DreamWorks Animation (DWA) is a movie studio controlled by Hollywood luminaries Steven Spielberg, Jeffrey Katzenberg, and David Geffen. Their crown jewels are the blockbuster franchises of Shrek, Madagascar, and Kung Fu Panda.
When we talk about great businesses, we tend to banter about pricing power and high margins and asset-lite models. In layman’s terms, it’s getting people to pay for something that costs you nothing. So what’s great about beloved fictional cartoon characters? They never demand a salary. They don’t get embroiled in real-life scandals. They don’t grow old.
Disney understood this almost 100 years ago. This is also why they acquired Pixar, then Marvel, then LucasArts. They all have intangible, indestructible franchises that live forever. Not only can you keep making movies about them, you can sell tons of merchandise and erect entire theme parks around them. All of this, if managed well, can be a perpetual geyser of profit.
It is, however, difficult and expensive to establish these franchises. It costs a lot of money up front to make movies. Accounting principles then dictate film production costs are to be amortized once revenue beings accruing. As such, most of the expenses are front-loaded. This is a quirk but it is not unreasonable – most filmmaking endeavors are boom or bust; they do not have a long tail. Only by thinking a little harder about the nature of animated films, and more specifically, successful animated films, can one come to the realization of the hidden intrinsic value in companies like DreamWorks.
Here are how their movies have fared for the past five years:
You will note: a string of profitable releases, with a number of blockbusters raking in over half a billion in gross receipts. Although it may not be in the league of the Pixars or Marvels or LucasArts, it certainly should be considered as a reliable hit-maker at this point. More importantly, they are strengthening their franchises, franchises headed by immortal and incorruptible animated characters that represent cost-free revenues in the long run.
The stock market, ever schizophrenic, does not seem very impressed. Over that same period, DWA has been as low as $16 and as high as $35 – a 100% swing from trough to peak:
Meanwhile, the world has been changing. Distribution of entertainment, once comfortably ensconced within the movie theater -> VHS/DVD -> network TV paradigm, is being disrupted by Netflix, Hulu, Amazon and their ilk. Content has become more valued in a world where distribution is being commoditized by the internet. You want people to watch your channel or subscribe to your service? Offer exclusive content.
You know how this story ends. In late April, Comcast made a bid for DreamWorks for $41 per share, a 50% premium above DWA’s 52-week high. Intrinsic value wins again.
Unlike the Virgin America case study, it was not guaranteed you would bank a great return if you bought DWA anytime within the past five years. If you bought at the peak at the end of 2013, you only made 6.5% annualized return. One would imagine, though, if you had the conviction then, you would have made additional, larger purchases as the stock sold off over the next two years. As such, a cost basis of anything under $25 within the past five years would have yielded a double-digit compounded return. Within the past three years, it would be in the high teens.
DWA was a stock I had watched for a long time. I never pulled the trigger because I never got comfortable enough with the valuation. Intellectually I understood the thesis, but I kept hoping for it to get cheaper. Patience can be difficult – a dual-edged sword, especially in the stock market. Patience in waiting for a security to become fully valued is a virtue, but excess patience in waiting for a security to reach an acceptable price could result in lost opportunities. Neither is preferable: Not taking enough risks is as big an impediment to wealth creation as taking too many dumb risks. Finding the balance is a never-ending quest, a life-long learning experience.
