DreamWorks Animation (NASDAQ:DWA) was founded in 1994 by Steven Spielberg, David Geffen, and Jeffrey Katzenberg, with Katzenberg currently at the helm as CEO. The animation studio has released only 31 films in its history, but with a couple of its Shrek movies alone, it's responsible for two of the 50 highest-grossing films of all time.
Recently, the company and the stock price have been hit by weakened box-office performances. Can this company turn it around?
Two movies a year?
Earlier this year, Katzenberg announced that DreamWorks will cut down annual production to two films a year. The company also aims to cut the budget per film from a range of $145 million to $150 million down to $120 million. That may not seem like a lot, but $60 million in annual expense savings for a company with just over a $2 billion market cap is significant and could be the difference between profitability or a costly writedown.
Lower budgets and special productions
The new focus on two films a year should give investors clarity about expenses. DreamWorks Animation has already finalized its film slate through 2018, which includes How to Train Your Dragon 3 and Kung Fu Panda 3.
Along with more concentrated bets and lower budgets, DreamWorks is going to occasionally create special productions such as Captain Underpants, which the company says "is being produced outside our normal process at a significantly lower cost, and is scheduled for release in 2017."
Potentially huge returns ... or misses
There is a sense of freedom for a small production studio nestled within a larger conglomerate. A flop of a Pixar film won't do any substantial damage to Disney's economics.
By remaining independent, DreamWorks shoulders a tremendous amount of risk. Compared with another independent studio, Lions Gate Entertainment, DreamWorks is more exposed by producing just two films a year. One flop would be damaging, while two could be potentially devastating.
By focusing on only two movies per year, the company also has tremendous potential upside. A billion dollars or more in worldwide gross for a company with a $2 billion market cap would likely propel the stock higher. If DreamWorks were a subsidiary of a $100 billion-plus company, the effect on the parent company's earnings would be nice but not enough to really move the needle.
International becomes more important
When the first Shrek film was released in 2001, the domestic gross was responsible for 55.3% of total box office sales. Those numbers have shifted toward the international market over time. The latest film in the series, Shrek Forever After, drew 68.3% of its sales from overseas.
In the past few years, DreamWorks Animation's films have routinely received over 70% of their total sales internationally. While it's good for the company to have success in international markets, more parity with domestic sales would be beneficial. For comparison, Pixar's top 15 highest-grossing films derived an average of 57.6% of their sales overseas.
Better off as a subsidiary? It depends.
This company isn't easy to model because of the choppiness of its sales and earnings. Success with 2016's slate of films wouldn't guarantee a similar level of success in 2017. Katzenberg has made it a point to get more hands-on with the production of great films after spending much of his time expanding DreamWorks "into other businesses like expanding into China, theme parks, live touring shows, licensing."
Getting back to basics and producing two great movies a year is all this company needs at its current size to outperform the market going forward. An investment in DreamWorks is a belief that Katzenberg can get movie production back to the levels of critical acclaim and profitability that it's experienced in the past.
The greatest upside for DreamWorks remains in staying independent and executing in this area. In the long run, I could see an acquirer that's good at leveraging intellectual property into multiple revenue streams, such as Disney, taking a stab at integrating the company into its own portfolio. Doing so would assure shareholders of a premium to current prices, but it would deny them all of the potential upside of DreamWorks as a stand-alone public company.
I'll be holding my shares for the near future while I see how the 2016-17 slate of films performs. I like the upside potential and think an acquisition could provide some potential downside protection if the company falters and the stock price takes a hit.
James Sullivan owns shares of DreamWorks Animation, Lions Gate Entertainment, and Walt Disney. The Motley Fool recommends DreamWorks Animation, Lions Gate Entertainment, and Walt Disney. The Motley Fool owns shares of Lions Gate Entertainment and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.