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July 30, 2008

Dreamworks Thesis Falls Apart

My thesis on Dreamworks Animation fell apart when the company reported 2Q results after the close on Tuesday. While I understand the 10% decline in the stock, I think it is overdone and actually leaves value in the shares ahead of catalysts that are coming but not until October and November. The problem is there are fewer catalysts and they won’t help at all in the near term.

DWA reported better than expected 2Q revenue and EPS but all of the upside came from a one-time event. Excluding that the results were in line, maybe even slightly light. A good 2Q report was my first catalyst.

My second catalyst was more important: a big second half as revenues from Kung Fu Panda flowed through the income statement. Unfortunately, during the conference call, management guided international marketing expenses upward due to dollar weakness. I had been assuming that these expenses might be higher but the new guidance went up to 10% above the top end of the old guidance. Importantly to the story beyond the next few days is that despite the guidance change on expenses (which actually impacts DWA on the revenue line due to their distribution agreement with Paramount), most all analysts maintained their e2008 and 2009 estimates. It is the upside that was lost and upside is what was supposed to drive this stock.

As I mentioned, other catalysts remain but....

....they don’t have the same potential to positively impact the stock price and they won't occur before late fall. Until that time, one thing that will help is the new larger, share buyback announced yesterday. Based on comments on the call about how and when the buyback is used I am confident the company will be a buyer at current prices.

The other catalysts are the November release of Madagascar 2, the December opening of Shrek musical, and the launch of a new TV show on Nickelodeon based on Madagascar characters. DWA is an event driven stock so this is the sort of the stuff that allows for good trading opportunities. In particular, excitement surrounding Madagascar, which apparently already scores well on awareness surveys should lead to upside in the stock.

I am still long DWA for Northlake clients which was bought throughout June and early July at $29-31. I had a sell order in at a little over $30 today but it never went off. I'll be looking for a chance to sell near that price over the next few days. Hopefully, investors will realize that the sell-off was overdone. If not, I'll have to re-evaluate.

Posted by Steve Birenberg at July 30, 2008 04:19 PM in DWA