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November 21, 2008

Why You Should Own Dreamworks Animation

This will be the first in a new series of columns I will write titled "Why You Should Own..."

The first stock is Dreamworks Animation (DWA) . DWA is currently trading at $21, a new 52-week low. The 52-week high was $32.73 on Sept. 2. The market cap is $1.9 billion. At the end of 2008, DWA should have about $350 million in cash and less than $100 million in debt. DWA pays no dividend.

The consensus estimate for 2008 is $1.82. For 2009, the estimate is $1.67. At $21, the P-E on 2008 is 11.5. For 2009, the P-E is 12.6. The lower 2009 estimate is because there are minimal revenues from Shrek, DWA's most profitable franchise.

Why You Should Own DWA for the Short Term

DWA has very positive earnings momentum that should hold through at least the first half of '09. The fourth-quarter 2008 estimate has risen over the last 90 days. The momentum is being driven by success earlier this year from Kung Fu Panda. Panda grossed $215 million domestically and $416 million abroad, making it DWA's most successful film besides the Shrek series. Even with a $130 million production budget and another $100 million plus for marketing, the film is profitable before DVDs. The DVD just went on sale and immediately went to No. 1 on the charts.

DWA will also benefit in the near term from the successful release of Madagascar: Escape 2 Africa on Nov. 7. The film is on track to match Kung Fu Panda and exceed the original Madagascar. While the timing of revenue and expense recognition means that Madgascar 2 will not contribute greatly to EPS in the near term, the success is a great confidence boost for meeting or even beating 2009 estimates, something that very few companies can now offer.

DWA has two other near-term catalysts. First, on Dec. 10. the company will be holding its first- ever analyst meeting. DWA has lots of good things to say about the near term and long term, so the timing is good.

Second, Shrek the Musical debuts on Broadway in December. On its own, the musical will not be a big profit-driver, assuming it is successful. But if it is a success, it further diversifies DWA's revenue stream and builds a greater base of long-term earnings power.

Finally, and maybe most importantly for the near term, DWA is a major media stock that has zero advertising exposure. There is minimal cyclical or secular challenge to DWA's business model unlike almost every other media stock.

Why You Should Own DWA for the Long-Term

2009 has been a critical year for DWA. The massive worldwide success of Kung Fu Panda and the successful sequel to Madagascar has dramatically boosted the company's long-term earnings power and the consistency of its financial results. Along with Shrek, DWA now has three franchises that can spin sequels. Each new film in each franchise boosts profits from the library via the films, merchandising and TV rights. Three franchises make it easier for DWA to release two films per year, one sequel and one original. It also takes the pressure off every original to be a resounding success. Wall Street rewards consistent long-term earnings growth. DWA exits 2008 in its best shape ever.

What Could Go Wrong

DWA trades at a premium to other media stocks, which now generally have single-digit multiples on 2009 estimates. The shares have also held up very well compared to other major media stocks that are down 50%-90%. DWA is subject to disappointing box office for any of its films. In the near-term, weak holiday sales for the Kung Fu Panda DVD or poor international box office for Madagascar 2 (it has only opened in Russia so far) are a risk. In 2009, DWA will be releasing two original films. Originals are not as profitable as sequels and present greater odds for a disappointment. DWA is also planning on a boost from 3-D for its films in 2009 and beyond. So far, the rollout of 3-D theaters has severely lagged expectations.

My Position

DWA was purchased in early November at just under $27. I have not added to positions since that time.

The Bottom Line

DWA has positive earnings momentum, minimal estimate risk, the potential for upside earnings surprises, a debt-free balance sheet and identifiable catalysts. These all support near-term performance while the long-term outlook has greatly improved, thanks to the broader portfolio of hit movies and franchises that now exist in the company's library.

Posted by Steve Birenberg at November 21, 2008 09:03 AM in DWA