Marvel (NYSE:MVL) seems to be taking its cue from the George Lucas handbook of moviemaking: Take a hit, sequel it for all it's worth, and merchandise, merchandise, merchandise. It's great work if you can get it, and between the successful Spider-Man and X-Men franchises, Marvel seems to be on top of the world right now.
Let's not forget, though, that even Lucas and Marvel can make mistakes. Lucas, after all, teamed up with Universal Pictures (now a unit of General Electric (NYSE:GE)) to produce Howard the Duck, a horrid movie based on a far less-awful Marvel comic of the same name. That movie was so bad, in fact, that it was named among Siskel and Ebert's worst films of 1986. That's a far cry from both Lucas' tremendous successes with the Star Wars and Indiana Jones franchises, and Marvel's more recent superhero blockbusters.
Such is the risk of tethering your company's fortunes to the ever-fickle entertainment world. No matter how big your name, the payoff is always uncertain until the receipts are counted. That makes speculating on the future of the business a very difficult task, indeed. Look no further than Disney (NYSE:DIS) and its market-trailing 10-year performance to see what happens when an entertainment company loses its magic.
Will history repeat itself?
I'm not in any way claiming that Marvel is a bad company, or that it produces bad products. On the contrary, I fully admit that a disproportionate share of my own entertainment budget helped fuel the company's recent successes. I dressed my own son as Spider Man for his first Halloween, in fact, and I also own more Marvel DVDs and comics than I care to count.
My problem with Marvel is that its shares look rationally priced only if you believe it will continue to put out hit after hit, year after year. Sure, its recent earnings growth looked spectacular, but how much of that was due to the one-time effect of revamping its toy licensing deal with Hasbro (NYSE:HAS)? What happens if the upcoming The Incredible Hulk or Iron Man flop? Marvel's $200 million in borrowed cash to produce those films won't repay itself.
They say that pride goes before the fall. Marvel itself went through bankruptcy in the 1990s, largely from overleveraging its name and reputation. The deeper the company reaches into its vault to find the next blockbuster, and the more leverage it takes on to juice its returns, the bigger its chances of a colossal flop.
What goes around comes around
In other words, it's dangerous to look at Marvel's recent straight-up growth trajectory and presume that it will continue into the future. To sustain that level of growth, every future blockbuster needs to be bigger than the last one, and the hits need to keep on coming at an ever-more-rapid pace. It simply cannot happen forever.
I sincerely hope that Marvel has learned enough to avoid another bankruptcy. At the same time, I can't help feeling that its financial picture closely parallels deep cyclical companies like Ford (NYSE:F), US Steel (NYSE:X), and Caterpillar (NYSE:CAT). Between the debt financing of its operations, the capital-hungry investments, and the reliance on customers who've proven themselves very price-sensitive, the parallels are uncanny. And with Marvel's stock looking reasonably priced only if it can continue to deliver frequent blockbusters, I simply see more risk than reward currently priced into its shares.
Marvel the company has kept me entertained for decades. Unfortunately, it looks like I missed my chance this past go-round with Marvel the stock. As long as its business model looks so eerily similar to some of the greatest cyclical companies in our economy, though, it seems worthy of keeping on my watch list.
The time to buy any cyclical company is when things look their worst, not when they're riding the high tide of stupendous earnings -- no matter how low the trailing P/E ratio may get. I'll wait 'til next time, and simply enjoy the entertainment Marvel provides.
