A Combined Comcast/DreamWorks Is Greater Than the Sum of Its Parts

Hardly anyone saw Comcast's (CMCSA 1.57%) acquisition of DreamWorks Animation (DWA) coming before the news dropped.

It's a deal that makes sense, but the purchase comes at a very high price for a company that counts Shrek, Kung Fu Panda, and How To Train Your Dragon as its signature properties. In this segment from the Industry Focus: Consumer Goods podcast, Vincent Shen and Sean O'Reilly explain what both parties are getting out of the deal.

Find out what the acquisition means for DreamWorks shareholders and how much the purchase could affect Comcast's bottom line. Learn how being owned by Comcast will increase the value of DreamWorks' intellectual property and how this acquisition measures up to Disney's (DIS 0.16%) acquisitions of Marvel and Lucasfilm.

A transcript follows the video.

This podcast was recorded on May 3, 2016. 

Vincent Shen: On the side of being acquired, for DreamWorks shareholders, I think overall investors are probably quite pleased with what is turning out to be a nice turn of events for them. The stock peaked in late 2013 at just over $35 per share, and since then it has generally been trading at a range between $20 and $25. They've had hits and misses at the box office.

Sean O'Reilly: That's what I was about to comment. They've obviously had some hits, like Shrek and Madagascar and stuff, but they've had a lot of flops, too.

Shen: Yes.

O'Reilly: It's kind of middling along, and of course they have to compete with the behemoth that is Disney's Pixar.

Shen: We've seen that in the results, too. The company's logged a net loss in three of the past five years. A lot of their adjusted earnings numbers are turning positive only after they back out some of these major restructuring charges that they announced, I think it was at the beginning of 2015. We're talking about millions of dollars in terms of employee termination contracts, but also write-offs that they took with properties that ended up not working for them.

Full-year 2015 results definitely showed some positive momentum. Revenue was up 34%, and they had pretty robust growth across the company. That included their feature films, their TV series, the consumer products, their new media. Looking at the ticket sales from Box Office Mojo, though -- this put things in perspective for me -- of DreamWorks' top 10 highest grossing movies in the U.S., only two of them are from the past five years.

O'Reilly: Yeah. That sounds about right.

Shen: When you adjust for ticket price inflation, that falls to just one. Only one of its top 10 best performers within the U.S. box office at least are recent properties. A lot of their bigger movies, their franchise Shrek, for example, that finished its last film in 2010. How to Train Your Dragon's done well for them. They have How to Train Your Dragon 3, I believe, coming out next year.

The thing is, the company's definitely struggled with some of its flops. That included Mr. Peabody & Sherman, Turbo, Penguins of Madagascar, where they basically could not recoup all the costs they spent on production and on marketing. Definitely, I think for DreamWorks shareholders, they're happy. [Jeffrey] Katzenberg said basically this is the deal that we've been waiting for. He's the CEO and founder of the studio.

On the Comcast side, obviously it's going to be much less of an impact. We have to keep in mind -- I want to make sure our listeners have the context for this purchase -- Comcast can pay for it with their cash on hand, $3.8 billion. They have about $5.6 billion, I think, cash on hand. That $41 per share; they're giving DreamWorks shareholders a payout of about 80 times their expected 2016 earnings for DreamWorks, so really, really big valuation.

At the same time, keep in mind that the film entertainment division, where DreamWorks is only going to be a part of, it still only makes up about 10% of total revenue of Comcast. Ultimately, the company still generates over 60% of its top line from its actual core cable business. If we remember that, this deal's likely, as I'll get through the details, it's going to be additive, it's still a very small piece of a much bigger puzzle.

Moving onto what Comcast is really getting from this. I think it comes down to three things: DreamWorks' content library, the opportunities it has to integrate that intellectual property into other segments, especially its theme parks, and then Jeff Katzenberg.

In the first, DreamWorks has a ton of famous characters. You mentioned a few of them. We're talking about Shrek, Kung Fu Panda, How to Train Your Dragon. They also have actually a lot of older characters I didn't know about, like Rudolph the Red-Nosed Reindeer, Casper, Lassie, I think Frosty the Snowman.

O'Reilly: I can't believe they own Rudolph.

Shen: That's really big for Comcast to be able to leverage, especially with some of their TV entertainment, their theme parks. A big project that Comcast has for its theme-park division, actually, they're building a multibillion-dollar new park in China, near Beijing. It'll occupy 300 acres. It'll eventually develop out through multiple phases to about 1,000 acres.

