Why DreamWorks Might Want a Takeover Offer (But Likely Won’t Get One)

Updated from 6/30 to include updated DreamWorks comments in 6th paragraph.

NEW YORK (TheStreet) -- As media conglomerates pair up (or at least attempt to), DreamWorks Animation  (DWA) is one of the few independents to be left on its lonesome to tackle waning interest in blockbuster films, animated or otherwise.

On the surface, DreamWorks appears to be an attractive takeover target. Its annual revenue hover around $707 million and it has a string of successful franchises including Shrek and The Croods that are likely to continue racking up sales through consumer products, licensing and home entertainment.

But after two quarters of losses far wider than expected, the family animation studio is now trading at its cheapest level ever. In its most recent second quarter, DreamWorks reported a net loss of 18 cents a share compared to losses of 2 cents a share expected by analysts, leading shares to crater more than 11% over Wednesday's session. Year to date, the stock has lost more than a third of its value, cratering 43.7% to $19.98 compared to the S&P 500's 6.6% gain.

Courting a deal would surely benefit DreamWorks. "As an independent studio, there could be more synergies as part of a larger media company, both on the production and distribution side," argued S&P Capital IQ's Tuna Amobi, who retained a "buy" rating, in a phone interview.

But, DreamWorks' intrinsic value is countered by a lack of demand. Television properties and merchandising opportunities aside, the company's performance is still primarily tied to how its films fare at the box office.

DreamWorks' head of public relations, Allison Rawlings, declined to comment on whether the company would be open to M&A activity. 

Weakness at the box office has plagued DreamWorks over the past several quarters. A quarter earlier, the Glendale, Calif.-based studio reported a net loss of 51 cents a share, more than three times wider than the analyst consensus, due to a $57 million impairment charge on its March release of Mr. Peabody & Sherman.

Its summer 2013 film Turbo also saw disappointing results domestically, generating only $83 million in U.S. and Canadian markets. The company took a $13.5 million write-down in February for that movie, the accounting for which is currently under SEC investigation.

If industry talk is to be believed, DreamWorks has flirted with the idea of a takeover before. "Although it was kept very quiet at the time, we're certain that CEO Jeffrey Katzenberg put the company up for sale two years ago and there were no buyers," Topeka Capital Markets' David Miller (who maintained a "hold" rating and $23 price target) told TheStreet.

Cowen & Company's Doug Creutz added he heard rumors as early as 2010, recalling, "They couldn't find any buyers back then and that was when their economics of their film business looked a lot better than they did now."

Therein lies the problem for DreamWorks. Though it has had several successful franchises in a relatively short history, albeit without the level of consistency Pixar has enjoyed, there isn't a market for movie studios at the moment. 

All the major media conglomerates already have an animation arm or have cash tied up elsewhere, Miller noted: Comcast (CMCSA) has Illumination Entertainment which has succeeded with its Despicable Me franchise, Warner Bros. (TWX) recently knocked it out of the park with The Lego Movie, 21st Century Fox (FOXA) owns Blue Sky Studios, producer of Rio and Ice Age, and Walt Disney Co. (DIS) animation is a force in animation which doesn't need fortifying.

Even if there were interest, softness at the box office could deter buyers from taking on more risk. As we near the end of 2014's summer blockbuster season, overall domestic box office sales are down 20%, according to The Hollywood Reporter, with analysts forecasting a 4%-5% deficit for the full year. No summer blockbuster this season, which included Maleficent, Transformers: Age of Extinction and The Amazing Spider-Man 2, has cracked the $300 million mark in North American markets, something not seen since 2001.

However, as big blockbusters fail to exceed expectations, perhaps then DreamWorks' tried-and-tested franchises are a balm to the major studios' hit-and-misses. "Go down a list of the top media conglomerates and I think any one of them would find this company potentially appealing, especially with the established franchises that are already in place that would be a good source of ancillary and home video recurring revenues and new franchise and sequels in the pipeline," Amobi argued.

Even if this box office slump continues, the studio is hedging its bets and making moves to diversify, investments that, if successful, could make an acquisition more palatable to buyers. "They're investing a lot of money. They gone from being over $100 million in cash and no debt three-and-a-half years ago to about $30 million in cash and $400 million in debt now," said Creutz.

In July of last year, the company poached Marjorie Cohn, a 26-year veteran of Nickelodeon, to helm its television division. The segment represented a move to diversify from its feature film division, its largest revenue-generator, albeit one losing earnings power in each quarter. While feature film contributed more than half of second-quarter revenue, DreamWorks' television segment climbed at a surprising pace, generating sales of $20 million, up 12% quarter on quarter. The segment includes a multi-year deal with Netflix (NFLX) to distribute original series Turbo F.A.S.T. and a contract with traditional television station to broadcast DreamWorks Dragons: Riders of Berkon.

"DreamWorks has infinitely made themselves a much better target with the strategic diversification that they've been making over the last year into television and consumer products, and location-based initiatives in China, etc," said Amobi. "They've broadened their appeal beyond the feature film business."

Additionally, recent release How to Train Your Dragon 2 hasn't had the chance to spread its wings and pull in its full potential, having not had been released in key international markets before second-quarter earnings were released. The studio's projects in production also show promise: Kung Fu Panda 3 is slated for release in late 2015 (the former two which collectively generated $380.68 million worldwide) while a third installment in the Dragon series is due the year after. If DreamWorks can deliver on those, an offer might be more likely.

"It's a question of more consistency. That's always a good thing when you're looking to shop yourself," said Amobi. "Pixar had that when they were bought by Disney. That's why they commanded the premium valuation that they did. At that point they were almost batting a perfect score."

A few more ogres, a few less snails and DreamWorks could become the winning studio of a decade ago.

--Written by Keris Alison Lahiff in New York. 

TheStreet Ratings team rates DREAMWORKS ANIMATION INC as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation:

"We rate DREAMWORKS ANIMATION INC (DWA) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. Among the primary strengths of the company is its solid financial position based on a variety of debt and liquidity measures that we have evaluated. At the same time, however, we also find weaknesses including deteriorating net income, disappointing return on equity and poor profit margins."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • DWA's debt-to-equity ratio is very low at 0.29 and is currently below that of the industry average, implying that there has been very successful management of debt levels.
  • The revenue fell significantly faster than the industry average of 12.4%. Since the same quarter one year prior, revenues fell by 42.7%. Weakness in the company's revenue seems to have hurt the bottom line, decreasing earnings per share.
  • DREAMWORKS ANIMATION INC has experienced a steep decline in earnings per share in the most recent quarter in comparison to its performance from the same quarter a year ago. This company has reported somewhat volatile earnings recently. We feel it is likely to report a decline in earnings in the coming year. During the past fiscal year, DREAMWORKS ANIMATION INC turned its bottom line around by earning $0.65 versus -$0.43 in the prior year. For the next year, the market is expecting a contraction of 78.5% in earnings ($0.14 versus $0.65).
  • The gross profit margin for DREAMWORKS ANIMATION INC is currently lower than what is desirable, coming in at 28.41%. It has decreased from the same quarter the previous year. Along with this, the net profit margin of -12.58% is significantly below that of the industry average.
  • Net operating cash flow has significantly decreased to -$53.95 million or 145.37% when compared to the same quarter last year. In addition, when comparing to the industry average, the firm's growth rate is much lower.

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