DVD Nightmare at DreamWorks

Updated from 8:30 a.m.

Shareholders who held on to Dreamworks DWA after its first-quarter profit wipeout were shredded anew.

The animation studio slashed its second-quarter profit forecast Monday, citing marketplace problems that have hurt sales of its home video titles. Dreamworks, which had previously predicted a breakeven quarter, now expects to lose 7 cents to 9 cents a share.

The company said the Securities and Exchange Commission is informally investigating trading around the first-quarter profit announcement. Dreamworks is complying with the probe, which revolves around the shocking first-quarter earnings miss of two months ago -- a setback that also stemmed from home video shortcomings.

The company also pulled a planned secondary offering in which investors including Paul Allen were hoping to unload $500 million of stock. "Based on the current valuation of our shares, we believe it is in the best interest of all parties, including the company and its current shareholders, to withdraw the offering at this time," Dreamworks said.

In its release, Dreamworks lowered its full-year profit guidance to 80 cents to 90 cents a share. Analysts had been expecting $1.39 a share. The high end of the revised range left the shares trading at 30 times earnings as of Friday's close. That multiple compressed to 26 Monday as the stock slid to $24.15, down $2.66, or 10%.

The hammering is all the more galling for shareholders in light of the first-run success of Madagascar, a feature that has grossed about $180 million domestically. Dreamworks' problems continue to lie in the video aftermarket, where Shrek returns sank the first quarter.

A similar fate befell rival Pixar PIXR two weeks ago.

Dreamworks said the Shrek situation led it to an extensive review of home video sales, inventories and returns, both at home and abroad.

"As part of this review, we have observed changes in the marketplace that appear to have impacted our titles," the company said. "While it is too early to determine if these changes are temporary or permanent, we think it is prudent at this time to adjust our guidance to reflect higher than expected returns as well as revisions to our video forecasts."

Sanders Morris Harris media analyst David Miller adds that the studios need to change how they handle DVD shipments to retailers. Retailers, he says, have become more aggressive in returning discs, and the studios need to undership while still being ready to ramp up follow-on shipments in cases of strong sustained demand.

In the case of both Shrek 2 and Pixar's The Incredibles, the studios and their wholesale partners shipped huge numbers of DVDs into strong early retail performances, only to retail buyers shun the films after a number of months.

Some have suggested that the DVD market has matured, but Miller says the reality is that penetration rates are 65% in the U.S. and only 45% in Europe. He asks why retailers would be expanding warehouse and shelf space if the DVD market were actually flagging.

Instead, he says, the animation studios are particularly vulnerable to retail woes because they are so dependent on single titles. By contrast, the bigger studios have a broader array of movies that they can draw their sales from.