

DreamWorks spends roughly the same amount of money per film, but the box office results have been unpredictable.

Investors should also note that impressive global box office figures don't equal the amount of revenue that actually goes to DreamWorks Animation. Movie theaters keep about 20% to 25% of the ticket sales during the first few weeks, after which their cut rises to 50% to 80%.

The film's production budget also doesn't cover marketing costs. That's why DreamWorks doesn't distribute or market its own films. Between 2006 and 2012, it relied on Viacom's Paramount to do both. In 2013, it signed a five-year distribution deal with Fox (FOX), and pays the company 8% of box office and home video receipts and 6% of digital distribution revenue.

Deduct all those figures, and DreamWorks' returns are a lot less impressive. By the end of fiscal 2013, The Croods grossed $587 million worldwide, but that only translated to $138 million in revenue for DreamWorks. And Mr. Peabody & Sherman, which looks like it did well worldwide, will ultimately be unprofitable for the studio.

Mr. Peabody & Sherman. Source: DreamWorks.

Since DreamWorks' business model is a hit-and-miss system dependent on two films a year, it would function better within a larger conglomerate, like SoftBank, than as a stand-alone company. For example, DreamWorks' rival Pixar functions better as a Disney subsidiary, because it is under less pressure to release films at regular intervals.

The Foolish takeaway
Media investors should keep a close eye on SoftBank's interest in DreamWorks Animation and Legendary Pictures. If SoftBank buys DreamWorks, more acquisitions could follow, which could turn it into the next Sony. DreamWorks investors, on the other hand, should hope for a buyout, since its dependence on two big films annually is far too unpredictable as a long-term strategy.