Below expectation sales of DVDs of The Incredibles coming on the heels of a much larger shortfall for Shrek 2 have accelerated already brewing concerns about DVDs as a growth engine for movie studios. This has ramifications for Disney (DIS) and Lions Gate Entertainment, (LGF). Disney (DIS) has benefited greatly from sales of DVDs from its library of animated hits and my investment thesis on LGF rests largely on margin expansion related to DVD sales from the string of recent box office success the company has enjoyed….

Prior to the shortfalls for The Incredibles and Shrek 2, Wall Street was already been worried about the sustainability of DVD growth due to peaking penetration of DVD players in households in the U.S. and abroad. There is also evidence that after several years of growth the ratio of DVD titles per DVD player has begun to plateau. Another factor that could be having an impact of DVD sales is an accelerated sales cycle. Much like theatrical box office, it appears that DVD sales have a shortening life span, possibly less than a month for most titles that were recently in domestic box office release. On the flip side, reading too much into shortfalls for titles with expected sales of 40 million or more units might not be applicable to companies that are not reliant on just one or two titles per year.
Given theses issues, my long positions in DIS and LGF should be questioned. Both stocks were under pressure last week, at least partially related to fears about DVD sales.
For DIS, DVD sales are not a catalyst to my bull thesis. Rather growth will be driven by the turnaround at ABC, improved theme park attendance and margins, a strong FY06 film slate, possible sale of radio, opening of Hong Kong Disneyland, the Disneyland 50th Anniversary celebration, and continued growth in cable networks. I think these catalysts will overcome any shortfall in sales of DVDs.
For LGF, I think the company has had enough recent box office success to offset any reduction in DVD unit sales. On its conference call last week, management noted that initial sales of Diary of a Mad Black Woman were extremely strong and I am willing to bet that sales of Crash to be released in September won