The following is part of our week-long Rule Breaker series, where we Foolishly examine several companies and ask, "Is it a Rule Breaker?" Hey, even better, we'll answer the question for you.
What type of parent are you? Do you fret about your 6-year-old having too much "screen time," and do you feel that the Cartoon Network threatens to corrupt the delicate virtues of our nation's youth? Or are you the type that joins your 5-year-old in watching Spider-Man (though you'd take care to cover his eyes when the Green Goblin gets impaled at the end of the film)? OK, so I'm in the second camp. Fortunately for parents, DreamWorks Animation
But DreamWorks isn't the only studio producing these types of movies, is it? Sure, it created the top-grossing animated film of all time in Shrek 2 and has another blockbuster in Madagascar planned for the end of this month, but isn't there another film studio doing computer-generated (CG) animation that is even more innovative and successful? Um, yes, there is. Even Jeffrey Katzenberg, CEO of DreamWorks Animation, refers to its main rival, Pixar
Just another brick in the wall
Let's begin our attempt to answer these questions by first considering DreamWorks Animation in greater depth. The company went public toward the end of 2004 and boasts revenues of more than $1 billion per year. Its extremely volatile shares are trading at 19 times forward earnings, and many Wall Street analysts believe the shares are overpriced at the moment. Some observers predict that there will soon be a glut of CG-animated films on the market, a situation that will greatly affect the firm's revenues. Others believe that the business is very hit-or-miss -- a situation that exposes investors to significant volatility.
As you can see, there are considerable doubts about the company. This might be the "wall of worry" that David Gardner, lead analyst for Motley Fool Rule Breakers, looks for in a great investment. The "wall of worry" refers to negative impressions the public might have about a particular company that keeps the stock undervalued in the short term. Insightful investors are able to see beyond the wall and scoop up great companies at reasonable prices.
The biggest worry relating to DreamWorks Animation is competition. In addition to Pixar, it will now have to contend with newcomers such as Sony
Common sense isn't that common
Here's why I'm not alarmed by the conventional wisdom. DreamWorks Animation spends about $125 million and devotes three to four years of production time for each of its films. It has recently announced that it will be releasing two films per year in the future, compared with one every 18 months for Pixar. These enormous up-front costs no doubt leave very little margin for error. I would also admit that there are numerous companies that have the money and technology to invest in such projects. But have these same companies assembled a creative team with proven successes under their belt? And will they be able to generate blockbusters on a consistent basis?
DreamWorks Animation has the creativity and products to perform extremely well over the next few years. The company is now committed to focusing solely on CG animation. It has already made four films in this area, with overall revenues from the box office and home video sales well over $2 billion. Shrek was wildly successful, and Shrek 2 almost doubled the sales of the original.
The pipeline of future films is particularly promising. I've mentioned Madagascar, which uses voice-overs by such Hollywood luminaries as Ben Stiller and Chris Rock. Shrek 3 is in the pipeline, as is a Jerry Seinfeld project called Bees. Can you really imagine a scenario in which any one of these films falls flat? I'm no Roger Ebert, but I'm going to go out on a limb: All three will be huge hits. When you factor in the box office take, DVD sales, and promotional tie-ins, each project has the potential to bring in $1 billion. So regardless of the competition, DreamWorks Animation can expect to be rolling in you-know-what in the near future.
Surely the market must be taking into consideration the future revenues of these films. Right? Actually, I'm not so sure. Did the market know how to value Google
Can No. 2 be No. 1?
Despite the outstanding potential of DreamWorks Animation, you could make a very persuasive case that Pixar is flat-out better at making CG-animated movies. I recently witnessed 20 first-graders, juiced up on Coca-Cola and chocolate birthday cake, sit spellbound while watching Pixar's The Incredibles in our living room. And few would deny that Toy Story was one of the great films of recent memory. For perspective, I've included a few numbers comparing the two companies:
|Revenues||$1,078 million||$274 million|
|Earnings per Share||$4.05||$2.38|
|Return on Equity||40.3%||11.6%|
Because of the choppiness of revenues in this industry, one year's worth of data might not be that useful. The table does allow for some interesting comparisons, however. Pixar obviously has outstanding profit margins, while DreamWorks is capable of putting together strong sales and earnings per share in any given year.
Quite often, we are faced with choosing between two strong companies. Do you like Netflix
Rule Breakers are the top dogs and first movers in important, emerging industries. For this reason, Pixar is the Rule Breaker here. But that was then and this is now. Pixar's throne is being challenged by a company with arguably just as much savvy and potentially more resources. While I'm not quite ready to call DreamWorks Animation a Rule Breaker, I think the company has excellent prospects in the near future. Actually, both companies should do very well, and it might defy conventional wisdom to invest in both of them. It might be extremely profitable to do so as well.
When the game was on the line, future hockey Hall of Famer Mark Messier would encourage his even more famous teammate, Wayne Gretzky, to "keep hunting" for goals. We have the same philosophy at Rule Breakers. While David Gardner has had some extraordinary investing successes with AOL, Starbucks, and Amazon.com, he and his fellow analysts never stop hunting for great investments.
So far, our team of analysts has identified 15 potential Rule Breakers on behalf of our investment community. To examine these companies in greater depth, take a 30-day trial on us. The free trial will give you access to all of our back issues, as well as our discussion boards and special features. If you find that this style of investing is not for you, just cancel your trial. You won't be out a dime. We promise.
For related Rule Breaker Foolishness, check out:
- Searching for Rule Breakers by David Gardner
- Is Apple a Rule Breaker? by Rick Munarriz
- Is eBay a Rule Breaker? by Alyce Lomax
- Is Dendreon a Rule Breaker? by Karl Thiel
- Is Geron a Rule Breaker? by Charly Travers
- Is Netflix a Rule Breaker? by Beirne White
- Is IBM a Rule Breaker? by Carl Wherrett and John Yelovich
- Is Google a Rule Breaker? by Tim Beyers