O'Reilly: Is that part of the ... you know what I'm talking about. DisneyLand or Disney World China's in a huge part outside Beijing.

Shen: That's Shanghai.

O'Reilly: OK. I'm sorry. Is that part of it, then?

Shen: I'd say it's part of a wider effort to develop these theme parks. China's becoming basically the biggest theme-park market. Within China, in that same market, which is, by the way, expected to soon outpace the U.S. as the biggest box office market, DreamWorks also has some relationships and joint ventures that I think Comcast could really leverage.

Just for example, currently in China they have basically a quota on the number of foreign films that can be shown in China, in part to protect their domestic features. I think that number's around three dozen, about 34 movies per year now, but with the recent release of Kung Fu Panda 3, basically DreamWorks was able to develop that with a joint-venture studio in China, and they were able to release that without being on the quota list, for example. Just part of that relationship they developed there that I'm sure Comcast wants access to, with China becoming a really big entertainment market for them.

In terms of the management, and getting back to Katzenberg. He's going to be like a consultant now to NBCUniversal. He'll also be focused on AwesomenessTV, which has been a big piece of growth for DreamWorks. It's basically this millennial-focused, multimedia platform. The actual leadership now for DreamWorks is going to be Chris Meledandri, who currently runs Universal's own animation studio, which is Illumination Entertainment.

Illumination itself, Comcast has already seen some success. Despicable Me, Minions have been huge, especially in the past two years. I'm really interested to see what this guy Chris is going to be able to do in terms of changing the vision a little bit. A lot of people were starting to think at least that Katzenberg had maybe taken DreamWorks as far as he could, with the somewhat lukewarm results over the past few years and some of the box-office disappointments, not really certain anymore in terms of where he can take the company. Now you have the resources of Comcast, its distribution platform, and where this new vision can take it. I think people are very bullish on that.

Just thinking about, also, I think how Comcast was tempted into this deal. You mentioned that it was a bit out of the blue. DreamWorks has been a potential acquisition target multiple times now for other companies.

O'Reilly: It's been a pervasive "Oh, they'll get acquired by somebody" stock for years, and here we are.

Shen: Based on some of the background for how this deal came about, I was able to find in a report from the Los Angeles Times. Basically, Katzenberg was potentially working with Chinese investors to take the company private. When Comcast management basically heard about this, they immediately jumped on the deal.

They flew out, met with Katzenberg, got a tour of the facilities, looked at the financials. I think it was just maybe a week or two later they were able to announce this deal. Really fast turnaround. Putting things, again, into context now for again some of the competition, we've mentioned Disney. Obviously, they have had a string of hits based on their prior acquisitions of Lucasfilm, for example, Marvel, Pixar --

O'Reilly: That's putting it mildly.

Shen: A lot of people see that as the gold standard of how that company has come to dominate the entertainment world. Let's just look at this a little bit. Marvel was a $4 billion purchase in 2009 for Disney. Lucasfilm was a $4.1 billion purchase. Right around the size of this deal for DreamWorks, $3.8 billion. The question is, does DreamWorks have those characters and that intellectual property that is able to generate these massive hits that Marvel and Lucasfilm have? People are not sure about that.

O'Reilly: Based upon the price tag that we're talking about for DreamWorks, that makes Marvel look like the deal of the century right there.

Shen: At the time a lot of people had considered Bob Iger as being willing to pay top dollar for these companies.

O'Reilly: Right.

Shen: Their value obviously played out as part of that Disney ecosystem, call it.

O'Reilly: Right. That's just it. When you were talking and everything, I kept thinking to myself, the reason it works for both parties is because DreamWorks is more valuable under the Comcast umbrella, just as arguably Star Wars is more valuable under the Disney umbrella because they can make rides and put on TV shows.

Shen: Yeah. I do believe that DreamWorks, in terms of its future and where its films will go, and its TV shows and things like that, I do think there's a lot of potential in joining with such an essentially bigger parent, with something with a lot of influence. NBCUniversal, Universal Studios did incredibly well in the box office last year. I think they led all the major studios, actually, in terms of ticket sales.

With all of that in mind, Comcast, this is a small deal for them even at $3.8 billion, and even at that high premium. Not excusing that, at the same time I do see where they find what they see as big opportunities in terms of in China in leveraging some of that IP library that DreamWorks has and then basically turning this into a good deal. I think Comcast management has proven themselves with previous acquisitions to be pretty savvy with integrating the companies that they buy and having a good eye for what they think will be strong assets for them. This is just another example of that.